Oh the irony… you’ve got to own gold and the dollar!?

Lacking the haughtiness of the pure ‘intellectual’ fields, the investment business is often thought to consist of all-encompassing ‘camps’ rather than ‘schools’. Apparently, if you’re buying gold, then you’ve got to be in the ‘inflationista’ camp; if you’re long government bonds, then surely you’re a patriotic bond bull; if you’re long stocks then of course you regularly sport rose-tinted glasses and are ever-vigilant for the silver lining,… right?


Wrong! We cannot stress enough that it’s most prudent to be in your own unique camp! However, for anyone who cares to listen, here I outline a key conviction of the greshams-law.com pack (yes… we’re even more brutish than the established investment community): — that it makes sense to be both long gold and long the dollar!


The Evidence:


Just before I grapple with the problem of reconciling a long dollar position with a long gold position, allow me to shamelessly remind you that we have advocated this peculiar stance for a (suitably) significant period of time now (so we’re not new converts courtesy of a dollar index above 80!)


In chronological order:



The Seeming Contradiction:


To clarify for anyone who might be (justifiably) perplexed by even the literal possibility of being both long the dollar and long gold; I’m talking about owning dollars against other currencies (periodically) in addition to owning gold against dollars (for the long-term). To many this is rather perplexing and seemingly contradictory; for if a long-standing policy of dollar debasement implies that it will sink over time – then why should it go up against anything?


The Prudent Presumption and The Faulty Inference:


The correct presumption (in our view) is that the Federal Reserve will continue its policy of monetary debasement for years to come — indeed, we share the inflationista presumption that the Fed will likely be the leader in this debauched practice! We truly believe that the thought behind this is correct — so in contrast to the majority of dollar bulls — upon hearing this we nod and utter ‘So far so good!’


So where’s the misstep then? Well, here’s the thing; as with all assets, the derivative of one higher order is always levered both on the upside and the downside. If you consider any asset — no matter how doomed it may be — it always lacks the peculiar damnation that is ascribed to the paper financial instrument whose very existence is dependent upon said asset. As we said in our September 2011 newsletter (incidentally we also outlined the positive prospects for the dollar in earlier newsletters):


We have this peculiar system of derivative money – the dollar, the pound sterling, the euro, the franc etc. are all irredeemable claims upon portfolios of assets held by their respective issuers (the Fed, the BoE, the ECB, the SNB etc.) However, it isn’t that straightforward, for the majority of central bank notes are – themselves – backed by dollars!


In this way, we have this peculiar international derivative money system that is centered around the dollar. So, when considering how these derivative monies trade against one another, one should throw this up=good, down=bad nonsense well and truly in the trash. For if we consider the analogous derivatives and underlying’s in the housing market, it becomes clear that things aren’t so emotionally satisfying. One must note that houses did appreciate against at least one thing during 2007-2009; housing derivatives! If you owned a house in the US, you no-doubt found that you could purchase more and more housing derivatives with your house as the housing collapse unfolded!


As we have reiterated tirelessly here on greshams-law.com; the dollar (i.e. the Federal Reserve note & the Fed reserve balance) is backed by a mountain of paper and a piddly pile of gold. Consequently, if we were to see the metaphorical ‘writing off’ of that paper (similar to the late 1970s/early-1980s) – the Federal Reserve note price of gold would have to rise several-fold for a profit-motive to be maintained in owning the dollar. That is; for the market to maintain the semblance of honesty and sanity, it would have to trade gold against dollars at suitable levels to reflect the fact that the entire stock of outstanding irredeemable claims upon the Fed’s assets (Fed Reserve notes & Reserve balances) are at most ’good for’ the assets held at the Fed.



Gold Covering of Backing the Dollar at Current Market Prices (Updated weekly on the 'Long-Term Charts Page'. Click to enlarge. Source: St Louis Fed & World Gold Council.


However, and here’s the important part. many global currencies are dependent upon the dollar as its reserve. The crux of the matter is that if you debase the reserve of a currency and nevertheless pursue a policy of debt monetization – the hard part of your reserves becomes evermore piddly and the paper becomes evermore mountainous! The dollar reserve system is one which involves a profligate Federal Reserve imparting greater profligacy upon it’s most loyal customers; dollar-dependent central banks.



The USDRUB currency pair has skyrocketed! Source: Yahoo Finance


ZIRP & Catching Up with Reality as the Influence of Speculation Subsides…


Nothing is more conducive to well-aligned prices than a deteriorating picture in the world of state-backed fractional reserve banking. As we have noted for several months, the situation in Western fractional-reserve banking systems has been deteriorating. Perhaps we are witnessing a catch-up in the currency markets, or perhaps a reaction to the consequences of a long-maintained zero interest rate policy?


Dollar Index Futures

Dollar Index Futures - Click to enlarge. Source: FINVIZ.com

See here for our collection of rare historical economic data.

Posted Oct 4, 2011