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Inflation Paradox - Full Version

A Reprint from a GoldenBar Report April 11, 2001

The Fed's McTeer says: Focus on Growth not Inflation!
Goldenbar's Bugos replies: Only if he will Focus on Inflation not Growth!!!

The yen dipped overnight against the U.S. dollar to its lowest since October 1998 after comments from Japan's Economics and Fiscal Policy Minister Taro Aso that the idea of allowing the yen to weaken had been discussed with the U.S. - from Reuters March 30th.

There is no manipulation… say it again… there is no manipulation! If we say it enough, maybe it will even work, the actual manipulation that is. Sorry, I couldn't resist. What does it mean that the idea of allowing the Yen to weaken had been discussed? Ok, to put it another way, substitute the word "Yen" with "the Nikkei" above, and it sounds like this:

The Nikkei dipped overnight to its lowest level since October 1998 after comments from Japan's Economics and Fiscal Policy Minister Taro Aso that the idea of allowing the stock market to weaken had been discussed with the U.S. - fictitious wordplay

Bloody well right it's manipulation! And it is nothing new to us. In fact, allowing the Yen to weaken really means "submitted to the political pressure by helping it weaken," which is precisely what happened when the Bank of Japan slashed interest rates back to zero last month. Of course, since the justification is to prop up the economy, there must be no evil. But there is a reason that this pressure exists in the first place, and it has to do with a global monetary order, which has evolved out of chaos.

The New Order
It has grown out of the necessity to create a world of efficient commerce, but its aim is always to stabilize the nearly century old Fiat paper money experiment. Entire privately financed infrastructures have been erected to exploit the inefficiencies one would expect to find in this kind of monetary system. Indeed, stability (currency or otherwise) is the prime directive of many a monetary policy AND it often appears that even the vast array of trading programs tend to (or perhaps should) collectively move the markets toward stability anyhow. But the volatility continues to grow.

Consequently, critics of capitalism accuse free markets of inherent instability, yet it is not capitalism that is the problem. If you think long enough, you might conclude that a multi trillion-dollar derivatives industry exists, for instance, only to hedge the risks that necessarily must rise if the aim is to stabilize the otherwise unsupportable paper markets at higher and higher levels. For it involves risk-taking to move the markets to higher levels in the first place. But why must a Fiat system expand to survive? Because the system, by the book called an inflationist system, is of use to no one if it cannot continue to grow, or inflate, because that is the very reason it exists in the first place.

So inflation is not the Federal Reserve System's number one enemy. It is their agenda to inflate, but to do it gradually so that it can be controlled, and remain unseen. On the contrary, inflation is your number one enemy, gradual or otherwise, and they have been allowed to do it right under our noses for so long now that it has become impossible to tell the difference between a real price and a nominal price. Historians of money note that our perception of purchasing power must rely on its recent past performance (of the unit), if you will. But today there is additional influence on our varied perceptions of purchasing power. The freely floating exchange rate system, which is really a negotiated (as opposed to free market) exchange rate between other allied nations who subsist under this new monetary order, is a constant source of price distortion. How many industries have grown out of the necessity to stabilize and exploit volatile exchange rates? Or perhaps it should be asked this way: how much business does the average multinational company do trading derivatives in order to balance its books these days? Is it all really necessary? Of course it is, if you want to stabilize an enormous international paper money system.

Anyhow, the Chaos happened long ago. Historians rightfully argue its precise origins, but for the sake of simplicity let's just say that the chaos we refer to here succeeded the Nixon dollar gold break, officially in 1973, and was largely monetary. It was not a good time to be a banker because the dollars that were lent quickly became worth less. Essentially, what Nixon had done was to throw away the anchor, and what the banking community had to do, if it was to survive, was to stabilize the mess, which they were able to do with international currency arrangements and by raising their interest rates into the high teens. This forced some deflation into the "inflationist" US economy in 1981, and thus replaced the anchor, symbolically at least, if only temporarily. Hence, the father of today's reborn Federal Reserve, the head of the global monetary order, must therefore have been Paul Volcker, then Chairman of the Federal Reserve Board.

