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Bad Hair Days for Gold and Silver OR Is the Most Powerful Man in the World Going to Plan B?

In September of this year 2011, Ben Bernanke, Chairman of the Federal Reserve Board of Governors, proved that he is the single most powerful man in the world. In the periodic meeting of the Federal Reserve’s Federal Open Market Committee on September 21-22, in which the country’s all important monetary policy is set, Ben moved his mouth, words came out, and the financial markets of the world blew up. Or nearly so. The ticker tapes of the world’s stock and commodity and bond markets still flow, but a sea change has occurred. The history book of this planet has had a temporal marker inserted… a dividing line demarcating the world the way it was before Ben’s mouth moved, and way it is after his words came out. And in my view, the fateful words were not the ones the talking heads on the financial channels gave import to. It was one single sentence Ben uttered that really did it. Before we replay that sentence, it may be helpful to first offer some perspective by backing up a bit.

Myself, I am a spectator, an everyday American, sitting in the bleachers, watching the game called The Troubled Global Economy unfold, and I’m listening to the referees make their calls. I hear the commentators analyze the game. They argue among themselves. They filter events through their own personal philosophy of how the world works. I listen and attempt to discern the truth tellers in the group. The ones free of rose colored glasses and with no axes to grind. I seek the true umpires of observation (I just calls ’em likes I sees ’em). And in doing so… the truth revealed itself. It’s simple. By sheer mathematics America, and many other countries, have borrowed more money than can ever be repaid. America has been spending more then she takes in for way too long now. To make up the difference the country has borrowed the money. To ease the pain of financing the growing debt, interest rates have been kept artificially low and the US dollar has been significantly watered down by growing the money supply faster than the economy. Such a game cannot be played indefinitely however, and at this point it seems we are somewhere in the 4th quarter. The endgame approaches.

With that in mind, in 2004 I purchased a few gold coins to hedge against what seemed an uncertain future. Gold had roughly doubled to $400 an ounce at the time from its multi-year lows. In mid 2008, shortly after the collapse of investment bank Bear Stearns, with gold at $800 oz, and myself being a teacher and writer by partial trade, I wrote an essay entitled The Thin Red White and Blue Line to warn friends and relatives perhaps too busy living their lives to take note of how dangerous the financial system had become and that trouble was afoot. Greed, corruption, and the resultant overleveraging threatened the foundations of the economy, and I suggested a few things that one might do to mitigate what appeared to be an inevitable crash. Here is the list from that article.

Lighten up on securities (stocks and bonds)

Buy gold and silver

Buy food

Become a farmer

Stock up on the basics

Keep some cash on hand

Take some security precautions

Buy a super-high gas mileage vehicle (electric car, hybrid, motorized bicycle, etc.)

Conduct a “disaster preparedness test”

The philosophy that derived the above list was/is simple. The paper based financial world we grew up with is beginning tocrumble. Paper currencies, and all things based on currencies, such as stock markets, commodity markets, bond markets, et al. are only worth the trust we put in them. The system works as long as everyone trusts that the value of the little pieces of paper we exchange with each other for goods and services will have a somewhat predictable value. On a related note, we also trust that if we put our money into the paper based investment world, the information we are given about the vehicle of choice is accurate and truthful.

But in fact, trust in most paper currencies of the world has eroded along with the purchasing power of said currencies. A dollar just doesn’t buy what it used to. And on that aforementioned related note, trust in the financial system was deeply eroded in 2008 when it was discovered that supposed A-A-A rated mortgage based investment vehicles (derivatives) sold to investors across the globe turned out to be based on fraudulent loans. As a result, investors, pension funds, money market and hedge funds, and other unsuspecting financial institutions around the world took a deep hit. The paper was proved nearly worthless and the taxpayer was asked forced to bail out a whole bunch of institutions. For these reasons and more trust in all things paper has been greatly diminished.

In 2010, with gold up to $1200 oz, a rapidly rising stock market, and a seemingly recovering economy, I wrote a follow up article entitled If The Future’s So Bright How Come I Don’t Need Shades, which argued that despite appearances, nothing had changed, and that we were actually still heading into an economic downturn so serve it would ultimately be termed a depression. The article suggested that cash, short term US government bonds, gold/silver bullion, and other tangible items might be the safest store of wealth at the moment.

