Monetary and Fiscal Policy Won’t Help

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Monetary and fiscal policy won’t lift us out of the new depression. Let’s first take a look at monetary policy.

Fed money printing is an exhibition of monetarism, an economic theory most closely associated with Milton Friedman, winner of the Nobel Memorial Prize in economics in 1976. Its basic idea is that changes in money supply are the most important cause of changes in GDP.

A monetarist attempting to fine-tune monetary policy says that if real growth is capped at 4%, the ideal policy is one in which money supply grows at 4%, velocity is constant and the price level is constant. This produces maximum real growth and zero inflation. It’s all fairly simple as long as the velocity of money is constant.

It turns out that money velocity is not constant, contrary to Friedman’s thesis. Velocity is like a joker in the deck. It’s the factor the Fed cannot control.

Velocity is psychological: It depends on how an individual feels about her economic prospects. It cannot be controlled by the Fed’s printing press. It measures how much money gets spent from people to businesses.

Think of when you tip a waiter. That waiter might use that tip to pay for an Uber. And that Uber driver might pay for fuel with that money. This velocity of money stimulates the economy.

Well, velocity has been crashing for the past 20 years. From its peak of 2.2 in 1997 (each dollar supported $2.20 of nominal GDP), it fell to 2.0 in 2006 just before the global financial crisis and then crashed to 1.7 in mid-2009 as the crisis hit bottom.

The velocity crash did not stop with the market crash. It continued to fall to 1.43 by late 2017 despite the Fed’s money printing and zero rate policy (2008–15).

Even before the new pandemic-related crash, it fell to 1.37 in early 2020. It can be expected to fall even further as the new depression drags on.

As velocity approaches zero, the economy approaches zero. Money printing is impotent. $7 trillion times zero = zero. There is no economy without velocity.

The factors the Fed can control, such as base money, are not growing fast enough to revive the economy and decrease unemployment.

Spending is driven by the psychology of lenders and consumers, essentially a behavioral phenomenon. The Fed has forgotten (if it ever knew) the art of changing expectations about inflation, which is the key to changing consumer behavior and driving growth. It has nothing to do with money supply.

The bottom line is, monetary policy can do very little to stimulate the economy unless the velocity of money increases. And the prospects of that happening aren’t great right now.

But what about fiscal policy? Can that help get the economy out of depression?

Let’s take a look…

Congress is far along in authorizing more deficit spending in 2020 than the last eight years combined. The government will add more to the national debt this year than all presidents combined from George Washington to Bill Clinton.

This spending explosion includes $26 billion for virus testing, $126 billion for administrative costs of programs, $217 billion direct aid to state and local governments, $312 billion for public health, $513 billion in tax breaks for business, $532 billion to bail out major corporations, $784 billion in aid to individuals as unemployment benefits, paid leave, direct cash payments and $810 billion for small businesses under the Paycheck Protection Program.

This comes on top of a baseline budget deficit of $1 trillion.

Moreover, Congress is expected to pass an additional spending bill of at least $1 trillion by late July, mostly consisting of assistance to states and cities. Combining the baseline deficit, approved spending and expected additional spending brings the total deficit for 2020 to $5.3 trillion.

That added debt will increase the U.S. debt-to-GDP ratio to 130%. That’s the highest in U.S. history and puts the U.S. in the same super-debtor’s league as Japan, Greece, Italy and Lebanon.

The idea that deficit spending can stimulate an otherwise stalled economy dates to John Maynard Keynes and his classic work The General Theory of Employment, Interest and Money (1936).

Keynes’ idea was straightforward.

He said that each dollar of government spending could produce more than $1 of growth. When the government spent money (or gave it away), the recipient would spend it on goods or services. Those providers of goods and services would in turn pay their wholesalers and suppliers.

This would increase the velocity of money. Depending on the exact economic conditions, it might be possible to generate $1.30 of nominal GDP for each $1.00 of deficit spending. This was the famous Keynesian multiplier. To some extent the deficit would pay for itself in increased output and increased tax revenues.

Here’s the problem:

There is strong evidence that the Keynesian multiplier does not exist when debt levels are already too high.

In fact, America and the world are inching closer to what economists Carmen Reinhart and Ken Rogoff describe as an indeterminate yet real point where an ever-increasing debt burden triggers creditor revulsion, forcing a debtor nation into austerity, outright default or sky-high interest rates.

Reinhart and Rogoff’s research reveals that a 90% debt-to-GDP ratio or higher is not just more of the same debt stimulus. Rather it’s what physicists call a critical threshold.

The first effect is the Keynesian multiplier falls below 1. A dollar of debt and spending produces less than a dollar of growth. Creditors grow anxious while continuing to buy more debt in a vain hope that policymakers reverse course or growth spontaneously emerges to lower the ratio. This doesn’t happen. Society is addicted to debt and the addiction consumes the addict.

The end point is a rapid collapse of confidence in U.S. debt and the U.S. dollar. This means higher interest rates to attract investor dollars to continue financing the deficits. Of course, higher interest rates mean larger deficits, which makes the debt situation worse. Or the Fed could monetize the debt, yet that’s just another path to lost confidence.

The result is another 20 years of slow growth, austerity, financial repression (where interest rates are held below the rate of inflation to gradually extinguish the real value of debt) and an expanding wealth gap.

The next two decades of U.S. growth would look like the last two decades in Japan. Not a collapse, just a slow, prolonged stagnation. This is the economic reality we are facing.

And neither monetary policy nor fiscal policy will change that.

Regards,

Jim Rickards
for The Daily Reckoning

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Economy Won’t Recover Until 2023

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I’ve argued that we’re in a new depression. The depth of the new depression is clear. What is unclear to most observers are the nature and timing of the recovery.

The answer is that high unemployment will persist for years, the U.S. will not regain 2019 output levels until 2022 and growth going forward will be even worse than the weakest-ever growth of the 2009–2020 recovery.

This may not be the end of the world, yet it is far worse than the most downbeat forecasts. Some sixth-grade math is a good place to begin the analysis.

Make 2019 economic output 100 (the actual figure is $21 trillion; “100” is 100% of that number, a convenient way to measure ups and downs).

Assume output drops 40% in the second and third quarters of 2020. (Many estimates project larger drops; 40% is a plausible if conservative estimate.)

A 40% drop for six months equals a 20% drop for the full year assuming the first and fourth quarters are flat on net.