Our central bankers must have gradually learned that when Americans fear that deflation can be bestowed upon them, this symbolic anchor, as effective as Smith's Invisible Hand, worked for enacting policy. For deflation expectations produce demand for hard currency, and thus help buoy the value of the currency that "appears" the hardest. There are certainly several economic laws that will help you determine which currency that is, but the nation with the most widely circulated currency, and the most net debt, ain't gonna be it by default. However, should the foreign exchange rate of the dollar rise, for many of the unrelated reasons that we will touch on this week, investors will find it expedient to conclude a deflationary outcome. Indeed, that is what has been happening. And accordingly, deflation expectations have been on the rise.

Inflation expectations, on the other hand, will typically produce a surplus of currency if confidence in it breaks down, which, if taken to the extreme, can produce the inflation breakdown Mises refers to as the "crack-up boom." Normally, bankers, being creditors, would prefer deflation to inflation for want of protecting the value of that particular currency, which they have lent in large sums and over long periods of time. But today, bankers are stock/equity holders also, and some are even likely to turn up net debtors. So, today, they are after the best of both worlds. And there is a way that they might have both too.

What if they could incite a fear of deflation without having to cause deflation, which incidentally is not just declining prices, but that part of the price decline attributable to a contracting stock of money? When money supply expands, and prices decline, that is not deflation. That is more profit for bankers. There is plenty of cash in the system. The question is first, what is its quality, and second, who owns it?

One of our subscribers emailed us a question this weekend. It was a challenging question, and I think one that is on all of our minds these days:

Dear Mr. Bugos,
While the Treasury yield-curve is getting steeper, the so-called real yields on the inflation indexed securities, and their prices, have not moved much. If inflation expectations were built into the yield curve, one would expect some movement in the indexed bonds. What am I missing? No other than the great investor Sir John Templeton recently urged investors to exit the share markets in favor of long-dated non-callable bonds... a remarkable statement from a very successful investor and someone who has seen both deflation and inflation. I am not one to dismiss his remarks lightly... signed Goldenbar subscriber.

Mr. Templeton isn't the only one. There is a long list of prominent money managers, who fall clearly in the deflation as the most likely successor to the recent excess (in the US) camp. But we believe that they are wrong and that the deflation fallacy is the path of least resistance, for them, at the moment. It is perhaps hard for a conservative investor to expect that excess will breed further excess until there is something to prevent it. Yet that is the nature of things today, and there seems to be nothing to prevent the Fed from cheapening the price of money at its own discretionary whims, until now. As Wall Street buzzes about rumors of another inter meeting rate cut, sending short term yields to new lows, the long bond is beginning to roll over, forcing a steeper yield curve. The event is so near I can smell it. A crashing long bond will change everything. It might even ignite the gold market.

One of the toughest things to do as an investor is to keep your head about you when all those around you have lost theirs. It is a challenge that the money manager faces every day. Whether he or she is ready for it or not, every day that money manager has to wake up, rid himself of his previous day's bias, and look at the facts with a fresh new perspective, hopefully the right one. It's a tough business, and not a place for egomaniacs to survive over the long run, normally. But these are not normal times. Investors are seriously confused largely because they have been so misinformed, probably by an egomaniac (kidding).

In order to be successful as an investor, you have to have an edge. You can be successful for periods of time with a formula that works under certain conditions, but if you are to avoid disaster, you will need to have the skills, and strength, required to be honest with yourself… to know what your own weaknesses, strengths, and bias' are so that when change comes you haven't deluded yourself. This is a lot, lot, lot, harder than it appears. Men like Mr. Templeton are where they are because they have learned to master these skills, in my humble opinion. But that doesn't mean that the challenge ever goes away. In fact, the challenge has never been greater than it is today. And there is no guarantee, that we've got it right either. I too face this challenge every morning.

Having said that, I believe that our case is strong, and that the vested interests have become contrary to your individual interests, some deliberately, others innocently. The Templeton group of funds, for instance, has grown five hundred fold since inception in 1954. John Templeton's foresight has proven nothing short of brilliant, but the reality is that he shares an undeniable bias with many other important money managers, which has grown stronger and stronger from 30 years of nearly unfettered asset growth. The mutual fund industry has been one of the industries that have benefitted from the impetus to asset inflation that came directly from the Fed. The entire process must have delivered great wealth to him, personally, and to his disciples generally. While he may not always favor US stocks or even stocks in general, his organization has a strong incentive to endorse the current system of Fiat.