As it happens, a good portion of the advice I had been distilling and passing on has proven helpful. As interest rates have dropped bonds have gained in value, and precious metals are significantly higher. Cash however is worth a bit less across the board. For the advice imparted I take no credit except perhaps to have been in a position to organize into readable format what seemed to be an obvious set of trends that were discovered upon parting the curtain to reveal the decrepit old man behind the face of Oz. Meaning, the mainstream press is not your friend. You have to dig for the truth.

So here we are now in the latter half of 2011, a significant Federal Reserve meeting under our belts, inflation up a bit, a fresh mini-crash in the stock markets of the world, and money ducking desperately into the shelter of the bond market in hopes of gaining cover from the increasing uncertainties of the financial world. On top of that we have a planet dealing out an endless series of catastrophes as time moves through each month of the year(s). Surprisingly, precious metals, which have skyrocketed in price this year, assumedly reflecting the continuing debasement of watered down currencies and an unprecedented world of uncertainties, have pulled a full reverse and headed straight down in price. Gold, which topped $1900 oz. in August, dropped in price to the 1500s. Silver got slammed too. A large chunk of the fall in precious metal prices, as well as a significant downturn in nearly every other market came right after Fed chairman Ben Bernanke made some words come out of his mouth on September 21st, 2011.

So what power does Ben have to make nearly every publicly traded market in the world drop like a stone? What did he say to rock the boat so severely? What words mixed in with the hot air emanating from his mouth shook the markets so deeply? And why is it that the antidotes to market turmoil and uncertainty -namely gold and silver- dove in price as well? Many analysts seem to conclude the reason is that Ben didn’t give the markets what they were expecting. The markets were expecting some additional form of Quantitative Easing (essentially printing money out of thin air). Yet Ben mostly promised only to move some existing money around to artificially suppress long term interest rates (read lower mortgage rates), and to leave most everything else alone. And truthfully, I think those many analysts are right- to a degree. The markets had rallied to the call of this Fed meeting and expectations were high. And indeed the Fed’s actions did disappoint. But that may not be what really set the markets ablaze. It may just be that it was not the Fed’s actions that tipped the apple cart, but rather the Fed’s words.

Ben said this:

…there are significant downside risks to the economic outlook….

What?? He actually said that? Given his audience, and the magnitude of focus on that meeting, what Ben said was tantamount to the Fire Marshall shouting fire in a theatre. If you don’t normally follow the statements made by the most powerful man in the world then you must know that folks of that ilk (politicians) don’t normally talk that way. For example, instead of recently saying that the housing market is still in the dumpster because people can’t get loans, Ben said; “Access to mortgage credit continues to be constrained”. That’s the normal Fed-speak.

So what exactly happened? Was Ben’s mouth broken or something? Maybe he didn’t think anyone would notice. He snuck the sentence right in between some standard Fed-speak that was rather tempered. His statement reminded me of those prescription drug commercials on TV that tell you how great life will be if you swallow their pills…. and between the hopeful statements and the pretty pictures they happen to mention that, oh, by the way, you could die from swallowing their pills.

Ben slipped in a Mickey. Would the markets notice? They did. And they reacted far more than just to the Fed’s actions. Ben’s words dashed the markets’ hopes. This is where the real damage was done. The psychological reaction of the markets to Ben’s words might best be explained in nursery rhyme form….

The markets

rocked easily to sleep

the results of dessert dishes filled deep

by their rich uncle Ben

who had told them they need never weep

were expecting a delicious treat

But instead

ben said

the Fed

would give them water and bread

What hope of desserts next week? Not a shred!

that filled the markets with dread

tears were shed

and the markets were sent off to bed

their faces all turned red

I think to the markets, it wasn’t just a case of being sent to bed sans extra helpings of dessert (i.e. money printing). Rather, Ben seemed to intimate that things were so bad even dinner was up for grabs. Holy cow Batman. I mean, Ben’s statement was akin to Iraq’s Baghdad Bob (a.k.a. Iraqi Information Minister Mohammed Saeed al-Sahhaf during the Gulf War), breaking from his typical party line of denying that coalition forces were rolling into Baghdad, and that the forces were actually on the verge of defeat… to instead admitting that those tanks behind him in the camera shot did indeed belong to the coalition, and they were in fact rolling unopposed into Baghdad at that very moment.

