Thursday, April 29, 2010

Easy Fed, strong gold

Gold continues its upward trend against the dollar, and it is making new highs almost daily against the euro. The Fed yesterday reiterated that it is still terrified (I'm exaggerating to make a point) that the economy remains weak and unemployment remains high, so it plans to keep interest rates very low for a long time. The prospect of an "extended period" of zero yields on cash and cash equivalents is driving investors to anything that shows signs of life these days, and gold now has a 9-year rising trend in place. Gold's current uptrend started almost the same day that the Fed belatedly recognized that the economy was weakening in the wake of the dot-com crash, and as a result of extremely tight monetary policy from 1997 through 2000. Since 2001, the Fed has been much more concerned about the strength of the economy than about the outlook for inflation. That is one big reason why gold is doing so well.

Obama's choice of three new Fed governors does little to reassure investors that the Fed will ever pay more attention to the value of the dollar than it does to the health of the economy. Indeed, all three picks promise to be firmly in the "dovish" camp when it comes to the hardest choice any central banker has to face: whether to tighten to defend the value of its currency, or to ease to support the economy.

While this is an ugly picture, it is also the case that measured inflation has been relatively tame for many years. The CPI has risen at a compound rate of 2.45% over the past 10 years; 2.0% over the past three years; and 2.4% over the past year. The early warning signals of future inflation, however, are not so good. Gold is a prime example, as are commodity prices, a record-steep yield curve, and a dollar that is only marginally above its all-time lows in terms of purchasing power relative to other currencies.

On balance, and given the reinforced makeup of the Federal Reserve, I think investors need to be concerned about higher, rather than lower, inflation in the years to come.

And the fact that gold is making new highs against the euro and almost all other currencies, means simply that our Fed is not the only central bank that is deciding to err on the side of ease. This is a global phenomenon. The forces of inflation are very likely to win out over the forces of deflation.


John said...

You can add the troubles in Europe as another reason not to be in a hurry to tighten. Central bankers tend to help each other or at least not be a hinderance if a crisis is brewing in one's territory. Europe's sovereigh debt troubles are a deflationary factor unless the ECB monetizes the debt.

Our economy is really either in a deflationary on inflationary mode to SOME degree. I like to see it as a seesaw like I played on as a child. It either tips one way or another and the slope is the degree. Right now it is tipping inflation but not by much. The danger is, as Scott suggests, the slope increases - maybe by a lot - in the years ahead.

Many feel inflation is a long way off - Benj is in that camp - as am I for now. But I see the possibility of that seesaw tipping further and further toward inflation. I will continue to add to my inflation hedges as we go along. As I have posted before, I like BHP Billiton, the giant Australian mining company, the integrated oils and a Canadian fertilizer company, Potash of Saskachewan. There are many many more but these are some I own and will be adding to.

ronrasch said...

I like your approach to investing John and your implications from Scot's post. The challenge is to time investing in oil, minerals, and other commodities. Small gold or silver mines may be good investments also. For those who can invest in gold futures or options on them may have a way to play the inflationary tip of the seesaw

John said...


Thanks for the compliment. Your small gold and silver mines are pretty speculative and as you say will require a sense of timing to be successful UNLESS you can endure a LOT of volatility.

I am in the camp that inflation is coming...but not yet. As you suggest timing is a big issue. I frankly do not feel confident that I can adequately predict when the market will aggressively begin to discount it. Thus I am slowly building positions in companies I believe will prosper over many years. I will endure the volatility but when the inflation fires ignite on Wall Street I will hopefully be well positioned.

Benjamin Cole said...

Frankly, I have long been mystified by the "strong dollar" crowd. To state the banal, a strong dollar is bad for exports and tourism (and balance of trade). I think people incorrectly derive psychic income from the phrase "strong dollar" when discussing exchange rates. But you cannot eat psychic income. China seems to do fine by a "weak" yuan.

