Despite the yellow metal’s unceremonious and painful meltdown since October 2012, gold bugs continue to forecast a price of $5,000 and a collapse of the U.S. dollar to zero.
How could they be so stubborn AND wrong?
Because they’re basing their views on ideology and the last economic war, the fight against inflation in the 1970s.
They’re completely ignoring all the facts, especially the one that the economic war we’re fighting now is about deflation and debt deleveraging (as it was in the 1930s).
So let’s set the record straight. Here are the seven reasons gold will continue to sink like a mafia boss with cement shoes in the river… and why the dollar will continue its resurgence like a rising hot air balloon.
Gold is an inflationary hedge. Gold bugs have assumed that the Fed’s unprecedented money printing, Quantitative Easing (QE) and stimulus programs would lead to inflation and, ultimately, hyperinflation.
Mark my words: That’s not going to happen!
Gold collapsed in the second quarter of 2013 when our QE3 ramp up and Japan’s off-the-charts QE saw inflation rates fall from around 2% to as low as 1%.
Leveraged hedge funds have been dumping gold ever since then to meet margin calls.
The first principle to understand here is that the U.S. created more debt than any other country or region in the world during the great boom from 1983 to 2007. Total debt, private and government, grew at 2.54 times GDP for 25 years. Private debt grew even faster at 2.7 times GDP.
Debt is how we create or print money. The Fed’s money-printing programs are just a sideshow we see during emergencies like World War II and the recent great recession.
$3 trillion in quantitative easing is a drop in the ocean when compared to the $42 trillion in private debt and the $17 trillion (and growing) of government debt in the U.S.
When we deleverage or write off debt, money is destroyed. That makes the U.S. dollar scarce and, therefore, more valuable.
The truth is that we debased the U.S. dollar in the boom with unprecedented debt creation. Compared to our trading partners, the dollar declined 58% from 1985 into early 2008.
It’s been rising ever since, and it surged 27% in the financial crisis of late 2008 while gold was down 33% and silver was down 50%. Holy crap!
Yes, the gold bugs were wrong. Gold didn’t protect them or you from a deflationary crisis. The U.S. dollar did the protecting.
The U.S. dollar is the safe haven play in a deflationary period like this one, not gold or Swiss francs or euros or Canadian dollars.
Currencies trade relative to each other, not over an absolute value like stock market earnings or real estate rent and replacement costs. That’s why the dollar could never go to zero… not unless there was a global collapse of the currency system.
Right now we’re the best house in a bad global neighborhood.
But there are other reasons the U.S. dollar will continue to rise in the coming years.
For one, our trade deficit has been declining since the great recession of 2008. We have consistently imported more than we export since the early 1970s. This floods the world with U.S. dollars as we borrow to buy more than we make. That creates liquidity in dollars for world trade.
A falling trade deficit and potential trade surpluses from the U.S. energy revolution – thanks fracking – will only cause the U.S. dollar to rise, not fall.
That’s what leading nations do as they build their trade empires, like Great Britain did in the 1800s and early 1900s and the U.S. has done since World War II.
The costs of building such empires are offset by reserve currency status that allows a rising currency to afford such expenditures. It’s a win-win for global trade and markets, until it goes too far and the empire costs too much to sustain. James Dale Davidson first made this argument in The Great Reckoning (1991).
But when we stop building our empire, as we clearly have after so many failed wars, our currency rises as imports slow, exports rise and dollars stop flooding the world. And as I said before, fewer dollars in circulation make for a more valuable currency.
We are likely to see currency wars as other countries – like Japan and China – continue to devalue their currencies to stimulate exports in slowing economies, as John Mauldin argues in his forthcoming book, Code Red.
And finally, as Dennis Gartman argues for an increasing U.S. dollar in difficult times: “Who’s your daddy?”
The U.S. has 20 larger aircraft carriers versus 12 combined for the rest of the world. To put it more simply, we have 70 acres of flattop space versus just 25 acres for the rest of the world. That means we’re still the Great Britain of this era, even though we are backing off of our global policeman role.
That makes the U.S. dollar the ultimate safe haven.
So don’t buy gold or Swiss francs or past inflationary hedges.
Be in cash. Buy the U.S. dollar.
And if you’re more aggressive, short stocks as they decline in inflationary or deflationary crises.
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Ahead of the Curve with Adam O’Dell
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