Global Recession Takes Air Out of Gold Market

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The Fed has cut rates. Central banks all over the world have “injected liquidity” into the system. But stocks and houses are still falling…and so is employment. The bull is bleeding to death…

“Tall Paul” Volcker spoke to the press and explained the problem. The Fed had permitted “too many bubbles,” he said. The bubbles encouraged too many people to borrow and spend too much money. Now, they have too much debt…and no good way to pay it off.

Asset prices are falling. The carry trades are unwinding (the yen and the Swiss franc are rising…causing serious losses for those who borrowed at low yen and swissy rates in order to buy stocks!) So, who would want to borrow more money? Only someone who was unlikely to pay it back…which is why lenders are looking for more guarantees.

The bubbles could have been prevented by the Fed, simply by making credit a little harder to come by. That’s the way you protect the quality of a currency…and the stability of an economy. But who wants to do that? “It’s no fun raising interest rates,” said Volcker.

And now, with a major bear market…and major recession…staring him the face, the former economist from Princeton, Ben Bernanke, is in a tough spot. His bull is getting killed. His reputation is on the line. And his lower rates seem to be too little and too late.

Yesterday, oil barely held above $90. The commodity index held above 490, and gold dropped $1.50. The day before, gold lost $20. Where is inflation when you need it?

“Fiscal action could be helpful in principle, as fiscal and monetary stimulus together may provide broader support for the economy than monetary policy actions alone,” said Ben Bernanke, appearing before the House Budget Committee. ‘Give us more helicopters,’ he might have said. He endorsed a plan for “fiscal stimulus” of $150 billion to be added to his monetary stimulus. Not only are they going to cut rates and make it easier to borrow, in other words; the government is also going to step in and spend money it doesn’t have — probably by giving tax rebates.

Here at The Daily Reckoning we’ve never met a tax cut we didn’t like. But we smell sushi. No country ever tried as much fiscal stimulus as Japan. After cutting rates down to “effectively zero,” the Japanese embarked on the biggest program of unnecessary government spending in history. With no military to waste money, it had to turn to public works. New highways to nowhere…new bridges… new rail lines, by the late ’90s, the little island of Japan was pouring more concrete than all the fifty states. It was very stimulating to cement sellers. But as to the economy…it did nothing. Here we are, 18 years later…and the Nikkei index is still down by two thirds.

“But wait…you said the price of gold went down 20 bucks, yesterday. And now you say the unstoppable force of inflation is being stopped dead in its tracks. Doesn’t the bull market in gold depend on rising inflation? And isn’t your Trade of the Decade going to look like it should have been abandoned three years early if the U.S. economy goes the way of Japan?”

A very good question, dear reader. We wish we had a very good answer.

Instead, we take a guess. Japan is a nation of savers…with a very positive trade balance. Japan has no armed forces to speak of. Nor does it have the world’s reserve currency. We got word yesterday, for example, that the Gulf States now have more than $2 trillion in foreign assets — most of it in dollars. The United States, by contrast, has only about $80 billion worth of foreign reserves.

It may be that a global recession takes the air out of the gold market. Maybe the price stops going up. Maybe it falls back some. But when it comes to the feds’ efforts to sink the dollar, in order to avoid a Japan-like slump, you ain’t seen nothin’ yet. Tax rebates. Rate cuts. Federal spending. Perhaps even direct intervention in the credit and equity markets. (What’s a Plunge Protection Team for, anyway?) Crank up the presses. Put the choppers on full alert. It will be interesting to see what happens. We don’t know. But our guess is that, at some point, gold is going to soar as investors seek safety from a disappearing greenback.

Meanwhile, imagine what happens to stocks in a major recession. Even if gold were to hold steady…or even decline…our guess is that the decline in stocks will be worse. The Trade of the Decade still looks good to us.

Bill Bonner [send him mail] is the author, with Addison Wiggin, of Financial Reckoning Day: Surviving the Soft Depression of The 21st Century and Empire of Debt: The Rise Of An Epic Financial Crisis and the co-author with Lila Rajiva of Mobs, Messiahs and Markets (Wiley, 2007).

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