A 20% drop from 100 = 80 (or $4.2 trillion of lost output).

Now let’s see what happens if we estimate back-to-back growth years of 10% in 2021 and 2022…

First, is 10% growth even a reality? Past history says no.

Since 1948, U.S. annual real growth in GDP has never exceeded 10%.

In fact, post-1980 recoveries averaged 3.2% growth. And since 1984, growth has never exceeded 5%. So 10% is a very optimistic forecast to begin with.

If our new base is 80 (compared with 100 in 2019) and we increase output by 10% in 2021, this brings total output to 88.

If we enter 2021 with a new base of 88 and add another 10% to that, we come to 96.8 in total output by the end of 2022.

Here’s the problem.

Using 100 as a yardstick for 2019 output and assuming an unrealistic back-to-back years of 10% real growth in 2021 and 2022, one still does not get back to 2019 output levels.

The hard truth is 96.8 is less than 100.

It would take the highest annual real growth in over 40 years, sustained for two consecutive years, to get close to 2019 output levels.

It’s far more realistic to assume real growth will be less than 10% per year. That puts the economy well into 2023 before reaching output levels last achieved in 2019.

This is the reality of this depression.

It’s not about continuously declining GDP. A depression is an initial collapse so large that even years of high growth won’t dig the economy out of its hole.

Analysts and talking heads debate the recovery’s strength using letters that mimic the shape of a growth curve as shown on a graph.

A V-shaped recovery goes down steeply and back up steeply to get output back where it started in a relatively brief time.

A U-shaped recovery goes down steeply, does not grow materially right away and then makes a sharp recovery.

An L-shaped recovery goes down steeply and is followed by low growth for an indefinite period of time.

Finally, the W-shaped recovery goes down steeply, bounces back quickly and then falters for a second time before finally recovering and getting back to earlier levels of output and growth.

The post-2009 recovery produced only 2.2% growth. It was an L-shaped recovery.

It was a real recovery, yet the output gap between the former trend and the new trend was never closed.

The U.S. economy suffered over $4 trillion of lost wealth based on the difference between the former strong trend and the new weaker trend.

That lost wealth was a serious problem for the U.S. before the New Great Depression.

Now the prospect is for even lower growth than the weak post-2009 recovery.

The new recovery, far from the 10% growth discussed in the example above, may only produce 1.8% growth, even worse than the 2.2% growth before the pandemic.

It’s another L-shaped recovery, the second in a row. Now the bottom of the L is even closer to a flat line and the output gap compared with the long-term trend is even greater.

There will be no V-shaped recovery. There are no green shoots despite what you hear on TV.

We’re in a new Great Depression and will remain so for years.

Regards,

Jim Rickards
for The Daily Reckoning

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Depression and the Great American Exodus

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Is the worst of the economic collapse over?

Not really. The economy is off the bottom, but that’s only to be expected after the historic collapse of March–May and the stock market crash in March and April.

The question now is not whether we’re growing again. We are. The questions are how fast is that growth, and how long will it be before we return to 2019 levels of output?

And this question applies not just to the U.S. but to the entire global economy, especially the large producers such as China, Japan and the EU.

Here, the news is not good at all.

Recent data suggests that we may not reach 2019 output levels until 2023 at the earliest, and that something close to full employment may not return until 2025.

A simple example will make the point.

Just Not Enough Growth

Assume 2019 GDP has a normalized level of 100. Now assume a 10% drop (that’s about how much the U.S. economy will decline for the full-year 2020 according to many estimates).

That moves the benchmark to 90 in 2020.

Now assume 5% growth in 2021 (that would also be the highest growth rate in decades).

That will move the benchmark back up to 94.5. Next assume growth in 2022 is 4% (that would also be near record annual growth for the past three decades).

That would move the benchmark up to 98.3. Here’s the problem…

An output level of 98.3 is still less than 100. In other words, back-to-back growth of 5% in 2021 and 4% in 2022 is not enough to recover the 2019 level after a 10% decline in 2020.

But the situation is even worse than I just described.

Worse Than a Technical Recession

China PMI figures have recently been 50.9 (manufacturing) and 54.4 (services).

The Wall Street happy talk brigade is cheering these numbers because they “beat” expectations and they show growth (any number over 50 indicates growth in a PMI index series).

But growth is completely expected. The problem is that growth is so weak.

A strong bounce back from a collapse should produce PMI readings of 60 or 70 if a robust recovery were underway. It’s not.

Here’s the reality: What the U.S. economy is going through right now is far worse than a technical recession.

A recession is defined as two or more consecutive quarters of declining growth along with higher unemployment.

A recession beginning in February has already been declared by the National Bureau of Economic Research (NBER), which is the private arbiter of when recessions begin and end.

If we judge strictly by growth figures, the recession may already be over (although we won’t know for months to come, until quarterly growth figures are available and the NBER has time to evaluate them and make a call).

Most recessions don’t last that long, usually only about six–nine months. But that misses the fact that we’re really in a new depression.

The New Depression

“Wait a minute,” you say. “Growth may be weak, but it’s still growth. How can you say we’re in a depression?”

Well, as I’ve explained before, the starting place for understanding depression is to get the definition right.

Economists don’t like the word “depression” because it does not have an exact mathematical definition. For economists, anything that cannot be quantified does not exist. This view is one of the many failings of modern economics.

Many think of a depression as a continuous decline in GDP. The standard definition of a recession is two or more consecutive quarters of declining GDP and rising unemployment, as I just explained.

Since a depression is understood to be something worse then a recession, investors think it must mean an extra-long period of decline.

But that’s not the definition of depression.

Defining Depression

The best definition ever offered came from John Maynard Keynes in his 1936 classic The General Theory of Employment, Interest and Money.

Keynes said a depression is “a chronic condition of subnormal activity for a considerable period without any marked tendency either towards recovery or towards complete collapse.”

Keynes did not refer to declining GDP; he talked about “subnormal” activity.

In other words, it’s entirely possible to have growth in a depression. The problem is that the growth is below trend. It is weak growth that does not do the job of providing enough jobs or staying ahead of the national debt.

That is exactly what the U.S. is experiencing today.

The key is a depression is not measured by declining growth but is measured by a combination of actual declines and a below-trend recovery. This happened during the Great Depression.

