http://www.economicpolicyjournal.com/2011/08/case-for-25000-per-ounce-gold.html
I came across the above link (article text below) on Robert Wenzel's site yesterday. My comments are in bold & italics. I'm hoping some people will want to address my questions or make additional comments.
Gold is trading off a bit from its recent high of $1,800 per ounce. This does not surprise me. Whenever a stock or commodity picks up strong momentum, short-term traders jump in for the ride. These short-term traders hold no fundamental understanding of why a commodity or stock is going up, they are just along for the price action. Since they have no fundamental underpinning for their purchase, when there is some short-term downward pressure, they sell because of that downward pressure. Indeed, in the EPJ Daily Alert I have warned that a $500 per ounce drop in the price of gold could occur. It could occur now, or when gold hits $2,500 per ounce. But this selling will have no relevance to the long-term price of gold,which likely will be much higher. Here is my case for a much higher gold price. It has often been said that gold climbs with the price level that 100 years ago you could buy a very nice suit for an ounce of gold and that you can do the same today. That was true, but I think things are about to change. Over the last roughly 50 years, gold has been accumulated by gold bugs. As prices climbed, gold bugs saw their incomes climb as well and thus they had more money to spend on gold. Thus, the price of gold climbed roughly in line with the price level. This is now changing. Can someone explain this without using the term "gold bug?" Or explain what constitutes a "gold bug." The gold bugs are still in the game, but they have company. Central banks have become net buyers of gold, as have many others. The crises in Europe has caused many overseas to seek gold out. And in the United States, the possibility for many new gold buyers emerging is very strong. During the inflation of the 1970's, gold climbed in price, but this only really started after President Ford made gold once again legal to own in the United States. It took much of the 1970's for people to realize that gold was an important inflation hedge. But now after we have that lesson under our belt and the recent decade long climb in gold from roughly $250 per ounce to $1,800 per ounce, most in America understand that gold is a very important inflation hedge. Yet the number of Americans who actually own gold is likely under 10%. The question must be asked, "What happens if price inflation really accelerates at some point, as it is likely to do?" The answer most likely is that many more will flock to gold. In the old days, if price inflation pushed prices up over a few years by 100%, gold would likely climb by as much. Based on its present level it would climb to roughly $3,000 area, as gold bugs continued their steady buying. But what if the next massive price inflation brings with it a flight away from the dollar as a reserve currency and causes the number of owners of gold in the United States to climb from under 10% to, say, 50%? This would result in huge new demand for gold. Instead of stopping at $3,000 per ounce, gold would be a multiple of that price. $25,000 per ounce would not be out of the question. It's possible that the new demand for gold could be so great that an ounce of gold instead of resulting in buying one good suit, could allow you to buy two or three good suits. I understand his point about increased demand, but I don't understand why the USD losing its status as reserve currency will result in that much increased demand. Bottom line: Greater price inflation is likely to boost the price of gold, just because of more gold buying from gold bugs, but the next great wave of inflation is likely to result in lots of new buyers. Stepped up buying by central banks, buying by the very wealthy and buying by the average American. Will such a price inflation come? The United States is already pumping money at very strong levels, six percent plus. The euro crisis may result in printing by the European Central Bank, which will magnify on a global scale price inflation. The printing in the United States will likely be enough to push gold much higher. If the ECB does the same, we could be very near global inflation---something never seen on this planet before. If global inflation occurs, $25,000 per ounce may be a conservative estimate as to where gold climbs. In other words, don't sell your gold coins just yet, in the next round of inflation, there is likely to be a huge new group of lawyers, doctors, corporate executives and business owners buying gold. They will drive the price to currently unimaginable levels.
I think it's a convinving summary. Does anyone have any constructive thoughts? Or like to play devil's advocate?
1. Gold Bug is a (sometimes pejorative) term used to describe investors who are very bullish on buying the commodity gold (XAU - ISO 4217).
2.
I understand his point about increased demand, but I don't understand why the USD losing its status as reserve currency will result in that much increased demand.
Because instead of China and everyone else using dollars to buy and sell oil and other things from each other [=dollar being reserve currency], they will find no use for the dollars in their everday affairs. Thus they will just spend them all in the USA. So all the dollars scattered around the world will come back here, creating high inflation [by law of supply and demand], meaning dollar loses tons of value. So peopl ewill dump their dollars and try to find something to buy with those bucks that will retain its value, i.e. gold [among other things].
