A Loss of Confidence

Gold up, silver up, stocks up, dollar down: This was the news through April, 2006.

Then the anti-Bernanke music video hit the Web.

It is a parody produced by students at Columbia University’s Business School. It appeared in the final week of April. It nails Bernanke. Within hours, it seemed to be everywhere. The thing is a riot. See for yourself.

It’s all here: the fear of inflation, the fear of recession (the inverted yield curve), rising interest rates, and doubts about a guy with a Ph.D. and beard.

Parody is a way to draw blood gently. The video is funny precisely because Bernanke was an unknown academic until President Bush nominated him as Chairman.


Part of the new investing environment came because of the departure of Alan Greenspan from the Federal Reserve. The sense of security — always misplaced — began to wane.

While gold’s price has been moving up since 2001, the realization of what was happening finally began to register with the investing public.

Gold rises for many reasons. One is a fear of war. This fear is escalating as the story of Iran gets more media coverage.

There is fear that the dollar is overpriced, given the size of the trade deficit. The dollar began moving down within weeks of Bernanke’s confirmation.

Then there is price inflation. It began moving up in January, 2006.

Silver has raced ahead of gold’s pace ever since 2003. This also seemed to confirm widespread doubts about economic policy.


The Federal Reserve must walk the tightrope between price inflation on the one side, which will raise long-term interest rates and mortgage rates, threatening to pop the housing bubble, and a recession on the other side.

The yield curve almost inverted in early April, 2006. This is the traditional harbinger of a recession. That would also threaten the housing bubble.

There is a clever reference to this possibility in the video. Investors are far more aware of this today than they were in 2000, when I used the inverted yield curve in November to predict the recession that arrived in March, 2001. The FED has less leeway because of public awareness of the implications of a debt market where 90-day T-bills carry a rate higher than 30-year T-bonds. I have covered this here.

The expansion of the U.S. money supply, beginning in late 2000, created the bubble condition of the housing market. The way to keep gold from going up, other than selling large quantities, is to stabilize the money supply. The FED actually began to follow this policy in January, 2006. But if this policy is extended, the fiat money-induced boom that began in 2001 will bust.

Bernanke must find a way to escape from the trap Alan Greenspan set for his successor. This can be done, but only at the expense of a major recession. In a Congressional election year, there is pressure on the FED not to let this happen.

The booming U.S. economy is being accompanied by accelerating prices. The dollar has continued to fall against major foreign currencies. The trade deficit threatens to accelerate because of the price of oil.

Gold is moving up, drawing attention to the long-term implications of a falling dollar. In the past, central banks timed gold sales to keep the rising price of gold from calling attention to a falling dollar. A falling dollar is bad for central bank reserves, whose foreign reserves are mostly invested in low-interest U.S. dollar debt instruments. But the gold-sale strategy seems moribund today, and for good reason.

The Bank of England sold 395 tons gold, 1999 to 2002, selling the last bars at $283. This reduced the BoE’s holdings to 300 tons: #18 in the world.

Gordon Brown, the Chancellor of the Exchequer, who had recommended the sale, has come in for repeated criticism whenever gold’s rise moved sharply upward. He has depleted the nation of great wealth, with nothing but depreciating T-bills and euros and yen to show for it. Every time gold has reached a milestone, public criticism has returned.

Criticism began as early as 1999. An article in The Spectator (Oct. 16, 1999), pointed out that the blunder had cost the Bank of England 60 million pounds sterling — about $100 million. As it has turned out, that was chump change. On March 21, 2006, the London Times ran this headline:

Chancellor under fire for gold sale as price nears $600

The story went on to explain:

Forecasts that gold prices are set to smash through the $600-an-ounce barrier saw Gordon Brown come under renewed pressure last night over his controversial decision to sell the majority of Britain’s gold reserves. . . .

The Chancellor sold 395 tonnes of Britain’s gold reserves between 1999 and 2002, generating $3.5 billion. At yesterday’s London closing price of $554.10 he would have generated more than $7 billion. . . .

To add to Mr. Brown’s well-deserved agony, gold rose another $100 over the next few weeks.

It is not often that a bonehead decision by a senior government official has a $7 billion price tag attached to it. This one did. Brown’s critics get to remind the public of just how expensive Brown’s decision was every time gold rises substantially.

Lifetime bureaucrats do not like public criticism. Central bankers are quite willing to "lease" gold at less than one-tenth of one percent per annum, knowing full well that this leased gold can never be repaid by the borrowers, but they do not want to get caught actually selling an appreciating asset. They can hide what are actually sales under the category of "leasing." They avoid criticism for now.

There will be enormous criticism of the gold-leasing programs when the public finally learns that their nations’ gold is gone and that the borrowers will go bankrupt if forced to buy it back in the open market and return it to the central banks. But that awareness may not happen until today’s senior central bankers are in retirement.

So, Bernanke’s FED has no central bank allies these days who are willing to put their reputations and careers on the chopping block, just to help out the U.S. government’s public relations program to deny the steady erosion of the dollar’s purchasing power.


The FED will not stabilize the money supply for long. Bernanke is famous for his speech in which he compared the FED to a helicopter full of paper money. He is attempting to overcome that blunder with tight money. But the result of tight money will be a recession. Then it will be a depression. He knows this. He has hailed Milton Friedman for having told the economists in 1963 that it was the FED’s deflationary policies that produced the great depression.

What no FED official admits is that in that same year, 1963, Murray Rothbard showed in America’s Great Depression, that it was the FED’s inflationary policies in the late 1920’s that produced the boom that turned into the bust, 1929—32. I read it in the summer of 1963. It changed my thinking. That book is on-line for free.

So, we see what lies ahead: more monetary inflation, more price inflation, and a falling dollar.

Historically, gold protects investors against price inflation. It didn’t, 1980 to 2002, but it does when central banks do not sell their gold to depress its price.

Of course, I am all for central bank sales. Better to have gold in the private sector than in the government-legislated monopoly sector. But from the looks of things today, gold will be leased into the market without fanfare, without anti-gold announcements in advance by government officials that they intend to sell gold, thereby driving down its price before the auction takes place.

The inexorable preference politically for more inflation in preference to recession and falling prices makes gold a hedge that is likely to gain increasing attention as the U.S. government’s deficit soars, its long-term Medicare obligations soar, and the trade deficit soars.

Meanwhile, you should watch the Bernanke video.

May 1, 2006

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 17-volume series, An Economic Commentary on the Bible.

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