Why Isn’t Gold Higher?

My colleague and erstwhile nemesis Gonzalo Lira posed the question above in a recent essay, and it is indeed a most puzzling one. Given that the world’s central banks — joined most recently by a shockingly reckless Switzerland — are waging all-out economic war by inflating their currencies, shouldn’t gold be soaring,? In fact, prices have continued to meander between $1500 and $1700 since September of 2011, when gold topped out at $1945 after a spectacular run-up from $728 in just three years.

What could have caused the bull market to go lifeless since then, even as more and more countries appear hell-bent on devaluing their currencies to keep their exports competitive? The FOFOA blogspot is the most persuasive case for hyperinflation that I’ve come across — a run on the dollar would force the Fed to absorb the entire supply of Treasury paper at auction. An unintended result, says Schiff, is that ostensibly unsupported bond markets such as corporates and municipals would collapse, forcing the Fed to extend open-ended buying to all fixed-income securities.

This would most surely trigger a hyperinflation – would in fact be a hyperinflation. However, this scenario, and virtually every other hyperinflation scenario of which I am aware, envision hyperinflation occurring as a result of political decisions made, Fed actions taken and markets “rescued.” My gut feeling, however, is that the collapse of global markets will be so swift as to preclude intervention, let alone rescue. Pent-up forces will take their course, and the entire financial system will experience an instantaneous collapse for which the May 2010 Flash Crash will seem to have been just a warm-up.

Whatever we might predict about the outcome, one result that seems entirely likely is that banks in the U.S and elsewhere will not open for business the next day. Over the short-run — a few weeks, perhaps — this would be ruinously deflationary, since a hitherto inexhaustible supply of digital money will have become inaccessible via checks, ATMs or charge cards. The fragility of the clearing system that allows such money conduits to function will be tragically obvious by then, as will the distinction between cyber money and the real stuff. And you had better have some of the “real stuff” stashed away in your home, by the way, since, The Morning After, that’s the only kind of money Safeway cashiers and gas station attendants will understand. Nor should you expect them to be up to speed right away on the junk silver you’ve socked away, since, at the retail level, although perhaps not in barter circles, pre-1964 coins are likely to be treated the same as the pot-metal coins that have driven silver dimes, quarters, halfs and dollars into secure storage.

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Gold Hoarders, Beware
A couple of caveats for gold hoarders. Don’t count on exchanging gold at $5000 an ounce for something with high intrinsic value, such as farmland. For all we know, supply-chain disruptions could be so severe that you’ll pay a Krugerrand just for a loaf of bread. And while it has always been possible in theory for short-squeeze pressures to push gold well above the $5000 level, this is most unlikely for reasons that Lira’s essay implicitly recognizes. Consider who is short all of that paper gold: carry-traders such as Morgan Stanley, J.P. Morgan, Goldman Sachs and other bullion bankers who have always been able to borrow gold for next to nothing. The likelihood of regulators forcing them to make good on their paper gold obligations can be dismissed in advance as negligible.

Despite the seeming paradox of intrinsically worthless fiat money gaining traction in a post-apocalyptic economy, there will remain the possibility of a hyperinflationary spike. It could happen if, say, the Fed were to attempt a lump-sum pension payment to all government workers. For political reasons, this would have to be matched by similar windfall benefits to private-sector workers in the form of Social Security, welfare payments, unemployment compensation and food stamps.

The Catch-22 of this approach is that any benefits in excess of what is needed to keep the economy functioning, if only barely, would touch off an inflationary spiral. Imagine how the world would react if someone in Congress merely mentioned that The Government was going to cover all of the obligations and liabilities of public and private pensions and health plans. If and when that day arrives, I will have no argument with Lira and the hyperinflationists about the likely outcome.

Written By: Rick Ackerman