For it holds general dollar positions so large that they simply cannot be sold en masse. He "is" in it for the long term, and like the captain of the Titanic, if the ship is going to go down, he will likely go with it. And if we are right, that the ship is going to go down, then he has probably got the toughest decision he will ever have had to make, ahead of him. The same goes for anyone else in the same position whose choices are restricted by virtue of his or her vested interests. One of the first things that was told to me as I became a stock broker was to forget about the gold argument. If the government goes broke we all go broke, it was said, effectively telling me that the government's paper is preferable, period. So, we are not surprised that any of these people have fallen for the deflation fallacy.

Hopefully by the end of this report, you will not be either. We are going to answer our reader's question by discussing the gold market, since it too is known to act as an inflation indicator from time to time, and because we believe that the answer has everything to do with current and future inflation expectations. In fact, I wouldn't be surprised to see that the value of the inflation indexed bond correlates somehow to the dollar price of gold, since both are supposed to reflect the same expectations. And if our analysis of gold, the dollar, and the treasury bond tell us anything, it is that these expectations are on the threshold of a significant reversal. The trigger may be the expected break down of the treasury bond.

The Dollars for Gold Program
Each of the charts in this section are basically the value of one ounce of gold relative to (or valued in) something else. Most of us are accustomed to valuing gold in relation to the US dollar and/or the Biritish Pound. That's because the trading of gold and gold contracts still occurs primarily in New York and London, through NYMEX and the LME. And since the Dollar is still the international reserve currency, even if only by virtue of the fact that the world is stuck with it, it is the most relevant measure of value.

But if you are trading gold, gold futures, or gold stocks, and you need to assess trading opportunities, it is worthwhile to compare it's relative strength against the other currencies, commodities, or assets.

Furthermore, economists such as Antal Fekete regard the Gold/Silver ratio highly because it reveals central bank buying and selling of Gold over time. We believe he is right. In fact, the bimetallic ratio is precisely that system of money, which the US constitution was founded upon, as a safeguard of your money from central bankers like Mr. Greenspan. Ironic isn't it? Jude Wanniski likes to look at the Gold/Oil ratio for signs of inflation or deflation, and thus to assess the most appropriate monetary policy action. This is important because he used to advise the Reagan administration, and was one of the chief architects of the supply side school of economic theory, which was first taunted as Reagonomics, though recently rationalized for its long term benefits to productivity.

Anyhow, by introducing another variable, such as oil or silver, the analyst can cancel out the influence of the dollar, and dollar policy. Unless, as we suspect in this case, the gold/oil ratio is also a target of dollar policy, which isn't too hard to accept if you consider that a highly regarded ex-economic advisor to the administration appears to endorse it.

Ok, so let's take a good look at this market shall we. As you look through the graphs, note in particular the action since November. That is where things have been changing, which is interesting to us as the dollar price of gold bounces around a few dollars off its twenty something year low, last made in August 1999 after the Bank of England crushed the market with a shrewd play.

Comex - Gold Futures
Gold versus the MIGHTY US Dollar:

Gold prices are (obviously) in a steady downtrend against the value of the dollar. But note the double test of all time lows near $250 (Feb and Apr), and the gradual increase in range volatility, easily depicted by the diverging moving average lines. This is just an observation at this point, but keep in mind that this volatility, which also shows up in lease rates, has been on the rise since mid October, the date noted in the preceding paragraph.

The first chart immediately below is the value of an ounce of gold measured against the US Dollar "Index," which is a broad weighted average of the foreign exchange rates of its main trading partners. We can already see that by diluting the dollar's influence a little, the picture changes. It changes even more when you look at the graph of gold against the Yen and Australian dollar. Indeed, then you will have pinpointed the latest reason for the declining dollar price of gold. It has little if anything to do with aggregate demand or supply, and everything to do with money, the increasingly oppressive monetary order (or international currency arrangement), and in the end, capitalism.

Gold versus Dollar Index
Gold versus Dollar Index

Gold versus Yen
Gold versus Yen

Gold versus Australian Dollar
Gold versus Australian Dollars

Gold versus Euro
Gold versus the Euro

Above charts are courtesy of Stockcharts.com and ShareLynx

The Euro price of Gold had been in a relative uptrend until November 2000, when the Euro finally bounced off of something hard, and was able to put a dent into both, the euro price of Gold and the euro price of the Dollar. But it has been giving that back, even against the price of Gold. Note the sequence of higher lows and higher highs since January, and compare that to the way that gold has traded against the dollar over the same three month period. Better. But could the Euro just be preparing to clobber both, again? If so, it will have to do better against the dollar. But if it does, and it just might, how will that affect the dollar price of gold? For a clue, would it be fair to compare what the dollar price of gold did between November 25 and December 31 2000 -- It rose almost 10 points, with momentum... 20 if you count all of November... see the first chart above.

