Monday, September 24, 2007

Gold Doesn't Care What the US Dollar Does

24 September 2007

There is a wide-ranging myth, popular in the gold community, that the US dollar has to fall in order for the price of gold to rise.


As
Ed Bugos, now with Agora Financial, demonstrated in a private communication, gold’s best historic gains have occurred during periods when the international value of the US dollar has been flat. Yes, you heard that right, gold does best not when the US dollar is falling, but when the US dollar is stable. We’re not talking about broad trends here, but the periods when gold surges.

Does that mean that the US dollar falls, and then the price of gold compensates by catching up? No, the evidence is to the contrary. The price of gold leads other markets, it does not follow them.

Think of it this way. When the US dollar falls against other currencies, the price of gold naturally climbs in US dollars. That is no surprise to anyone versed in monetary theory, particularly Austrian Economics. But gold climbs best when inflating currencies are temporarily stable. Why? Because all currencies are then falling against the true international and historic standard of value, the price of gold.

Sol Palha, in a
recent article on the Gold-Eagle website, argues that despite the US Dollar Index’s head-and-shoulders technical profile, despite popular sentiment to the contrary, and despite massive short positions against the US dollar, the currency of our southern neighbour is due for a bounce to the upside – possibly even a long recovery run of several years.

I'll discuss this problem only briefly.

In terms of purchasing power parity, the US dollar is now certainly very cheap internationally. It will cost you $5.00 to order a cup of coffee in London, and US vehicles sell for 70% of the price of their counterparts on the European continent. Certainly for Canadians, it has become ridiculously cheap to cross the border, and pay perhaps 30-50% less than we pay here for equivalent goods in the United States.

Further, though the United States is profligate and arguably asea in the midst of a perfect financial storm, and obviously navigating without a rudder, this situation is in fact little different than that of the world’s other major powers – as their currencies are – no differently than the US dollar – also on certain trajectories towards utter worthlessness.

Is the US currency situation then fundamentally different than that of other nations?

Perhaps, at least for now.

Of the major powers, it is only the Americans who insist on spending far beyond the funds they have on hand in order to purchase lower-priced goods and services overseas, now primarily from the Asian economies. Only the Americans run guns-and-butter economic policies at home, funded by the practice of running up unending government debts. And only the Americans are taking on mountains of personal debt, often financed through home equity extraction, that far exceed their rate of income growth.

In fact, American home equity, as a percentage of the value of the average American home, is in a downtrend according to the New York Times, perhaps the first time in US history that this has occurred when home values were rising - and of course the rising trend in US home valuations now seems to be committing a radical about-face, further squeezing already-declining levels of American home equity, and this at a time when mortgage rates are also turning upwards (recently prodded in this direction by pressure on long-term bond rates caused by increased inflationary expectations as a result of the Federal Reserve's surprise 50% Federal Funds rate cut at the short end of the debt market).

As a result, the Americans must sell about $¾ trillion of their currency each and every year in order to fund their profligacy. No other major nation is so deeply financially irresponsible at this time.

The US is presently playing in a league with such nations as Zimbabwe in terms of the quality of its broad fiscal policies. Argentina and Brazil – even Cuba – are presently far more fiscally conservative than the American government and its citizens. It is shocking but true, to contemplate how far the US has fallen in only a small number of years.


So it can be argued that there has been an epidemic of collective financial insanity in the US.

But bear in mind, the present economic madness in our neighbour to the south takes place against a backdrop of historic economic and technological innovation and long-term economic vigour which cannot easily be reversed even by many years of utterly ungrounded economic policies (consider Johnson’s Vietnam adventure in the 1960s, Reagan's military expenditures in the 1980s, and the almost two decades of irresponsible Federal Reserve economic policy under the loose-fingered Greenspan chairmanship – now succeeded by the present Bernanke Helicopter crew).

What then am I arguing?

Despite the above facts and arguments, I have no standard by which to value the pitiful and neglected US dollar against the world’s remaining currencies.

Living in Canada, we are presently blessed – and in some ways troubled – by what is currently the developed world’s strongest currency. The Canadian dollar reached parity with the US dollar last week for the first time in over 30 years.

Yet our nominal Canadian conservative government is staunchly confiscatory and anti-business (consider the perfidious reversal of income trust legislation, which has plunged the Canadian natural gas production business into a dire state – with the implication that Canada’s precious and irreplaceable natural gas reserves will soon be sold to the highest international bidders and removed from Canadian hands at the very time when natural gas prices are at their lowest point in a multi-decade uptrend).

I predict that Canadians will live to regret this short-sighted and mean-spirited policy in the not-too-distant future.

In Europe, the Euro partners cannot persuade France to abide by the requirements of responsible fiscal policy on which the Euro was necessarily founded. The Euro is presently one of the world’s strongest currencies, but it, too, is on shaky foundations.

The resource-driven Russian Ruble is being steered by a regressive government that is attempting to back-pedal as far as possible in the direction of the departed Soviet era when the KGB ruled supreme over all the land.

In the Middle East, some of the smaller and more independent states are diversifying into the tourism and financial management industries, and they are snapping up Western assets at a furious pace – but this region of the world continues to be hobbled by its now almost century-long inability to produce very much of abiding international economic value other than petroleum.

It is not that long ago that the entire Arabian peninsula could not match the economic value of the exports of tiny Finland (when the value of petroleum product exports was stripped out of the equation).

Yes, the US dollar could certainly collapse from its already compromised position against other international currencies.

Or the US dollar index could bounce from its present low level, which is equivalent to its 1992 record low, and soar upwards in a surprise uptrend for years to come.

I have no idea what will occur.

As Mr. Palha indicated in
his article, the game of currency investment is analogous to rats escaping one sinking ship to swim to another. All of the ships are going down. So what, exactly, does it really matter if the US dollar falls or rises against other global currencies?

It is in reality little more than a global shell game.

There is not one good international currency out there – no, not one (apart, perhaps from the Swiss Franc – a story for another day).

So, here is what I do know.

The US dollar is on a trajectory towards worthlessness.

So also is virtually every other currency of every other major global power.

The price of gold has its best runs (in US dollar terms) when the US dollar is stable, not falling.

And that is all I need to know.


Gold and silver are now easily available to the common person as investments. They have lasting value at all times and in all places.

So what are we doing arguing about the value of the US dollar relative to the Euro, the Canadian Loonie, the Pound Sterling, or the Australian dollar?

Who cares?

They are all fundamentally without lasting value.

It doesn't matter.

Gold and silver are of value, regardless of what becomes of the world’s currencies.

That is all any of us needs to know.

Let me close by borrowing a citation from Mr. Palha – who in this context is referring to the travails, and the uncertain prospects – of the US dollar:

“Experience has taught me this, that we undo ourselves by impatience. Misfortunes have their life and their limits, their sickness and their health.”

(Michel Eyquem De Montaigne 1533-1592, French Philosopher, Essayist)

Again, it truly does not matter how the international currency exchange value of the US dollar fares.

Nor does the exchange value of the Canadian dollar, nor the Euro, nor the Yen, nor the Pound Sterling, nor the Chinese Yuan – matter – one whit. They are each and every one in perpetual decline.

Gold and silver are of value. That is all that matters.

($9000 gold as the US dollar collapses? Click here.)

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