Depressions Leave Lasting Impressions

There was declining growth and a technical recession from 1929–1932. Then a recovery (from a low level) from 1933–36. Then a second technical recession in 1937–38 and then another recovery from 1939–1940.

The entire period 1929–1940 is known as the Great Depression in part because the stock market and commercial real estate never recovered their 1929 levels even by 1940 (they finally recovered in 1954).

Depressions are also categorized by large behavioral changes including higher savings rates, smaller family size and internal migration. These effects are intergenerational.

Many behavioral changes from the 1930s were still prevalent in the 1950s and early 1960s and lasted until the baby boomers came of age in the late 1960s.

This kind of profound change with lasting impact is happening again.

The Great American Exodus

Due to a combination of COVID-19 spreading in densely populated areas, business failures, urban riots and failing mayors and police departments, Americans are migrating from the big cities to suburban and country areas by the millions.

American families are leaving dysfunctional cities such as New York City, Seattle and San Francisco and heading for Montana, Colorado, Maine and upstate New York in the Catskill Mountains among other safe havens.

Big cities have always offered a trade-off between higher taxes and urban stress in exchange for entertainment, great restaurants, museums and intellectual buzz.

Today the venues and buzz are gone, the crime rates are soaring and all that is left is the stress and taxes. So people are getting out.

Changes like this are not temporary. Once people move out, they don’t return ever. Their children may return someday but that could be 15 or 20 years away.

And those who leave tend to have the most capital and the most talent. This leaves the cities as empty shells populated by oligarchs with personal bodyguards and the poor, who have to deal with the street-level violence.

This shift can be helpful for individuals who move, but it’s devastating for the economics of major cities. And that’s devastating for the U.S. economy as a whole.

It’s one more reason we will be in depression for years even if the technical recession is over soon.

Investors Will Learn the Hard Way

The best case is that it will take years to get back to 2019 levels of output. The worst case is that output will drop even lower as the recovery fails.

We’re not really in a recession right now. We’re in a depression and will remain there for years.

No one under the age of 90 has ever experienced a depression until now. Most investors have no working knowledge of what a depression is or how it affects asset values.

But they’re going to find out, and probably the hard way.

Regards,

Jim Rickards
for The Daily Reckoning

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The Election’s a Toss-up

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Voters don’t change their minds in October despite the occasional “October surprise.” Evidence shows that the debates don’t change many minds either despite their high profile.

Most voters make up their minds sometime between Labor Day and Oct. 1 based on overall impressions of the candidates without getting too bogged down in policy details.

One of the primary rules of politics is “You can’t beat something with nothing.”

Biden isn’t much, but at least he’s something. Voters perceive him as steady, experienced and somewhat of a “regular guy.” (Never mind that the reality is quite different and Biden is in a state of cognitive decline; it’s the perception that counts, not the reality).

Trump appears to be nothing. He has no program, no platform and no plan for the next four years.

Voters don’t blame him for COVID, but they will judge him by his response. Voters don’t blame him for the depression, but they will judge him by the recovery.

Right now, Trump is not responding well or showing leadership; he’s just blaming others and complaining about the Democrats.

We’ll learn a lot as Joe Biden picks a running mate and as the Democratic and Republican conventions approach in August. I won’t rule out a shock such as Democrats working behind closed doors to dump Biden in favor of someone they perceive as more electable, such as New York Gov. Andrew Cuomo, California Gov. Gavin Newsom, or popular favorite Michelle Obama.

But let’s consider the two different scenarios — a Trump win and a Biden win.

If Trump wins, the extent of Trump hatred and anti-Trump resistance will get worse, not better. The idea that the Trump-bashers will finally come to grips with reality and accept Trump as president (even one they don’t like) is fantasy.

The Trump-bashing has been a steady, never-ending 24/7 spectacle for the past four years. There’s no reason why the media, the Resistance and the Democrats in Congress can’t keep it up for another four years.

How about more impeachment hearings? (Don’t worry, those plans are already underway.)

The Antifa crowd will use a Trump victory as evidence that “democracy doesn’t work,” which will validate their violent tactics at least in their own minds. They’ll find plenty of supporters.

Get ready for more riots, urban looting and burning and “autonomous zones” in major cities by early next year if not sooner.

What about a Biden victory?

A Biden victory brings its own set of fiascoes waiting to happen. Biden’s cognitive capacity is clearly impaired at least to some extent. That can happen with age, sooner in some than others.

Supporters and the media have tried to cover up the Biden mental issues by saying he is “gaffe-prone” and that he has had a lifetime struggle with stuttering. Both statements are true and have been for decades.

But they don’t explain what we’re seeing now.

Biden can’t complete sentences, can’t remember well-known quotes, can’t construct a coherent argument and seems to drift off in the middle of answering a question. Those are all signs of a deteriorating mental capacity.

We’ll see how far this Biden-in-hiding can make it. The Democrats’ convention has already been turned into a “virtual” convention at which Biden can hide behind a teleprompter again.

The fall debates will be a huge challenge for Biden, except they may be rigged as to length, number and format to minimize the stress on Biden’s presence of mind.

Politics aside, the real problem is not the campaign but the election.

If Biden wins, his mental health issues won’t go away. We will have a cognitively disabled president with his finger on the nuclear war-fighting trigger.

Biden will pose a serious case for removal from office under the 25th Amendment. This was mooted for Trump, but it was based on animus, not health. In Biden’s case, the health threat is real.

This is why the vice presidential nomination is so important. When the vice presidential pick for Biden is announced (likely a far-left voice), investors should immediately think of that person as a de facto president now and actual president by 2022.

So there are your choices. Trump brings more social unrest, and Biden brings mental health issues that will lead to his removal. As they say in sports betting, “Pick ’em.”

I said earlier that if the election was held today, Trump would lose. But because so much can happen over the next four months, my forecast for the outcome of the presidential election is still a toss-up.

There are so many wild cards in the deck that will be played between now and Election Day. These wild cards include the strength of the economic recovery, the continuation of social unrest, a possible second wave of COVID-19, international hot spots, Trump’s petulance and Biden’s mental health.

Now, a toss-up is bad news for Trump because he had a 74% probability of winning as recently as January.

But that has gone by the boards as a result of the pandemic, the depression, the more recent riots and Trump’s inability to understand that a different type of leadership is required when the crisis is not strictly political.

The key takeaway is that the Trump-Biden contest is still basically 50-50.

