Which is overvalued, the dollar or gold?

A recent bulletin from a major Swiss Bank argues that the price of gold has never been higher, that its price has peaked, that the run up was driven by fear, that fear is now waning and it is time to sell gold.

The problem with comparing the price of gold in dollar terms today and its price in the past is that it ignores dollar inflation.  The price of gold today is around $1,600 per ounce.  It peaked in dollar terms roughly a year ago at just under $2,000 per ounce.  Prior to the recent run up, the peak price of gold at year end occurred in 1980 at $612 per ounce.  So, let's look at the price of gold today, taking into account dollar inflation since 1980.

First let's look at the government's own Consumer Price Index.  In December 1980 the CPI stood at 86.3.  In January 2013 it was 230.3. (This is hardly believable; i.e., that prices have gone up only 2.7 times since 1980.)  Nevertheless, adjusting for the CPI increase since 1980, the price of gold today should be $1,633...about where it is right now.

But now let's look at inflation of the money supply.  In 1980 M1 was $.420 trillion and M2 was $1.605 trillion.  As of January 2013, M1 is $2.470 trillion and M2 is $10.445 trillion.  So, taking into account the great inflation in M1 and M2, the price of gold should be either $3,600 per ounce (M1 equivalence) or $3,983 per ounce (M2 equivalence) for the price of gold, IN DOLLAR TERMS, to match its price at year end 1980.

Another way to look at the relationship between the dollar price of gold and dollar inflation is to calculate gold's dollar coverage price; i.e., for the Fed, which owns 262 million ounces of gold, to back the dollar in gold and make it truly redeemable, it would be forced to set the price at either $9,427 per ounce (M1) or $39,866 per ounce (M2).  In other words, at any lower price the Fed would not be able to redeem all of its dollars.

One last thing.  In 1980, Paul Volcker was clamping down on the US money supply and would drive interest rates to over 20%.  Ronald Reagan continued the Carter deregulation policies, and he reduced taxes and slowed government spending.  The forces that drove the price of gold to $612 in 1980 were arrested by the policies of Paul Volcker, Ronald Reagan, and, to some extent, by Jimmy Carter.  But today government policy is pursuing the opposite of all four of these beneficial policies.  It is pursuing the same policies that drove the price of gold to its previous peak in 1980., but there are no politically powerful voices advising monetary restraint.

So, which is overvalued today--gold or the dollar?

My letter to the Wall Street Journal re: If Bernanke were your doctor...

Re: Bernanke Defends Easy Money Policy

Dear Sirs:
Bernanke's easy money policy is a complete failure, simply reigniting another bubble, even bigger than the last, that will burst as surely as did all previous ones. Easy money disrupts the time structure of production, sending scarce capital to chase long term investments for which there are insufficient resources for their completion. The Fed has learned nothing. It is stuck in a Keynesian mindset that accepts no alternative explanation of how an economy works. It is all "aggregate demand", fostered by money printing to create a false sense of wellbeing. If Bernanke were your doctor, he would advise you to cure your fever by placing the thermometer in the refrigerator.

My letter to the Wall Street Journal re: What determines currency exchange rates

From: patrickbarron@msn.com
To: wsj.ltrs@wsj.com
Subject: What determines currency exchange rates
Date: Fri, 22 Feb 2013 12:30:24 -0500

Re: On currencies, what's fair is hard to say

Dear Sirs:
The main determinant of currency exchange rates is purchasing power parity. In a currency market without government interventions a currency will be bid up or down so that the cost of export goods is equalized net of shipping, insurance, and other costs of moving goods internationally. In a currency market that is manipulated by governments, currencies will have an additional cost or benefit associated with the public's expectation that a currency will or will not suffer debasement in the future, thus losing purchasing power. For example, in the past year holders of euros, fearful that their currency would be debased, exchanged their euros for Swiss francs, but received fewer and fewer francs for their euros over time. The Swiss export industries lobbied their government to debase the franc in an attempt to prevent the franc from trading higher against the euro, causing them to lose sales. This process is being repeated all over the world, as central banks print more and more of their currency in order to placate export industries. The tragedy is that any export sales from currency debasement are paid entirely by that country's citizens in the form of higher prices, what the popular press calls "inflation". The exporters get the newly printed money before prices go up, but the rest of society gets the new money (if it gets it at all) only after prices have risen. Eventually the newly printed money finds its way throughout the economy, causing higher prices for resource replacement and removing any advantage to the exporter. At that point the exporter demands a new shot of monetary expansion. And round and round we go, until a general collapse in all currencies.

