No Two Ways About It; Gold Over $2,000

Since ancient times, gold has been a safe haven for investors worried about market volatility and political uncertainty. Even the rise of paper currencies hasn’t managed to kill the idea of gold in people’s minds. That’s because gold is no one’s liability — currencies come and go, but gold remains the same.

For that reason alone, precious metals should always have a permanent place in your portfolio. It is the ultimate hedge.

But today holding gold is more important — and can be more profitable — than it’s been in years. That’s because we’re seeing a repeat of the same forces that pushed gold from $35 to over $800 between 1971 and 1980. I’m talking about things like a weakening dollar, easy monetary policies and geopolitical uncertainty.

Now, if you’ve watched the news, you know gold has already breached the $1,000 mark. But there’s every reason to suspect this is only the beginning. Even after this tremendous run-up, we expect gold to head higher… much higher. That’s because gold’s “true” high is actually closer to $2,000!

Let me explain…

When people talk about the gold price, then tend to forget one thing — the dollar’s decreasing value over the years. So comparing yesterday’s gold price to today’s is like comparing apples to armadillos.

Adjusted for inflation, a $35 ounce of gold in 1971 would be worth $175.55 today. 1975 gold rockets to $697.02. In today’s dollars, 1980 gold, the peak year at $850, clocks in closer to $2,275.99.

So, in real terms, gold has a long way to go before it reaches its top. The question is, how likely is that?

Let’s take a look…

The Trillion-Dollar Sinkhole

The chart below illustrates two of the biggest problems in today’s economy.

As you can see, the amount of money in circulation has been skyrocketing for over 40 years. In fact, since the late 1990s, it’s gone up almost in a straight line.

Its reason is pretty simple. The Fed knows regular cash and credit injections make everyone feel rich. The theory goes, when you’ve got cash and low-priced credit, companies borrow and expand. Consumers borrow and spend. Families borrow and buy homes.

And for a while it seems to have worked — U.S. GDP growth had averaged 3.2% over a 5-year period. Consumption was healthy and new jobs were being created daily.

But while that sounds good, there is a serious downside to this plan… debt.

Consumers are weighed down with a backbreaking $2.4 trillion of outstanding credit. That’s over a trillion more than they had in 1998 — and every dollar needs to be paid back.

The U.S. government is also running over a $1.1 trillion domestic deficit. And it’s only getting worse…

The first wave of baby boomers has started to retire. Entitlement programs like Social Security and Medicare, in whatever form they exist, will start paying out larger sums of money relative to revenues.

Combine that with the ever-increasing multi-billion dollar “bailout” packages that congress approves and you can see that it doesn’t look like there’s anyway to reverse this deficit trend.

So instead, the government has tried another tactic to make up the shortfalls — by going deeper into debt. There are trillions of U.S. dollars now held outside of the United States. Since U.S. dollars are only legal tender within the United States, whether foreigners continue holding them depends on whether they have confidence in the dollar.

There is one final trick up the government’s sleeve. But this “solution” isn’t a solution at all…

How Can Push-Button Money Have Value?

Before becoming Fed Chairman, Ben Bernanke famously said in a speech at the National Economists Club in Washington, in November 2002…

“Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), which allows it to produce as many U.S. dollars as it wishes at essentially no cost… We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.”

In other words, if you want to juice an economy… turn on the printing presses and make it easy to borrow money at a low rate of interest. The Fed won’t lose control, he says, until short-term rates go to zero. And maybe not even then.

The problem is, money can’t escape the natural law of supply and demand. When there’s too much of it floating around, each dollar is worth that much less relative to the whole. Suddenly, you’ve got price inflation. Suddenly, every dollar you have in the bank is worth less.

Hemingway called it the “first panacea of a mismanaged nation.”

Already this disastrous stance has plummeted the purchasing power of our dollars by a mind-blowing 96%. Today it’s worth just pennies compared to what it bought a century ago. Or even what it was worth the last time gold boomed, in the 1970s.

Flooding the market with easy money like this is more like burning your furniture to keep warm! We like to think an even smarter economist, Ludwig Von Mises, got it right…

There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of the voluntary abandonment of further credit expansion… or later as a final and total catastrophe of the currency system involved.

Apparently, we’re not the only ones who think so…

More on that next time.

Until we meet again,
Byron King
Whiskey & Gunpowder

September 29, 2010

The Daily Reckoning