Ben told the truth! Fed-speak for significant downside risks to the economic outlook translates to; we are in very deep doo doo. It might be the first time the truth had sputtered out at one of these monetary policy meetings in some time. It’s almost like the Fed is giving up, and it took folks by surprise. To be fair, Ben has been hinting at the truth for a while now in other forums like the Fed’s Jackson Hole summit in August, where he admitted that the Federal Reserve couldn’t fix the economy. None-the-less, the markets were not ready for the words uttered at this particular the-whole-world-is-watching-with-baited-breath meeting. The markets concluded, “Gee If BEN is saying it’s bad, it must be REALLY bad. And gee, he’s not passing out any candy to take the sting away,” and thus the markets were instantly repriced for a slowing, not a growing, economy.

Why is Ben breaking from the traditional oratory the Federal Reserve has been putting forth all these years? It may be more years before we really know, but a best guess is that he is losing his consensus of support from the other Fed governors. We are seeing more and more of this breaking with the party line stuff going on all over the place (like Europe). The Powers-That-Be are not longer speaking with one voice. One might think that it’s getting close to every man (slash woman slash country) for himself time.

But why did gold and silver get stomped along with most everything else? Simple. The market is now expecting deflation. Deflation with a capital D. The current [US / world] economy can be likened to a punctured balloon. As long as the balloon is tethered to a tank of hot air (Ben’s mouth and/or the wind from a high-speed printing press), it will stay afloat. But cut the tether and the balloon WILL deflate. Meaning, without further stimulus, or talk of stimulus, the economy will contract, or more precisely, continue to contract. Right now the declining price of the benchmark metal copper along with a variety of other indicators is telling us the economy is slowing again. A slowing economy is people buying less stuff, resulting in companies making less stuff, resulting in the hiring of fewer employees to make the less stuff, and in turn causing even less demand for stuff, and thus the price of stuff comes down. That’s price deflation, and gold/silver are not always immune.

Of course that is a simplified explanation, and many factors combined together to bring the price of gold and silver down so hard and fast. Cyclical factors, forced liquidation to raise cash to cover other bets gone wrong, possible market manipulation, as well as the fear that everyone else will sell their gold ahead of you -to name a few- all may have contributed to the shocking drop in precious metals prices. The question now is; what does the road ahead look like for gold and silver?

The answer is; nothing has changed. Nothing has changed. The paper based financial world we grew up with is still crumbling. Confidence in the system is still eroding. Governments are intervening to forestall a day of reckoning that is sure to come. Money has been lent that can never be repaid in full. There’s only two ways this can end, and both ways portend well for precious metals; either governments will continue to print money to service old loans and take out new ones, or, governments will default and the loans will never be paid back. It’s really that simple, and you don’t need to be an economist to understand that any more than you need to be a meteorologist to know when you are being rained on.

Greece is in the headlights at the moment to see if they will default. Either Greece gets more loans (that can never be paid back) -that’s plan A- or the country will default -that’s plan B-. You will notice that both plan A and plan B have the same ultimate result. In America, it’s hard to believe we will willingly opt for plan B though. Politicians are controlling that option, and politicians know they will be in serious trouble with the voters if they pull the plug on loan repayments. One of the best quotes I’ve ever heard was stated by Luxembourg’s Prime Minister Jean-Claude Juncker: “We all know what to do, but we don’t know how to get re-elected once we have done it.”

So plan A, continuing to borrow-print-spend (and more quantitative easing), will likely continue to boost prices for gold/silver just as it has done for the past decade, as water-downed currencies get re-priced in terms of precious metals. Plan B could be triggered by a variety of countries though, and if so we would likely see the most massive unwinding of debt in the history of the world catch fire (that would be monetary deflation, which leads to price deflation). A house of cards would fall, leaving a huge number of people with far less money almost overnight as the derivates market collapsed, overleveraged financial institutions went broke, money market and pension funds invested in those institutions took a bloodbath, and the multi-trillion dollar derivatives market imploded. The music would stop and everyone would scramble for a chair. With the resulting drastically reduced money supply, most stock and commodity prices would be priced far lower. However, historically, even though precious metals tend to fall in deflationary periods, they drop in price less relative to the cost of other things. Hmmm. Perhaps this is why gold/silver have historically been a means of preserving wealth.