The real bailout of Greece comes from the ECB

From today's Open Europe news summary:

Greece set for next tranche of bailout funds as another strike brings country to a standstill
Separately, the euro working group meeting today, is expected to approve the release of the next €2.8bn tranche of bailout funds for Greece, due at the end of the month.  Kathimerini Kathimerini 2 FT WSJ Kathimerini 3

The next tranche of bailout funds for Greece is merely a shadow of the total support coming from the European Central Bank in the form of TARGET2 credits. The balance sheet of the Bank of Greece shows a one hundred billion euro liability to other eurozone banks, an amount that has grown from almost nothing ten years ago. The Bank of Greece buys Greek debt and uses it as collateral for euro borrowing from the ECB. There is no practical limit to this borrowing; the other members of the eurozone have voted to allow the ECB to lend unlimited amounts to support its members national central banks. This places the concept of charity on its head; i.e., the recipient gets to decide how much he wants rather than the contributor deciding how much he wants to give.

Using language to obsure the true meaning of things

From today's Open Europe news summary:

Commission to examine plans for eurozone fiscal union as part of agreement on new economic governance rules The Council of Ministers and the European Parliament yesterday reached an agreement on the ‘two-pack’ rules for eurozone economic governance, which will see countries having to advise Brussels of their budget plans and give the Commission greater oversight of struggling economies. As part of the agreement the Commission will set up a working group to look into the formation of a debt redemption fund or other forms of debt mutualisation in the eurozone.
CityAM WSJ EUobserver European Voice Volkskrant Irish Times

Part of the euro-elite's march to forming a eurozone fiscal union is to use words whose meaning are not always clear. What exactly is "oversight" of struggling economies? And what is a "debt redemption fund" for the "mutualization" of debt in the eurozone? Notice the use of language to disguise true intentions. The word "oversight" sounds so professional, but what does it mean and can it be effective? What is most important is to hide from the public that fiscal union means that Germany and the few other relatively responsible nations will have to shoulder the debt of the many irresponsible nations...probably forever and in increasing amounts. Think not? What is to prevent it? Nothing.

What is the meaning of "more Europe" and "European ambitions"?

From today's Open Europe news summary:

German opposition leader: Merkel entered an “unholy alliance” with Cameron over the EU budget
Former French Minister: The Anglo-German axis is an extremely important diplomatic shift In a debate in the German Bundestag this morning, Chancellor Angela Merkel said that Germany has achieved all its goals in the EU budget negotiations, including an overall reduction, warning that she expects difficult negotiations with the European Parliament. SPD’s Chancellor Candidate Peer Steinbrück criticised Merkel for engaging in an “unholy alliance” with the British Prime Minister David Cameron, adding that “if you want more Europe in the future [Germany] needs partners who see its future in Europe.” FDP faction leader Rainer Brüderle hit back at Steinbrück saying that “I am glad that our Chancellor Angela Merkel negotiated [in Brussels] and not Peer Steinbrück who sometimes is described as a diplomatic neutron bomb.”

Meanwhile, Former French Environment Minister Jean-Louis Borloo told French radio RTL yesterday that the prospect of the Franco-German axis in Europe being replaced by an Anglo-German axis “is extremely worrying. This means that we’re probably turning our back on the great European ambitions…This is an extremely important political and diplomatic shift.”
ARD Phonix Livestream EUobserver RTL

My question to Herr Steinbruck and M. Borloo is this: What do you mean by "more Europe" and "European ambitions"? If this means more socialism, perhaps Chancellor Merkel and Prime Minister Cameron have had enough. If the EU's future is as a transfer union, then I can understand why the transferees would want to participate, but I cannot see the benefit to the transferors. The goal of Europe should be to expand trade and reduce its cost, prevent war, offer greater freedoms, etc. None of these goals can be achieved by expanding the welfare state to include placing entire countries on welfare for unlimited periods of time. Socialism is a failure within a country and will fail as the structure of an international organization, because the beneficiaries of welfare, whether individuals or nations, benefit greatly from their failures and payers benefit hardly at all from their successes.

Listen to my interview with Professor Harry Veryser about his new book

Re: It Didn't Have to Be This Way

Click on the link above to hear my 30 minute interview with Professor Harry Veryser, author of It Didn't Have to Be This Way.

The last half of the program concentrates on Germany's unique position from which it can put an end to worldwide monetary destruction.

Potential US-EU trade deal is managed trade not free trade

Re: US and EU trade deal in the works

Improving trade between the US and the EU is a good thing, especially if it results in a reduction of red tape and tariffs. But note that this is not "free trade" but "managed trade". No negotiations are necessary for a country to have free trade, because it is a decision for that country alone to decide that it will accept goods from anywhere in the world without tariffs, quotas, or other artificial barriers. But this is managed trade that will require reciprocity from one's trading partners. It is analogous to saying that you will not go on a diet and exercise to improve your health unless everyone else does the same. The benefits to free trade are what a nation imports not what it exports. Also note that the commentator said that Europe was asking its industrialists to come forward with their "wish list". What will these industrialists wish for? Let me guess--managed trade that is beneficial to them. Also note that the commentator claims that a strong euro is bad for trade. Nonsense! If this were so, then Zimbabwe would have the best trade policy in the world.

