Over the past couple of years, a lot of popular theories related to the demise of gold have been proven false. A popular theory in 2009 was that a “green shoots” economic recovery would cause gold prices to collapse. That was a good one. Then there was the popular “contrarian” argument that the real threat was deflation, and that gold would sell off as a result. That theory is now dead, and Prechterites have gone conspicuously silent.
A Word on Deflationists
Some deflationists have salvaged a modicum of respectability, but only because they recommended gold as an investment that does well in a deflationary environment. They pointed to the Great Depression as an example of a time when gold did well in a deflationary environment. Of course they failed to point out that there was a sovereign debt crisis back then that made hot money flood to the U.S., which was on a gold standard. So they are right, but for the wrong reason. When gold is money, it will rise with deflation. In our current currency setup, gold should fall with deflation. Of course this doesn’t stop these deflationists from using their circular logic that we must be experiencing deflation since gold is rising. So while Prechterites have lost all credibility, there are some deflationists that are still misleading a lot of people. They are recommending buying Treasuries because we can’t technically default on our debt. I’m warning you not to believe these arguments whose false premises are often veiled by esoteric language.
Ok now let’s look into the argument that rising interest rates are bearish for gold.
First of all, gold rose with interest rates back in the 70′s, and this is sufficient to prove that gold doesn’t always fall with rising interest rates. But for an example that pertains more closely to our current situation, look at Greece. They are experiencing massive unemployment, wage deflation, and rising interest rates, yet gold is hitting new highs as Greeks flock to gold. A couple of myths are destroyed by the current situation in Greece: 1) that gold rises with inflation, and 2) that gold falls with rising interest rates.
Debt is inherently inflationary if you have the ability to print your own currency. Greece inflation rates are relatively subdued because they are linked to the Euro; hence the only way they can attract capital is by raising interest rates to obscene levels. Higher interest rates help sustain the never-ending cycle of higher debt servicing costs leading to higher nominal debt levels. There is a better solution to this crisis than making banks whole on their failed investments in Greek debt.
Interest rates on Treasuries will eventual rise because of a collapse of confidence. As you are seeing in Greece, a collapse in public confidence leads to people emptying their savings accounts to buy gold, even at “expensive” prices. In the 1980′s, higher interest rates were more of a policy move by the Fed; this time around it will be the market that forces higher interest rates upon us. These are two totally different scenarios. Gold is bound to rise along with interest rates due to a loss of confidence.
P.S. Just saw a poll on CNBC that said 98% of people have NO CONFIDENCE in the way Bernanke is running the economy. I guess Americans are finally learning.
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