Wednesday, February 08, 2006


Bernanke, Inflation And Gold

This Forbes piece has some insight on the new Fed chief. "Inflation is going to make the new year look better than it really will be. Excess money initially induces extra spending and more investment. The Federal Reserve will continue raising short-term interest rates, but unless it stops printing an excessive amount of money, it will give us a replay, although a milder version, of the dreadful stagnation experiences of the late 1970s and early 1980s. The nominal cost of money went up and up, and so did prices."

"Alan Greenspan will have left town by the time his inflationary blunders become all too evident. Greenspan & Co. started to turn out excess money more than a year ago. The Fed's blunder is a shame. The economy's fundamentals are astonishingly strong. Ben Bernanke, Greenspan's about-to-be successor, disdains gold as both an indicator and a guide to monetary policy; he won't be prepared for what's going to hit him. He'll look at the Fed's multitudinous measures of money and conclude they haven't grown enough to cause inflation."

"No one has taught him that he can't just look at supply, he also has to look at demand. The world is flush with liquidity. U.S. corporations have nearly $2 trillion in cash, a record high in absolute terms and proportionally. Banks, insurance companies, equity funds, venture capitalists, hedge funds, all are desperately looking for investment opportunities. Bernanke's explanations for the events that are about to unfold will be interesting. Will he blame Arab sheikhs? Rapacious corporations? Budget deficits? Trade deficits? Hedge funds? Sunspots? All of the above? Or will he have the courage, the understanding to point the finger at the institution he will soon be piloting?"

"Given his statements that gold is an obsolete, if not destructive, guide to monetary policy, Bernanke is not likely to recognize the inflation problem until it hits him, and the economy, square in the face. A year from now Greenspan's successor may, unfairly, resemble the ill-starred G. William Miller, whom Jimmy Carter appointed to head the Fed in December 1977 and who proceeded to stoke inflation to record highs."

"Bernanke should let short-term interest rates float and simply mop up the excess liquidity until the price of gold comes down to a tad below $400 an ounce, a price still above the average of the past ten years. Sadly, such a timely, sensible approach is so beyond Bernanke's mind-set, not to mention that of most other economists and policymakers, that he'll never do it."

I remember when Steve Forbes was running for President. He was interviewed on CSPAN about the Fed, and he asked, 'what is success for a central banker? They don't know.'
For gold to get back to $400/ounce, the Fed would have to unplug the printing presses for a couple years and raise rates above 8%. As Mr. Forbes said, it will never happen.
Since Bernanke thinks gold is obsolete, he will choose to ignore its price completely. The things he's written and said make him scary.

Will he be able to fool foreign markets into buying our $2+ billion debt daily for the next 20 years? $14+ trillion? Doesn't seem plausible.
I agree that inflation will be out of control and run unchecked this year and next, but I disagree with the prediction that gold will pull back to $400/oz.

For that to happen it would not only require Bernanke to be blind to inflation, but the entire investment community as well. This is clearly not the case. Obviously, an enormous portion of the investment community is well aware of the absurd shortcomings of the CPI and other inflation "measures" -- even as the Fed totes their validity. Since those same investors are responsible for gold's recent rise, it stands to reason they will continue to maintain current prices.

There seems to be a lot of this kind of rhetoric coming from oil and resource analysts these days: We hear that oil, gold and silver are "overbought" and "will retrench at lower positions", while at the same time we hear that the economic fundamentals driving their rise will be *increasing* over the next year. This would all seem to suggest that oil and PM's are in fact, *not* overbought, but have expectations correctly priced-in to current values.

If as the article suggests, Bernanke 'won't see what's coming until it hits him', then IMHO gold should rise consistently between now and the time that 'it hits him'.
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