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Follow the Money


Bill Fleckenstein and I had a short conversation on Buzz yesterday about gold: we are both bullish (in the long run), but while I believe that the monetary authorities are highly attuned to the price of gold and are playing an active hand in suppressing the price, he believes they are more passive and not intervening.

I made my point for two reasons. First, the price action seems to me to be very unnatural: large periodic spikes down overnight followed by several days of grinding back up in price. It seems there is a large seller insensitive to price (a central bank) knocking the price down until real buyers sensitive to price step in and slowly pick away at the supply, eventually driving the price back up.

A more important reason has to do with why central banks care about the price of gold. I have made my position clear in past articles: the central banks are caught up in round after round of currency devaluation in an attempt to stave off the inevitable consequences of overcapacity in world production. I believe chronic overcapacity (the capacity utilization rate has not improved much: it still hovers around 76% while at this stage of a recovery should be more like 85%) is the result of too much liquidity and too much debt over the years, thus allowing unproductive and inefficient businesses to remain and absorb capital. The by-product is higher and higher debt.

The ironic fact that every country wants to devalue their currency to spur their economies indicates the difficulty of this situation. After years of debt creation, it takes more and more debt to spur increases in economic activity. The devaluation process is manifest in the price of gold: gold appreciates against any currency that is devalued.

The Federal Reserve I believe watches closely the price of gold in all currencies, but especially the dollar. I believe each country who is devaluing is doing the same. Todd brought up "the last sentence", which points out how worried Japan is about the price of gold rallying in yen and the reasons why. Devaluation can lead to a panic out of one's currency, something that would occur if rates are artificially low and the economic output is falling.

Like the U.S., Japan is worried about a flight of capital into gold. As they print more and more yen to buy dollars they risk the same psychological event that the U.S. does: a loss of confidence in a fiat currency. This is why when gold begins to rise against the yen they must consider less purchases of the dollar.
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