Deflation and the Gold Price Trajectory

What happened last week?

The Great Correction gave notice: it’s not going away.

On Friday, the Dow rose 42 points. The gold price advanced towards $1,600. Oil seems to be headed for $100.

With gold over $1,600, is it time to sell? Nah…not even close. It will have to go to $2,500 just to reach the high – adjusted for inflation – set 30 years ago.

But a lot of water has gone under the bridge in the last 3 decades. And almost every drop of it gurgles to us: Gold will go higher.

There’s much more debt than there was 30 years ago…and much more ‘funny money.’ What’s more, Paul Volcker is no longer at the Fed. This time, America’s central bank is run by Ben Bernanke…who has made it very clear what his response to crisis will be – print more money!

Yes, dear reader, gold is going higher. A lot higher. But not necessarily right away.

Harry Dent sent us the manuscript for his new book. He argues that gold will go higher…but not before it sinks. Debt is deflationary, he says. Everyone owes dollars. As debt is destroyed in the Great Correction the price of the dollar will go up and gold will go down. We will have deflation before we can move on to a super-boom, he believes.

He could be right. The markets always find a way to surprise us; you can count on that. But, by one route or another, gold will end up at twice today’s price – at least.

So let’s go back to see how the Great Correction is proceeding:

“Economy Faces a Jolt as Benefit Checks Run Out,” was a headline in The New York Times last week.

Europe’s debt market was melting down last week too. In all of the excitement, we overlooked this NYT item. But it is important. For two reasons. First, it shows the extent to which the US economy has been zombified. Second, it shows what happens when you let the zombies take over.

A large part of Americans’ income now comes neither from the sweat of their brows nor from the toil of their money. Instead, it is money that is given them by the government.

A large part of the population has turned away from profit-seeking, growth-enhancing work and towards zombie-ism, feeding at the public trough. And the more people who live at the expense of others, the less incentive the others have to bust their humps. Real GDP – the real wealth of a nation – goes down.

Then, the zombies get squeezed too. If you’re going to live at someone else’s expense, you better hope that he is doing well! But as the Great Correction continues and intensifies, zombie benefits run out…

Here’s the NYT article:

An extraordinary amount of personal income is coming directly from the government.

Close to $2 of every $10 that went into Americans’ wallets last year were payments like jobless benefits, food stamps, Social Security and disability, according to an analysis by Moody’s Analytics. In states hit hard by the downturn, like Arizona, Florida, Michigan and Ohio, residents derived even more of their income from the government.

By the end of this year, however, many of those dollars are going to disappear, with the expiration of extended benefits intended to help people cope with the lingering effects of the recession. Moody’s Analytics estimates $37 billion will be drained from the nation’s pocketbooks this year.

In terms of economic impact, that is slightly less than the spending cuts Congress enacted to keep the government financed through September, averting a shutdown.

Unless hiring picks up sharply to compensate, economists fear that the lost income will further crimp consumer spending and act as a drag on a recovery that is still quite fragile. Among the other supports that are slipping away are federal aid to the states, the Federal Reserve’s program to pump money into the economy and the payroll tax cut, scheduled to expire at the end of the year.

In Arizona, where there are 10 job seekers for every opening, 45,000 people could lose benefits by the end of the year, according to estimates from the state Department of Economic Security. Yet employers in the state have added just 4,000 jobs over the last 12 months.

In a study for the Labor Department, Wayne Vroman, an economist at the Urban Institute, estimated that every $1 paid in jobless benefits generated as much as $2 in the economy.

If that last item is correct, could the reciprocal also be correct? Will withdrawing a dollar’s worth of benefits take $2 out of the economy? That’s what we’re scheduled to find out.

Stay tuned, dear reader…

Bill Bonner
for The Daily Reckoning