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Ready for The Poe Standard?

By Jon Nadler       Printer Friendly Version
Sep 12 2008 4:10PM

www.kitco.com

Good Afternoon,

Two weeks after it began a monumental daily slide which pounded prices down to a low of $736 an ounce, gold found some firmer ground on Friday and applied the brakes, hoping for at least a resting period. Bullion's gains today came primarily from a slew of background financial news on Leman and WaMu's woes which unsettled the money markets enough to have the US dollar drop to 79.02 on the index and back to 1.417 against the euro. AIG and Merrill were also among the names making the whispered rounds among some of the more apprehension-oriented trading pits (such as gold's). The Dow lost about 75 points mainly on AIG-related nervousness

While the Fed has stated that it will "help" Lehman find (perhaps a consortium of) buyers, it has become more reluctant to inject a fresh dose of "moral hazard" into the market by taking on deceased Lehman assets in the process. The perception that Fed intervention does not always imply plugging holes with its money has markets showing a lot less apprehension about whatever the outcome eventually shapes up to be for Lehman. BofA may be taking the lead in the probable consortium expected to form in order to salvage whatever is left of the firm.

New York gold prices showed a $14 gain this afternoon, at a bid of $761.00 per ounce. Players are still on alert about the negative bias that the breach of the $750 level has engendered among gold investors but are willing to apparently take on a few small cautious positions as the weekend offers some uncertainties worth hedging against. At the same time, longs in the dollar took today's opportunity to pull a significant amount of profitable chips off the table and sit it out for the weekend, as uncertainty reigned supreme.

Retail sales in the US fell on fast-dropping gasoline prices and producer prices fell by nearly 1% in August. US foreclosures and housing price drops also underpinned values in early going but the going was far from smooth, as options contracts reveal a projected US/euro target of 1.30 before 2008 is over. Other currencies and economies are not faring well enough to present a risk large enough to derail the dollar train at this time. China's industrial output growth sank to the lowest level in 18 months following the materialization of the post-Olympic 'exhale' that had been forecast by many an analyst.

Silver gained 11 cents to $10.67, while platinum added a fairly robust $56 to rise to $1187 and palladium rose $11 to $239 per ounce. The worst week in nearly two decades for platinum may not benefit much from news that US auto sales rose 1.6% in the past year. Oil prices exhibited a rather short-lived advance even as the outer edges of Hurricane Ike started to touch the Texas coast. In fact, the commodity fell below the century mark for the first time since the beginning of April. Pivot points were likely reached with the break above 80 on the index and the 1.40 euro this week. Dollar specialists opined that this move amounts to a "monumental shift" in the US currency and that the strength may continue for some time to come. As the dollar strengthens, holding gold has become less attractive for spec funds.

This being a time infused with political overtones, we though it might be interesting to read what some lawmakers in the US feel ought or ought not to be done as part of Congress' mandates as regards the dollar, and the US economy. We have all heard Mr. Ron Paul and his Fed-abolitionist proposals. We have also heard Mr. Mike Gravel and his list of suggested drastic measures. Now, we learn that Rep. Ted Poe of Texas has come up with his own set of recommendations on how to fix whatever appears to be ailing the greenback. While the bill he introduced aims to take care of a broad range of issues such as gas prices, inflation,

Congress MustStabilize the Dollar

Rep. Ted Poe

On July 31, I introduced H.R. 6690, the “Sound Dollar and Economic Stimulus Act of 2008�. It is vital that this bill become law.

The U.S. dollar affects every American citizen and every American business. Our economy is totally dependent upon the dollar. To have a stable economy, we must have a stable dollar. Unfortunately, for many years we have not had a stable dollar. Today, people are angry and afraid. The crumbling, gyrating dollar has created an economic crisis.

I was a judge for 25 years. I believe in law and order. The U.S. Constitution is the supreme law of the land. Article I, Section 8 of the Constitution provides that: “The Congress shall have Power…To coin Money, regulate the Value thereof, and of foreign Coin, and fix the Standard of Weights and Measures…�

So, what has Congress been doing about the dollar? Nothing. Since 2001, Congress has stood idly by while the dollar has lost almost 70% of its value, whether measured against gold or retail gasoline. When a currency begins to lose value, the effects show up first in the price of gold, followed quickly by other commodities, such as oil. However, eventually the inflation works its way through the entire economy, raising prices across the board. In the process, the hard-earned savings of Americans are devalued—or, the way I look at it, stolen.