So what keeps stopping that momentum, especially against the dollar? The simple answer is the momentum of the dollar relative to the other currencies, particularly the Yen and Australian dollar. And why is the price of gold in Yen on the rise if they are expected to have deflation? Because dollar bulls have been over flexing their muscle.

The conventional explanation for this surge in the exchange rate of the dollar is based on two fallacies: the first is that, according to David Malpass of Bear Stearns, an expansionary monetary policy equals a strong currency while a tight monetary policy produces a weak currency. Bogus. That's my name spelt backwards to symbolize how backwards the preceding idea is. The second fallacy is that Japan is going to export deflation to the United States, and interestingly, it was also mentioned by Mr. Malpass. The deflation argument, which sees a $180 (US dollar) Gold price before it sees $400 is one helluva hurdle. But hopefully, by the time you finish reading this week's report, you will understand why the deflation fallacy is really an inflation paradox.

The Deflation Fallacy is a Red Herring
There is enormous confusion in nearly every corner of the modern world as to what inflation and deflation really are, despite, but maybe because of, the obviously Fed inspired inflationist infrastructure. The big paradox is rooted in that the infrastructure lay upon the business of credit, as a mechanism of money expansion or contraction.

In any kind of Fiat system of money, we know that the expansion of money without an equal expansion in the quantity of real goods, services, or assets, will result in no additional real benefit, or wealth. Consequently, it must manifest in rising prices for these things, many of which will not rise at the same time or rate. We know this, and we know how political prowess, rather than economic proficiency, can direct this marginal money. And even better, by allowing the money stock to expand only slowly, we can hide the mechanisms by which we influence these resources to our own benefit, by conferring upon the rest of society an ephemeral wealth. Thus, certain prices rise over others, and where those prices are rising the fastest, is where you will find those gaining the most advantage from this daily process of the Federal Reserve System.

But in a more dynamic (Fiat) system based on credit money, participants are convinced that credit cycles will regulate the money supply. And the fact that US policymakers have been able to extend this credit cycle, with all sorts of interesting financial tools, has only made the perception of the eventual contraction larger. You know, when the remaining wheels come off this cycle, it is so hard to know what will blow first… for there is such a complex array of financial relationships that hold it all together. However, by applying a pyramid model to this scheme, and then turning it upside down, we discovered only that the sides just flap right down like soggy banana peels.

So the paradox is how can an inflationist monetary policy produce deflation fears? Through the threat of instability in the credit cycle, which when it contracts creates the demand for hard currency to pay off debts with, which reinforces the contraction in the credit cycle and the money stock of a financial system dependent on credit creation.

Humans being the practical types though, find the thought of a contraction in any kind of wealth, real or otherwise, inconvenient. Accordingly, the global monetary authority today awakes to a new order where its private members have become large institutions fully capable of perpetuating this cycle without any help from it, or the government. The derivative markets allow them to hedge their risk, so that they can take on ever more risk. The proliferation of money markets allows them to monetize high and low quality credits and sell them for the same price to indiscriminate buyers, for cash.

This is important because whereas these credits are not securitized, they are not really negotiable. Thus if the banker wants to reduce his loan exposure, he would have to call the loan, which action would result in the cancellation of that debt, and a contraction in money supply, all else being equal. On the other hand, should the banker choose to securitize his credits (and thereby make them negotiable/saleable), he will receive cash or equivalents for them, most likely from a foreign investor who thinks he is buying a souped up t-bill, though the buyer could also be another bank if the Fed is easy enough.

At any rate, this process of securitization, and thus the monetization of credits have enormous consequences for a credit contraction. How many irredeemable dollars have been issued to foreign interests now? What are they going to do with those dollar denominated debts when they want to call them and cannot? If they sell them, what are they going to do with the dollars? Are they going to buy government securities because why again? Right, because there is no inflation in dollars, because there is plenty of productivity in the United States labor force, and because the government is going to pay down the public debt in one fowl swoop this decade.

