The air was stifling. It was thick with dust and hung in clouds through the sweltering corridors. I was 7,000 feet deep in a Transvaal gold mine.
Worse than the heat was the noise. I had to yell to my guide, the chief economist for JCI Mines.
I cupped my hands to make a horn, and over the roar of tractor engines and jackhammer drills I yelled: “What do you see for gold next year?”
My Afrikaner escort shouted over the din: “You tell me what the dollar does and I will tell you what gold does!”
It just so happened that the year was 1990 and the U.S. greenback was about to make one of its biggest bull runs ever. The result was a bear market in bullion that took the price of gold all the way down to $252 per ounce.
Today, with the price of gold about $900 higher than it was then, the same question regarding gold in 2010 cuts to the wick: What is the dollar going to do?
An Avalanche of Money
One thing is certain. This is not your father’s Federal Reserve.
The Fed that existed 30 years ago was chaired by Paul Volcker. Volcker was brought in to curb soaring inflation. To do that he decided his first priority was to protect the dollar, recession be damned. At the same time Ronald Reagan was coming into office. He was trying to curb government spending.
As the chart below shows, Volcker jacked the Fed funds rate up to almost 20 percent. In the process the United States endured a great rolling recession that devastated the commodity markets and farmers. Yet for the next two decades the dollar would be the world’s kingpin currency.
With the exception of The Crash of 1987 the U.S. economy was on firm ground, and prosperity was growing.
Then came a speculative stock bubble, 9/11 and runaway deficits.
In the wake of all this are President Obama and Fed Chairman Ben Bernanke who are not squeezing a single thing! Instead they are creating a tsunami of money. It amounts to throwing gasoline on a fire.
In just over a year the Fed has increased our monetary base by a whopping 120 percent! That is more than double the previous highest annual increase over the past 50 years. The Fed has made huge loans to private lenders and bought more than $1 trillion of mortgage securities and hundreds of billions of dollars of long-term Treasury bonds. It has succeeded in lowering the federal funds rate below 1 percent—and even, for most of the time, to less than half that.
Washington is trying to jump-start the economy with unprecedented amounts of money. Yet the old economist adage holds, “It’s like pushing on a string.”
Unless there is demand for money by willing lenders and borrowers the economy is not going to improve. What is going to happen is a train-wreck for the dollar.
The dollar is more than 14 percent off its March peak, and some worry that additional losses could prompt foreign investors to start selling dollar-denominated assets.
But while a sluggish U.S. recovery and low interest rates mean the dollar may have further to fall in the year ahead, very low inflation means a crisis is far from imminent, said Henry Kaufman, president of Henry Kaufman & Company, Inc.
"There has been no dollar crisis," Kaufman said. "The retreat of the dollar has been gradual, it has been orderly and it has not had an impact on the securities market."
Perhaps so, but as this U.S. Dollar Index chart shows, the greenback is still fading fast in a bear market that began eight years ago. If the dollar continues its slide in 2010, as I think it will, it will break below its 2008 lows of 71.5. When that happens the dollar will be in uncharted territory. Just how far it could slump from here is anybody’s guess, but with offshore investors holding trillions in dollar assets, the dollar’s direction is of critical importance to everyone.
Of course if you want to you can buy a 30-year T-bond today that will pay you a 4.7 percent annual return. Given that the real rate of inflation is at more than five percent, that is a losing proposition.
Now the only reason that Washington has been able to get away with selling such risk for such a miserable return is two-fold:
- Nations like China, India, Japan and Germany don’t have another currency to put their surpluses into.
- The deflation fears from 2008 still linger, so rather than put money into real estate or real assets, trillions of dollars are being invested in U.S. Treasuries.
But disgruntlement among lenders is growing quickly, leaving the U.S. bond market ripe for a collapse. Last month Treasuries fell, with the gap in yields between 2-year and 30-year securities reaching its widest margin since 1980. This means that people holding long-term Treasury bonds want a much larger return than those investing in short-term Treasuries. The reason is simple—long-term confidence in the dollar is evaporating.
Meanwhile the U.S. continues to be a beggar of last resort. To pay for all of President Obama’s plans the government has to auction off hundreds of billions of dollars in U.S. Treasuries this year.
In 2006 the U.S. bond market was worth an estimated $44 trillion. If interest rates rise, as I think they will, trillions of dollars in wealth could disappear. That is not just wealth held by foreigners but by all Americans.
Furthermore, the biggest danger will be the U.S. will have to finance its deficits with additional Treasury debt. To get those loans, interest rates will certainly climb.
Forecast for 2010
Dollar: Look for an even weaker dollar in 2010. The U.S. Dollar Index is close to breaking down and losing all technical support. That could throw traders into frenzy.
Bonds: Expect a smash-up in the bond market as investors are now holding bonds that pay a pittance. To sell off its Treasury debt the Fed is going to be forced to raise interest rates which will throw bond prices into a tailspin. Higher rates will also be a stake in the heart of the…
Stock Market: The Dow Industrials are flirting with 11,000. My expectation is that the Dow may touch upon this level before higher rates drive stock prices lower. Look for the Dow to be under 7,500 by the end of the year. I expect an even worse year for the tech-packed NASDAQ. This year will be a tough year for investors unless they are in real assets, especially…
Precious Metals: Gold continues to shine, although expected profit taking will happen along the way. Washington and other governments would love to keep a cap on the price of bullion, but right now they have much bigger fish to fry. My expectation is that the Midas metal will top $1,500 per ounce before year’s end and silver will rise from the $17 range to $25 per ounce. That leaves us with one other key sector…
Energy: It is going to be a mixed bag for energy this year. In fact, oil could easily fall back toward the $60 per barrel range if interest rates increase enough to choke off the recovery. Still, world demand for oil continues to grow. I think that over the long-term oil prices are headed back toward $150 per barrel. That may not happen, however, until we are closer to 2012.
Well, there you have it… my forecast for 2010. But keep in mind something that the Yankee great, Yogi Berra, said, “Prediction is very hard, especially about the future.”
Yours for real wealth and good health,
Myers’ Energy and Gold Report