Bernanke Saves the World (for now)

(written September 5, 2010)

Marc Faber has warned investors of all types, but particularly gold bugs, of becoming too dogmatic when they make investment and trading decisions.  Whatever one’s principles in politics, economics, philosophy, and just life in general, the market often moves contrary to what we know in our bones it should be doing.  Why would anybody in their right mind buy a government bond from the US or anywhere else?  Why are otherwise intelligent investors and citizens not putting more money into gold and commodities?

The prejudice against gold—or against rational economic principles, to be more precise—among the intellectual classes makes the gold bugs’ dogmatic attachment to gold investing noble in one respect and, in any case, probably inevitable.  But, there are certain risks in this dogmatism.  For one, when the market moves against us, we tend to become paranoid—our suspicion of Wall Street pseudo-capitalists, egghead academicians, and their hybridized, bastard children who work at the Federal Reserve and central banks around the world gets the best of us.  We see conspiracy and manipulation.  Worse, we lose money and credibility.

These are mistakes we cannot afford.  As Keynes pointed out, failure that springs from contrarianism is judged much more harshly than conventional failure, no matter how catastrophic the latter is, even in our free-thinking, risk-taking age.

With this in mind, I would like to suggest a certain scenario for the economy that those who believe in free markets and sound money should consider as not only possible but perhaps likely over the course of the next, say, two years—roughly until the 2012 presidential campaign, which will probably begin any day now, but nevertheless.

This year, we have seen relative strength in US bonds, gold, the dollar, and the yen.  Since concerns about China’s overheating property market and how the Chinese state would deal with that problem first emerged in the winter, as well as the European crisis, there has been a return to risk aversion.  Fears about stalled economic recovery and defaults in Europe, Dubai, and elsewhere pushed each of these sectors up, not fear of inflation.  And with the more recent weakness in equities and the dismal index numbers, there has been growing concern about the possibility of a double-dip recession.  Again, gold has been strengthening and threatening to overtake its recent record levels.

But, what is remarkable about the last few months is how buoyant equities and oil have remained, despite having every reason for bearishness, and this is indicative, I humbly submit, of a double-dip, but not a double-dip recession.  Moreover, with interest rates as low as they are, negligible likelihood of a tightening by the Fed, and growing pressure in Japan to weaken the yen, all signs point to a resumption of a bullish economy and equity markets.

If that should occur, there is good reason to suspect that risk appetite will return, and that all of the asset classes that have performed relatively well over the course of the year will begin to give up ground.  Although it is still early, I believe we are already seeing this begin to occur with interest rates modestly rising and stock markets responding positively to better-than-expected economic data over the course of the last week.

Should we see resurgent equities markets in the US and abroad alongside weak bonds and gold, there is a strong possibility that the real economy may reignite as well, fueled by the massive amounts of liquidity pumped into the banking system.  We may therefore see falling unemployment, rising property markets, and rising commodities to boot.  In other words, we may see a kind of economic Indian summer over the next year or so, a return to something like the 1990s, followed quickly by exploding inflation and a collapse in the bond market.  In other words, 2011 will look like the Clinton years, but 2012 will resemble 2009 in terms of its extreme volatility.

To push this scenario even further, this extreme economic volatility will likely feed into and feed off of political volatility associated with the 2012 election cycle, which will itself occur in the wake of the 2010 mid-terms and the possibility of a Republican takeover of at least the lower house of Congress.  This kind of economic volatility, a dramatic shift back to economic growth, however ephemeral, and then into a repeat of early 2009 will cause even greater havoc abroad, and one thinks particularly of China.

Now, any reader with half a brain has every reason to greet this kind of speculation with a great deal of skepticism, but even if that is the case, one should nevertheless consider the possibility of a significant period, e.g., a year or so, of a strong reversal in the Dow/gold ratio before the wave of inflation that many of us have been waiting for washes over the world.  Many in the gold camp seem psychologically accustomed to temporary dips in the gold price before it resumes its inevitable rise, but we should also be prepared for more significant moves in gold and other markets that may challenge our faith in our principles.


2 comments so far

  1. […] have argued over the previous weeks that the credit machine is back in working order, despite the rather […]

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