The polls could simply be underestimating Trump’s support — a phenomenon sometimes referred to as the idea of the “hidden Trump voter.”

At the same time, Trump’s difficulties do not mean clear sailing for Biden. The biggest single variable in success or failure in electoral politics is not polling but turnout.

Even a candidate behind in the polls will win if his supporters turn out in force. Likewise, a candidate ahead in the polls will lose if his supporters stay home.

On that front, Biden will have great difficulty getting the “Bernie Bros” and other left-wing elements of the Democratic electorate to turn out on Election Day. There’s a noticeable lack of enthusiasm for Biden even among those who favor him in the polls.

These two trends — Trump’s lagging in the polls and Biden’s lag in enthusiasm — will help define the presidential race over the next four months.

In addition to the pandemic and the economy, which are the dominant factors, other campaign themes will include Trump blaming China for the pandemic and Biden attacking Trump’s handling of the pandemic.

Both candidates have a path to victory. For Biden, it’s keeping a low profile and hoping to coast to victory on the anti-Trump feeling in the country. For Trump, it’s getting past his petty feuds and laying out a vision for a second term.

In politics, something beats nothing every time.

The election will be close no matter what happens. That was always in the cards.

For investors, it’s important to know that the markets have not priced in a Biden victory. Biden has plans for higher taxes, more regulation and the Green New Deal.

It’s one more reason to lighten up on stocks and build cash reserves until we have more clarity on the election.

Regards,

Jim Rickards
for The Daily Reckoning

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Will Trump Win Reelection?

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For another month, America has proceeded almost as if there is no presidential election this year. Of course, there is a presidential election on Nov. 3, just four months away.

Normally a coming election would dominate the headlines and conversation. We’d be discussing the coming conventions, the choice for vice president on the Democratic side, the platforms, the polls and other minutiae of the political process.

Those conversations are taking place among some and the polls are being reported on cable news on a consistent basis, but almost no one cares.

People may care by October, but not now. Instead the public is focused on three other issues of more pressing concern: the pandemic, the New Depression and social unrest. That’s as it should be.

Joe Biden has been confined to his basement recreation room. Donald Trump has been mostly confined to the White House, although he has begun to venture out and even attended a campaign rally in Tulsa, Oklahoma.

Now, it’s too soon to make definitive forecasts at this stage.

But if the presidential election were held today, Trump would almost certainly lose to Biden.

This reality is reflected not only in the national polls (which don’t mean much because the U.S. does not have national elections; we have state-by-state elections implemented through the Electoral College).

It is also reflected in polls from key battleground states such as Michigan, Pennsylvania and Wisconsin.

Even allowing for the fact that some of the polls are poorly constructed and oversample Democrats relative to Republicans, Biden’s leads are substantial.

I was one of the very few analysts who predicted a Trump victory in 2016. I did this in national TV interviews in Australia, London and New York in addition to writing about it in my newsletters.

I made this forecast at a time when polls and pundits were giving Hillary Clinton a 92% chance of victory. So I know something about how to interpret polls, search for anecdotal evidence and not get caught up in the mainstream media narrative.

Yet those same skills that caused me to predict a Trump victory in 2016 now point to a Trump defeat.

I’ve often defended Trump’s policies, especially regarding trade with China, so I certainly can’t be accused of being anti-Trump.

That’s just an objective analysis based upon the latest data.

Of course, the election is still 125 days away and there’s time to turn things around. A lot can happen in politics in a week let alone four months. But that’s not as much time as it sounds.

Regards,

Jim Rickards
for The Daily Reckoning

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Central Banks Driving Gold

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Gold as an asset class is confusing to most investors. Even sophisticated investors are accustomed to hearing gold ridiculed as a “shiny rock” and hearing serious gold analysts mocked as “gold bugs,” “gold nuts” or worse.

As a gold analyst, I grew used to this a long time ago. But, it’s still disconcerting when one realizes the extent to which gold is simply not taken seriously or is treated as a mere commodity no different than soy beans or wheat.

The reasons for this disparaging approach to gold are not difficult to discern. Economic elites and academic economists control the central banks. The central banks control what we now consider “money” (dollars, euros, yen and other major currencies).

Those who control the money supply can indirectly control economies and the destiny of nations simply by deciding when and how much to ease or tighten credit conditions, and when to favor (or disfavor) certain types of lending.

When you ease credit conditions in a difficult environment, you help favored institutions (mainly banks) to survive. If you tighten credit conditions in a difficult environment, you can more or less guarantee that certain companies, banks or even nations will fail.

This power is based on money and the money is controlled by central banks, primarily the Federal Reserve System. However, the money-based power depends on a monopoly on money creation.

As long as investors and institutions are forced into a dollar-based system, then control of the dollar equates to control of those institutions. The minute another form of money competes with the dollar (or euro, etc.) as a store of value and medium of exchange, then the control of the power elites is broken.

This is why the elites disparage and marginalize gold. It’s easy to show why gold is a better form of money, why it’s more reliable than central bank money for preserving wealth, and why it’s a threat to the money-monopoly that the elites depend upon to maintain power.

Not only is gold a superior form of money, it’s also not under the control of any central bank or group of individuals. Yes, miners control new output, but annual output is only about 1.8% of all the above-ground gold in the world.

The value of gold is determined not by new output, but by the above-ground supply, which is 190,000 metric tonnes. Most of that above-ground supply is either owned by central banks and finance ministries (about 34,000 metric tonnes) or is held privately either as jewelry (“wearable wealth”) or bullion (coins and bars).

The floating supply available for day-to-day trading and investment is only a small fraction of the total supply. Gold is valuable and is a powerful form of money, but it’s not under the control of any single institution or group of institutions.

Clearly gold is a threat to the central bank money monopoly. Gold cannot be made to disappear (it’s too valuable), and it would be almost impossible to confiscate (despite persistent rumors to that effect).

If gold is a threat to central bank money and cannot be made to disappear, then it must be discredited. It becomes important for central bankers and academic economists to construct a narrative that’s easily absorbed by everyday investors that says gold is not money.

The narrative goes like this:

There’s not enough gold in the world to support trade and commerce. (That’s false: there’s always enough gold, it’s just a question of price. The same amount of gold supports a larger amount of transactions when the price is raised).

Gold supply cannot expand fast enough to keep up with economic growth. (That’s false: It confuses the official supply with the total supply. Central banks can always expand the official supply by printing money and buying gold from private hands. That expands the money supply and supports economic expansion).

