Greenspan's Last Bubble Has Popped: Gold

by Gary North
by Gary North

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"Greenspan gaveth, and Bernanke hath taken away."

Put a different way: "Ludwig von Mises was right. The Federal Reserve System is wrong." (This rule is always correct – as Mises used to say, with "apodictic certainty.")

I knew gold's decline was near. Also silver's. How did I know? Because I understand Mises' theory of the business cycle. The central bank inflates. This creates a boom. This creates sectoral bubbles. Then the central bank ceases to inflate. The bubbles will pop. The economy will go into a recession.

On Monday, March 17, I posted this article on my website, www.GaryNorth.com: "How to Short Gold and Still Keep Your Gold Coins."

I had asked a specialist in commodity futures to write it the previous Friday. He sent it to me on Saturday. I scheduled it for automatic posting at 12:01 Monday morning.

That article must have seemed strange all day Monday. Gold was at $1,005. In the aftermarket, it rose to $1,029. Then it fell back.

Why did I have this article written? Because I have believed for months that the Federal Reserve's policy of monetary deflation would at last break the commodities market, which I believed had all the characteristics of a bubble. This was the last remaining Greenspan bubble.

On Friday, March 14, I wrote this article: "In December, I Predicted Disinflation. Now It's Happening. Is Your Portfolio Hedged?" It was posted on Saturday. I reported on the most recent figure for the Consumer Price Index for February: 0% price inflation. I wrote this:

There are good reasons to invest in gold and silver. Inflation hedging in 2008 is not one of them.

I realize that what I have been saying is opposed to almost everything you have read. All I can say is that February confirmed my predictions. We will see if March does. And April.

Next time someone rants and raves about mass inflation, sit tight. Be polite. Don't believe it. Someday, yes. Not in 2008 or 2009. Probably not in 2010. This recession is going to see to that.

The general commodities boom is adding fuel to the fire. Of course, this can reverse along with commodities in general. Recessions push down commodities prices. I have discussed this before.

When you buy coins, buy for the long haul. If you are buying bullion stored off shore, you should be prepared to sell half your holdings – not all at once – if gold moves down. Pick a price move and stick with it, such as $50. Sell 10% of your holdings for every $50 move down. If you are in a gold ETF, the same rule applies.

These articles, posted on Saturday, were the background material for the article on Monday on how to short gold.

On Monday, the base metals fell sharply: copper, zinc, lead, and aluminum. I wrote an article predicting that gold would be next. I posted in on Tuesday. It was titled, "What Base Metals Are Saying About Gold." I wrote:

Hold gold bullion coins. These are for hedging against disaster. They are held to pass down to children. Don't buy them as a hedge against inflation in 2008. There is neither monetary inflation nor price inflation today. The CPI in February was flat: 0%.

In a recession, short-term credit is king. This is why the T-bill rate fell on March 17 to 1.11%.

If you are not sure which way gold is going, but you want to hold your physical position, you can short gold. What you lose in one account, you will make in the other. This is a break-even strategy.

Don't sell yet, but get ready emotionally to sell. If gold falls to $949, sell 10% of your bullion position, or short enough bullion to protect 10% of your investment. Sell 10% on $50 moves downward: daily closing prices.

Consider this: events that would push gold up to $2,000 would collapse the stock market. But a recession could drive down both gold and stocks. It's safer to sell gold and use the money to short stocks. I don't see the stock market rising and gold falling for months on end.

By that point, I was convinced that the bull market in commodities had ended. Gold would soon follow. So, I wrote a long essay that explained in detail why I thought that it was time to sell gold or short it. It was posted on Wednesday, March 18. I opened it to the general public, so that everyone could see the logic of my warning. I titled it: "Every Investment Strategy Needs an Exit Strategy, Even Gold. Do You Have One?"

I made it clear in that article that I was using Mises' theory of the business cycle to make my prediction.

I believe in the Austrian School's theory of money, including the business cycle. I have written a short book on this. I am not so committed to a position proclaiming the ever-rising price of gold that I am willing to abandon Mises' theory of the boom-bust cycle in order to hold such a position.

Gold is ideal for Mises' inflationary crack-up boom, although not as good as a home with a garden in the country and a few thousand gallons of diesel. This is not the crack-up boom. There has to be monetary inflation for a crack-up boom to occur. Today, there isn't any.