But if you exclude these incontrovertible truths (you know I'm kidding right?) the advantages of buying US government debt over domestic issues, if you are a foreigner, disappear. However, if they aren't true to begin with, and there is inflation, which there is, and if the productivity debate really is an immeasurable red herring, and finally, if the US government, by some stretch of the imagination, simply cannot reduce its debt this decade, then there will be plenty of disadvantages in owning this debt, whether you are a foreigner or not, and you will demand a higher return to attract your interest or to dissuade you from selling dollars. Consider the next chart:

Gold versus Treasury Bond
Gold versus Treasury Bond (30 year) Index

Note the steep downtrend. Besides the dollar, here is where the deflation argument gains most of its substance. The downtrend reveals declining inflation expectations here as well.

But that is about where the good news ends for the Fed, as you will soon see. Note the higher low in this ratio at the beginning of April, even as the dollar price of gold made a lower low. The value of gold can only continue to decline against the relative value of the 30 year treasury only as long as the Treasury can continue to persuade us that their bonds will continue to be more scarce than gold, which they can do so long as the Government can sustain a budget surplus. When it is perceived that it no longer can, investors will be forced to re evaluate the credibility they have assigned to government promises that their buy backs will continue. Please recall that we do expect this point to be near. When it arrives, it will usher in the most rapid reversal in inflation expectations we have ever seen.

Last week's announcement that the senate allowed only a $1.2 Trillion "refund" -- about 25% less than Bush asked for -- is only one of the few last remaining psychological boosts that the US treasury has at its disposal. They can now tell everyone that they got the best of two worlds: a relatively happy consumer and yet, some austerity to keep the bond markets happy to boot. Perfect, for about a week. At any rate, we believe that the the bond charts ought to test our hypothesis soon. In fact, they are doing that as this is being written... and already, I hear reasons for the event, which include the little stock rally as the cause of the bond market's ills.

US Treasury Bond Price

It was significant that Mr. Rubin acknowledged that the long term budget surplus projections, used by the Bush administration (but invented by the Clinton administration) are indeed speculative (CNBC March 31). Obviously he is opposed to the administration's handout, and his opinion is important as the head of Citigroup today... though his choice of timing in making public his position on the matter puzzles me. Nonetheless, we can be certain of one thing. That Rubin understands how important maintaining the (illusion of a) budget surplus is for the strong dollar policy. He should. He invented it. Therefore, to us, it is almost a no brainer to expect a shift in public perception towards a position of doubt that the Bush Administration will keep the budget balanced. Perhaps Mr. Rubin has indeed symbolized the lead in this already shifting paradigm.

Likewise, the unexpected stand by the ECB, fair-weather or not (we have yet to see), is perhaps another symbol of this shifting paradigm.

What will drive currencies in the future, return or risk aversion?

New York, April 4 (Bridge News) - The euro surged to a two-week high of 90.52 cents to the U.S. dollar and to a 17-month high of 113.71 yen as additional evidence of economic weakness in the euro zone increased the odds that the European Central Bank (ECB) will cut interest rates. The dollar also suffered from liquidation of long positions after apparently peaking versus key currencies on Monday.

Stuck in the nineties! That's our take. 10 years ago, had you approached someone - anyone - and said that you think the dollar will rise because the Fed will lower interest rates, they would have thought you were a nut. Still, it proved to have been the correct analysis, then, even though it would have been a few years early. I am not trying to point out why these rearview mirror analysts will never make it out of the Regal Playpen, but rather, that it is a crime they are allowed to pretend that they are more than just news disseminators. At any rate, this quote serves as the perfect illustration that a little bit of knowledge is dangerous. Whoever is responsible, be it the writer, editor, or executive that is not able to distinguish between fact and speculation, they are guilty of journalist larceny. They miss so many other steps, in making "conclusions" like this, that it can cost you money if you aren't aware of their credentials.

If a currency rises because interest rates fall, it is only if the buyers have confidence that such an action will result in higher investment returns for other investments denominated in that currency… be it stocks, bonds, real estate, or in their private business dealings. Most analysts have not yet come to terms with the implications of the reality that the emerging investment climate in the United States during the 1990's was unique, abnormal, ephemeral, maniacal, and most important, largely behind us now for a long time. Adjusting the cost of money cannot prevent global stock prices from falling out of their enormous topping patterns, as if it were the only factor that ever drove stock prices to begin with. Just as these wannabe Henry Blodgets didn't see the big bull market coming, they didn't see it leaving either, and many of them still don't by the way.

