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Essays 4
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| The Maestro | |||||||||
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| The Main Protagonists |
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March 28, 2008
Short and Long Term Prospects for Gold: Monetary Policy, Elections, and the Iraq War.
Short Term (1-3 months): Lower Gold prices are expected as a continuation of the correction that began recently. This correction started almost immediately following the release on March 18 of the FOMC's (Federal Open Monetary Policy Committee) decision to lower the Fed Fund rate but by somewhat less than the market expected, This decision was due to new concerns about inflation and the Dollar's decline as well as to a burgeoning dissension among Committee members concerning the real need for the proposed interest rate reduction. Such intimations of a greater Fed's restraint in the future conduct of monetary policy promptly led to a Dollar rally and a concomitant retreat not only of Gold but also of Oil and the Euro. This Gold's correction is expected to continue for at least several weeks until the results of additional FOMC's meetings in forthcoming months will be known. It should be noted that the Fed's action of March 18 did not occur in a vacuum but was consistent with a significant body of opinion recently developed among many economists to the effect that the interest rate policy pursued by the Fed was inappropriate as a remedy for the sub-prime mortgage crisis while at the same time inducing a disorderly and inflationary decline of the Dollar.
Short and Long Term Prospects for Gold: Monetary Policy, Elections, and the Iraq War.
Short Term (1-3 months): Lower Gold prices are expected as a continuation of the correction that began recently. This correction started almost immediately following the release on March 18 of the FOMC's (Federal Open Monetary Policy Committee) decision to lower the Fed Fund rate but by somewhat less than the market expected, This decision was due to new concerns about inflation and the Dollar's decline as well as to a burgeoning dissension among Committee members concerning the real need for the proposed interest rate reduction. Such intimations of a greater Fed's restraint in the future conduct of monetary policy promptly led to a Dollar rally and a concomitant retreat not only of Gold but also of Oil and the Euro. This Gold's correction is expected to continue for at least several weeks until the results of additional FOMC's meetings in forthcoming months will be known. It should be noted that the Fed's action of March 18 did not occur in a vacuum but was consistent with a significant body of opinion recently developed among many economists to the effect that the interest rate policy pursued by the Fed was inappropriate as a remedy for the sub-prime mortgage crisis while at the same time inducing a disorderly and inflationary decline of the Dollar.
Intermediate Term (3-12 months): Gold prices are expected
to move sideways to up depending on whether, beyond the short term, the Fed's restraint will prove real or just wishful
thinking, particularly in the face of a probable worsening of both the credit crisis and the economic recession. An additional
factor will be the ECB's (European Central Bank) decisions on monetary policy easing. If 0.25 basis points interest rate
cuts will be implemented in June, September, and December as economists now expect. then the Dollar will find support at the
current level. In this case, Gold prices are likely to remain capped below $1,000 and move sideway for as long as the end
of the year. If the Fed is forced to further lower rates to below 2.0% and the ECB decides not to go along with its monetary
easing, then Gold will be unleashed to new, much higher prices.Long Term (2009 and beyond): There is no mistaking the importance
that a resolution of the Iraq War, or lack thereof, will have on the long term prospects of Gold, not to mention of every
aspect of the US economy and quality of life for all Americans. In this context, to the extent that the results of the coming
Presidential Elections will determine whether or not the War will continue and, if so, for how long, it is not possible to
overstate the importance of who will be elected. As far as the long term prospects of Gold are concerned, the importance of
factoring in the election results and their impact on the prosecution of the War derives quite simply from the fact that the
War has been, and still is, by far the major determinant of the Gold's bull unleashed in the past five plus years. However,
to be absolutely clear about this attribution, it is necessary to add a qualifier to the above statement, namely that the
origin to the Gold bull was NOT just the War but the unwillingness to pay for it. It is the failure to properly fund the war
that resulted in the dramatic appreciation of Gold prices through the transmission conduit of Dollar's devaluation. To
fully understand the veracity and implications of this fact, it is helpful to step back in history and review the two similar
episodes that preceded the present one. The first episode occurred in the late 60s and 70s with the end of the Viet Nam War
which not only was not fully funded but was combined with the launch of the Great Society and the attendant explosion of Welfare
spending and fiscal deficits. The Viet Nam war came to an end but not before the Arabs rebelled against the US regulated oil
prices and the debased currency they were forced to receive so that the immediate benefits of a peace dividend were spoiled
by their unleashing of an Oil crisis in two waves and a consequent inflation spiral. Gold surged from $35 to $850 in few tears.
The Fed was boxed in by the regulated interest rates imposed by Regulation Q and could do little until Congress in 1979 came
around to abolish Reg Q, deregulate interest rates, and approve the appointment of Fed Chairman Volker as the Inflation Dragon
Slayer. Volker wasted no time to slam his now famous anti-inflation monetary hammer which put an instant end to inflation,
the Dollar's decline, and the surging Oil and Gold prices. From 1980 to the end of 1984 the Dollar Index nearly doubled
from 85 to 160. The next and present episodes are graphically illustrated in the Chart below. The Chart is self-explanatory
so that no additional narrative is required except to point out the tremendous impact of the "Peace Dividend" that
followed the end of the Cold War. As soon as the cashing in of this dividend began in earnest in 1996 and fiscal deficits
dramatically turned to surpluses, Gold began a multi-year decline that halved its price. Going back to Gold's long term
prospects, the principal question to be asked then must be: is there any chance that the Iraq War may be ended and another
Peace Dividend be realized by a new Administration fairly soon after Inauguration, say beginning in 2010?. An affirmative
answer will mark a cyclical peak for Gold. A negative one will promise higher and higher Gold prices as far as the eye can
see. With this background, each reader can provide his/her own answer. As far as this page is concerned, it is the Presidential
Tracking Polls that will receive the most careful attention rather than the technical analysis of Gold charts
| USD: Impact of Unfunded Wars and Peace dividends |
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| Data updated to March 28, 2008 |
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