My letter to the NY Times: How many Fed economists does it take to screw in a lightbulb?

Re: Fed Governor Raises the Specter of a Bubble in Junk Bonds

Dear Sirs:
So the Fed thinks that it just might be possible that its unprecedented bond buying programs will cause a bubble in junk bonds. How many Fed economists does it take to screw in a light bulb? And will the light actually come back on with a new bulb installed? If you are a Fed economist, these things must be tested and tested and tested and....

When the Fed finds evidence of such a bubble, of course it will be too late. And if it takes regulatory action to prevent its base money production from going into junk bonds, the money just will go somewhere else. It must go somewhere! Isn't that the point?

The Fed has no idea what it is doing or what the consequences will be. Nevertheless, when the markets crash, the Fed will blame everyone but themselves.

My letter to the NY Times re: A Picture of EU Failure

Air Frame: US airmen load a French military vehicle on an Air Force C-17 Globemaster III at Istres, France, for transport to Mali, Jan. 23, 2013. The United States is providing airlift, aerial refueling, and intelligence support to the French military as it battles Islamic extremists in northern Mali. (Air Force photo by SrA. James Richardson)

Re: Europe's Plans for GPS Limps to Crossroads

Dear Sirs:

The picture and short caption above from today's Air Force Magazine Online illustrate the lack of true leadership in the European Union and supplements your article about a bankrupt Europe continuing to fund a GPS project that is not necessary and may never be completed. The French cannot provide its own airlift to fight al Qaeda in Mali. Yet it and the rest of the EU nations waste money on the completely redundant European GPS project. It is clear that the European GPS project is no different than the wasteful Common Agricultural Policy; i.e, a jobs program to politically connected industries in exchange for almost nothing in return.

My letter to the NY Times: The Fallacy of Government as Savior of Markets

Re: Case Offers a Peek Behind the Curtain of a Security

Dear Sirs:
Floyd Norris makes the preposterous claim that the government's PPIP program saved the Mortgaged Back Securities market by its $18.6 billion handout ($18.6 BILLION!!!!) to nine politically connected money managers for the purpose of buying risky mortgaged backed securities from a supposedly frozen market. This vast amount represented 75% of their investment and is nothing more than a gift of free money with which to take undue risk. (Otherwise the money managers would have invested their own funds in the first place and not had to share any profits with the government.) But the big picture is that PPIP is nothing more than a government cover-up of its own failed policies. The MBS market was overblown due to government's intervention into the mortagage market and the Fed's intervention to drive down the interest rate. This created massive malinvestment in mortgages that spilled over into the MBS market, eventually creating uncertainty into the real worth of most MBS's. A market is never "frozen", but potential sellers may be reluctant to invest more money or sell at a loss. The PPIP program created classic moral hazard in that the money managers were willing to offer higher prices for risky MBS's because they had to put up only 25% of the money. Let's get over the idea that government saved anyone but its own reputation.

My letter to the Wall Street Journal re: Italy and Germany

Re: Germany, Italy Data Show Divergence

Dear Sirs:
Let's assume that your neighbor's finances are completely out of control. His family runs a deficit every month, and that deficit gets bigger and bigger. But, not to worry, he can print all the money he needs in order to buy your farm produce and everything else he needs and desires from your extended family, which runs a budget surplus due to a history of financial probity. Would you be happy with this arrangement? You are producing and handing over real goods for ever depreciating pieces of paper. That is what is happening in Europe. Italy, Greece, etc. run budget deficits, print euros, and buy German goods. German exporters are happy, as are their union laborers. But Germany's capital is being decumulated before its very eyes. It is being shipped to Italy, Greece, and the rest of the profligate countries of the eurozone, who have no compelling reason to stop the spending.

My letter to the NY Times re: Rotten Tomatoes

Re: United States and Mexico Reach Tomato Deal, Averting a Trade War

Dear Sirs:
The biggest losers in this rotten tomato deal with Mexico will be U.S. consumers. In fact, to call it a "deal" is not accurate. Mexico agreed to the so-called deal, which will raise the minimum sale price for Mexican tomatoes, only to prevent a worse outcome; i.e., a renewal of the U.S.'s "anti-dumping" charges. So, Mexicans invest billions in greenhouses to meet the demands of the specialty tomato market in the U.S., while U.S. growers in Florida pick their tomatoes while green and then treat them with a gas to change their color. U.S. growers object to losing this market and march like all good socialists to government to stop the evil foreigners from offering American consumers what we want at the price we are willing to pay. I am certain that this plunder of the American consumer is just a tip of the iceberg of government protection of inefficient and backward industries.