And just as they did not understand why the dollar was going to react to lower interest rates by rising, after 1995, they do not understand why it cannot react to lower interest rates by rising for very much longer. In this era of rising (definitely rising) financial volatility, uncertainty, and international hedge-money, investors are fickle. They, whatever is left of them, are not looking for the highest returns any longer. Instead, they're on a hunt for the perfect SafeHaven, having just been reminded that risk still exists in many kinds of stock speculation. At the moment, they are watching in astonishment as the invisible hand, which angrily slapped the "speculative" Nasdaq, as well as the junk bond markets, begins to work on adjusting upwards the equity risk premium in the blue chip averages - the Dow and NYSE Composite. This process is far from over, and after looking at one 10-year chart after another, looks to be only beginning.

The number of stocks sporting major market tops, and I mean that to be inarguable, is overwhelming. Global stock markets suffer from complete exhaustion. There is no SafeHaven in that kind of paper today. If we are correct, the Prudent Bear will become very wealthy over the next few years, and eventually, he will likely acquire a taste for all paper as if it were a big garbage heap at Yellowstone national park. The fate of the stock market, economy, and the dollar are hopelessly intertwined. Wall Street Bulls think they can have their (your?) cake and eat it too... same appetite as their banker friends I guess. Need they be reminded that it was the bullish interplay between these three economic variables (simplifying here) that made for the good times (1995-1999)? I suppose so.

So as rising national default rates gradually undermine the US money markets, and as the windfall in capital gains that the government's budget (surplus) projections are based on disappears, the rising risk premium will ripple through financial markets - denominated in dollars - moving investor priority further and further away from the emphasis on seeking return and deeper onto the hunt for a SafeHaven. When they finally figure out that the key to their long-term investment survival in this big paper mind game is to seek out scarcity, the dollar will finally buckle.

And that point has got to be near now. The invisible hand is making its way into the US Treasury market. It is pulled back and ready to slap, hard. What is it waiting for? Proof that the surplus will turn into a deficit, or some acknowledgement that the treasury will change its course from buying back debt to issuing debt, once again, or is it just waiting for Mr. Greenspan to sign the sell ticket? When the Fed's focus publicly shifts to the dollar, it will be too late, for then the game will necessarily come to another inflection point… whatever that may be.

Promoters make promises too
Regardless that the slick Bill Gross is targeting the 3% range for long term interest rates, history and some sense suggest that a trade deficit as large as this one is, in proportion to GDP, requires a much higher national interest rate to finance it, else risk dollar devaluation. So far, Wall Street has been full of promises to foreign dollar owners. From promises of deflation and ever more interest rate cuts to spur a big dollar-bond rally, to promises of a V bottom for the economy, to promises of the buying back of long term treasuries, to promises that the productivity burst is not finished and will hold down dollar inflation. They are all lies, we are sorry to say, but more importantly, the market has priced them as if they were true.

Could the market be wrong? It often is and we certainly think that it is here. Can a market be promoted? Certainly nothing as large as the US government bond market, unless all the big guys are on the same team. We believe that they are, and if we are correct, they are all also on the same side of the market. Oh boy, where is the trigger? Whoever or whatever pulls that trigger, it will become clear that the Fed's biggest weapon for managing your inflation expectations, the long bond, will develop a mind of its own.

What if that trigger is a spike in gold prices, which will blow a hole in the American dominated global banking system the size of the grand canyon? Before we write those odds off, consider what would happen if gold prices spiked to $400 an ounce. How would the resulting derivatives losses ultimately show up on their balance sheets -- we can only imagine. Will they have to buy physical gold to settle (fudge) their books? Probably. Forget about it though. Look at the first chart. We're going to $US 180. Everyone knows it. Bugos cannot let go though. Why? Because he doesn't buy the deflation argument.

Analysts will point to how the CRB has declined 6% or so since the beginning of the year, strengthening their deflation theme, but forget to tell you that is after a 25% two year ticket to ride, up! But still, who can blame them. After all, gold prices continue to decline, and gold is supposed to be an inflation barometer. Thus, there is no inflation. Recall that it is only in relation to the dollar and bond that gold prices sag. Let's consider what they have been up to with the dollar.

3 April 2001: Dollar Bulls Turn Up the Heat

  • Merrill Equities cut its gold price forecast in 2001 to 275 from 285
  • A U.S. federal court has granted a one-year injunction barring oil producer group OPEC from fixing prices
  • CNBC builds nice story blaming Japan as becoming suddenly relevant and responsible for the stock market's current anxiety. They are already trying to write (revise) history, and they haven't even won yet. Arrogance.
  • Stock bulls are telling us not to worry because it is not a question of too many sellers, just not enough buyers… very different, they say.