Gold is rising because Indians and Chinese are buying gold (with rapidly expanding disposable incomes), and it is a bit of a fad now--reminds me much of the mid-late 1980s. There are now bought blocks of time on radio/TV where gurus hustle gold. Since gold is worth what the next guy will pay, I can's say when this will stop, but there is every likelihood gold will be worth less in 20 years than it is now. If you doubt that, consider gold prices from 1986-2006. Gold could be one of the worst investments you will ever make--and I think gold long ago became detached from Fed actions. China is expanding its money supply by 22 percent annually, and their economy is growing at nearly a 12 percent annual rate. They like gold. That is what is driving gold prices up.

Scoot is right about capital looking for a home--there is gobs of money on the sidelines, even now, as we barely exit a near-death recessionary experience. Imagine how much capital will be hunting a home after two or three good years.

Gold belongs in your wife's jewelry box, not in your investment portfolio. Invest in productive enterprises, not baubles or shiny metals. If you like metal, put a tin-foil hat on and join my club.

As John points out, I fear not inflation, and see powerful deflationary shock-waves that are still working their way through the economy. Rents and wages are lower than three years ago, certainly in SoCal.

John-I was a fan of BP back when it was paying a 9 percent divvie, and I have always liked divvie stocks. Now they are paying in the high five percent divvie range, and, of course, they make money on oil, a commodity. You like BP?

Another positive bellwether (I think) Stodgy ol' IBM says they will boost divvies and start buying back stock. If IBM has turned the corner, I think we can say it is time to rock and roll. Oh, Ford too. And GM paid back the money (sort of).

As I always say, the only negatives I see out there is the chronic federal budget deficit and trade debt. I see no hope of a balanced federal budget on the horizon. We don't want to end up like Greece.

John said...


Gold outperformed stocks in the last decade by a wide margin but I'm not willing to bet it will do it again. I agree quality stocks will be the place to be, along with good quality real estate in the decade ahead. However industrial commodities like copper, iron ore, palladium, platinum and many rare earth minerals will also do well if the global economy grows as many expect. At the risk of being accused of pumping my position here, I do suggest those interested in minerals look at BHP. They are a one stop shop for most of these.

I own a small position in BP. I am sweating their oil spill in our beautiful Gulf of Mexico at this hour. It is still a long way from my home in Miramar Beach but I may yet be out there with my grandson's sand shovel scooping the stuff up. Offshore drilling in this country will take a BIG hit from this. Wish us luck.

Finally, confidence is the key to not ending up like Greece. We despertely need to address our budget deficits. Once confidence is lost it can snowball into a disaster quickly. Our politicians need to heed what is going on in Europe. We too have played fast and loose with our budgets and we risk losing the world's confidence. For now we still have it. But it is a fragil thing and nobody knows where the tipping point is.

Benjamin Cole said...

Yeah, the blowout is terrible, especially, of course, for the fellas who died, and their families and friends.

But BP is a huge company, pays a good divvie, and oil may go up from here.

A couple of eons ago, there used to be studies to the effect that stocks paying good divvies appreciated the same as stocks with no divvies. The divvies are just icing on the cake. Don;t know if that is true anymore.

W.E. Heasley said...

Mr. Grannis:

Oh yes! If Janet “Phillips Curve” Yellen gets appointed, then you need to re-welcome your readers to 1975.

Your call on gold has to make Don Luskin happy. Luskin has been oh-so-right for some time now regarding gold. Mater-of-fact, Don Luskin for Federal Reserve governor!

John said...

Mr Heasley,

I think gold is being influenced lately by the brewing debacle in Europe. A bailout/debt monetization is being percieved as inflationary. Defaults/restructurings are seen as bringing back the recession. There is a flight of capital out of Europe into the US Dollar (see our rising treasury bond prices) AND into gold. It is FEAR that is driving this. Fear and uncertainty. Money is seeking a sanctuary and it is finding it in gold and US treasury bonds.

