All That Glitters

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Of all the many miseries that man faces on his journey from cradle to grave, few of them can be eased by enlightened central banking. And a credit contraction is not one of them. Japan proved it. After the Japanese market collapsed in 1990, public officials went to work with their characteristic energy and incompetence. They lowered the cost of borrowing to nearly zero. But did consumers take up the money and add to the demand for bread and bicycles? No. They didn’t want to borrow. They wanted to save. They had speculated during the previous bubble years and lost money. Then, with retirement approaching, a penny saved was worth even more to them than a penny earned. They saved more than ever…and the consumer economy sank.

The Japanese persisted. They lent so freely that the yen became the “funding currency” for a worldwide boom. Prices rose all over the planet — except in Japan itself. The land of the rising sun couldn’t seem to get up in the morning. Property investors lost money. Stock market investors lost money. Japanese consumers sewed their pockets shut.

And now that the dollar is the world’s “hot money” the world’s surviving gold bugs see their moment of rapture fast approaching. Gold is not an investment category. It is no investment at all. Instead, it is more like a religion or a political position. True believers stick with it through thick and thin. When gold goes up, they are insufferable. When it goes down, they are unrepentant.

The price of gold peaked out in real terms in 1979 at over $2,000 in today’s money. Briefly, an ounce of gold was so loved — and stocks so despised — that you could buy all the stocks in the Dow index for just a single ounce of gold. But then, the gold martyrs suffered a terrible persecution — nearly two decades of steadily falling prices. Not just in real, inflation-adjusted terms, but in absolute terms. By the end of the period, it took 43 ounces of gold to buy the Dow stocks, and gold bugs were gathering in small groups praying for salvation and awaiting the end of time. It seemed as though the cult might be extinguished; few were still alive. Fewer were still solvent. Of those, even fewer were still sane. But then, like Christians huddled clandestinely in an unheated Soviet apartment, the wall fell. Gold began a comeback.

What inspires this little reflection, apart from a night of heavy drinking, is the price movement. At the beginning of the week, gold closed comfortably above the $1,000 an ounce mark. Then, on Wednesday morning…it shot up. The end of the world has been delayed, perhaps indefinitely. And yet, gold — an option on financial chaos — trades as if it were coming next week.

What gives? Here on the back page we keep an eye on the yellow metal. Not because we expect the end of the world. Still, you never know; maybe the gold bugs are onto something. No monetary system lasts forever. This one — an impromptu experiment, at best; premeditated larceny at worst — has already lasted longer than most marriages. The bust-up, when it comes, threatens to be nasty and expensive.

The easiest story to sell in the current marketplace is the inflation story. In an effort to revive the go-go economy of the bubble era, the feds are adding to the money supply. They will continue doing so until inflation rates go up. They make no effort to hide it. They have as much as warned the world: prepare to be robbed. According to the popular story line, the gold market now anticipates inflation. Investors should too. We have told this story ourselves; we still believe it. But today, we caution readers: there may be a plot twist.

The problem with inflation is that there is none. Consumer prices are falling in China, Europe and America. And if we look harder, we find out why. The feds are pumping the money supply as hard as they can. David Rosenberg reports that the monetary base rose at a 141% annual rate over the past four weeks. But the money fails to reach the real economy. The money supply figures that relate to actual cash in people’s hands — M1, M2, and MZM — are shrinking, at —28%, —4.9% and —6.2% respectively. Why? Because the banks don’t lend and consumers don’t borrow.

In short, the feds’ money goes into cool bank vaults and hot speculative trades. When it tries to find its way to the consumer, it gets lost. As Rosenberg explains it, the transmission mechanism has broken down. We live in a bust economy, not a boom one. In a bust, consumers cannot borrow. They have nothing to borrow against. Both their wages and their assets are going down. Who would lend to them under those conditions? Not a bank that almost went broke itself 12 months ago.

And even if consumers had access to credit, they wouldn’t take it. Consumers too, almost went broke a few months ago. Instead of saving money during the boom years, they spent it…or gambled with it. Then, when the bust came in ’08, they realized that they were 10 years closer to retirement with little money saved. Now they have to make up for that lost decade, by cutting spending and saving as much money as they can.

Still, gold speculators think they’ve got God on their side. They march into the coliseum confident that the feds will inflate consumer prices and cause the price of gold to soar. Maybe gold will rise. If so, it will be thanks to speculators and Chinese central bankers, not consumer price inflation. The smart money is still on the lions.

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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