The Case for Gold [Part 1]
By Andy on May 2, 2008 in Our Theory
Ben Bernanke and his posse at the Federal Reserve have to choose between lessening the availability of liquidity to banks that desperately need it (raising rates) or giving them liquidity but risking inflation (doing nothing or lowering).
No matter what happens in the April meeting, inflation has already gotten out of control, and this can be seen in the core CPI, which climbed 3.96 percent last month. Core CPI measures the rate of inflation of a basket of goods, minus “volatile” products such as gasoline and food.
Unfortunately, Bernanke is in a difficult situation. Raising rates would create a situation ripe for deflation. The amount of debt the US government owes to foreign nations and the future liabilities promised to Americans in the form of health care and Social Security is substantial. The Federal Reserve fears that creating a deflationary environment could sink the US economy.
To find the cause of the rises in prices, you only have to look at the Federal Reserve and their actions in attempting to stave off the effects of the Crisis on the US Economy. Since the banks are starved for liquidity, and deflation is not an option, the Fed is taking onto their books all of the mediocre performing loans and derivative products that are causing problems. This achieves the following:
- Puts more money into play into the economy.
- Backs the American Dollar with worthless subprime, option ARMS and credit default swaps.
- Provides a temporary boost in the economy through stimulation. This increases velocity of the money supply.
As a result:
- Too much money is chasing the same set amount of goods, causing rising prices across the board for wheat, corn, precious metals, oil
- The US dollar continues to fall in value
- Gives the appearance all is well, and that a “bottom” has been reached in all troubled markets.
To protect your investments against this policy of inflation, one needs to look towards precious metals, in particular, gold. The recent pullbacks in price present a buying opportunity.
Part 2 - Will analyze recent gold mining stocks that will provide good protection versus inflation.
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As much as I hate to say it about a Princeton man, Bernanke is proving to be a disaster. First of all, he is making the Fed a temple of Moral Hazard: the idea is spreading that it is the job of the banking authority to step in to protect market losers.
Second, he has injected the Fed as a participant in capital markets, sweeping up assets which can only be properly evaluated and eventually liquidated by players in the private sector.
And, as Andy says, the Fed has become incontent in the creation of liquidity. It was the excess liquidity created by Greenspan and Co which created the crazy real estate and derivative markets to begin with. Then Bernanke’s bunch decide the way to solve the problem is (wait for it) create more liquidity!
The inflationary spiral which the Fed has launched will, in the end, cause more damage, and be harder to tame, than the sub-prime mortgage crisis, which has in any case by now been fully discounted by the market.
Senectus | May 3, 2008 | Reply
I wholeheartedly agree that the Fed is bailing out all those banks that created all these shoddy loans and derivatives. This is not an example of free markets.
Bernanke truly believes he can rescue an economy by printing more liquidity. Just recently the Fed announced that it is backing $400B of student loans. God help us all.
Andy | May 4, 2008 | Reply
I’m tempted into making a YouTube video of myself under the sheets crying: “Leave markets alloooooonnnneee!” I doubt it’ll be as viral as the original Chris Crocker video but the ridiculousness of it all seems to be appropriate. Can anyone tell me since when did the ‘invisible hand’ become one that belongs to the government?
Jason | May 4, 2008 | Reply