Inflation creates turbulence in financial markets and provokes conflict between economic groups. People become angry because they feel that they are being robbed. They become afraid because they know that unchecked inflation can lead to economic collapse. In 1913, Congress delegated its power over money to the Federal Reserve. Unfortunately, the Fed has been preoccupied with manipulating interest rates. Since 2001, the Fed has lowered its Fed Funds rate from 5.00% to 1.00%, raised it to 5.25% and then lowered it to 2.00%. Meanwhile, the value of the dollar has declined by nearly 70%.

Trying to regulate the value of the dollar by manipulating the Fed Funds rate makes no sense. The Fed Funds rate is the price of one type of capital. Because the Fed cannot supply capital (real resources) to the economy, it is not clear why it should be in the business of setting interest rates. Logically, interest rates should be set by the market—by the supply and demand for capital.

Unlike capital, the amount of money in the economy should not be limited by anything physical. It should be determined by the demand for money, which depends upon the transactions people want to do and how much money they want to hold. What matters about money is not its quantity but its value. In this, dollars are no different than foot rulers. No one cares how many foot rulers there are in the world. What matters is that each one is the length prescribed by the U.S. Bureau of Standards.

My bill directs the Federal Reserve to bring the price of gold down to $500/oz and then to keep it there. The Fed would do this by announcing that its Open Market Desk was prepared to sell government bonds and contract the monetary base until the price of gold falls to $500/oz.

At last measure, the monetary base was about $872 billion. In December, 2005, which is the last time the price of gold was at $500, it was $827 billion. So, it is possible that the Fed might have to sell as much as $45 billion worth of bonds to implement the new policy. Because this is only about 0.8% of the total amount of bonds currently outstanding, this should not be a problem. However, I believe that the demand for the newly-stable dollar will be so great that the Fed will actually have to expand the monetary base to keep the gold price from falling below $500/oz.

Once the Fed implements its new directive from Congress, every dollar in the world will have the same market value as one five-hundredth of an ounce of gold. From then on, the monetary base will expand and contract automatically in response to market demand. Why gold? My bill defines the value of the dollar in terms of gold because the financial markets want, and the American people deserve, a dollar that is “as good as gold�.

Why $500/oz? At $804/oz, the current market price of gold reflects the expectation (and fear) of future inflation. I believe that fixing the value of the dollar now in terms of gold at $500/oz will stop the current inflation without causing deflation. However, my bill also provides a powerful supply-side stimulus, in the form of first-year expensing of all capital investment, to ensure that economic growth accelerates at the same time that inflation is being stopped. Bringing the dollar price of gold down to $500 will bring the price of gasoline down from its current $3.50/gallon to less than $2.50/gallon. It will strengthen the dollar against foreign currencies. Most important, it will prevent Americans’ incomes and savings from being stolen by inflation.

My bill will not put America on the gold standard, like we had in the early part of the 20th Century. Under the old gold standard, gold was money. Limiting the supply of money to the supply of gold was a huge mistake. It was the basic error that caused the Great Depression. Under my bill, our money will be the same “legal tender� currency that we have now. There will be no limit on the number of dollars except market demand. The big difference will be that every dollar will always be worth the same as one five-hundredth of an ounce of gold.

When I became a Congressman, I took an oath to uphold the Constitution. The Constitution commands Congress to regulate the value of our money. My bill will do this. This is why it is essential that it become law."

Interesting. We closed out the week with a $70 loss from last Friday, but the good news was that the slide did not extend into a tenth session. Next week promises to be quite dollar-centric as we might learn Lehman's fate and continue the house-cleaning process that is now at least a year-old. It will also be time to tally Ike's damage and project where US energy supplies will be heading before fall sets in. Judging by today's mild rise (gold) and actual decline (oil) - the worries about the dollar appear to remain on the muted side, profit-taking corrections notwithstanding. A calendar-related pause in Indian demand could start on Monday and reach towards month-end. Let's see who else is willing to buy, and how much.

Happy Trading. Pleasant Weekend.

Jon Nadler
Senior Analyst
Kitco Bullion Dealers Montreal

 

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