The uncertainty is also contributing to the correction in the US stock market. It will likely continue until some decision one way or another comes from the EU power brokers. It is not going to sink the US economy, as Scott has said, but fear and uncertainty will be the most important short term factors for awhile IMO.

I enjoy your posts.

John said...


If you want an example of a strong currency economy take a trip to Switzerland. I had a planned trip there right after 9/11 and my wife and I had a good time. A lot of travelers cancelled and it was not crowded. Its a fairytale land of beautiful lakes and mountains.

I have a friend that just returned and he reports tourism is down but prices of imported goods are cheap and there are few lines for anything. Restaurants are busy but not badly crowded. Everything is clean and orderly.

Go over the Alps to Italy and you experience a significant difference.

Benjamin Cole said...


No doubt the Swiss are tops, but how much of that is due to their strong currency? They also have recently adopted national health insurance. They also have a great work ethic, and strong culture.

BTW, I did some math, and my friend U. B. Ware has some things to say when it comes to the yellow metal.

Well, gold hit a peak of $850 in 1980. Did awful thereafter until recent history, and yes, in nominal terms it is at new highs in recent years.


Obviously, adjusted for inflation gold still waaaaaaaaaaaaaaayyyyyyyyyyyyy off 1980 peak, or compared against any other investment one could make in 1980, be it the DJIA or property or much else. Dow is up eleven-fold from 1980.

If you bought Apple somewhere along the line, you are not reading this, but you are vacation permanently in Swiss, and clinking glasses with John when he happens by. Clink-clink.

BTW, in yen, the value of gold is still down from 1980, even nominally!!! That is what I call a cruddy "investment."

It could be gold will go back to its 1980 high, even after adjusting for inflation. Big whoop. Gold will have to hit $2,170 just to get people even to the 1980 price. And then you would have broke-even.

Gold is a very iffy investment, yields nothing, costs something to store. It is lower today (adjusted for inflation) than in 1980, after 31 years!!!!

Gold fever belongs in your wife's jewelry box, not your portfolio.

Gold is for the tin-foil hat crowd. The medieval money-miesters.

Forget gold.

John said...

Part of the reason the currency is strong is a culture of hard work and savings. Switzerland has few natural resources. They have almost no oil or gas reserves. They do have a strong conservative banking system and their own currency, the Swiss Franc. They do not spend beyond their means and they believe strongly in education. I believe their values could stand to be imulated in a LOT of other places.

In a nutshell, their strong currency is a reflection of their national values.

BTW, they can afford their national healthcare....unlike others I might mention.

Nite, ya'll

Scott Grannis said...

Benjamin: A strong currency is the bedrock of a strong economy. What hurts exports is not a strong currency, it's a currency that strengthens. Exporters eventually adapt to whatever the currency does; it is currency instability that is the problem.

It is a myth that a stronger currency will boost the economy by boosting exports. What about all the imports that get more expensive with a stronger currency? Why does helping the export sector but hurting all other sectors help the economy in general?

W.E. Heasley said...

John said...

Mr Heasley,

“It is FEAR that is driving this. Fear and uncertainty. Money is seeking a sanctuary and it is finding it in gold and US treasury bonds.”


“Expectations” are a very strong influence in economics.

Benjamin Cole said...


Well, I am sure you know this, the GDP=C+I+G (X-M).

If we surge exports, we grow our economy. A weak dollar would help exports. It would also encourage Americans to vacation in Miami and not Italy.

If we do become more and more a global economy, then more and more of our livelihood will depend on exporting and tourism, and capturing our share of international capital flows.

As we globalize, more and more we will be subject to the monetary policies and actions of other nations, especially China, which will in 10 years have a larger GDP than ours.

A trading nation survives on exports, and attracting capital. A cheap dollar would make US assets and labor look cheap, and attract capital here.

Why does a multi-national source production where it does? The cost of setting up a factory and ongoing labor. The cheaper we are, the better we look.

