15 Sep 2008

Blood Bath on Wall Street: Buy Gold

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Since today has been the worst day for the Dow since the September 11 attacks, I should probably say something. Back in July 2007 I prepared a report for a client (pdf) in which I predicted recession and tough times for the US dollar; you can see op ed treatments here and here.

My basic story is that Greenspan sowed the seeds for the present crisis by keeping interest rates ridiculously low in the aftermath of the dot-com crash. In this respect, I feel sorry for Bernanke and Paulson. Even though they are (in my opinion) making horrible decisions, Greenspan left them a bed full of roaches.

Financial advice? Get some gold. (At one point today, I’m pretty sure gold was up over 2% while the S&P was down over 4%.) In the coming weeks I will lay out why the Fed has run out of options and will have to either (a) let the market sink, or (b) inflate the money supply. Up till now, Bernanke has done what he could to minimize inflation, by “sterilizing” the injections of liquidity into the financial sector through selling off Fed assets. But the Fed’s piggy bank is running low.

One final point about gold and depressions: For some reason, 99% of financial commentators believe that during sharp economic downturns, you get falling prices. I show why that’s empirically not the case in recent decades here.

Now during the Great Depression, it’s true that there was price deflation. However–and I owe this point to Arthur Laffer–the US was on the gold standard* back then; the dollar-price of an ounce of gold was fixed. So if people rushed to hold gold during the 1930s (as they surely did), the dollar-price of gold couldn’t shoot up 300% (or whatever). Rather, the dollar-prices of other goods had to fall.

In the present institutional environment, there is no gold standard holding back the printing press. The relative price of gold will shoot up (just like in the 1930s), but so will the absolute dollar prices of gold and everything else.

* At least until FDR said, “You know, I find this whole gold standard rather inconvenient. Who controls the guns in this country? I do? Great. Everyone, hand in your gold. And let’s build a fort to stockpile it. Where do we need votes? Kentucky?”

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