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The 911 Scapegoat

Some people figured we were under the wrong impression that there was a war going on or something in the business of money with last week's title, "Gold Bulls Unite." Hah.

  Keynesianism - you can fool all the people all the time (people are irrational anyway, subject to the "fetish of liquidity" and "animal spirits")

Rational Expectations - you can never fool anyone, even a little bit

Austrianism - you can fool most of the people some of the time but it will come back and bite you

- Robert Blumen

Let me clear that up for those puppies right now: you bet there is, but gold bulls unite was simply "descriptive" of what has been happening. Isn't it? Just doing my job. Babies. They're probably short.

For those unacquainted with monetary history or the relationship between capitalism and gold, it is also a jab at Marx's "workers of the world unite" plea. Yes, gold and money happen to be smack in the middle of a war between capitalism and socialism. If you don't care or believe us, change the channel, because the rest of our analysis discounts it.

US Dollar IndexIs gold going to correct now? We don't know? I don't think so however. Not if its rising momentum is an indication of anything. Not if the US dollar index falls through 112 in the short term, and certainly not if it falls through 108, where dollar bulls guard primary bull market support.

Gold prices have certainly far from reached a reasonable revaluation relative to their fundamentals in our view, so whatever corrections there will be, we expect they'll come when we least expect but also that they will continue to end before we generally expect. Sentiment is far from too bullish at this juncture to claim an end to what is unfolding today. The dollar is fighting for its life in Forex markets as our governors try and figure out how they can keep the inflation away from gold. So far, there hasn't been much of a bounce. Dollar bulls are still pitted against the ring wondering when round 1 will end.

At various points in the not too distant future I'd bet there are going to be concerted attacks at the gold market by its opponents. I've tried to come up with some plausible angles that the banking community supporting the dollar might attempt, but have concluded we aren't likely to see them until the momentum dissipates in the market.

Reg Howe cleverly anticipated one: a potential cancellation of the Washington Agreement on gold signed by 15 European Bankers in 1999, which was seen as capping further sales of gold at the time by the global banking industry.

Underlying this potential PR bomb (favoring the dollar) is the debate about whether it would work or not. Of course it will, for a while, at least until investors really begin to understand the nature of the gold market's ascent today. But in the end it wouldn't, and would only aggravate the supply & demand imbalances already boiling beneath the surface. In theory it should actually increase the speed by which the market rejects the bankers' notes as money altogether. But all of that depends on investor's perceptions of the truth.

The truth is that the banking system needs its gold if it wants its notes (currency) to stay competitive with gold on the free market, as money. They would not have the nerve to act in contempt of this truth except when confidence in the reserve currency at least is strong, and when they think they can control the process. But today, the key players, which have shared the risk in this, have grown weary of bullion banker's hedging ideas, not to mention the fact that confidence in the dollar is undergoing a big test right now.

The truth is "probably" that the Washington Agreement was related to the launch of the Euro, and was intended as a self-regulated measure that would prevent a further competitive devaluation of their gold reserves. It would be a hair-brained scheme to believe that by canceling the W.A. they could inspire support for the Euro.

Or it would be motivated by US interests trying to support a strong dollar/euro rate.

Anyway, concerns about an increasing tendency to war haven't been dispelled, and I don't know that Terror fears in some US cities have vanished. This is seen as one of the main drivers of recent investment interest for gold in the US. It has been. But here is the thing. Analysts that have been bearish on gold are beginning to explain this as the reason for gold's comeback, blaming September 11th and subsequent reports of growing fear in New York. Accordingly, it must seem as if the gold market has been forecasting just this. Thus, if global terrorism came to a halt, gold prices should fall. Whew, then they could all be right.

For, there could be no other reason to be bearish on the dollar could there? It's the same thinking that leads investors to conclude the only reason the stock market fell in September was due to the terrorist bombings, as if it would have went up without that event. There were plenty of reasons the stock market was going to fall anyway.

