Forbes: Gold, Money Creation, and the Monetization of Debt

March 30, 2012
Jerry Bowyer, Contributor
OP/ED |3/29/2012 @ 11:20AM |2,986 views

In the previous article in this series I pointed out that even after recent dramatic sell-offs gold prices are still higher than one would expect if one saw them as being driven only by money creation. And this state of affairs has been sustained for a period of years, which suggests that it is not driven by a panic reaction, because panics by definition tend to last for a short period of time.

Having noticed that although gold did fall to the top end of my expected value range using money metrics, I wondered why it did not fall at least to the middle range.

Trying to solve the puzzle, I reasoned that perhaps gold is not just a function of domestic money creation, but of international money creation as well. In other words, gold prices might go up in dollar terms even more than the excess creation of dollars alone would dictate. If other countries also debased their paper currencies, the citizens of those countries would similarly demand gold as a hedge against inflation. And since much of the world seemed to be at least partially following the U.S.’s lead in weakening their currencies, perhaps global gold demand was driving gold even higher than dollar devaluation would suggest.

This is an interesting theory, but there are some problems with this view.

First, the view that global inflation drives domestic gold prices has an obvious theoretical problem. Yes, global inflation would lead to global growth in demand for gold, but it would also lead to growth in global supply. Gold is a commodity with both a demand curve and a supply curve, and if it has both curves it has an equilibrium price and the equilibrium price for gold and dollars is a function of the comparative demand and supply of each of those.

If among the three billion new capitalists around the world there is a certain proportion of gold buyers and consumers, then among those three billion capitalists around the world there is also a certain proportion of gold producers and sellers. As gold goes up in price, the incentives to discover it increase proportionately. That’s how the global economy kept its monetary equilibrium for millennia before the emergence of the global fiat money system.

Second, the biggest problem with the global inflation as driver of domestic gold price theory is that it doesn’t work. If one had used global inflation to try to predict dollar gold prices, or used dollar gold prices to try to predict dollar inflation, one would have had very little success. Global inflation does not seem even to explain the times in which gold prices detach themselves from currency debasement factors.

It seems that gold investors are not just concerned about how much money the Fed has created, nor are they principally concerned about how much money the Fed-wannabes around the world have created; they are worried about something else, and they might have good reason to be. What they are worried about, and what seems to be driving current gold prices, is that public debt levels have risen to the point where the debt will be paid off in highly debased currency. In other words, they’re afraid of what is called ‘debt monetization’.

Debts are monetized when governments decide to use their monetary authorities (in theU.S.context, that is the Fed) to create new money which is then lent to the government. This tends to happen when the government has borrowed up to its capacity and decides to continue borrowing above its credit capacity. When that happens, private lenders are no longer willing to take the chance of lending to an over-indebted government. At that point, governments often attempt to verbally intimidate private lenders, especially banks which are subject to very high levels of government oversight. Sellers of bonds are verbally assaulted as vigilantes and speculators, and in more extreme cases attacked for their ethnicity or religion. Jews have been frequent targets of this type of attack.

In some cases regulators require financial institutions to lend to the government anyway, often for reasons other than the stated ones. For example, recent changes in regulation associated with Dodd-Frank and the Basel Accords purport to act in the interest of financial stability by requiring banks to hold larger proportions of ‘Tier 1 capital’, such as Treasury Bonds, for the purpose of risk reduction. But the problem is that this public Tier 1 capital is in many cases riskier than, for example, the corporate bonds which it replaces. That’s one reason why the European sovereign debt crisis has been so devastating to the private banking system, because earlier versions of risk reduction forced extremely risky public bonds down the throats of the private system. What’s even more maddening is that after suffering through all of that, we still have to sit through political sermonizing about market failure in the banking system.

So, once private lenders have been brow-beaten, and then eventually law-beaten into buying as much public debt as they can possible stand, the rapacious public spending beast’s hunger remains un-slaked. That’s where monetization comes into play. Gigantic piles of money are simply created and then shoveled into the mouth of the Leviathan.

Continued on Pg.2


CNBC: Gold Price ‘Too Low’: Goldman Sachs

March 28, 2012
Published: Wednesday, 28 Mar 2012 | 7:06 AM ET
By: Catherine Boyle and Madeline Laskoski

The price of gold, one of the most eagerly watched indicators of market confidence, is currently “too low” relative to real interest rates, according to commodities analysts at Goldman Sachs [GS=  Unavailable      ()   ].

