Gold Vs. Treasuries - Which Do You Believe? By Michael Pento
| Oct. 12 2010 - 5:43 pm
Any psychoanalyst looking at the behavior
of investors today would see clear strains of schizophrenia
in a comparison between the markets for gold and US Treasuries.
Currently, the 10-year Treasury yield is
setting new lows on a daily basis. In the financial models
all economists were taught at school, this would be an indication
of an economy with low inflation expectations and a strong
currency. But the dollar has fallen over 12% since June,
and the price of gold continues to hit all-time highs. These
results are completely antithetical. Bonds are flashing
a warning sign of deflation, while gold and the dollar presage
hyperinflation.
During the last period in which the US experienced
significant economic stress, the late 70’s and early
80’s, the markets in gold and Treasuries showed a
much higher degree of harmony. At that time, the Fed’s
extreme depression of interest rates led to rapidly rising
inflation, a weakening dollar, and a massive spike in the
price of gold. More significantly, yields on Treasuries
soared as investors demanded higher rates as compensation
for the added inflation risk. In other words, everything
made sense.
Beginning in January of 1977, gold began
an epic bull market which ended just prior to February of
1980. In that time, the metal soared from $135 per ounce
to just under $860 per ounce, and the Dollar Index lost
about 20% of its value. Yields on the 10-year Treasury soared
from 7.2% in January of 1977 to 12.4% in February of 1980.
This occurred in an environment where the Federal Reserve
– under Arthur Burns – pursued an inflationary
monetary policy. He increased the monetary base from $62
billion to $114 billion in just eight years.
Today, the environment is similar to what the country confronted
30 years ago. Like then, our monetary base has surged –
but this time even faster. Instead of merely doubling in
eight years as it did under Burns’ watch, Alan Greenspan
and Ben Bernanke have tripled the base in twelve years (from
$621 billion in 2000 to over $2 trillion today). Accordingly,
the dollar price of gold has more than quadrupled, from
$280 per ounce in 2000 to over $1,300 today. Over that time,
the dollar has registered a 35% drop in value. However,
in stark contrast to 1980, the yield on the 10-year Treasury
note has collapsed from 6.6% in 2000 to less than 2.4% today.
A nation should only be able to enjoy ultra-low
interest rates if it has a high savings rate, stable monetary
policy, low inflation, and very low levels of debt. The
US savings rate, which had been range-bound between 7.5%
and 15% during the ‘60s and ‘70s, now stands
at just 5.8%. And that rate reflects recent belt-tightening
in the wake of the credit crunch. The personal savings rate
had been negligible and sometimes negative from 1998 thru
2008. Washington’s current annual budget deficit is
9% of GDP and the national debt is 93% of GDP. And, of course,
the Fed has – in its own words – undertaken
“unconventional measures” to push up inflation.
Therefore, none of the conditions that should engender low
interest rates currently exist.
Clearly both gold and the US dollar agree
that Ben Bernanke will be victorious in his quest to foment
robust inflation. But Treasury investors seem to believe
that despite its current inflationary disposition, the Fed
will be able to either: A) hold down interest rates for
an extended period or B) withdraw its liquidity before things
get out of hand. To take this position, one would have to
not only believe that the forex and gold markets have it
wrong, but also think that the Fed’s printing press
will lose its power to depreciate the currency. This is
a seriously misguided set of assumptions.
Bernanke asserts that the Fed brought on
the Great Depression by allowing the money supply to contract
by 30% after the Crash of 1929. He has also written that
the Depression relapse of 1937 stemmed from Washington’s
attempt to balance the budget and raise interest rates.
Therefore, I can reasonably assume that he will not stop
the presses until inflation has a firm and undeniable grip
on the American economy.
Many currently believe that ‘Helicopter
Ben’ has yet to ignite inflation on the ground because
the money he dropped from the sky is still stuck in the
trees. In other words, the funds are caught in the banking
system and not spreading among the populace. Yet, M1 is
up 6.2% YoY; and, in the last two months, the compounded
annual rate of change in M2 is 7.4%. Although these single-digit
increases do not yet indicate runaway inflation, a program
of relentless quantitative easing has a conclusion as predictable
as driving 100mph around an icy mountain turn. Since the
Chairman has shown no will to hit the brakes, you’d
have to be mad to ride the yield curve alongside him.