It sure is. Now, just the simple fact that these kinds of people are still allowed on the air is reason enough to call for another big bear market sell off. They are powerful, they are groomed, they have connections, but they do not know anything except how to persuade or to seduce you, depending on how big your bank account is. They are the same people who are telling you to buy and hold for the long term, today. But hold what? Which stocks? But we'll leave stocks for next week.

Dollar bulls have ripped through one bearish stronghold (resistance point) after another. They have rallied through important primary trend support for the Yen, at 125, testing the nation's resolve. What are they telling us? That they want more dollars and less Yen!?! Mr. Greenspan, please sell some more.

Oki doky smokey...

Simultaneously, buyers show up in Europe, screaming that they have to buy more dollars now because they have lost confidence in the ability of the Europian Union to stay the course. What do they mean? They could mean with regard to whether the EU can manage the new untested currency arrangement against the backdrop of a deteriorating economic outlook. That is what they do mean in fact, but here is where they split into factions.

One side will have it that generally, the glue of the arrangement has not been tested and is subject to the diverse dissenting opinion towards the handling of monetary policy through an economic crisis. This group would rather hold dollars even if they yielded less. The other side has developed a more sanguine outlook, undoubtedly a reflection of the casualness with which they approach their investment decisions. They simply hold that they are forced to buy dollars over euros because whenever the Fed lowers the interest rate, dollars become cheaper to borrow, and thus become more plentiful. By the way, if that irony is confusing it is only because mainstreet has filled your head with mush. I sincerely fear that a group of third graders would get that before most of us would even have a chance.

Then, of course, without an oz. of shame, they show up to slam the other dollars: the Australian, the Canadian, and the Rand, pushing them over a cliff and on to new all time lows. The punishment doesn't stop there. Some dollar bulls are even buying dollars over other commodities, not having learned their lesson in 1998, as the low dollar price of these commodities will only strengthen the tension, or relative scarcity, which is behind the explosion of global energy prices at the turn of the millennium. Already, the falling Aussie, Canuck, and Rand, in relation to the dollar, are creating the incentive for additional gold supply from existing production facilities, in exchange for the rapidly rising, and abundantly more plentiful dollars. As perverse as that may seem, consider that the same forces will work with equal power in reverse, as (the dumb ass) dollar bulls should have learned from the stock market accident, recently.

The Politics of the Dollar "Policy"
If you can imagine a world where the monetary authority tries to gradually inflate the money supply, supporting the value of the excess currency with crafty financial mechanisms under the guise (mandate?) of a national currency "policy," what kinds of things might you find under such a policy? Would it be in the interest of policy makers to manipulate the value of those things that challenge the value of its currency? Gold would be a target if this were our world, since Americans used to understand this aspect of its value, though it puzzles me that the World Gold Council doesn't see this even as the Fed takes control of the BIS (Bank for International Settlements). Right under all of our noses, the mother of all central banks is being erected, and we don't see why it would be in their interest to manage the price of gold in dollars.

But what if that no longer worked? What if people started to notice other things, such as rising oil prices? Well, one way to deal with that would be to somehow force sellers of oil to trade only in your currency, creating some additional reasons that other nations have to buy dollars. Another way to deal with it would be to sell oil out of the treasury in exchange for dollars, to hold down energy prices claiming an energy crisis as justification. You can always get all of Africa hooked on the currency by giving it away over there. You might have to make it look as if you're doing them a favor though, but that shouldn't be difficult to do. Still, what if all of that effort still didn't work to hold down prices? You could resort to misinforming people. After all, who in their right minds would believe that you could do that in the information age? Actually, you probably couldn't for long, if it were the only tool at your disposal. So what are you going to do? Begin to collapse the other currencies, which subsist under this order? Wouldn't that be crazy?

Indeed, it would be self-defeating if taken to the extreme, but extreme is where we are today. For isn't that what is going on? Isn't the US financial community putting pressure on global central bankers to cut their own interest rates? Why, to stimulate foreign economies, or so that the Fed can stimulate the US economy? And when the Bank of Japan does so and when the Yen buckles, would you expect any of these dollar governors to surrender their line of reason? Instead, they are likely to blame Japan for not doing enough! More they yell, more!! Print more Yen damn it, so that you don't export your deflation. But Japan is not set up like the United States. It doesn't have a strong Yen policy, yet. Thus printing more currency will collapse the Yen because Japan is an exporter of capital, not a consumer of goods! But that's Ok for our policy makers, because it forces up the Fiat foreign exchange rate of the dollar against the Yen, which makes it easier to depress the dollar price of goods, and which accordingly helps to induce the specter of deflation.