Gold causes financial panics and crashes. (That’s false: There were panics and crashes during the gold standard and panics and crashes since the gold standard ended. Panics and crashes are not caused or cured by gold. They are caused by a loss of confidence in banks, paper money or the economy. There is no correlation between gold and financial panic).

Gold caused and prolonged the Great Depression. (That’s false: Even Milton Friedman and Ben Bernanke have written that the Great Depression was caused by the Fed. During the Great Depression, base money supply could be 250% of the market value of official gold. Actual money supply never exceeded 100% of the gold value. In other words, the Fed could have more than doubled the money supply even with a gold standard. It failed to do so. That’s a Fed failure not a gold failure).

You get the point. There’s a clever narrative about why gold is not money. But, the narrative is false. It’s simply the case that everyday citizens believe what the economists say (usually a bad idea) or don’t know enough economic history to refute the economists (and how could you know the history if they stopped teaching it fifty years ago).

The bottom line is that economists know that gold could be a perfectly usable form of money. The reason they don’t want it is because it dilutes their monopoly power over printed money and therefore reduces their political power over people and nations.

To marginalize gold, they created a phony narrative about why gold doesn’t work as money. Most people were too easily impressed by the narrative or simply didn’t know enough to challenge it. Therefore the narrative wins even if it is false.

If gold is viable as a form of money, what does gold’s recent price trading range combined with fundamental factors tell us about its investment prospects?

Right now, my models are telling me that gold is poised to breakout of its recent narrow trading range.

As always in technical analysis, the term “breakout” can mean sharply higher or sharply lower prices. Using fundamental analysis, a breakout to sharply higher prices is the expected outcome. This may be the last opportunity to buy gold below $2,000 per ounce.

For the past three months, gold has been trading in a range between $1,685 per ounce and $1,790 per ounce (it’s trading at about $1,782 today). For most of those three months gold was trading in a fairly narrow band.

When trading a volatile asset narrows to that extent, it’s a sign that the asset is ready for a material technical breakout. The question is will gold breakout to the upside or downside?

To answer that question, we can turn to fundamental analysis. (Technical analysis is data rich and is useful for spotting patterns, but it has low predictive analytic power).

One of the most important fundamental factors forcing gold higher is shown in Chart 1 below. This shows central bank purchases of gold bullion from 2017 to 2020 (each year is shown as a separate line measured in metric tonnes on the left scale).

Chart 1 – Central Bank purchases of gold
(in metric tonnes) 2017 – 2020

IMG 1

Chart 1 shows significant purchases of gold with 2019 running ahead of 2017 and 2018 at about 500 metric tonnes.

The chart also shows over 150 metric tonnes of gold purchases through April 2020, which puts 2020 on track to show 450 metric tonnes purchased for the year if present trends hold.

Of course, the actual result could be higher or lower. Cumulative central bank purchases from January 2017 to April 2020 are approximately 2,050 metric tonnes.

In fact, central banks went from being net sellers to net buyers of gold in 2010, and that net buying position has persisted ever since. The largest buyers are Russia and China, but significant purchases have also been made by Iran, Turkey, Kazakhstan, Mexico and Vietnam.

Here’s the bottom line:

Central banks have a monopoly on central bank money. Gold is the competitor to central bank money and most central banks would prefer to ignore gold. Yet, central banks in the aggregate are net buyers of gold.

In effect, central banks are signaling through their actions that they are losing confidence in their own money and their money monopoly. They’re getting ready for the day when confidence in central bank money will collapse across the board. In that world, gold will be the only form of money anyone wants.

Central banks are voting with their printing presses in favor of gold. What are you waiting for?

Here’s a once in a lifetime opportunity to front run central banks and acquire your own gold at attractive prices before the curtain drops on paper money.

Regards,

Jim Rickards
for The Daily Reckoning

The post Central Banks Driving Gold appeared first on Daily Reckoning.

Central Banks: Gold’s Greatest Ally

This post Central Banks: Gold’s Greatest Ally appeared first on Daily Reckoning.

You’re likely aware of the price action in gold lately. Gold has rallied from $1,591 per ounce on April 1 to $1,782 per ounce as of today. That’s a 12% gain in less than three months.

My earlier forecast was that gold would hit $1,776 by the Fourth of July. I guess I was a bit early!

Today’s price of $1,782 per ounce is the highest since 2012 and a 70% gain from the low of $1,050 per ounce at the end of the last bear market in December 2015.

The history of gold bull markets (1971–80 and 1999–2011) shows that the most powerful gains come toward the end of the bull market, not at the beginning.

That means even if you’ve missed out on the gold rally so far, you could still score huge gains as gold trends toward $10,000 per ounce or higher over the next four years.

As I’ve stated on multiple occasions, I didn’t just come up with that number out of the blue or to be controversial.

It’s simply the implied nondeflationary price of gold based on the M1 money supply and assuming it will have a 40% gold backing.

What’s driving this bull market in gold?

It’s not retail investors (apart from a small number who understand the dynamics) and it’s not institutional investors (institutional portfolio allocations to gold are typically about 1–2%).

Instead, the steady buying is coming from central banks (especially Russia and China) and from the super-rich, who typically store their gold in private nonbank vaults in Switzerland and other good rule-of-law jurisdictions.

The drive toward larger portfolio allocations to gold (in some cases up to 10%) is coming not just from the rich themselves but from their wealth managers and portfolio advisers.

This is a sea change.

For decades, wealth managers have rejected gold and pushed their clients into stocks, corporate credit and alternative investments including private equity. Recently all of those portfolio allocations have backfired. Equity markets crashed in March and are set for another fall soon after recovering over half the losses.

Corporate credit downgrades are at an all-time high and that market is being propped up by the Fed in nonsustainable ways. Private equity looks increasingly illiquid as IPO markets dry up and most hedge fund investors have badly underperformed.

This leaves gold as one of the best performing asset classes around.

But it’s still early. Here’s how I expect the process to play out…

As confidence in the dollar is eroded due to Fed money printing and congressional super-deficits, investors gradually look for alternative stores of wealth including gold.

These trends begin slowly and then gather momentum. As the dollar price of gold begins to soar, investors take notice. Even more people invest in gold, driving the price still higher.

Investors like to say that the price of gold is going up. But what is really happening is that the value of the dollar is going down (it takes more dollars to buy the same amount of gold).

