Friday, January 4, 2013

Likely Scenarios that Will Force the Fed to Tie the Dollar to Gold

From Dan Amoss of the Daily Reckoning, originally published in September 2012:

"For years, I’ve expected that at the end of all this central bank printing, we’ll see the end — not a reversal — of quantitative easing programs and a re-pegging of the US dollar to gold at much higher gold prices. A new gold standard would allow the Fed and other central banks to save face after the following sequence of events:

1. Central banks inflate their balance sheets and buy up many of the bonds governments issue to fund soaring budget deficits
2. Once the largest suppliers of scarce products realize they’re exchanging products for infinitely diluted paper money, they start demanding more and more money in exchange for sending their scarce products to the marketplace
3. Consumer prices start rising
4. Calls for monetary tightening (reduction of central bank balance sheets and interest rate hikes) grow louder
5. These central banks won’t be able to slash money supplies without crashing government bond markets and stock markets. They talk about tightening, but don’t tighten
6. As central banks lose credibility, gold launches on a final, near-vertical stage of its bull market
7. In response to inflation expectations running wild, governments and central banks draw up plans to re-peg currencies to gold in order to avoid having to drain trillions worth of cash from the banking system."

In the face of imminent hyperinflation, Dan Amoss postulates that the Fed will back the dollar with gold at some significantly higher price in order to avoid a complete collapse of the dollar. It is reassuring that the Fed can do this, but will it? Another scenario is that some large and important country, such as Germany or China, will back its currency with gold and cause demand for the dollar as the preferred means of international settlement to fall. This will cause prices to rise in the US as overseas dollars start to flow back into the only economy where they must be accepted for all debts public and private. Then the Fed will follow-the-leader of this major country and tie the dollar to gold.

1 comment:

  1. Patrick suggests a gold standard? What about this economic gobble de gook circulating internet:

    "How could Washington avoid a
    debt ceiling default? Mint a few
    trillion dollar platinum coins.

    Platinum Coin Option

    “While raising the US debt ceiling has not gotten as much
    attention — yet — as the risk of falling off the fiscal cliff, it
    soon will. The limit will likely be hit by year end. And if
    Congress fails to raise the borrowing cap, the Treasury
    would likely run out of money-management options to
    void a default some time in the February.”

    “So what to do? Analyst Chris Krueger at Guggenheim
    Securities’s Washington Research Group outlines four
    options. Pay particular attention #4:

    1. Traditional Raise. This would involve a straight raise
    2. in the debt ceiling without any Congressional strings
    3. or new/alternative mechanisms. By using “back of the
    4. envelope accounting” the USA burns approximately
    5. $100B in debt per month.

    “2. Raise by Congressional Disapproval. This is the system
    engineered last summer. Essentially, the Congress passes
    a motion of disapproval to raise the debt ceiling, Obama
    vetoes, and the Congress fails to override the veto. Assuming
    there is not enough votes to override the veto (there are not),
    the debt ceiling is raised.

    “3. Constitutional Option. The debt ceiling forcing mechanism
    could be demolished if Obama invoked the “constitutional
    option” and unilaterally raised the debt ceiling. The 14th
    Amendment of the Constitution states the validity of the public
    debt shall not be questioned. Under this option, Obama would
    invoke the 14th Amendment and unilaterally raise the debt
    ceiling – a move that was encouraged by former President Clinton
    last summer in the height of the debt ceiling stare down. This
    option would trigger a wave of lawsuits and a likely Supreme
    Court decision. The biggest problem with going this route would
    be to – in effect – set up two tranches of Treasuries. Those that
    are not subject to a legal challenge (issued under the old debt
    ceiling) and treasuries that are subject to a legal challenge, which
    would likely trade at a discount.

    “4. Platinum Coin Option. This is even more theoretical than the
    Constitutional Option, though some argue that it is a stronger
    legal option. There are limits on how much paper money the
    U.S. can circulate and rules that govern coinage on gold, silver,
    and copper. BUT, the Treasury has broad discretion on coins
    made from platinum. The theory goes that the U.S. Mint would
    create a handful of trillion dollar (or more) platinum coins. The
    President would then order the coins deposited at the Fed, who
    would then put the coin (s) in the Treasury who now can pay all
    their bills and a default is removed from the equation. The effects
    on the currency market and inflation are unclear, to say the least.
    You would also likely trigger a wave of lawsuits similar to the
    Constitutional Option and create two tranches of treasuries. Both
    this option and the Constitutional Option are VERY low probability

    OK, you got me. The platinum coin option is a new one on me.
    I agree with Krueger that the “effects on the currency market
    and inflation are unclear, to say the least.” I would rather not
    find out.

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    Ed K