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Easy Money. Who Needs It?

By Jon Nadler       Printer Friendly Version
Feb 13 2009 4:39PM

Good Afternoon,

A $4 spike overshadowed practically every other market development on this lucky for crude oil Friday the 13th. Gold picked up on the vibes coming from the oil pits and cut its earlier losses, while aiming towards a close at, or near the 940. Players feel that another jump above $952 would set the stage for a likely run to the $980 target. Background conditions did not show too much in the way of change, as the dollar gained marginal ground on the index, and as US stock fell once again, following investor selling.

The House passed President Obama's $787 billion stimulus package, and attention now turns to how this will all play out. Optimists hope it will play out along the lines it is apparently now doing in China. That country's stimulus injection seems to be doing something. All the more reason to run out and buy some cheap oil, at the very least. Something that was of no interest? Gold, to Indian buyers. Not at this price. The country imported no gold this month, following an import number of only 1.9 tonnes in January. Evidently,

New York gold trading was off by $6 late in the afternoon on this Friday the 13th, but investors were still viewing the pullback as anything but unlucky, and were likely welcoming the pause as a sign that the march to $1K is hopefully more orderly than has been the case on occasion. Spot gold was quoted at $941.10 per ounce at last check.

Silver ended up gaining 19 cents to trade at $13.69, while platinum fell $7 and palladium lost $1 to $213 per ounce, respectively. The only news of import on noble metals' players minds for today, are the severe cutbacks and other signs of difficulties over at Toyota North America. That, and the European car market's 27% slippage in January. Toyota now pays the few remaining sales personnel in some dealerships strictly on what they actually sell. Which, is about half a car a week...

We noted a couple of exciting, but also potentially disturbing trends in gold vis a vis currencies, of late. While there is much encouraging news to note in gold's latest romancing of the dollar and vice-versa, these strange bedfellows may disappoint those who seek the hot relationship to maintain its Valentine Day's-flavored closeness, when and if the tables turn, and the dollar slips out of bed. It is not likely that we can have it both ways, so to speak.

The fact that very little is being made of the fact that conventional punditry did not (at all) expect a gold price near $1K without a concurrent coma in the dollar, speaks volumes. The record shows that expectations were for gold to make these types of front-page headlines while the dollar made only the obituary columns, thus confusion about the parallel honeymoon is obviously being masked at this time.

The only noises being made these days, are about how brilliant it is that gold can coexist with the greenback as the perfect safe haven. We could not agree more, (please note the italics before shooting off various e-mails) but ponder the opposite scenario (as was seen on a couple of occasions lately). Just a thought for food...when you recall the words of sage Paul Van Eeden who once said: "There is no such thing as a gold price" - when referring to the metal as a barometer of the dollar's state of health at any given time.

As for the state of health of the economy, well. Let's just say that worries about wheelbarrow inflation are most premature. Marketwatch explains the Fed's current angst:

"In 2002, Ben Bernanke was absolutely certain that he and his colleagues at the Federal Reserve could act to prevent an extended bout of deflation in the United States by force-feeding money into the economy. The cure for deflation, Bernanke said, is simply inflation, or giving the economy so much money that some of it will be spent chasing goods and services.

Bernanke still may be persuaded of the Fed's ability to create inflation at will, but the rest of us are having our doubts.

For the second time in a decade, the Fed has sounded the alarm that deflation could be lurking. While most people might suppose that falling prices would be a godsend, a little reflection shows that deflation would be devastating for any economy based on debt.

In deflation, borrowers are forced to repay debts with dollars that are rapidly rising in value, and therefore much harder to come by. Creditors, who should be overjoyed at receiving these more valuable dollars, are instead worried sick that the debts won't be repaid at all.

The first time the Fed got worried about deflation was in 2002 and 2003. That episode didn't end well, even though we did avoid deflation. The economy was stuck in neutral and consumer inflation slowed sharply. The Fed reacted by slashing its overnight lending rate to 1%, and kept it low for a very long time.

The easy-money policy worked, perhaps too well. Low rates boosted spending in the economy, as desired, but they also inflated a credit and housing bubble that came back to haunt us. In a famous speech in November 2002 titled "Deflation: Making Sure 'It' Doesn't Happen Here," Bernanke said he was pretty sure that deflation couldn't happen here for two reasons: "the resilience and structural stability of the U.S. economy itself," and the fact that the Fed itself "would take whatever means necessary to prevent significant deflation."

The first line of defense is gone. The economy is not resilient and is not stable. And the second line of defense is eroding. The Fed already has taken interest rates to zero, and lent out nearly $2 trillion in fruitless attempts to revive demand. In his speech, Bernanke proposed that the central bank "can always generate higher spending and hence positive inflation" by simply printing money as fast as possible.

We're nowhere near that point yet. But the Fed hasn't demonstrated convincingly that lowering rates to zero and lending out trillions of dollars has had any impact on increasing final demand. It turns out that the Fed can print all the money it wants, but it can't make anyone spend it."

Therein lies the rub. Consumer have shifted towards savings. Consumers are avoiding borrowing. Banks will eventually turn to making more credit available than they now are, but if there are no takers for their loans, well, you know the rest. It's called the waiting game. Waiting for prices to fall, and watching employers not hiring. And thus, the spiral whirls until it becomes a hypnotizing, self-perpetuating fall into an abyss. Once again, we are hearing the desirability of 'positive inflation' - what a label.

Enjoy your weekend.

Jon Nadler
Senior Analyst
Kitco Bullion Dealers Montreal



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