This is the real inflation and the real dollar collapse most investors miss at the early stages.

Eventually, confidence in the dollar is lost completely, central bankers need to restore confidence, and they turn to some type of gold standard to do so.

We’re a long way from that point right now.

But if central banks, the super-rich and their advisers are all jumping on the gold bandwagon, what are you waiting for?

Gold’s worst ever bear market (2011–15) is behind us and gold is positioned for new highs of over $2,000 per ounce in the short run and much higher over the next several years.

The time to go for the gold is now.

Regards,

Jim Rickards
for The Daily Reckoning

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Goodbye, Free Market

This post Goodbye, Free Market appeared first on Daily Reckoning.

Fremdschämen.

Fremdschämen is a noun of the German language. It translates this way:

Embarrassment for those incapable of feeling embarrassment.

Today we suffer embarrassment for Mr. Jerome Powell and his fellows of the Federal Reserve…

For no action they take lowers their heads in shame… or blushes their cheeks with embarrassment.

Mr. Powell is simply in the hands of Wall Street… and on his knees to Wall Street.

Well does he know the taste of shoeblack.

Yesterday Mr. Powell got a fresh coat on his tongue. Details to follow.

But first, let us look in on his masters…

A Banner Day on Wall Street

Wall Street was in full roar today.

The Dow Jones jumped an additional 582 points. The S&P gained 58 points; the Nasdaq, 169 points of its own.

CNBC, by way of explanation:

Stocks rose on Tuesday as a record jump in retail sales — coupled with positive trial results from a potential coronavirus treatment and hopes of more stimulus — sent market sentiment soaring.

Government number-torturers reported this morning that May retail sales jumped a record 17.7%.

The chronically erring Dow Jones survey of economists had projected a 7.7% increase.

Yet we are not surprised by the surge. April’s numbers were true abominations. But certain economic restrictions were waived in May.

A trampolining back was therefore expected.

Meantime, a medicine named dexamethasone — a widely available medicine — is evidently effective in the treatment of deathly ill coronavirus patients.

It reportedly axed hospital deaths by perhaps one-third.

Thus the market had its spree today. But it merely added to yesterday afternoon’s joys…

Powell Licks Wall Street’s Shoes

The Dow Jones had been off 762 points in early trading yesterday, quaking with coronavirus-related fear.

But then Mr. Powell sank to his knees… and tongued Wall Street’s wingtips…

For the Federal Reserve announced it intends to purchase individual corporate bonds — not merely ETFs.

By its own admission, it will:

Begin buying a broad and diversified portfolio of corporate bonds to support market liquidity and the availability of credit for large employers.

We will not burden you with the plan’s intricacies. You need only know this:

Yesterday’s announcement “pressed the risk-on button,” as money man Bill Blain styles it…

“Central Banks Are Now de facto Guarantors of the Corporate Bond Market”

Fears about the rising number of reopening coronavirus hotspots and economic threats were superseded by unbounded joy as the Fed announced it will buy secondary market corporate bonds direct[ly] rather than through ETFs, without any need for companies to certify their eligibility. That pressed the risk-on button — and markets recovered.

And so the free market sinks deeper into oblivion:

Central banks are now de facto guarantors of the corporate bond market.

What has all this QE Infinity and ZIRP interest rates created?… Where market prices have become meaningless as a result of financial asset inflation? Where junk bonds are priced like AAA securities, allowing private equity funds to thrive?

I am beginning to wonder if there is any point in thinking about markets any more… Just follow the central banks… don’t think. Just buy.

“Don’t think. Just buy.”

We think the proper advice might rather run this way: “Don’t buy. Just think.”

Yet we do not dispense financial advice.

Picking Winners and Losers

Our own Nomi Prins penetrates to the core of yesterday’s message. Nomi rings dead center when she says:

As if the Fed hasn’t done enough to destroy honest markets, now it plans to start buying individual corporate bonds. It’s just another step closer to the Fed deciding the winners and losers in the market.

Thus the Federal Reserve is a referee who has taken a bribe, a butcher who thumbs the scales, a rogue, a traitor to justice.

A central banker with a conscience might lower his head in shame… and a red flush of embarrassment might stain his cheeks.

Yet Mr. Powell holds his head high and puffs his chest, proud as any peacock.

His cheeks, meantime, are pale.

Yet ours are scarlet — scarlet with embarrassment for the man incapable of embarrassment.

“From Lender of Last Resort to Stockjobber”

The Federal Reserve was originally fashioned to be the “lender of last resort.” Yet that designation is presently a cruel and mocking jest.

It has passed from lender of last resort to stockjobber.

Economist Thomas M. Humphrey is the author of Lender of Last Resort: What It Is, Whence It Came, and Why the Fed Isn’t It.

From which:

While there exists such an entity as the classical lender of last resort (LLR) — the traditional, standard LLR model, to be exact — the Fed has rarely adhered to it… The Fed has deviated from the classical model in so many ways as to make a mockery of the notion that it is an LLR. In short, the Fed may be many things, crisis manager included. But it is not an LLR in the traditional sense of that term.

What is the proper function of the central bank, by Humphrey’s lights?

Six Mandates of Sound Central Banking

As summarized by Wikipedia, a central bank exists to:

(1) protect the money stock instead of saving individual institutions; (2) rescue solvent institutions only; (3) let insolvent institutions default; (4) charge penalty rates; (5) require good collateral; and (6) announce the conditions before a crisis so that the market knows exactly what to expect.

A word of explanation, perhaps, on “penalty rates.”

The central bank should charge interest rates above the market rate.

Otherwise the central bank would be a lender of resort — not the lender of last resort.

A high rate further encourages debtors to retire their debts rapidly… to shake loose the heavy burden as soon as circumstances allowed.

Yet what does the Federal Reserve’s actual record reveal?

(1) “Emphasis on credit (loans) as opposed to money,” (2) “taking junk collateral,” (3) “charging subsidy rates,” (4) “rescuing insolvent firms too big and interconnected to fail,” (5) “extension of loan repayment deadlines,” (6) “no pre-announced commitment.

Professional Incompetence

That is, the Federal Reserve takes sound central banking and knocks it 180 degrees out of phase.

It wars against all six mandates and massively against Nos. 1, 2, 3, 4 and 5.

Imagine a plumber who does not patch leaks but creates leaks… a doctor who does not mend bones but cracks bones… a head shrinker who does not shrink heads but expands heads.

