The gold price blasted through $1,110 per ounce, rising 1.3% and setting another new all-time high as investors increase their exposure to the price of gold amidst renewed commitments across the globe to maintain fiscal stimulus and loose monetary policies. Chairman Ben Bernanke and the U.S. Federal Reserve, along with policy makers in G20 nations, have given no indication that their war on deflation - stemming from high unemployment, low capacity utilization, and reduced bank lending driving low money velocity - is over. The actions of the Fed, as well as other nations across the globe, are consistent with Bernanke’s obsession with the policy errors made following the Crash of 1929.
In the Chairman’s infamous 2002 speech, he presented his case that a determined central bank could render deflation impossible by “dropping dollars out of helicopters.” Deflation poses systemic risks to the banking system at-large as loan collateral values fall. Moreover, and perhaps more importantly, deflation implants in the consumer psyche the belief that prices will be cheaper in the future, and that delaying purchases makes economic sense – a psychology that exacerbates and reinforces the slowdown in economic activity.
By ballooning the Fed’s balance sheet to $2.2 trillion through aggressive policies that include direct purchases of U.S. Treasury debt, Bernanke is following his 2002 playbook, in which he stated that “the prevention of deflation remains preferable to having to cure it.” Without opining on the merit of the Fed’s decision to wage an all-out war on deflation, the fact remains that there are implications and unintended side effects from such policies. The rise in the gold price to its current record high is one such side effect.
Friday’s jobs report, headlining a 10.2% unemployment rate and a 17.5% U6 rate, a figure that includes part-time workers, offers the Fed cover to continue its aggressive campaign to stimulate private sector demand. In the eyes of policymakers, fighting deflation is preferred – despite the inflationary implications – when compared to the economic and social costs incurred if deflation is allowed to feed on itself without aggressive policy responses.
The problem is that these policy responses lead to government deficits and debts that must be funded in some manner. According to John Mauldin, acclaimed author and market commentator, “we will need to find $15 trillion in the next ten years, just to pay for U.S. government debt, let alone state, county, and city debt.” Mauldin goes to ponder this future, “Where can all this money come from? The answer is that it can’t be found.”
A rising gold price is the result of this dilemma - as the policy actions being undertaken threaten the integrity of fiat currencies. The deficits and debts being incurred are a threat to the future purchasing power of sovereign currencies, which may be devalued as governments have no choice but to resort to monetary inflation to lessen the balance sheet burden. Private investors have been adding exposure to the gold price via physical gold bullion, gold ETFs, and gold mining equities over the past year in response to the concerted effort across the globe to flood the system with money. The gold price has been appreciating not only in terms of U.S. dollars, where it is up 24% this year, but also in terms of nearly all global currencies. Versus the euro, yen, and Swiss Franc, the gold price is higher by 16%, 22%, and 17.5%, respectively, in 2009.
Even central banks are taking steps to insulate their foreign exchange reserves from currency depreciation. Last week, the International Monetary Fund (IMF) reported that India had purchased from the agency 200 metric tons of gold, valued at $6.7 billion over the last two weeks of October. Later in the week, Sri Lanka revealed it too was currently in the market buying gold as a reserve asset. The emerging nations of the world are under-reserved in gold bullion relative to their more developed counterparts.
There is no doubt that, with gold gracing page one throughout the financial press, the possibility of a correction to shake out some of the current speculation in the price of gold remains a possibility. However, the longer Chairman Bernanke and the Federal Reserve continue their effort to fight deflation, the higher the gold price will eventually go.