A voice of reason in a sea of monetary insanity

From today's Open Europe news summary:

Hollande: Eurozone should have foreign exchange rate policy;
German Economy Minister: Objective is more competitiveness, not weaker currencyFrench President François Hollande told MEPs yesterday, “A monetary area should have an exchange rate policy. Otherwise, it has an exchange rate imposed on it that does not correspond to the real state of its economy…This is not about externally setting a target for the ECB, which is independent, but about engaging the essential reform of the international monetary system.” German Economy Minister Philipp Rösler commented, “The objective must be to improve competitiveness and not to weaken the currency.” Reuters reports that Slovakian Prime Minister Robert Fico voiced support for Hollande’s proposal.

Finally, there emerges an objection to the worldwide monetary insanity whereby every central bank tries to drive down the foreign exchange rate of its currency in the fallacious theory that doing so will revive an economy by stimulating exports.

The Mercantilist Myth Continues

From today's Open Europe news summary:

EurActiv reports that free trade agreement talks between Canada and the EU have reached a deadlock due to EU opposition to raising Canada’s quotas of imported beef and pork and Canadian opposition to increasing imports of EU dairy products, eggs and poultry.EurActiv
Both Canada and the EU subscribe to the Mercantilist myth that a nation is harmed if it allows its citizens to purchase desired goods from producers beyond it borders than it sells to those same producers. It is obvious that both Canada and the EU are less concerned about the standard of living of ALL their citizens than about protecting the livelihoods of politically connected, inefficient industries. (If they were efficient, they would not need tariff protection.)

My letter to National Review re: How to End Bailouts

From: patrickbarron@msn.com
To: letters@nationalreview.com
Subject: How to End Bailouts
Date: Tue, 5 Feb 2013 12:55:36 -0500

Dear Sirs:
I read with interest Mark A. Calabria's detailed recommendations for bank reform titled "An End to Bailouts". Unfortunately, it is the nature of man to use a power that he possesses; therefore, eventually all the powers stripped from the Fed will slowly be returned, probably due to so-called "crisis management". But, let us assume that the Fed's powers were scaled back to those recommended by Walter Bagehot' i. e., “Lend without limit, to solvent firms, against good collateral, at ‘high rates’.” Why is a central bank required to perform this function? If a bank is fundamentally sound, yet short of liquid funds, it has no problem borrowing short term from other banks. The Fed's vaunted discount window power is used soley to bail out banks that are NOT fundamentally sound. As long as the Fed possesses the power to lend to unsound banks, it WILL lend to unsound banks, because the political pressure not to do so will be irresistible. Better to "End the Fed" now. There is no reason to reform it, and there is no possibility that reform will last.

Why Central Banks Cannot Allow Any Competition

I found this article about the ECB being worried about competition from BitCoin to be similar to the U.S. Postal Service threatening to prosecute a Boy Scout troop for planning to make a little money by delivering Christmas cards. Neither inefficient organization can stand competition from any source. This supports the contention of many economists that all that props up fiat currencies is legal tender laws. If we were allowed to use any currency mutually desired, Gresham's Law would work in the reverse; i.e., sound money would drive bad money out of the market.

Another Way the EU Plunders Germany

From Open Europe online of Feb 1, 2013:

Süddeutsche Zeitung reports that Germany's Federal Social Court has ruled that a Bulgarian immigrant without work permit is entitled to social benefits. The ruling may now set a precedent for immigrants from other EU states claiming welfare benefits in Germany.Süddeutsche Ruling of Federal Social Court

So, the weak countries can print euros and buy German products or their citizens can travel to Germany and go on welfare. Germany's economy will be hollowed out, and few will understand how that happened.

My letter to the Wall Street Journal re: Hooray! We've Debased Our Currency and Lowered Our Standard of Living!

Dear Sirs:

Will the madness ever stop? Will the editors and reporters at the Wall Street Journal ever critique monetary debasement honestly? The Japanese are thrilled that they have driven their yen to new lows against the dollar (Yen's Tumble Brightens Earnings Prospects in Japan), and the European Central Bank is concerned about the euro's strength (Threats Cloud Euro's Flight). Both believe that prosperity lies in making exports cheap through monetary debasement. This is a horrible myth. No nation can make another pay for its own recovery. On the contrary, monetary debasement makes exports cheap through internal subsidies. The central bank gives more local currency to the foreign importer. The exporter benefits from buying replacement factors of production before the additional money raises the cost of living for all members of society. After the new money works it way through the economy, raising the cost of replacement resources, the exporter is right back in the same position; i.e., he can sell more goods only through another round of monetary debasement. The nation's wealth has been transferred to the foreign importer, using the exporter as the intermediary. Monetary debasement to spur exports is no substitute for the hard job of lowering costs of production through productivity improvements (that are the result of savings and investment), reduced regulations, lower taxes, and better management.