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Gold and the Impending Death of Keynesian Ideology?

Commodities / Gold and Silver 2010 Jul 07, 2010 - 01:25 PM GMT

By: Ned_W_Schmidt


Best Financial Markets Analysis ArticleWhile planning the wake would certainly be premature, perhaps some funeral plans could be considered. Could we possibly be witnessing the impending death of Keynesian ideology? For more than 70 years governments have been controlled by Keynesian ideologists and those that have succumbed to their alchemy. Converting sand into Gold was a dream ultimately discarded as futile.

However, the siren’s song of Keynesianism offered too much alluring hope. Rather than sand into Gold, Keynesianism suggested governments could convert public spending and debt into prosperity. No work would be ultimately required as the government could pay for everything.

Greece, Spain, England, et al have now shown that like all “isms,” Keynesianism was fatally flawed. Greece is being forced to go “cold turkey” on using debt to finance an otherwise unaffordable lifestyle. France is raising the retirement age for some pension schemes, heretofore political heresy.
England is talking budget cuts, and dreams of balancing the books some year in the future. At the latest G-20, the Obama Regime’s continued call for more government spending was essentially ignored, as it should have been.

While Greece, et al received plenty of headlines, inadequate coverage is given to the ongoing financial crises in Illinois, California, and New Jersey. Recent New York Times headline kind of sums it up for Illinois, “Illinois Stops Paying Its Bills, But Can’t Stop Digging Hole,” 2 July. Per the same article, Illinois has $5 billion of unpaid bills, a pile of IOUs that is growing daily.

California is attempting to reduce the pay of many state works to the minimum wage, if the state’s computer system will allow it. Perhaps the problem with California’s computer system is that it may only permit pay increases for public employees. Reducing public employees’ pay was probably not considered ever to be a possibility when the system was designed. By the way, they have been working on that computer system since 2006, and are still not done.

While we might hope that these financial problems at governments around the world would lead to the abandonment of Keynesian dogma, the purveyors of that financial chicanery are well entrenched in governments. Their ineptness is no more evident than at the Federal Reserve. In one period they pursue wild-eyed “inflationary” policies only to be followed by the now present “deflationary” policy.

In our first chart, to the right, is plotted Federal Reserve Credit, blue line using the left axis. Red line is the  six-month rate of change of Federal Reserve Credit, using the right axis. Federal Reserve Credit is essentially the size of the assets on Federal Reserve’s balance sheet. It is the monetary base from which money supply sprouts.

In the early period of that graph, policy was clearly of an “inflationary” nature. The rate of change actually rose to more than 50%. Any reasonable analysis of Federal Reserve policy in that early period would have concluded that U.S. inflation should go higher. However, in November 2009 the Federal Reserve changed policy. It slowed the growth of Federal Reserve credit. Then, in March the Federal Reserve halted its massive program of buying U.S. mortgage paper.

Result of all this confusion in monetary policy is that Federal Reserve Credit is essentially unchanged since October 2009. Since May the growth rate of Federal Reserve Credit has been negative. Consequences of their current policy are certainly not “inflationary.” Rather, the current policy if continued could result in a collapse of U.S. economic growth, lower prices, and a rising value for the dollar.

Any hopes for growth in the U.S. economy can be now tossed for any number of reasons. Among them is deflationary monetary policy. Second, Obama Regime has been able to engineer a massive set of tax increases that will hit the economy in the next year. Consequences of these policies will be to stifle investment and economic growth. Was that the intention of the Obama Regime? Finally, the Financial Institution “Destruction” Act of 2010 now in Congress, and being pushed by the Obama Regime, is a growth killer. Hobbling one’s financial institutions with onerous regulations will not, as the Great Depression demonstrated, encourage economic growth.

What might be some consequences of the above? Economic growth in the U.S. will be far less than expected. Employment growth will be far less than expected. U.S. investors and consumers will increasingly hoard cash. Unable to sell their homes and with withering stock market values, investing in cash will continue popular, and perhaps expand. Neither prosperity nor depression is likely. It will be more like the dreary bowl of porridge that Goldilocks chose.

What about $Gold in such an environment? Uninteresting might be the best descriptor. This environment is neither good nor bad for $Gold. A change in the environment will be necessary to enhance the value of $Gold in the short-run. In the longer term, insurance will be still necessary against the possible resurgence of Keynesian evil.

Which brings us back to valuation of $Gold, about which we talked last time. In the following table are listed results of applying four valuation methods to $Gold. First two rows are based on the ratio of the price of $Gold to the S&P 500. First row uses the ratio for the period 1945-Current to calculate valuation. Second row uses the ratio for 1989-Current. For more on these two calculations see our last posted Gold editorial. Last two rows are the results from using our longer term monetary/debt valuation methodology. Forecasts of $5,000 and $10,000 are not evaluated in this table as they represent pure fantasy.              

$Au Valuation
Assuming S&P 500 at current value

Au Current Methodology
For Valuation
Potential % Change
$1,198 Ratio of $Au/S&P 500 1945- Present $1,236 3%
$1,198 Ratio of $Au/S&P 500
1989 - Present
$597 -50%
$1,198 Fundamental Valuation
Fair Value
$832 -31%
$1,198 Fundamental Valuation
Long-Term Target
$1,768 48%

By Ned W Schmidt CFA, CEBS

GOLD THOUGHTS come from Ned W. Schmidt,CFA,CEBS, publisher of The Value View Gold Report , monthly, and Trading Thoughts , weekly. To receive copies of recent reports, go to

Copyright © 2010 Ned W. Schmidt - All Rights Reserved

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