This strategy of forcing all other countries into a vested position where their chief role is to continue to vest in this currency may be called the borrowing of foreign purchasing power, and the US government is addicted to it. Witness the trade imbalance. Indeed, the entire nation has become addicted to it. In fact, by virtue of vested interest, the entire world is dependent on the benefits of selling purchasing power to the owners of dollars. Unfortunately, that just gets them more vested.

Since the ECB decided not to give into this game and held firm on interest rate policy, the Euro has strengthened. Yet, national newspapers quote dumb witted analysts telling us that the reason the Euro is rising is because they expect the bank to cut interest rates the next time around. My essay, the misinformation highway, comes to mind here. What if the Yen is collapsing because the BOJ lowered interest rates, creating the incentive in Japan to export more capital? If so, what if the Euro has been rising because their interest rate policy appears firm, discouraging an outflow of additional capital?

Do you see how I got there? Because this is precisely the world we do live in today. It is run and "planned" by "central" bankers. It has to be now. We allow it because we know that our safety is in their hands. Recall Benjamin Franklin: those who give up essential liberties for a temporary safety, deserve neither their liberty nor safety.

So the inflation paradox is only a paradox because the deflation fallacy exists. Has any nation ever seen deflation where there exists no monetary anchor? Sir John Templeton knows the answer to that. The last "involuntary" deflation this country has ever seen was in the thirties. Very few people alive today fully understand that era, and those who do may have forgotten the chief difference between then and now. The current global monetary order is completely without an anchor, and true deflation is about as likely as the surprise announcement that the Bank for International Settlements has decided to adopt a gold standard for the world currency arrangement. In fact, that is what it will take to have deflation.

Now let's review some facts:

Gold versus SPX500
Gold versus SP500:

Look at that! Stock prices are falling faster than gold prices. No surprise here or the next chart, against global stock prices. And beyond that, note the steadily rising relative strength of gold when compared with everything else, below, with one exception.

Gold versus Dow Jones World Stock Index
Gold versus Dow Jones World Stock Index:

Gold versus GS Agriculture Index
Gold versus Goldman Sachs Agriculture Index:

Agricultural prices are deflating now. This makes sense if the commodities are becoming less scarce than gold is. But they are certainly not as scarce as the dollar. So what gives? Aggregate demand or the dollar exchange rate?

Gold versus GS Energy Index
Gold versus Goldman Sachs Energy Index:

Gold versus Industrial Metals Prices
Gold versus Industrial Metals Prices:

Gold versus GS Livestock Index
Gold versus Goldman Sachs Livestock Index:

Gold versus West Texas Crude
Gold versus West Texas Intermediate:

If the gold/oil ratio is a legitimate target for the strong dollar policy, Mr. O'Neill better get to work on bidding up oil prices...

Gold versus GS Precious Metals Index
Gold versus Goldman Sachs Precious Metals Index:

A change in leadership within this sector?

Gold versus the CRB
Gold versus CRB (Commodity) Index:

Gold versus GS Commodity Index
Gold versus Goldman Sachs Commodity Index (TR):

Gold versus Silver
Gold versus Silver:

According to the bimetallic ratio, gold has been under accumulation. And while everyone is talking about gold sales that have already been announced at the time of the Washington Agreement, the bulk of the data above, bear out gold's historic role as a hard asset. And for gold prices to trade down to $180, AND stay there, will require an enormous interest rate hike by the Federal Reserve Board... no, lower rates will not equate to a stronger dollar unless US policymakers force the BOJ and ECB into outright submission.

So how high can gold go? If we are at a critical inflection point in this game and the historic Dow/Gold ratio is any guide at all, gold prices will either go to $4000 an ounce or the Dow will decline to 700, or they will meet somewhere in between. In the 1930's, Roosevelt robbed investors of the ability to exchange their currency. The Dow declined by 85% but gold hardly doubled in value. In the seventies, Nixon allowed individuals that freedom, and they voted against the dollar, at one point pushing this ratio to an unprecedented parity with the Dow (1980). Today, while this ratio has just come off of a historic low at .03, the question is no longer when, but how high will it go?

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