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Falling Gold Is a Good Thing

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In the last two days gold has plunged so deep that it’s being called the worst drop -- at least in percentage terms -- in 30 years. That brings us back to the early Reagan period, when falling gold was regarded as a good thing.
Back then, lower gold showed inflation coming down after the horrible 1970s. It also showed confidence in the economy recovering and greater respect for the dollar. Over the next two decades, in the ’80s and ’90s, gold basically dropped in round numbers from $800 an ounce all the way to $250. Stocks soared. So did jobs and the economy. It was one hell of a good period.
But markets have reacted a bit differently this time. On Monday, stocks fell over 200 points in tandem with gold’s $150 drop. Maybe it was tax-selling in the stock market. Or the constant rumor of Cyprus gold-selling to raise bailout cash. But investors aren’t happy. It doesn’t look like the ’80s and ’90s. And I’m hearing the usual cacophony of impending catastrophe.
But I’m not buying it. I still think falling gold is a good thing. And whatever the short-term turbulence, a more subdued price for gold (and commodities) bodes well for the future economy.
There is no end-of-the-world scenario here, as there was after the financial meltdown. Nor is there an end-of-the-U.S.-dollar scenario, as many investors fear, nor an end to euro. Nor is there any massive inflation scenario, supposedly from the Fed cranking up all those printing presses.
The reality is that all those QE reserves from the Fed never circulated through the economy. Most of them are on deposit at the central bank. And because everyone is still risk-averse, the demand for cash is so high that the turnover, or velocity, of money keeps falling.
Last I looked, the M2 money measure was growing at less than 7 percent. And the Fed’s favorite inflation target, the personal consumption deflator, was only 1.3 percent over the past 12 months. The much-heralded printing-press/roaring-inflation episode hasn’t happened -- at least not yet.
The U.S. economy is growing slowly at 2 to 3 percent, but at least it’s growth. Profits have propelled stocks to all-time highs. Housing is gradually recovering. Jobs are erratic, but rising. And even the dollar is up over the past year against the broad trade-weighted index of currencies.
It’s not a Reagan recovery, nor is it a Clinton recovery. But it’s not the end of the world either.
A friend of mine calls gold an end-of-the-world insurance contract. We don’t need it. That’s a big reason why gold is falling.
And here’s a key point regarding gold and the dollar: Hat-tip to economist David Goldman for reminding us that the U.S. will become energy independent in the next ten years. The fracking revolution for oil and gas has already put us well on that path. Among its many benefits, in addition to growth and jobs, energy independence means U.S. oil imports from Saudi Arabia and elsewhere, which have already dropped substantially, will continue to fall more and more. This could lead to a current-account trade surplus and a continuous rise in the exchange value of King Dollar. Energy independence and a strong dollar are negative signs for gold.
The peak in the yellow metal actually occurred at about $1,900 in August 2011. It’s been gradually moving lower since then. But this recent plunge is probably attributable to rumors that financially strapped Cyprus and Egypt will sell gold to raise cash. It is possible that Italy and Spain will join in.
So no one knows where the current sell-off will end. But economist Scott Grannis calls this the end of the second great gold rally. The first was in the 1970s, when Nixon unhinged the dollar from gold. The second one began in 2001, with an over-easy Fed, and continued until recently.
There are plenty of challenges ahead, regarding all manner of money, fiscal, and regulatory policies -- entitlements, tax reform, Obamacare, you name it. But falling gold is a market signal that gives me some confidence that these are solvable problems, and that our economic and stock market story will turn out okay.
I think that’s the real message of the gold sell-off. It’s a good thing, not a bad one.


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