$1,000 Gold, No Inflation?
Rick Ackerman
TRADING NOTES: In Friday's edition I published a letter from a subscriber concerning the question of which is more likely, inflation or deflation. I've responded below with some extremely bullish comments on gold, and my conclusions may surprise even long-time subscribers of MarketWise Black Box. My comments were prompted by a follow-up query from the same subscriber, who wrote as follows: "The important issue which must be addressed is this: Given that we are in a period of deflation, how can gold go up? Obviously I agree with your conclusion that it is in a strong uptrend, but why? We know that in periods of deflation, legal-tender fiat money will go up in value against goods and services--it should be going up against gold, not down. The balance of my e-mail is directed to possible explanations of why that is happening although I am more interested in provoking you to advance your view than I am in defending my own."
My reply:
Gold is especially strong right now for one reason -- the speech several weeks ago by rookie Fed Governor Ben Bernanke. With a bluntness that stunned the economic world, and with the obvious backing of his boss, he said in so many words that the Fed would do whatever it takes to ward off deflation. Now, it's one thing for an official spokesman to say the government will no longer support a strong dollar, as various spokesmen of the central bank have done from time to time when it advanced America's interest to have softer dollars. But it is quite another thing to declare that the central bank is ready to throw the dollar overboard if that's what it takes to get the economy moving.
Why Dollar Hovers
Even so, and try as it may, the dollar cannot immediately fall relative to other currencies because 1) the euro is tied to the performance of German and French economies that over the short- and long-run lie beyond salvage either politically or demographically; and 2) the Japanese government has just begun monetizing stocks (!), buying depressed shares directly from the portfolios of banks. This suggests that the beggar-thy-neighbor game of competitive devaluations has become so deadly earnest and aggressive that one currency can no longer fall very much relative to the others. For the moment, however, all currencies remain subservient to a dollar that is linked to one of the last theoretically viable economies on earth. Regardless of how much longer the major currencies move in a seemingly stable relationship to each other, all currencies, including the dollar, will come to be measured more and more against gold. And that is why I continue to assert, as stridently and as often as possible, that as the third millennium begins, gold is the no-brainer investment of our lifetime.
But how does this square with my deflation prediction, whereby the dollar presumably would be "king" and grow in purchasing power, even relative to gold? It doesn't, actually -- at least, not in a way that conventional thinking can comprehend, much less interpret. In fact, we are headed into an economic typhoon for which there is no historical precedent: a world drowning in debt, but also awash in fundamentally valueless money. Can deflation occur as global funny-money mounts into the hundreds of trillions of dollars? My answer is yes, but not across all classes of assets. I will be examining them one by one in the coming weeks in MarketWise Black Box, since I've concluded that no one, even die-hard deflationists such as myself or Bob Prechter, has yet parsed the specific and seemingly contradictory details of a deflationary bust occurring in a global monetary environment characterized by worthless fiat.
Inflate What?
During my trip to California over the weekend I had a chance to talk with a friend who has always managed to stimulate my thinking about the economy. My thoughts jelled in the drive back to the airport, and I think you will find them both highly original and compelling. For now, though, let me say that I'm convinced gold could go to $1,000 an ounce without producing a commensurate repricing of goods and services straightaway -- or even much of a change in the relative valuations of currencies. (Bonds and certain other assets are another matter, but we'll save that discussion for later.) After all, it is not perceptions that drive inflation, but physical dollars chasing goods and services. If gold went to $1,000, would dollars necessarily "chase" college tuitions up to $70,000 per year, or ground beef to $20/pound, or doctor visits to $300? I seriously doubt it -- for how could prices possibly soar without a corresponding increase in incomes -- or at least, in asset valuations that can be further leveraged? If you think more housing inflation is the answer, then, along with our Fed chairman and his board of governors, you flunk both economics and common sense. Meanwhile, we won't even mention the scenario of a wage-driven inflation, since even those who believe fervently in the economic-recovery tooth fairy are not dumb enough to believe their pay is about to double.
Stagflation Pipe-Dream
And what about stagflation? In our dreams, perhaps. For even with the Fed striving desperately to pump up asset prices, 1970s-style inflation remains a remote prospect. The economic system is simply too stressed by gargantuan debt for a muddled and gradual resolution. Moreover, unlike the economy of the 1970s, today's is characterized by a deflationary global market in goods, primarily from China, and the mounting unaffordability domestically of health care, college tuition, and, as deficits swell, services provided by state and local government. We survived the 1970s inflation mainly because our homes, if not always our paychecks, kept pace with inflation, and because the weight of our debts was being inflated away by a depreciating dollar. But it is a far different matter to survive deflation, when wages and most asset values are falling in both real and nominal terms. It is anomalously strong housing prices that we should be most concerned about, since they have been sustained entirely by Fed smoke-and-mirrors. To the extent the Fed chairman, a PhD in economics, continues to propagate the idea that rising housing prices represent an increase in wealth, an insidious and dangerous ignorance has come to cloud the average American's thinking about the economy. Catharsis will not likely come so easy as a mere 40% fall in the Dow Average.
December 17, 2002
Rick Ackerman
MarketWise Black Box
"Six hours ahead of its time"
r.ackerman@MARKETWISE.COM
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