The Economic crisis is coming

Billmon notes that Gold is selling at a very high price - currently at over $600 per oz. [See Chart here] The last time it got this high was 1980 and 1981, back when the problems of stagflation and high oil prices helped to kill Carter's attempt at reelection. America learned to deal with the (then) high oil prices, and Carter's 1979 appointment of Paul A. Volcker who tightened interest rates, put the U.S. into a recession and wrung inflationary expectations out of the economy.

High gold prices are a warning. Investors are concerned that the wheels are likely to come off of financial investments that pay fixed interest rates, so they retreat to investments that do not pay interest, but will go up in price as the economy gets worse. It's a defensive move. When things get economically bad, investors first want to avoid losing their investment. Gold fits that bill, even though investing in gold means that an investor is losing any return as long as he owns it. This quote is from Billmon:

[But] it's hard to look at that gold chart and not suspect a much bigger game is afoot. This may be the perfect storm for metal prices, but it's not that perfect. The 1987 stock market crash, the collapse of the Soviet union, Saddam's invasion of Iraq -- none of these events triggered a move even remotely close to what we're seeing now.

Maybe it's just another speculative bubble -- proof that in an age of expandable currencies and deregulated markets, pushing one down sooner or later causes a new one to pop up somewhere else. But gold is no ordinary get-rich-quick scheme, like Google stock or beachfront condos. It's still a monetary asset, comprising a not insignificant share of total central bank reserves. For the price to be moving like this, it's highly likely (approaching near certainty) that some central bankers somewhere are trading their surplus dollars -- lots of them -- for gold bars. I can think of a few candidates, and they don't all wear turbans or live in Tehran.

If you're familiar with the fact that the United States is the world's largest debtor nation, and the only one privileged to borrow such huge sums in its own currency, you already understand the Enron-like implications. If not, here's some background reading -- here and here and here.

One way to put it is to say that the insiders in charge of the world's only superpower are going massively short their own stock -- have been for years. What's more, management is starting to talk about launching another hostile takeover, once again financed with junk bonds. Some of the non-voting shareholders have decided it's time to lighten up their portfolios.

In economic terms, though, what we're really looking at is a enormous pump (the U.S. current account deficit) connected to an equally huge pipe (the Federal Reserve) that has been flooding the world with dollar liquidity. This is lifting everything that can float -- oil, gold, real estate, even equities. Things that can't float -- like bonds and non-interest bearing dollar accounts -- are being submerged. And some of our creditors are, not unreasonably, swapping one for the other.

Globalization seems to be preventing inflation. So far. The Dollar is dropping against the Euro and the Yen a little bit, but not enough to significanly cut the trade deficit.

The People's Bank of China is still buying U.S. government bonds rapidly enough so that we can coninue to buy their products without causing inflation, but this simply cannot last. It has to stop some time, sooner rather than later, and when it does the world economy is in real danger of the wheels coming off.

What's the solution? At the moment, I have no idea. I hope that some bankers and politicians in China and in the U.S. have some workable plans, but my suspicion is that all they have is hopes that the problem can be eased off of, or that the collapse will occur after they are out of office and not responsible.

For myself, my income is tied to the Consumer Price Index, and my mortgage is a 30-year fixed rate. Beyond that, I join the sages in their hope for better days.