On that day, gold, silver, and platinum fell like stones. Gold was down almost $50. It breached the $949 figure. So, I took my own advice. I sold a chunk of my gold. I did not sell all of it. But I decided that it was time to begin taking profits.

I report all this to let you know that what I am going to tell you here, I told my site's members before it happened. I saw this one coming.

WE ARE IN A DEFLATION

I define deflation as "a decline in the money supply." Deflation produces price deflation.

Precious metals' prices do not normally rise in a deflation. When they do, it's because they are in a bubble. Deflation will pop the bubble.

Deflation has now popped the bubble.

I have repeatedly warned my readers that the Federal Reserve was deflating. I have warned for a year that under Bernanke, FED policy had changed, that he was determined to whip inflation, and that the FED was barely inflating – in the range of 1% a year. If you have read my reports, you knew about this shift long ago.

I kept saying that all forecasts based on the useless and misleading M3 figure would turn out to be wrong. M3 has always vastly overrated the rate of monetary inflation. The FED was correct in scrapping it in 2006.

So, to make my position crystal clear one last time, I posted this article on February 18: "What the Federal Reserve Is Doing to Solve the Credit Crunch. This Is Getting Little Publicity." I began the article with these words: "The Federal Reserve is deflating." Then I offered evidence. I opened this article to the general public.

I realize that you have read article after article about Federal Reserve inflation. All of them were wrong – not a little wrong or sort of wrong, but completely wrong.

We now see the effects of deflation: a CPI of 0% and a falling gold market. Housing is falling. This has not happened since the Great Depression.

The T-bill interest rate fell to 0.61% on Wednesday, March 18. I have not seen T-bill rates under 1% in my adult lifetime. We are seeing a frantic dash to liquidity. This is a deflationary mentality. In the Great Depression, T-bill rates fell below 1%.

WILL THE FED INFLATE?

Of course the FED will inflate. But it is not inflating now. This is why gold is falling now, and why real estate is falling now.

Will gold come back? Yes.

The question is: How far will it fall?

The other question is: Will you sell gold now and buy back more later?

I don't mean sell all of it. I mean sell some of it and sell more of it as the price falls. Then buy gold when you think inflation has returned. Sell gold mining shares first. Then sell bullion. Then sell a few coins. Sell the coins last, and maybe not at all. You can short gold to protect the value of your coins. The money you lose in holding the coins is offset by the profit you make by shorting.

The FED has been in deflation mode ever since last August. We are now seeing the results. The equity markets are falling. Treasury bonds have risen.

It is going to take a complete reversal of FED policy to re-inflate this economy. The solvency of major firms and investment banks is at risk. Mere fiat money at (say) 6% per annum will not save them. The capital markets are unraveling too fast.

I do not recommend getting rid of all your gold because there are still offsetting factors, such as war with Iran, a falling dollar, a major terrorist attack, a major purchase of gold by a central bank.

There is another factor: the bullion banks. They have borrowed gold from the central banks for an annual interest payment of 1% per annum. They have used the money from the sale of this borrowed gold to buy bonds. Rising gold prices threaten them with bankruptcy. They don't have enough money to buy back the gold and return it to the central banks.

In a deflation, gold falls and bond prices rise. This two-fold action will save the bullion banks. These banks are where the elite invest their money. They will be able to unwind their positions. They can sell their bonds and re-buy gold if the want to.

If I were them, I would want to.

What is happening is a dream come true for the bullion bankers who borrowed gold to get money to invest in bonds.

If they start buying gold to repay the central banks, this will put a floor under gold. That's why I think gold will not collapse in price to $100 or anything like that. But I think it will fall enough for the carry trade in gold to be unwound quietly.

That's why I recommend selling 10% of your gold in response to $50 downward moves. I don't know where the bottom is.

CONCLUSION

This recession is going to be a bad one. You need to protect your investments against deflation. I still recommend foreign currencies. I have for years.

I think your first line of self-defense is your job. If you lose your job, you are in big trouble. You will have to sell your assets in a fire sale economy.

You need to do whatever it takes to increase your value to your employer.

March 22, 2008

Gary North [send him mail] is the author of Mises on Money. Visit http://www.garynorth.com. He is also the author of a free 20-volume series, An Economic Commentary on the Bible.

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