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Gold post bubble Original Source Link: (May no longer be active)
http://www.gold-eagle.com/gold_digest_01/milhouse021701.htmlhttp://www.gold-eagle.com/gold_digest_01/milhouse021701.html
Gold, Deflation, and the Fed
The following are slightly-modified extracts from recent commentary that appeared at The Speculative Investor web site.
Gold in a post-bubble environment
Under the present fiat-money system, with central banks having the power to create an unlimited amount of currency, true deflation (a decrease in the total supply of money) is almost an impossibility. Subsequent to the removal of all official links to gold, the closest any country has come to a prolonged period of deflation is Japan during the 1990s. Therefore, the aftermath of the Japanese bubble provides us with the only empirical evidence of what to expect, as far as the gold price is concerned, during a period of deflation.
Below is a chart showing the Yen gold price from the beginning of 1988 through to the end of 1995. It shows that a) during the final year of Japan's bubble the Yen gold price rose 20%, and b) during the 5.5-year period beginning from the point at which the bubble burst, the Yen gold price fell by almost 50%.
The above empirical evidence is consistent with our thinking on the matter. When gold was officially linked to the national currencies (pre-1971), it was a hedge against deflation and would lose purchasing power during periods of inflation. When gold was 'set free' it became a hedge against inflation (or, more to the point, a hedge against the loss of confidence brought about by inflation).
We are, however, medium and long-term bullish on gold because:
a) In Japan a deliberate attempt was made, once the extraordinary excesses were finally recognised by the bureaucrats at the central bank, to deflate the bubble. In the US it appears that an all-out effort is being made by the monetary authorities to prevent the deflation of the bubble. The recent interest rate cuts are a pre-emptive strike and, at this stage, the credit bubble lives on. We expect to see major weakness in the US Dollar and strength in the USD gold price prior to the eventual bursting of the bubble.
b) When the US credit bubble does finally burst the response of policy makers will almost certainly be more of the same, that is, liquidity will be maintained at all costs.
c) We are probably now in the early stages of the up- (inflationary) phase of the Kondratieff Wave (55-60 year cycle). Since the price-fixers at the Fed were able to maintain inflation at consistently-high levels throughout the 18-20 year deflationary influence of the Kondratieff Wave, just imagine what they will be able to achieve with an inflationary wind at their backs.
Further to the above, we don't think anyone should be concerned that the US is about to embark on a prolonged period of deflation.
The Fed - Armed and Dangerous!
The cutting of official interest rates may or may not work to support the stock market and prolong the US expansion (or, at least, help sidestep a severe recession). However, contrary to popular opinion, interest rate cuts are not the Fed's main weapon - they are its first weapon. Another weapon in the Fed's arsenal is the power to reduce the reserve requirements of private banks - all the way to zero if deemed necessary. But this, once again, is not its most potent weapon.
The Fed's most effective weapon, should all else fail and it finds itself fighting a losing battle against the forces of deflation, is its power to purchase loans and other assets from private financial institutions. The following passage, taken from Bob Woodward's book "Maestro", discusses the tactics contemplated by Greenspan and the Fed in the immediate aftermath of the 1987 stock market crash and highlights the extraordinary power of the US central bank.
"They [the Fed] had the legal power to buy up the entire national and private debt, theoretically infusing the system with billions, even trillions, of dollars, more than would ever be necessary to restore liquidity and credit. Of course, the result of that would be Latin American-style inflation.
In addition, there was an ambiguous provision in Section 13 of the Federal Reserve Act, the lawyers told Greenspan, that could allow the Fed, with the agreement of five out of seven members of its board, to loan to institutions - brokerage houses and the like - other than banks. Greenspan was prepared to go further over the line. The Fed might loan money, but only if those institutions agreed to do what the Fed wanted them to do. He was prepared to make deals. It wasn't legal, but he was willing to do it, if necessary. There was that much at stake. At that moment, his job was to do almost anything to keep the system righted, even the previously inconceivable." [emphasis added]
When the US credit bubble eventually unravels, the major risk faced by the US will not be deflation - it will be hyper-inflation.
Steve Saville
Hong Kong
17 February 2001
The reader is invited to respond to Mr. Saville's wisdom via email:
sas888@netvigator.com
Regular financial market forecasts and analyses are provided at our web site:
http://www.speculative-investor.com/new/index.html
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