Is the World Ready for This Gold Rally?

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Meanwhile, in yesterday’s market action…the big thing that happened was the same thing that seems to happen every day lately. Gold hit a new record high. It rose almost $18 to close at $1,164.

Now, the question we must ask ourselves is an old one: is this the final, blow-out phase of the gold bull market that began 10 years ago? Or is it a trap…intended to catch the Johnny-come-latelies in the gold market? Of course, we don’t know any more than any other human being knows. But we’ve been watching Mr. Market for a long time. And we’ve come to the conclusion that he’s an SOB. Trouble is, you never know exactly what kind of an SOB he’s going to be.

Is he going to lure investors into the gold market and give them a good whack? Or, is he going to drive the price of gold all the way to $3,000…and leave us behind?

The old-timers, the scarred and battered confrere of gold bugs, in which your editor humbly confesses membership, are a bit skeptical of this latest run-up in gold prices. We bought gold years ago. Heck, we bought so many gold coins so long ago that we’ve forgotten where we buried them. So, we wouldn’t mind seeing gold race right up to its rendezvous with monetary destiny — without stopping for red lights or little old ladies in the crosswalks.

Trouble is, we don’t think the world is ready for it. What do we mean by that?

We were hoping you wouldn’t ask. It’s complicated and confusing. In many ways, it’s more of a feeling…an instinct…and a hunch…than a hard analysis. But here goes:

Look, here’s the hero of the financial crisis, David Einhorn. In 2007, he figured out that the banks were going to get killed on their mortgage debt. He shorted them — particularly Lehman Bros. He made a fortune for himself and his investors.

Well, what’s he doing now? Guess. He’s buying gold:

David Einhorn, quoted in MarketWatch, said that given the present situation gold was the bet he felt most confident to make:

“If the chairman of the Fed is determined to debase the currency, he will succeed,” Einhorn said. “Our instinct is that gold will do well either way: deflation will lead to further steps to debase the currency, while inflation speaks for itself.”

In other words, gold is a one-way bet. But wait. It’s not like Mr. Market to offer investors one-way bets. There’s usually more to the story. And the twist is probably this:

Deflation will surely lead to more steps to debase the currency, but those steps don’t necessarily or automatically take the feds where they want to go. We have no doubt that the Fed chairman is determined. What we doubt is that he is capable. We doubt, too that a 3.5% downturn over 24 months corrected 30 years of credit excess. There’s still Hell to pay. It means another big takedown in the stock markets…crashes in China and emerging markets…and collapsing commodity prices. Investors won’t like it.

Will they turn to gold for safety? Or to the dollar? A year ago, they dropped gold and ran to the dollar. Will they do the same this time? We don’t know, but we doubt that SOB, Mr. Market, will make it easy for us, either way.

Now on to Mr. Thomas L. Friedman. What we like about Mr. Friedman is that he is such an unworthy opponent. It is like playing darts with a blind man or a boxing match against a paraplegic. In a battle of wits, The New York Times columnist is unarmed. We get to pummel him, confident that he can’t hit back.

Yesterday’s column must have been intended to reassure Americans. The 21st century might be the American century too, he says. Yeah, yeah…the Chinese have more of our money than we do. And yeah, they can beat the pants off of us in commerce. And yeah, we’re all growing old and going broke. But we still have something that nobody else has: imagination!

Forget capital formation. Forget savings. Forget relative pay scales. Forget the trade deficit. Forget de-leveraging. Forget mortgage debt and the zombie banks. And forget the public debt and the other $100 trillion worth of financial obligations of the US government.

We can still walk with a swagger and hold our heads up high. Because we’ve got…imagination!

Why don’t other nations have imagination too? Why couldn’t they invent things such as sub-prime mortgages, color-coded Terror Alerts, and the Ultimate Fighting Competition? Friedman does not attempt to explain the Imagination Gap. So, we will just take it as a given.

But he goes on to say that he is worried. In addition to imagination, the other critical ingredient to success in today’s world, he says, is good governance. And here, he’s not so sure that the US has it as a genetic advantage. Indeed, he thinks that the body politic USA sometimes comes up with “suboptimal” solutions.

“A great power that can only produce suboptimal responses to its biggest challenges will, in time, fade from being a great power — no matter how much imagination it generates,” he warns.

Wow…deep…right up there with Machiavelli, Clausewitz and Toynbee.

How do you come up with optimal solutions, you might wonder? Simple. At least, it’s simple in Friedman’s world…where everything is simple. His planet is populated by a race of such simpletons that they can come up with better governmental solutions simply by being “better citizens.” What’s a better citizen? It’s someone who is “ready to sacrifice, even pay, yes, higher taxes…”

Is that all there is to it? If we pay more in taxes we will have better governance. But how much more do we have to pay? Maybe it can be graphed out. If we pay 25% of our incomes in taxes, perhaps our solutions will be 25% optimal. If we raise taxes to 50%…well, 50/50 on the optimal scale ain’t bad. But if we go the Soviet route — to 100% taxation — can we expect optimal solutions 100% of the time?

Oh, Friedman, what a lamebrain you are! We’ll spot you one on that imagination thing; we don’t have any idea what you’re talking about. But on governance, where have you been for the last 50 years? If there’s one thing we’ve learned it is that governance is subject to the law of diminishing returns, just like almost everything else — like greenbacks and girlfriends, the more laws you have, the less you appreciate another one.

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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