Now you have the flavor of it.

Yet the Federal Reserve’s professional pride is unruffled. It displays no embarrassment, no shame at a job done wrong.

In fact, it believes it is a job done right…

Regards,

Brian Maher
Managing editor, The Daily Reckoning

The post Goodbye, Free Market appeared first on Daily Reckoning.

“Stocks Only Go Up”

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How crazy have markets become lately?

One new investor has said, “Stocks only go up,” while unemployed people are using their stimulus check to trade stocks:

“It was basically free money,” said one of them… “It’s like a gambling game.”

If you want to talk about craziness, just look at Hertz…

Fools Rush In

Hertz filed for bankruptcy on May 22. Then a bizarre thing happened. Some of those newbie investors who had just received their coronavirus stimulus checks opened online retail accounts at brokers like Robinhood and started buying Hertz!

The stock was sure to end up with zero value, but they didn’t care. If you bought it for $1.00 per share and could dump it for $3.00 per share, you tripled your money even if the stock ends up at zero.

That’s crazy enough, but then things got crazier.

Hertz saw its stock price going up and decided to sell $1 billion of stock in a new issue.

Investment bank Jefferies Co. agreed to underwrite the deal. The SEC signed off on the offering document.

Of course, in bankruptcy you have to get approval from the bankruptcy court. Many assumed the judge would put an end to the nonsense, but he didn’t. The judge approved the deal.

Just to be clear, if Hertz raises $1 billion, that money will go straight to creditors. Stockholders will still get zero. That’s why the judge approved the deal, because his job is to help the creditors.

This will be an expensive lesson in bankruptcy law for those who buy the equity, unless they sell to another sucker just in time.

I wish them all well.

Stocks Can Go Down After All

But the frenzied market rally of the past few weeks hit a snag last week. The Dow lost 5.5% on the week, while the S&P gave up 4.7%, making it the worst week since March 20.

I guess stocks go down after all.

The market was down big this morning, extending last week’s losses, before rebounding this afternoon.

But it’s clear that investors are getting nervous about the resurgence in U.S. coronavirus infections, which places the prospects of a V-shaped recovery further in doubt (it wasn’t going to happen anyway).

The Good News

Well, we’ve all lived through the first wave of coronavirus infections (technically the SARS-CoV-2 virus and the COVID-19 disease).

Along with that came an unprecedented economic lockdown that has triggered a global depression.

Even during the Spanish flu pandemic of 1918–19 that killed 100 million people, there was no full-scale lockdown, although many large gatherings, sporting events and concerts were cancelled.

We’re just now starting to come out of our self-quarantines and small businesses are gradually reopening. That’s the good news.

The Bad News

The bad news is we’re hearing a lot about a so-called “second wave” of infections that could bring back another lockdown.

One professor of medicine at the Vanderbilt University School of Medicine has said, for example, “The second wave has begun.”

These concerns are causing market declines and volatility. But I don’t think many people really understand what a true second wave is.

There are new outbreaks of the disease, but these are still part of the first wave. We’re still experiencing the first wave, in other words.

Watch out for the Second Wave

The virus has a predictable pattern in a given locale. That generally means about an eight–10-week course with a peak after five weeks, then a gradual diminution.

But it does not hit every locale at the same time. What’s happening in Florida, Arizona, Texas and elsewhere today is just another version of what already hit New York. It’s just happening later in the timeline because of population density and different lockdown rules.

But again, it’s still the first wave. A true second wave happens after a period of relative calm. The virus mutates into a more lethal form and strikes again.

Those with antibodies from the first wave may do better, but others are highly susceptible to the second wave and the fatality rate can be much higher.

That’s what happened in the Spanish flu a century ago. The first wave was March–June 1918. It was fatal but tailed off quickly. The second wave hit in October 1918 and was much more fatal.

Bodies were piled up like firewood. They ran out of coffins. They ran out of grave diggers. They ran out of graveyards and dug mass graves, wrapped people in sheets and dusted them with disinfectant and threw them in. That’s how bad that was.

COVID-19 isn’t anywhere near as bad as the Spanish flu was. But if we get a second wave, it could be more lethal than the first. It is likely to strike in December 2020. Let’s pray it doesn’t happen, but it’s too soon to rule it out.

The Rise of the Pezzonovante

What we can count on is that power-hungry politicians and bureaucrats will continue to throw their weight around…

Pezzonovante is a colorful Sicilian term famously used in the script for The Godfather. It basically means “big shot” or “self-important.”

It’s used in a derogatory sense to describe politicians who think they’re better than everybody else. One of the unpleasant side effects of the coronavirus lockdown is the rise of a new pezzonovante class among U.S. politicians.

It is true that political figures, especially governors and mayors, do have emergency powers to deal with public health crises or natural disasters. However, all such powers must be conducted in a constitutional framework with consideration for economic, medical and other factors balanced out.

The problem is that every elected official has an inner dictator who can’t wait to start bossing people around with arbitrary executive orders and no due process of law. That’s what’s been happening since the lockdowns began.

State governors were issuing “lockdown” orders, arresting people without face masks and revoking business and liquor licenses from small-business owners trying to earn a living, all without legal authority.

When these neofascist tactics are challenged in court, the state often loses. But not every small-business person can afford the legal fees to bring suit.

The lockdown did slow the spread of the virus and did save some lives, that’s true. But, the gains may only be temporary.

Remember, “flattening the curve” does not mean reducing total infections and deaths. It just means stretching them out over a longer period so the hospital system is not overwhelmed.

Let’s look at one pezzonovante…

An Offer You Can’t Refuse

New York Gov. Andrew Cuomo was responsible for 5,000 unnecessary deaths because he ordered COVID-19 patients to be forced into assisted living facilities where residents got ill and died as a result.

Now he’s threatening to reimpose a lockdown on New York beach resorts and Manhattan if people don’t follow his version of “social distancing” and face mask etiquette.

(Never mind that the science of face masks is not at all clear; many experts take the view that they don’t work and can do more harm than good except for medical personnel who face constant exposure.)

The point is that transparency and good communication with the public combined with voluntary compliance can get the job done. Orders and threats don’t help and prompt many people to do the opposite.

Leaders like Andrew Cuomo will just delay the economic recovery without doing anything to slow the spread of the virus. This is just one example of the new pezzonovante throwing their weight around without concern for the public good.