The analysts forecast that gold [XAU=  1674.79   -5.25  (-0.31%)   ] will rise to $1,785 per ounce over the next 3 months, $1,840 over the next 6, and $1,940 over the next year.

“At current price levels gold remains a compelling trade but not a long-term investment,” they wrote in a note.

They argue that U.S.real interest rates are the most important driver of the price of gold in dollars – but that this relationship broke down late last year and has not yet returned to the level current negative or low yields on 10-year Treasurysimply. The low yields have come following the Federal Reserve’s Operation Twist – which involved the central bank buying up longer-term Treasurys and selling shorter-term Treasurys and helped restore the markets’ confidence in theU.S.

“We believe that despite last fall’s decline in 10-year TIPS yields, the gold market may have been expecting that real rates would soon be rising along with better economic growth, leading to a sharp decline in net speculative length in gold futures,” the analysts said.

“OurU.S.economists expect subdued growth and further easing by the Fed in 2012, which should push the market’s expectations of real rates back down near 0 basis points and gold prices back to our 6 month forecast.”

More bearish views state that the gold price has already peaked at last year’s record high of $1,920.70, as markets get more confident about the future of Western economies.

Malcom Norris, CEO of Australia-based miner and explorer Solomon Gold, told CNBC Wednesday the precious metal could even reach $2,000 per ounce.

The Goldman analysts admit that stronger-than-expected U.S. economic datais a “growing risk” to their forecasts for the gold price. Better-than-expected data on the slowU.S. recovery, as well as mass liquidity injections in the European banking system, have helped to drive the price of gold down this year.

There is also some speculation that central banks around the world may start buying gold again, after the UK’s Chancellor of the Exchequer George Osborne hinted that the Bank of England may stockpile the precious metal in last week’sBudget – although he later said he meant reserves in general rather than specifically gold.

“By holding more gold central banks are insuring themselves against their own profligacy. They print money. The price of gold goes up. And if they hold a lot of the stuff in their vaults, they are the big winners from the rise in price,” Matthew Lynn, founder of Strategy Economics, wrote in a research note.

“If you can pull it off – and there isn’t anything to stop you – that sounds like an easy way to make a living.”

© 2012

CNBC – Buy Gold Now Before it Gets to $2,000: Newmont CEO

March 27, 2012

Richard O'Brien, Newmont Mining president & CEO.

The head of Newmont Mining told CNBC Monday he sees the price of goldrising to $2,000 an ounce and the time to buy it is now before inflation “comes roaring back.”

At a time when investors want to invest in gold exchange-traded funds rather than the gold miners that pull the metal from the ground, Newmont [NEM  52.62    -0.83 (-1.55%)   ] CEO Richard O’Brien said either option is an “opportunity to participate in a bull market.”

But investing in Newmont gets you a dividendpegged to the gold price, and if gold does hit $2,000, as O’Brien predicts, investors would be getting a boost. Last year, when O’Brien predicted gold at $1,750 an ounce in 2012, Newmont’s dividend rose in each quarter and was 35 cents a share in the fourth quarter.

Right now, the company pays a 2.3 percent dividend, he said, but “when we get to $1,700 gold, it will go up to 2.5 percent. When we get to $2,000, we’d be 3.5 percent to 4 percent higher.” He did not say when he expects gold to rise to $2,000 an ounce but did say the company sees flat production and escalating costs this year.

But taking a longer view, he said, “If you think about the next year, the next three years, the next five years we’re in an upwardly sloping gold price environment.”

O’Brien said Federal Reserve Chairman Ben Bernanke’scomments on the economy earlier Monday show currencies are “going to continue to be cheap, and when inflation comes, it’s going to come roaring back and gold will look like an asset class that people should own. Buying it now is the best time to buy it.”

CNBC: Gold Nears $1,680 After Bernanke Comments

March 26, 2012
Published: Monday, 26 Mar 2012 | 8:39 AM ET
By: Reuters

Spot gold hit a session high just short of $1,680 per ounce on Monday, fueled by a stronger euro, after Federal Reserve Chairman Ben Bernanke said the U.S. labor market was “far from normal,” despite recent improvement.

Spot gold [XAU=  1686.0601    23.92  (+1.44%)   ]rose 1 percent to $1,679.39, with some hoping the Bernanke comments might be a hint at further quantitative easing. [GCCV1  1683.90    21.50  (+1.29%)   ]for April delivery was up 0.3 percent at $1,667.20.

Bullion prices posted the biggest one-day rise so far this month on Friday, reflecting higher oil prices and a sharp fall in the dollar as a result of disappointing U.S. housing market data.

