All That Golds is Not Glitter

The current discussion of why the price of gold is rising falls into two camps, with two potentially different results. The first is that the unlimited sums of money that are being thrown at the financial system by the Obama administration and the Democratic Congress will result in the mother of all inflation builds. Gold, the argument goes, is the primary beneficiary of this inflationary action, and smart money recognizing the possible inevitable, is climbing on board. The other camp says wait a minute. How can you have inflation with falling home prices, falling stock markets, and falling jobs. In fact, deflation, not inflation, is the watch word. Thus, gold would be a suckers bet, and would eventually plummet.

Which result is right? Maybe neither. Here’s the real story of why gold could be just beginning its ascent.

To understand what’s happening, we must return to a time when President Herbert Hoover said: “A chicken in every pot.” In 1930, we just finished a decade when production was high, but consumption was starting to decline not only in the United States, but around the world. Congress, besieged by U.S. businessmen, felt threatened by the influx of foreign goods, whether they were better or cheaper was not the point. Therefore, The Smoot-Hawley Tariff Act was passed to place large tariffs on imported goods. For example, a U.S. desk sells for $100, a Brazilian desk sells for $80. It’s obvious which one you buy. After Smoot-Hawley, a U.S. desk costs $100, a Brazilian desk costs $80, plus a $50 tariff (tax) = $130. Unfortunately, unintended consequences often occur when decisions are short sighted, because the rest of the world imposed the same kind of tariffs. Thus, exporting and importing came to a dead halt all around the world. Protectionism failed and the Great Depression was off to the races.

Fast forward to current times: We still have tariffs, but they are usually negotiated tariffs, therefore avoiding the all-out tariff war of the 1930’s. But here is where it get’s interesting. Governments have learned that businesses and people (tourists) will travel and buy where their currency gets the biggest bang for the buck. For years, you could go to Canada, have a $100 dinner, and yet see your American Express bill say $60 U.S., a pretty good value for your U.S dollar. However, once the U.S. dollar started falling, tourists, businesses, speculators, and governments, started coming to our shores in droves, because foreigners could get such good value for their currency. However, the problem that gradually arose was that as buyers bought in the U.S., they abandoned their own home country. From the smallest business to the largest corporation, they watched business flowing elsewhere. When economies are thriving, competition from other countries is good and healthy. However, when economies are on the verge of collapse, competition from other countries is unwanted, and could be very destructive.

What countries have discovered around the world is that the tariffs, like the 1930’s, are too overt, and too threatening. But devaluing your currency will have the effect of stimulating your economy, if you are the only one doing it. Unfortunately, every country is talking down their currency at the same time. Therefore, paper currency of the world, including the U.S. dollar, is being viewed as basically worthless. This could continue to get worse, not better.

The only currency that has maintained its value over centuries, and recognized by all countries is…..yes, that’s right, gold. Gold is rising because the politicians, the economists, and even media personalities, have once again misjudged the impact of protectionism. Gold is rising because smart money knows that the impact of isolationism could be depression. To compound the matter, the stimulus package has a “buy America” clause in it, allowing only U.S. companies to participate in the infa-structure build out. Do they honestly believe other countries will not raise walls to our companies for projects they are initiating?

Those who don’t understand history are doomed to repeat the failures of the past.

The icing on the cake for gold could ultimately be the unavoidable inflation. The 1930’s only had tariffs. Currently, we have tariffs, currency devaluation, deflation, and the specter of runaway inflation. Gold, you’ve got to love it!

Till next time,

Bill

Long: Gold and silver. Short: Treasuries.



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