I think the call for a strong dollar stems from US corporations that wanted to establish overseas operations. An artificially strong dollar helped them in that regard, to acquire assets and labor cheaply.

If cheap currency does not work, then why does China grow at 10 percent annually compounded? They have huge reserves and stability. Exporting nations become wealthier, in short order.

I do not think we can import our way to prosperity.

John said...


This is an economics blog so I think the question of a strong vs weak currency is a good one and does relate to the 'easy fed, strong gold' topic here.

For me I would approach this from a practical standpoint and say take each to an extreme and see what you get. A progressively weak currency would eventually result in high and rising inflation with chronic shortages (goods would be hoarded because they could not be replaced except at a higher prices). Money would eventually become virtually worthless and the economy would revert to a barter system with likely chronic corruption. Unemployment would be high because wages would be paid in products instead of currency.

The opposite, an ever rising currency would result in deflation (falling prices) and a chronic recession/depression environment where cash would be king and unemployment would be high. Demand would be low and again, bartering would become a useful means of exchange.

In both cases, the extremes to me do not appear desireable. Keep in mind, these are my guesses at what things would look like in that hypothetical example.

I really think the best answer lies in what Scott called relative exchange rate stability so commerce can adjust and live in a low currency volatility environment. With so many dynamic factors bearing on things sometimes stability can be hard to come by.

No easy answer. But interesting to think about.

Benjamin Cole said...


I agree with your analysis--one of many, many reasons, btw, why I am not a gold nut. I think if we went on a gold standard, everything you point to--deflation, sluggish growth, rising currency, would be true.

Interesting question: How could you get a property loan, if the value of the property, in nominal terms, would decrease over time? That is the gold standard in action. Who would lend on an asset that depreciates, even nominally?

Of course, when I say I prefer a "weak" currency, I prefer it within reasonable grounds. No one wants double-digit inflation, or Weimar Republic etc.

My gut (that powerful rational scientific instrument under my sweater) tells me the USA can become a manufacturing powerhouse again, and maybe we will in another decade or two. I sense it will become more and more expensive to produce in China, as it has in Japan. Of course, there will be cheap labor elsewhere, but not with the culture of China.

Producing in Wild West Third World nations has it drawbacks, such as corruption, power outages, misinformation etc. The world is running out of cheap labor in suitable production environments.

Look for China, as with Japan, to start locating some production here, where it will be cheaper than the homeland. Thailand will benefit too.

Bring on the cheap dollar, and let it happen sooner than later.

Scott Grannis said...

Benjamin: If the policy of a country calls for cheapening its currency, why would that increase the appeal of investing in that country? You also ignore the impact of a cheaper currency on inflation: sooner or later, a cheaper currency WILL lead to higher inflation.

Benjamin Cole said...


Well, like I said, everything is a matter of degree.

I can offer you a drink, without saying let's roll around in the gutter with our Thunderbird fortified wine coolers.

If we could lower the exchange rate of the dollar to a lower, but stable level, that would make our assets cheaper, and our labor cheaper, and this more desirable to others. It would attract capital here. On top of flight capital.

I am not calling for a continually cheaper dollar, just one that is cheaper than now.

It is of course true that higher import prices mean higher inflation. But by how much? Is a point of inflation worth a point of GDP growth?

I think increasing worker productivity and global competition means the inflation genie has his big feet stuck in the bottleneck.

The long run is that manufactured goods and commodities get cheaper all the time. Sheesh, the cameras, cars and computers in 15 years will boggle the mind.

Skilled labor (we can hope) should become more expensive, and land and equities. But asset inflation should not be confused with general price inflation. As there will be lots of capital out there, equities and land values should rise.

Well, that is what I think, but then I tend to the optimistic side.

I also think that manufacturing nations develop schools, cultures, networks that become self-reinforcing. Once it is ripped down, it gets hard to put back up.