Money managers in U.S. gold futures and options cut their bullish bets for a third straight week to the weakest level in two months as bullion prices tumbled after a strong run of U.S. economic data triggered fund selling.

Physical demand fromIndia, the world’s largest bullion buyer, remains a concern with a jewelers’ strike entering its second week after the government announced a hike in import duty on bullion.

The U.S. dollar index [.DXY  79.07    -0.25  (-0.32%)   ] edged up from a two-week low hit on Friday, dampening sentiment on dollar-priced commodities by making them more expensive for buyers holding other currencies.

“There’s a good chance we’ll see a relapse in U.S. data since the economy is in a fragile recovery, which will lead to speculation on more quantitative easing, and that is positive for gold,” said Hou Xinqiang, an analyst at Jinrui Futures in the southern Chinese city of Shenzhen.

Hou said oil prices are unlikely to slide easily from current high levels given the sticky situation in Iran, another supportive factor for gold. Investors will closely watch changes in holdings of various physically backed exchange-traded funds  in the last week of the quarter. The SPDR Gold Trust[GLD  163.75    2.2171  (+1.37%)   ], the world’s biggest gold ETF, said its holdings fell 0.8 percent last week, the biggest weekly decline since late December.

This week, investors will also monitor key economic data fromGermany, bond auctions inItaly, and a meeting of euro zone finance ministers, during which the size of a bailout firewall is to be discussed.

2012: Buy Gold on the Dip

March 23, 2012

Gold is retracting, giving back much of its gains for the year to date. We are seeing gold at mid-January levels and it is finding resistance in any moves over $1675.  The projection for 2012 ,an election year, are for mostly good news and economic sunshine. Jim Rogers, Chairman of Rogers Holdings,  commented while on CNBC’s The Kudlow ReportThis is 2012. There’s an election in november. There’s an election in france. There are 40 elections this year. The germans are having an election a year from now. You will see a lot of good news and a lot of money being spent. A lot of money being printed. Yes, this year’s fine. Worry about 2013. Be panicked about 2014, but this year, a lot of good news is coming out.

Jim Rogers isn’t alone he is join by Marc Faber , of the Gloom, Boom & Doom Report, who told CNBC, If you don’t own any gold, I would start buying some right away, keeping in mind that it could go down. He was later quoted in ETF Daily news: The possibility of the gold price going down doesn’t disturb me, says Faber.  Every bull market  has corrections. Adding that investors who own no gold today should immediately  begin to incrementally allocate no more than a total of 25 percent of their  portfolio holdings in gold.

We have commented on Fed Chair Ben Bernanke’s change of tone on QE3 & the economy after Rep. Ron Paul blasted him on the floor of Congress about the real value of silver & gold. This year is  should be viewed for investors as the summer before the long hard winter of recession. Now is the time to acquire precious metals & rare coins to build up your Tangible Asset Portfolio.

Fed Chair Ben Bernanke Back in School Trashing Gold

March 21, 2012

Fed Chairman Ben Bernanke delivered his first of four lectures to students at George Washington University trashing the Gold Standard.

Fed Chair Ben Bernanke is taking some time out of his busy schedule to go back to the class room and mold young impressionable minds.  After Rep. Ron Paul ambushed him in committee with the value of a Gold Standard, Bernanke seems to be hitting back with economic sunshine & no hint of QE3.

Yesterday he took the direct approach, while teaching a class at George Washington University attacking the Gold Standard as a waste of resources.  Gold retracted slightly in light of this but is moving back forward today as it steadies above $1650.

Mr. Bernanke can take his best shot at gold but until the global debt issues are resolved and global demand slows, the fundamentals of the yellow metal will continue to drive the price through the end of the decade.

Read further below:

Forbes – Bernanke: Gold Standard A ‘Waste Of Resources’

The problem with a gold standard is there just isn’t enough of the yellow stuff.

So said Federal Reserve Chairman Ben Bernanke Tuesday afternoon in the first of four lectures he will give at George Washington University over the next two weeks. (See “Bernanke Goes Back To School.”)

Paraphrasing economist Milton Friedman, Bernanke said it takes a lot of effort and work to go to South Africa, or somewhere else in the world, dig up a bunch of gold, then just put it back into another hole – in this case the basement of the New York Fed.

Later, during a Q&A period after his lecture, Bernanke acknowledged the main arguments for a gold standard, before dismissing them. Proponents, like Rep. Ron Paul (R-Texas), argue that a gold standard maintains the value of the dollar, under the premise that paper money is inherently inflationary. Bernanke dismissed this, arguing that while the argument may hold for long-run price stability it is not valid on a year-to-year basis. A gold standard, Bernanke said, also stops the central bank from being able to respond to booms and busts through monetary policy.

