Bernanke Talks and Gold Tumbles

Ben Bernanke spoke today and markets reacted.  As this article notes, “Bernanke’s comments suggest that the Fed has made no decisions about another round of quantitative easing – sure to be nicknamed QE3.”  The price of gold tumbled.  The gold ETF (symbol: GLD) fell $9.20, which translates to about a $92 decline in the metal.  Gold is now around $1,700 per ounce after several weeks of steady gains.

The most amazing thing about this is how sensitive the price of gold is (in terms of the dollar) when Bernanke speaks.  It just shows the power of one person (or one committee).  There is no reason it should be this way.

This also shows that the price of gold in terms of dollars is not only a reflection of past monetary policy, but also a reflection of expectations for future monetary policy.

This is where gold is really different from consumer prices.  Consumer prices such as food and clothing are more likely to rise because of past increases in the money supply.  Gold on the other hand is more likely to rise because of expectations of a coming increase in the money supply.  It is not to say that food and clothing do not take the future into account, but just that it does not seem to be as great of a factor as it is for gold.

These roller coaster rides in the price of gold will likely continue.  I still think that as long as the economy does not drop off a cliff, then the gold price will likely go higher.

The federal government is in major trouble.  The debt-to-GDP ratio is now over the 100% mark.  The yearly deficits are over one trillion dollars and it is only going to get worse with the unfunded liabilities of Medicare and Social Security.  The government is going to try to default through inflation first.

I just don’t see the Fed saying “no” to the government right now.  If the U.S. government needs someone to buy its debt, then the Fed will buy.  If the Fed doesn’t buy, then interest rates will rise and the government will be forced to severely cut spending.  That is why the Fed will say “yes”.

There will eventually come a time when the Fed says “no”.  It will be when the dollar is threatened.  It will be when we see double digit price inflation as we did in the 1970’s.  At that point, I expect the Fed to stop buying U.S. government debt for a while.  That is when you will see a severe cut in spending.  That is when you will see a depression.  That is when you want to sell some of your gold investments and take your profits.