Gold Drop Makes Yahoo! Finance/CNN Money

Courtesy of this article, "The gold 'bubble' takes a bow to the dollar." I note the inverted commas around the word "bubble."

From it:

"There are a lot of people throwing in the towel as gold moved below $1,100 for the second day running," said Adam Klopfenstein, senior market strategist at commodities brokerage firm Lind-Waldock. "I do think the bull case for gold is going to be on hold for the rest of the year."

Also quoted in the article is senior Kitco analyst Jon Nadler, who says that investors got carried away by a lot of hype - some ridiculous in retrospect. What's interesting about these two is that Klopfenstein is a longer-term gold bull, and Nadler's employed by a big gold seller/information depot.


Some things have to be learned the hard way. Unfortunately, the investment markets have a definite tendency to make fools of us all. That's why so much investment education comes courtesy of the school of hard knocks. The markets are so confounding, it often takes recovering from a spell of foolishness to even understand many oft-quoted market lessons.

I've found that understanding is helped by realizing that many investment consensuses, the kind that fall apart, are plausible; many are logical. The thorn on the rose is on the blind side. Consequently, many consensuses are blindsided by what an honest and reasonably well-informed observer would consider an extraneous or irrelevant factor. ["A real-estate decline? Won't matter, because declines in one region have been made up for by gains in another." "A general real-estate decline? Not possible unless there's another Great Depression. That's the last time we ever saw one of those."]

Consensuses can be negative as well as positive. Remember how many people thought that the United States would become like Japan? Now, a recovery is in the offing. It's been tepid so far, and largely goosed by government action right now, but the U.S. is still the U.S.; it's not Japan. I think one of the reasons why so many people are cynical about the recovery is because they remember the Bush stimulus, and what followed it. I was one of the people who thought that the Bush stimulus marked the end of a slowdown, rather than a prelude to a vicious recession. That fake-out made a lot of people wonder how fragile the U.S. economy really was. However, the U.S.-as-Japan case was always based upon "this time, it's different." Just because that slogan was used pessimistically instead of optimistically this time, doesn't change its nature.

The same consideration applies to the hype - negative hype, of course, but still hype - about the U.S. dollar. Greenback bears have been fairly logical in their case, and still are. The exploding U.S. deficit isn't going away anytime soon, and foreign buyers of U.S. Treasury securities are beginning to show reluctance. However, there are no signs of serious U.S. inflation as yet. And, as we now know, the greenback is far from being dethroned as a safe-haven asset class. The problems that the U.S. dollar bears point to haven't really kicked in as of yet; they're largely potentialities as of now.


Now that I'm finished sounding off, I'd like to make this point: more gold bulls are folding their hands near-term. Contrarians may be interested.


An afterthought: One possibility that the deflationistas haven't considered is tepid growth while debts are whittled down. Case in point: the 1950s. [Graph here.] That decade saw two recessions and a growth rate that was much lower than that of the '60s, '80s and '90s - even lower than the '00's. The two recessions in that decade were relatively mild, but the overall slowness in growth was an issue in the 1960 election.

Granted that the 1950s didn't have a huge debt bubble, but it did have high marginal tax rates combined with a restrictive fiscal policy and a not-very-expansionary monetary policy. I think that this outcome may be the one that government planners are counting on, where a restricted consumption budget combined with loose fiscal policy is a rough stand-in for moderately expansionary private spending combined with rectitudinous government spending.

Of course, an alternate scenario is the slow-growth 1970s. The chief difference between the 1970s and now is that the U.S. government found it much easier to export inflation back then. On the other hand, it's a lot easier to sell Treasury securities now - even with the deficit as huge as it is.

I'm not a conspiracy-minded fellow, but one possibility to consider is that the U.S. government has an interest in the U.S.-as-Japan trope propagating. If the U.S. is widely believed to be in for a "Lost Decade," then the bond-market vigilantes will nod off and become torpid. Any resurgence of inflation is likely to be greeted as aberrational, buying the U.S. Treasury some time when it can borrow at low (or even negative) real rates.

The capacity-utilization argument already serves in that capacity. "If capacity utilization [currently 60%, well below this decade's norm of about 80%] is so low, how can there be any sustained inflation? A blip, nothing more. You'll see."

If inflation ramps up in the face of sub-normal capacity-utilization rates, we're looking at stagflation - the kind that can fool the credit markets. It may be a homely truism, but inflation policy always seeks to turn the creditor into the patsy. There are times when creditors do act like suckers; at such times, inflationary policies are pursued.


There's another way to kick the can: covertly encourage the banks to shift more of their assets into U.S. Treasury securities. Not only does it keep demand for U.S. Treasuries higher, making the rate the government borrows at lower, but also it short-circuits the usual expansion of the monetary base. When banks loan to the general public, they create new balances that add to the money supply. That's what happens when a loan is approved: the borrower's account is credited with the funds once the loan is agreed to. As long as the bank in question has more reserves than required, the bank need not deploy already-existing funds into the credit. The new loan (a new asset) balances the credited funds (a new liability) in the bank's books.

When banks lend to the government, on the other hand, they buy securities with already-existing funds; no new balances are created. Thus, lending to the feds doesn't push up the money supply - unlike lending to the public. This charmed circle keeps both real and nominal rates low, preventing U.S. Tresury debt-servicing needs from crushing the fisc.

Under this scenario, unlike the previous one, gold won't fare all that well. That's because this approach will turn the U.S. economy into Japan's! Makes for a neat self-fulfilling prophecy...