The “inner dictators” are on the loose and economic recovery will suffer as a result.

Unfortunately, they’re not going away.

Regards,

Jim Rickards
for The Daily Reckoning

The post “Stocks Only Go Up” appeared first on Daily Reckoning.

Why Gold?

This post Why Gold? appeared first on Daily Reckoning.

Why gold?

That’s a question I’m asked frequently. It’s usually followed by a comment along the lines of, “I don’t get it. It’s just a shiny rock. People dig it out of the ground and then put it back in the ground. What’s the point?”

I usually begin my reply by saying, “It’s not a rock, it’s a metal” and then go from there.

I have a lot of sympathy in these conversations. The fact that people don’t know much about gold today is not exactly their fault. The economics establishment of policymakers, academics and central bankers have closed ranks around the idea that gold is a taboo subject.

You can teach it in mining colleges, but don’t dare teach it in economics departments. If you have a kind word for gold in a monetary context, you are immediately labeled a “gold nut,” “gold bug,” “Neanderthal” or something worse. You are excluded from the conversation. Case closed.

IMG 1

Your correspondent holding a gold bar in a vault near Zurich, Switzerland. The bar is a so-called “good delivery” bar under the rules of the London Bullion Market Association. That means the bar weighs approximately 400 ounces, is 99.9% purity (or higher), and has a specified shape and dimensions. The bar I’m holding is worth about $700,000 at current market prices. In 1971 it was worth $14,000.

It wasn’t always this way. I was a graduate student in international economics in 1973-1974. Many observers believe that the gold standard “ended” on August 15, 1971 when President Nixon suspended the redemption of dollars for gold by foreign trading partners. That’s not exactly what happened.

Nixon’s announcement was a big deal. But, he intended the suspension to be “temporary” and he said so in the announcement. The idea was to call a kind of “time out” on redemptions, hold a new international monetary conference similar to Bretton Woods in 1944, devalue the dollar against gold (and other currencies such as the German Deutschemark and Japanese Yen), and then return to the gold standard at the new exchange rates.

I was able to confirm this plan with two of Nixon’s advisors who were with him at Camp David in 1971 when he made the announcement. I spoke to Kenneth Dam (an executive branch lawyer) and Paul Volcker (at the time, the Deputy Secretary of the Treasury). They both confirmed that the suspension of gold redemptions was meant to be temporary, and the goal was to return to gold at new prices.

Some of what Nixon wanted did happen, and some did not. The international conference took place in Washington, DC in December 1971 and resulted in the Smithsonian Agreement. The dollar was devalued from $35 per ounce to $38 per ounce (it was later devalued again to $42.22 per ounce), and the dollar was devalued against the major currencies of Germany, Japan, the UK, France and Italy.

Yet, the return to a true gold standard never happened. This was a chaotic time in the history of international monetary policy. Germany and Japan moved to floating exchange rates under the misguided influence of Milton Friedman who did not really understand the role of currencies in international trade and direct foreign investment. France dug in her heels and insisted on a return to a true gold standard.

Also, Nixon got caught up in his 1972 reelection campaign to be followed closely by the Watergate scandal, so he lost focus on gold. In the end, the devaluation was on the books but official gold convertibility never returned.

All of this monetary wrangling took a few years to play out. It was not until 1974 that the IMF officially declared that gold was not a monetary asset (although the IMF carried thousands of gold on its books in the 1970s, and still has 2,814 tons of gold, the third largest holding in the world after the U.S. and Germany).

The result was that my Class of 1974 was the last class to be taught gold as a monetary asset. If you took economics after that, gold had been consigned to the history books. No one taught it and no one learned it. Gold was still a “commodity” and something that was taught in mining colleges, but not in economics.

No wonder most people today don’t understand gold.

Maybe gold was banned from the classroom, but it was not banned from the real world. In fact, there was another major development just one year after I graduated. In 1974, President Ford signed a law that reversed President Franklin Roosevelt’s notorious Executive Order 6102. FDR made ownership of gold bullion by American citizens illegal in 1933. Gold was contraband like heroin or machine guns.

President Ford legalized it again. For the first time in over 40 years, it was once again legal for Americans to own gold coins and bars. The official gold standard was dead, but a new “private gold standard” had just begun.

That’s when things got interesting.

Now that gold traded freely, we saw the beginning of bull and bear markets, something that doesn’t happen on a gold standard where the price is fixed.

The two great bull markets were 1971-1980 (gold up 2,200%) and 1999-2011 (gold up 760%). In between these bull markets were the two bear markets (1981-1998 and 2011-2015), but the long-term trend is undeniable. Since 1971, gold is up 5,000% even after the bear market setbacks.

Now the third great bull market is underway. It began on December 16, 2015 when gold bottomed at $1,050 per ounce at the end of the 2011-2015 bear market. Since then, gold is up over 65%. That’s a nice gain, but it’s small change compared to 2,200% and 760% gains in the last two bull markets.

When it comes to capital and commodity markets, nothing moves in a straight line, especially gold.

But this pattern suggests the biggest gains in gold prices are yet to come. And right now, my models are telling me that gold is poised for historic gains as the third great bull market gains steam.

Right now gold’s trading at over $1,700. What could push it firmly over $2,000 per ounce and headed higher? There are three main drivers:

The first is a loss of confidence in the U.S. dollar in response to massive money printing to bail out investors in the pandemic. If central banks have to use gold as a reference point to restore confidence, the price will have to be $10,000 per ounce or higher. Any lower price would force central banks to reduce their money supplies to maintain parity, which would be highly deflationary.

The second driver is a simple continuation of the bull market. Using the prior two bull markets as reference points, a simple average of those gains during those durations would put gold at $14,000 per ounce or higher by 2025.

The third driver is panic buying in response to a new disaster. This could take the form of a “second wave” of infections from the Wuhan Virus, a failure of a gold ETF or the COMEX exchange to honor physical delivery requirements, or a victory by Joe Biden in the presidential election.

The gold market is not priced for any of these outcomes right now. It won’t take all three events to drive gold higher. Any one would do just fine. But, none of the three can be ruled out.

These events (and others) would push gold well past $2,000 per ounce, on its way to $3,000 per ounce and ultimately much higher along the lines described above.

Regards,

Jim Rickards
for The Daily Reckoning

The post Why Gold? appeared first on Daily Reckoning.