When the US Congress passed its US$787 billion stimulus package last week, the
size of the plan caused many observers to forget the water that has already
passed under the bridge. Fewer still are wondering what havoc will erupt when
all this liquidity eventually washes ashore.
The latest spending, signed into law this week by President Barack Obama, came
on top of $300 billion committed to Citigroup, $700 billion for Troubled Assets
Relief Program 1, $300 billion for the Federal Housing Administration, $200
billion for the Term Auction Facility and some $300 billion for mortgage
guarantors Fannie Mae and Freddie Mac. Just over the past six months, which
excludes the initial George W Bush administration
stimulus and several massive, unfunded Federal guarantees, nearly $5 trillion
has been committed by the government to the financial industry. Rational
observers cannot be faulted for concluding, despite administration claims to
the contrary, that the government is merely throwing money at the problem.
Although the rhetoric has managed to convince many observers of the possibility
of success, the gold market appears to clearly understand the implications of
this unprecedented spending.
The feeling that the government has no idea how to proceed has created palpable
panic. In response, pragmatic investors are seeking the ultimate store of
wealth. In 2009, as has occurred countless times throughout history, that store
will be stocked with gold. Thus, whether the Federal government's interventions
will succeed or fail will be anticipated by the price of gold. Right now, the
market is screaming failure.
Prior to the latest round of Federal spending, the Federal government had
committed $4 trillion to postpone bank collapses and to lay the groundwork for
subsequent restructuring. But has any of this activity actually rescued the
banking system? In light of the evidence of deepening recession, is it likely
that the additional $787 billion in the latest stimulus will instill enough
confidence to restore economic growth? If not, what damage will it do to the
Congressional rescue packages rarely work. Nevertheless, Congress is turning up
the heat with previously unimaginable increases of government debt to fund
stimulus and rescue packages. Senator John McCain rightly describes the scheme
as "generational theft". Each package of debt will encumber many future
generations, halt restructuring and also threaten latent hyperinflation.
While Congress claims that the seriously over-leveraged economy is in desperate
need of restructuring, it appears blind to the fact that deleveraging will
encourage such restructuring. Instead, Congressional leaders actively seek to
increase leverage and add debt. They warn of fire, while pouring petrol on the
The seriousness of the situation is magnified by the rapidly increasing scale
of the problem. Just this week, the release of the latest minutes of the
Federal Reserve confirmed that even that bastion of eternal optimism is
sobering. The American economy, which shrank by 3.8% in the last quarter of
2008, is forecast to decline by some 5.5% in the first quarter of this year. In
some pockets, the unemployment rate is already in double figures. Despite
massive government spending on rescue and stimulus, the American consumer
clearly is becoming increasingly nervous, and the credit markets show few signs
With bad news only getting worse, investment markets are turning into
quagmires. The Dow Jones Average is testing new lows, and the commodities
markets show few signs of life. In such times, the price of gold should fall
along with the prices of other assets and commodities. But, the reverse has
occurred. In the past two months, gold has staged a remarkable rally. This is
despite the activity of price-depressants such as official gold sales by the
International Monetary Fun and official "approval" for massive naked short
positions to be opened by new "bullion" banks.
Not only have gold spot prices risen in the face of such selling pressure, but
the price of physical gold is now some $20 to $40 per ounce above spot. This
would indicate that investors are now so nervous that they are insisting on
taking physical delivery.
Make no mistake, the economy will not turn around soon. When the recovery fails
to materialize, look for governments around the world, and especially in the
US, to send another massive wave of liquidity downriver. When it does, the
value of nearly everything, except for gold, will diminish. Don't be
intimidated by the recent spike in gold. Buy now while you still can.
John Browne is senior market strategist, Euro Pacific Capital.
(Euro Pacific Capital commentary and market news is available at
http://www.europac.net. It has a free on-line investment newsletter.)