It’s not a pretty picture either way, but interestingly, for the average person the precautions to protect oneself from the resulting chaos of either plan A or plan B are similar. Let’s look at that aforementioned recommended list of precautions again:

Lighten up on securities (stocks and bonds)

Buy gold and silver (and perhaps gold mining stocks)

Buy food

Become a farmer

Stock up on the basics

Keep some cash on hand

Take some security precautions

Buy a super-high gas mileage vehicle (electric car, hybrid, motorized bicycle, etc.)

Conduct a “disaster preparedness test”

Ok. Now you could say something like; “Gee, why worry about my gas mileage if plan B takes hold? Because in a deflation some things fall in price but others don’t. Even though demand for many things dries up (people either don’t have money or they wait for a further drop in price before buying), the supply of other things tends to dry up as production drops. If less gas is being produced due to the economic downturn then gasoline may escalate in price. Or, if food crops fail due to bad weather (like, say, ummm, THIS year), then food can get very expensive. Plus, we have to eat. We have to drive to work. But we don’t have to buy a brand new car or iPhone.

So are we going to plan B? The fact is we are already getting alternating doses of both plan A and plan B. We are on a rollercoaster of costs of raw materials going up and then going down. At the end of the day perhaps all we can do as citizens is make plans for ever larger doses of both plans A and B. Meaning, we will likely continue to see both inflation and deflation as the rollercoaster ride continues and governments and investors struggle to heard in the right direction. Volatility and government intervention are the only certainties. At the end of the day, plan B (massive debt default and resulting deflation) seems inevitable. But that doesn’t mean we won’t see hyperinflation first. It’s just a matter of how much inflationary money printing we get before we give up and accept the reality that the world as a whole got too far into debt, and that more debt is not the solution. The longer we wait the more painful it will be, which is why the Too-Big-To-Fail argument ultimately does not hold water. Perhaps it is in recognizing our powerlessness over this situation that we become empowered. In pragmatic terms we have to deal with this global issue on a local level. The above list of precautions should help ride out any storm.

Which brings me to another point to end this essay. I believe it is a mistake to think of this financial and economic crisis as an isolated event. It may be best to take a holistic approach in viewing the problems of the world. Can it be coincidence that our world is so deluged with every kind of crisis these days? We see changes in the planet, the climate, the economy… and, in people. Is human nature evolving? We are realizing more and more that our old systems of governing ourselves need to be updated. Many people feel that a change of ages is upon us, and that amidst all our woes and concerns we are giving birth to a higher level of human consciousness. Most folks I talk to feel a shift in the wind to one degree or another. This is a time to be awake and aware. Perhaps more so than at any time in our lives. It’s really not business as usual.

This is where our real power as a race of humans may lie. If we believe that the future is not set in concrete, but is more like wet cement, we may be able to shape it. Our thoughts, words, and actions may have more affect than we realize. Not necessarily in the daily unfolding of world events, but at a higher, more archetypal level. This is a time therefore to remain, for lack of better words, positive. We may be living in some of the most interesting and evolutionary times of all civilization. So no matter what the months and years bring us, let’s not panic and give in to fear. That never works. Instead show love and compassion for our neighbors. Think of this time on the planet as a test. If we are being tested, let’s conduct ourselves -each and every one of us- in a way we can look back on and be pleased with our behavior.

Americans can take a cue from Europe as to what one possible future looks like. Many Europeans are being required to adjust to a very different lifestyle. But I say if things go sour for us too, let’s take whatever lemons we are dealt and make lemonade. In the meantime, it seems prudent to migrate out of paper based assets (stocks, bonds, etc.) and toward real assets like farm land, food, tangibles, etc. And yes, even though gold and silver could drop further in the short term, precious metals are a store of value, and should be part of a ‘complete breakfast’ of securing ones future in uncertain times.

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