Such a standard is not practical though, Bernanke continued, as there is not enough gold in the world to achieve a global gold standard without tremendous cost (though that would undoubtedly be a boon for miners like Barrick Gold or Goldcorp).

The Fed chairman also mentioned the deflationary aspect of linking currency to gold, referring to William Jennings Bryan’s famous “Cross of Gold” speech, and noting how a gold standard links the policies of all countries on it, restricting the ability for region-specific monetary policy. (See Bernanke’s lecture and presentation materials here.)

Lastly, Bernanke acknowledged the fallibility of central banks. A gold standard only works if markets are convinced that maintaining that standard is the sole priority. Any hint of wavering and the currency becomes subject to speculative attacks.

Gold prices were down more than $21 to $1,645 an ounce Tuesday. The U.S. dollar index, a measure of the greenback against a basket of foreign currencies, was up 0.2% Tuesday afternoon to 79.59.

Forbes: Gold Set To Fall To $1,550 As Need For Macro Risk Hedge Dissipates

March 20, 2012
Agustino Fontevecchia, Forbes Staff
Bringing You The Bull And Bear Case From The Markets Desk
Markets | 3/19/2012 @ 4:18PM

Gold suffered what appears to be long-lasting damage since the onset of March, with prices falling nearly 7% from 2012 highs.  As Treasury yields surge, markets have entered a new phase marked by generalized optimism, where fears over economic weakness and of an implosion in the Eurozone have receded.  These are ominous signs for safe havens, and gold has gotten clobbered, forcing UBS’ Edel Tully to lower her one-year price target to $1,550 an ounce, a 12.7% downgrade.

Still, the yellow metal could once again look attractive if any of the major risk scenarios play out, or if the Fed signals it has no intention to begin “normalizing” policy.  QE3-or any form of additional easing-, rising inflation, or a major oil price shock should add fuel to gold’s decade-long rally once again.

Gold was trading up 0.4% to $1,625.80 an ounce by 4:18 PM in New York.  Only two weeks ago, the yellow metal was up above $1,700.  On the flip side, 10-year Treasury yields, which were as low as 1.8% in early February, are now up to 2.38% and promise to move higher (Nomura’s short-to-medium term outlook is 2.4%, possibly overshooting to 2.5%).

Last week’s violent Treasury sell-off marked the shifting of a market paradigm.  Forcing the Fed to acknowledge the improving economic landscape, February’s jobs report signaled a strengthening recovery.  Greece’s widely expected default has momentarily taken Europe’s sovereign debt crisis off investors’ radar screen, while the economic outlook for the Eurozone looks less bleak, with UBS’ 2012 GDP estimates now between -0.4% and -0.7%, suggesting a milder recession than expected.

What does this mean for gold?  It means investors have lost their appetite for a macro tail risk hedge, according to Tully.  Concerns over sovereign credit and inflation have eased, and investors have begun to question the Fed’s intention to maintain ultra-loose monetary policy.  Expectations for QE3 have pared back, with some market players expecting rate hikes to begin before the Fed’s pledged late-2014 time-frame.  UBS’ macro analysts expect policy normalization to begin in mid-2013.

Thus, Tully has cut her one year target to $1,550 an ounce; UBS’ 3-month target was axed from $1,950 to $1,600.

In terms of market fundamentals, both physical and speculative buyers have failed to step up.  China has lowered its growth outlook and India has recently raised its import duties on gold, which, coupled with a weakening rupee, is structurally bullish for the yellow metal.

With physical demand failing to step in to help put a floor under gold, the investment community has taken the opportunity to short the yellow metal, rather than buy cheap, Tully explains.

Does this mean game over for gold’s multi-year bull run? No, says Tully.  The Fed, along with other major central banks, have seen their balance sheets explode as they inject liquidity into the system, while central banks in emerging markets are beginning to ease in the face of a global slowdown.  There are no indications the Fed will begin to hike rates any time soon, particularly given the dire state of U.S. housing markets, and real interest rates in many regions are still negative.

The elephant in the room, though, is the rising price of crude oil.  WTI was trading around $107.7 per barrel while international crude benchmark Brent recently hit all-time highs in euro terms.  An Israeli-Iranian conflict still threatens to disrupt flow through the Strait of Hormuz, while the structural supply-demand balance remains tight.

Continued on Pg. 2