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It is Official: The Fed Will Print

December 13, 2002

In July, while stocks were being pummeled, the price of gold also suffered a sharp decline, dropping below $305. In our July 16 commentary, titled A Line in the Sand (see below), we warned gold investors not to be "shaken out." The commentary was so titled because we believed that the Plunge Protection Team had drawn a line in the sand at $330.

With stocks literally collapsing, the PPT could not have gold skyrocketing. That would have meant that the powers that be had lost control. And, since July, gold had been unable to better its May highs--until Thursday when it shot straight from $326.50 to $333.10.

Thursday’s action was the result of demand finally overwhelming the PPT’s efforts--at the $330 level. The PPT has not folded its tent, however. More likely, it has retreated and will attempt to stymie gold’s advance at a higher level. Gold may advance to $350 over the next few weeks, as predicted by the most rabid gold bulls, or it may slug its way higher. One thing is clear, though. Gold slammed through the feared $330 level in great form.

The culmination of many developments convinced investors to buy enough gold to push back the PPT’s forces. Yet, the dollar’s weakness played a major role.

In February, the dollar began a steady decline that stopped just short of falling below 104 in July, nearly a 14% fall in only six months. Worries about the swelling balance of trade deficit were undoubtedly the primary reason for the fall. Since then, however, another load has been heaped on the back of the dollar.

Concerns about deflation (falling prices) and fears that the US economy may become mired--as has Japan’s--have moved the Federal Reserve to action. Since March, the Fed has increased the broad M3 money supply 5.8%, and over the last seven weeks, has pumped money into the system at a 15%-annualized rate. These are huge numbers for M3. As if such increases were not enough to prove the Fed’s intent to stave off deflation, recent statements by Dr. Ben Bernanke, the newest member the Fed’s Board of Governors, lay out the central bank’s intent: The Fed will print whatever quantity of dollars needed to defeat deflation.

Speaking last month at the Economist Club in Washington, Bernanke delivered a speech titled Deflation: Making Sure "It" Doesn’t Happen Here. An excerpt from that speech:

"As I have mentioned, some observers have concluded that when the central bank's policy rate falls to zero--its practical minimum--monetary policy loses its ability to further stimulate aggregate demand and the economy. At a broad conceptual level, and in my view in practice as well, this conclusion is clearly mistaken. Indeed, under a fiat (that is, paper) money system, a government (in practice, the central bank in cooperation with other agencies) should always be able to generate increased nominal spending and inflation, even when the short-term nominal interest rate is at zero.

"The conclusion that deflation is always reversible under a fiat money system follows from basic economic reasoning. A little parable may prove useful: Today an ounce of gold sells for $300, more or less. Now suppose that a modern alchemist solves his subject's oldest problem by finding a way to produce unlimited amounts of new gold at essentially no cost. Moreover, his invention is widely publicized and scientifically verified, and he announces his intention to begin massive production of gold within days. What would happen to the price of gold? Presumably, the potentially unlimited supply of cheap gold would cause the market price of gold to plummet. Indeed, if the market for gold is to any degree efficient, the price of gold would collapse immediately after the announcement of the invention, before the alchemist had produced and marketed a single ounce of yellow metal.

"What has this got to do with monetary policy? Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation....... If we do fall into deflation, however, we can take comfort that the logic of the printing press example must assert itself, and sufficient injections of money will ultimately always reverse a deflation."

There you have it. The Fed will print whatever dollars needed to stave off deflation, even at the risk of driving the value of the dollar to zero. Inflation--whatever definition you choose to use--lies in our future. With the Fed taking such a position, the dollar is bound to fall further, perhaps through the 104 level as gold went through the $330 level. Consequently, the prices of gold and silver are bound to rise.

Readers should not make the mistake of thinking that just because Dr. Bernanke is the newest member of the Fed Board that his comments are not significant. Lightweights do not get appointed to the Board of the Federal Reserve. Before his appointment, Bernanke was the Chairman of the Department of Economics at Princeton, was the Director of the Monetary Economics Program of the NBER (National Bureau of Economic Research), and the editor of the American Economic Review. He coauthored a widely used textbook on macroeconomics and is well-respected in economic circles. John Mauldin says he will be one of the more influential governors.

Further, Greenspan undoubtedly approved Bernanke’s speech. Greenspan may speak off the cuff, but Board members do not, especially on such weighty matters. And, Greenspan reiterated that the Fed would do whatever necessary to defeat deflation. Shortly after Bernanke delivered his paper at the Economist Club, Greenspan said, "Governments, including central banks...have the responsibility to prevent major financial market disruptions through development and enforcement of prudent regulatory standards and, if necessary in rare circumstances, through direct intervention in market events."

Direct intervention in market events means the Fed can monetize anything it wants--bonds, stocks, real estate, home mortgages, car loans, whatever. [When the Fed monetizes something, it simply prints (creates) the dollars to buy that something, which used to be only US Treasury debt but now can apparently be any financial instrument. Viola! Fed purchases are turned into money or are monetized.]

If a member of any other central bank’s board had made similar remarks--about printing its currency until it was driven down in value--that currency would have collapsed. But, here we are talking about the currency of the most powerful country in the world. Yet, there will be consequences, i.e., a lower value for the dollar, because the Fed has said that a weakened (devalued) dollar will be used to defeat deflation. With such policies, how can anyone say gold and silver are not the appropriate investments for the times?

Call CMI at 1-800-528-1380 for answers to any questions or clarifications.  Our hours are 7:00 a.m. to 5:00 p.m. Mountain Standard Time, Mondays through Fridays.  Our offices are in the middle of the Phoenix, Arizona financial district.  CMI has had the same bank account since its inception in 1973.  References available on request.  http://www.certifiedmint.com

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