But some analysts always pick the explanation of an exogenous event as if you could neatly chart the history of the market according to certain such events through time.

Whether it is deliberate or not we can only speculate, but one of the ways that the banking community might fight the rising gold tide is through propaganda like this, where professionally designated "economists" pin the blame neatly on 9/11.

The very convenience in pinning the blame on exogenous events is their temporary nature. In other words, once they go away everything is back to normal. Or so it is hoped.

Whatever one thinks, however, it can't possibly be argued that the closer to the truth he or she is, the better they'll do with their money. The moral of the story is to think again before pinning the blame for a collapsing economy and rising value of gold on September 11. The explanation we prefer is that the (global) economy is suffering from an inflation breakdown in the United States. In the one case, the investor may see the "temporary" fear and terror as a buying opportunity for dollar assets. In the other case, investors' confidence in dollar assets is far from bottoming out.

(If you're not sure of what we mean by the term "inflation breakdown," we've written a summary of that idea at: Inflation Breakdown Nears

Before choosing sides however, we recommend that you eliminate from your reading list any articles or essays written by past or present employees of the Fed or perhaps even any major investment bank. I can already tell you that in each and every one of those the main explanation for the deteriorating economy and rising gold values is going to be related to the war on terror.

Not one of them is likely to blame the government and bank's inflation policies for a declining return on financial assets (as in who do we blame for the bust side of any monetary boom), and now the waning confidence in the dollar. But they will be quick to list several problems in the economy today from bad loans to rising default rates to contracting expenditures by business as if they weren't just the symptoms of too much money in the 1st place.

Simply making that connection should illuminate the real reason for rising gold prices today: investors are losing confidence in the management of the inflation agenda, or in other words, support for the dollar to date. And all of this began long before last September.

Inflation expectations are ever-present, but the question is where will they show up next? Bankers and the government prefer them to show up in asset prices.

Investors today need to determine how inflation is affecting the valuation process. They are challenged to do what every monetary historian knows they cannot do: predict how the inflation will manifest. It's manifesting in gold today for many reasons, but foremost is the loss of confidence in US dollar denominated assets, and the shrinking US dollar investment premium. All of which, in our view, were set into motion long before 9/11.

[Inflationism] is, technically regarded, bad policy, because it is incapable of fully attaining its goal and because it leads to consequences that are not, or at least are not always, part of its aim. The favor it enjoys is due solely to the circumstance that it is a policy concerning whose aims and intentions public opinion can be longest deceived. Its popularity, in fact, is rooted in the difficulty of fully understanding its consequences - Ludwig von Mises, The Theory of Money and Credit, pp 251

Dow Jones Industrial AverageGold's recent rise began in May 2001 just after the FOMC initially slashed borrowing rates to keep asset values from devaluation (we don't need to prove that they target asset prices; to believe they don't is preposterously naive) and the consumer from saving. The Dow had just dropped 1900 points or so and the US dollar was faking us out with a small topping pattern near prior highs.

At the time, dollar bulls worked hard channeling participants' inflation expectations towards asset prices, for the dollar turned to make a marginal new high in July after the Dow recovered all of its prior losses. Yet gold prices, while correcting, did not fall to new lows as most every mainstream analyst expected. This we saw as bearish for the dollar.

Since then, and for the past year in fact, we've been writing about the visible inverse relationship between gold (including gold shares) and dollar assets.

Now as the more conspicuous drumbeat of global wars and conflicts rises, mainstreet is suddenly flooded with geniuses claiming to have epiphanies about the nature of the rise in gold this year, that it must have been discounting war and fear all along, and suggesting that it is temporary because it is only driven by exogenous, unpredictable events. What can we say about that except that the same analysts that couldn't see it coming now say they've figured out why it's here, and why it will end.

Anyway, we'll leave you with a highly controversial thought to which I don't know the answer. Why is the terrorism such a convenient scapegoat?

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