3.
Does anyone have any constructive thoughts?
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It's easy to refute an argument if you first misrepresent it. William Keizer
Don't forget that the world's debt markets operate with the good 'ole USD. All of the countries that make payments to the IMF or World Bank need USD's to do so. The USD losing that status would drop demand for the Dollar as holdings for virtually every financial institution on the planet, which will mean those notes rush back into our markets and cause inflation.
Dave and Aristophanes,
I was recently having a talk with someone about the implications of the USD losing its reserve currency status. I said something like this to him:
The USD is currently being used as the world’s “reserve currency” and I understand this to mean that it is held in large quantities by foreign governments and global institutions as part of their foreign exchange reserves and that international commodities such as oil and gold require possession of USD to trade. Also, all countries that make payments to the IMF or World Bank need USD to do so. The USD losing this status would cause a sizable decrease in the amount of USD that foreign governments and financial institutions choose to hold. But these USD need to go somewhere. So these foreign governments and financial institutions will spend the dollars in the US. The dollars which were once scattered around the world will rush back into the US and create high inflation and the value of the dollar will decrease further. And it will be an interesting scenario as investors will be looking to trade their dollars in search of things that will retain their value.
If this were to actually happen, my guess is that individuals who believe in the Fed’s ability to effectively control the money supply would say that the Fed will step in to shrink the money supply, but I am becoming suspect of their ability to do this effectively.
This person said that he thinks the likely scenario will be some sort of "basket" of reserve currencies which will be agreed upon by the US, China, Eurozone, UK, Japan, etc. Each currency would be used to some percentage in transactions which, today, require dollars.
To this I said that it would still leave the issue of dollars flowing into the US economy from abroad when they are no longer needed or desired as the "reserve currency" compared to the extent they are needed and desired today. To this he said "well the Fed can always take dollars out of the system, and by the time this actually happens, economic conditions will likely be very different from today, and the Fed will have no problem enacting tighter monetary policies to avoid the inflation."
My thoughts are that I am very suspect of both the Fed's willingness and ability to take dollars out of the system/ enact tight monetary policy. I mostly doubt their willingness. The political effects of this are incredibly unpopular and the public seems to be getting more and more convinced that the Fed can print money for as long as it would like without any consequences, and therefore there would be huge political pressures to keep monetary policies loose "forever." I also think the economy will not recover to a point where GDP is increasing at a significant enough rate for anyone who currently works at the Fed to finally say "Ok, NOW we can raise rates."
How do you guys feel about his response? Any other thoughts?
JH,
I don't know much about it, but it seems to me you have it right. I'll add a comment or two to the persons reply.
"well the Fed can always take dollars out of the system...
I don't really understand how the Fed takes money out of the system. I think it's by selling bonds etc. from their huge pile. They then erase the money they got for those bonds out of existence [just as they created the money used to pay for the bonds in the first place into existence].
So if we are talking about many many trillions of dollars in bonds that the Fed will have to sell. Who will buy them?
and by the time this actually happens, economic conditions will likely be very different from today,
How will they be very different? And why will things be better, or better suited to the Fed taking dollars out of the system?
and the Fed will have no problem enacting tighter monetary policies to avoid the inflation."
What are tighter monetary policies? It can only mean very high interest rates. And how exactly will the US govt be able to pay those high interest rates on the national debt? How will banks make money? To whom will they lend? How will homeowners pay off their mortgage? Or consumers their credit card debt?
Smiling Dave, I am thinking along the same lines as you. I don't understand a lot about how the Fed actually implements any of its policies. I may start a separate thread with some questions on it.
I don't understand how the process of Fed asset purchases/sales works. I'm looking into it. My guess is that they offer the treasuries (which they currently hold on their balance sheet) at a yield which is higher than where treasuries are currently trading to a group of banks and then these banks will want to buy the treasuries because they are being offered at a discounted price to where treasuries are trading currently. Just my guess but I haven't thought it out well.
We didn't get into any of the reasons of why economic conditions will be better suited to the Fed taking dollars out of the system. To be honest, my read on his response was that because this person is older than I am, the tone of his response was as if he were saying: "You're a young kid who thinks that this recession will last forever. I'm older and have lived through recessions and this one is going to end sooner or later." He made me feel as if I were being presumptuous to state that the outlook for economic growth and employment are not favorable given policy "stimulus" responses and government debt levels.
All good questions for which I have not yet thought out any answers.