Advice from the sane on gold and the dollar

One of the perils of the gold discussion is that gold people are generally kooks. I happen to think they are right, but it's hard to deny that Marc Faber, Peter Schiff, et. al. are a little bit odd. It's kind of like the guy on the street corner with the "End of the World" sign. He may very well know something you don't know, but your first instinct is that he's just crazy. Faber, for example:
Capitalism has been the engine driving America and the global economies for over two centuries. Faber predicts its collapse will trigger global "wars, massive government-debt defaults, and the impoverishment of large segments of Western society." Faber knows that capitalism is not working, capitalism has peaked, and the collapse of capitalism is "inevitable."

When? He hesitates: "But what I don't know is whether this final collapse, which is inevitable, will occur tomorrow, or in five or 10 years, and whether it will occur with the Dow at 100,000 and gold at $50,000 per ounce or even confiscated, or with the Dow at 3,000 and gold at $1,000." But the end is inevitable, a historical imperative.

So it was a pleasant surprise today to come across two sensible articles by decided non-kooks: Charles Schwab's Liz Ann Sonders and Greenlight Capital's David Einhorn.

Moderate, characteristically optimistic Sonders suggests that everything might work out if we simultaneously get real deficit reduction and robust economic growth:
History shows we can run lofty deficits for some time before the cart tips. But the markets' and investors' tolerance won't last forever.[emphasis Sonders']

If the bond market specifically, and investors generally, see a credible deficit-reduction plan that's aided by strong economic growth, a dollar crisis can likely be avoided. However, without that plan, the doomsayers could be proven right.

Strong economic growth and a credible deficit reduction plan? Why don't you throw in world peace and free houses for everybody while you're at it?

As Christina Romer pointed out today, deficit spending is the only thing keeping GDP propped up where it is. We're running 10% GDP deficits to generate 4% GDP growth. And this is not organic, sustainable GDP growth but the economic equivalent of a crack hit -- a big but very temporary frenzy of activity with no employment generation that will end as soon as the crack runs out.

If Sonders' only non-disaster scenario requires unicorns puking rainbows, I'm heading for the bunker.

Secondly, David Einhorn of Greenlight Capital gave this speech this week to the Value Investing Congress. Read the whole thing; it has wonderful commentary on the Wall Street - Washington corruption. But here I will highlight only what Einhorn says on gold, which is similar to what I've said many times before:
Four years ago I spoke at this conference and said that I favored my Grandma Cookie’s investment style of investing in stocks like Nike, IBM, McDonalds and Walgreens over my Grandpa Ben’s style of buying gold bullion and gold stocks. He feared the economic ruin of our country through a paper money and deficit driven hyper inflation. I explained how Grandma Cookie had been right for the last thirty years and would probably be right for the next thirty as well. I subscribed to Warren Buffett’s old criticism that gold just sits there with no yield and viewed gold’s long-term value as difficult to assess.

However, the recent crisis has changed my view. The question can be flipped: how does one know what the dollar is worth given that dollars can be created out of thin air or dropped from helicopters? Just because something hasn’t happened, doesn’t mean it won’t. Yes, we should continue to buy stocks in great companies, but there is room for Grandpa Ben’s view as well.

I have seen many people debate whether gold is a bet on inflation or deflation. As I see it, it is neither. Gold does well when monetary and fiscal policies are poor and does poorly when they appear sensible. Gold did very well during the Great Depression when FDR debased the currency. It did well again in the money printing 1970s, but collapsed in response to Paul Volcker’s austerity. It ultimately made a bottom around 2001 when the excitement about our future budget surpluses peaked.

Prospectively, gold should do fine unless our leaders implement much greater fiscal and monetary restraint than appears likely. Of course, gold should do very well if there is a sovereign debt default or currency crisis.

A few weeks ago, the Office of Inspector General called out the Treasury Department for misrepresenting the position of the banks last fall. The Treasury’s response was an unapologetic expression that amounted to saying that at that point “doing whatever it takes” meant pulling a Colonel Jessup: “YOU CAN’T HANDLE THE TRUTH!” At least we know what we are dealing with.

When I watch Chairman Bernanke, Secretary Geithner and Mr. Summers on TV, read speeches written by the Fed Governors, observe the “stimulus” black hole, and think about our short-termism and lack of fiscal discipline and political will, my instinct is to want to short the dollar. But then I look at the other major currencies. The Euro, the Yen, and the British Pound might be worse. So, I conclude that picking one these currencies is like choosing my favorite dental procedure. And I decide holding gold is better than holding cash, especially now, where both earn no yield.

So yeah, I'm still buying gold even though it's at all-time nominal highs. There still may be a violent pullback in gold prices at some point, central bank orchestrated or otherwise, but if that happens I'll back up the truck.

UPDATE: See the prolific Michael Panzner's 10/22 post for horrifying facts, figures, and graphs.

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