How many times have you heard the phrase “not since the Great Depression” applied to today's economic climate?
It's fitting, given that the United States has endured the deepest and longest economic correction since the 1930s.
The U.S. manufacturing base has been shipped overseas. The few jobs being created are in the service industry or government sector.
The official unemployment rate hovers near 10%, and 1 out of every 8 Americans is on food stamps. Volatility plagues the stock market.
The 2008 economic implosion gutted real-estate values, sent foreclosures skyrocketing and required a nearly $1 trillion bailout of the
“too big to fail” investment banks. Fannie Mae and Freddie Mac are under U.S. conservatorship, along with General Motors.
The U.S. government has fallen into a mammoth gulch of multi-trillion-dollar deficits and unfunded liabilities, and it's not going to
emerge from that hole without higher taxes and painful austerity measures. Meanwhile, debt time bombs already are exploding in some of
our biggest cities and states.
As the market does its daily job of balancing fear and greed, it becomes increasingly apparent that fear predominates.
Investors are abandoning anything with the slightest hint of risk. The sovereign-debt crisis that started with Iceland and Greece
is threatening to spread across the globe. Fearful investors are shifting assets from the euro and other weakening currencies into gold.
Even the recently sagging U.S. dollar has benefited, but given that the debt-laden federal government is about as bad off as Greece in
every important economic metric, the world's reserve currency is living on borrowed time. The stock market rebounded from its 2008-09 depths,
but some analysts say it's overbought and due for painful correction. And the Dow's 1,000-point plunge on May 6, 2010, showed investors just how
breathtakingly vulnerable paper assets can be. Meanwhile, the winds of war continue to howl across the Middle East, Asia and elsewhere, exacting
huge costs in Ameri can blood and treasure.
The Federal Reserve has kept U.S. interest rates at virtually zero, with no sign of a hike on the horizon, thereby lowering the opportunity cost of
buying gold. And investors have responded with astonishing eagerness, even forcing the U.S. Mint to ration popular bullion products in order to meet
overwhelming demand. After all, gold's value does not arise from its industrial applications but from its worldwide acceptance as a safe store of value.
As the public loses faith in debased paper currencies, the clamor for gold will increase exponentially. Also fueling demand are the world's central banks,
which in a major trend reversal have now become net buyers of gold instead of sellers. Expect central banks in China, India and Russia to fuel demand for gold.
Beijing not only is stocking up on gold as it divests itself of its dollar holdings but also is encouraging its increasingly affluent billions of citizens to
buy gold. And the creation of “paper gold” – the metal-based exchange-traded funds, which Blanchard and Company does not endorse because of
their inherent risks – has increased investment demand and buttressed the price of gold.
Gold benefits from the cure for deflation, rather than from deflation itself. At some point, the market is going to get over its concerns about deflation and
become concerned about inflation – that will be the real inflection point for gold. The Federal Reserve, the European central banks, the Swiss national bank,
and the Bank of England have drastically increased their balance sheets. Huge amounts of money supply growth will be sending so much money sloshing through the
system that it will eventually generate a bad case of inflation. Though inflation isn’t apparent today, stimulus packages and bailouts mean much more money
in the system, which is classically inflationary. Historically low U.S. interest rates, U.S. dollar weakness, and the longer-term inflationary pressures of the
Federal Reserve throwing trillions of dollars at the U.S. economy make the environment favorable for gold and other tangible assets. Of the major assets, only
Treasuries and gold have escaped the selling panic that has gripped the markets. Rushes on gold have caused mints around the world to run out of popular gold coins.
Because of the inflationary impact of government bailouts, analysts think that when gold reaches $1,500 it will be the floor, not the ceiling.
5. The Dollar
The dollar has benefited from the global flight from risky assets, as well as the unwinding of bets made with borrowed dollars. That has come as a surprise to many
who expected that increased government spending and a collapsing U.S economy would cripple the dollar. In the longer term, the dollar’s health remains dependent
upon foreigners’ appetite for U.S. assets, which will decline as the economy falters and the government continues to inject additional liquidity. Dollar weakness,
plentiful liquidity and policy reflation will be persistent themes in the future. Massive fiscal and monetary stimulus has weakened the dollar, whose current resurgence
stem mainly from the European debt crisis. Once that crisis rears its head in the debt-burdened United States, the dollar's weakness as a currency will be evident to all,
and its role as the world's reserve currency will be in jeopardy.
Gold Prices: Expect a New BreakoutWe expect to see a new breakout in gold prices once the dollar softens more decisively and once reflationary policies gain economic traction.
The current gold price indicates that U.S. monetary and fiscal policy is finally getting ahead of the deflation curve. Liquidity conditions will be easier
and easier as the year progresses – part of the fight to support the economy and reduce deflationary pressures. Such conditions are consistent with
higher gold prices, and we expect to see gold prices continue to rise, with a breakout to $1,500 becoming a new floor.