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Manipulated U.S. Interest Rates Seesaw Gold Prices

Interest-Rates / US Interest Rates Nov 23, 2011 - 12:32 AM GMT

By: John_Browne

Interest-Rates

This week, world attention finally shifted away from debt problems in Europe to the unresolved and worsening debt crisis here in the United States. The Congressional Super Committee, which had been created over the summer to postpone making tough cuts, chose to avoid responsibility itself. In so doing, the Committee has followed the path of least resistance and maximum irresponsibility. Given the likely after-effects, the outcome should be judged as criminal dereliction of duty. It should now be crystal clear to even the most casual observer that a solution to the U.S. debt crisis will not come from within, but will be imposed, perhaps brutally, from without.


But while the media focused on Washington, institutional investors remained focused on Paris and Brussels where beleaguered European banks continue to suffer from dangerous overexposure to bad sovereign debt. To avoid these risks, institutions are locked into a flight to what they perceive as 'safety.' Despite the abject failure of American politicians, many of these institutions may be flooding into U.S. dollars and U.S. Treasuries, driving yields to historic lows.

This unexpected fund flow is acting as a fortuitous camouflage for the U.S. Congress. With the U.S. dollar rising, and U.S. interest rates falling, the inability of Congress to curb its profligate spending habits appears in some eyes to be less urgent. At the same time, commonly held secure investments such as precious metals, appear to be increasingly volatile and viewed increasingly as less of a safe haven.

Both these conclusions are fatally flawed and risk serious investor disappointment.

First, it is likely that a collapse of either the euro or the European banking system will flow rapidly to America, threatening U.S. banks, the U.S. Treasury market and even the continued viability of the fiat dollar-based monetary system. In short, the U.S. dollar and U.S. Treasury bonds are two massive but latent bear traps. Investors should be wary of both.

Second, the safe haven aspects of precious metals, especially that of gold, have been distorted by the Fed. Most debtor central banks and politicians would be pleased by any reduction in the embarrassing 'safe haven' image of gold, and have historically done all that they could to undermine confidence in the gold market.

It is important to recognize the major distortion that Fed Chairman Bernanke has thrust into the gold price. Under his guidance, the Federal Reserve has abused its monopoly power to manipulate short-term interest rates, which are currently 1.5 percent below the level of inflation, a level that has inflicted, and will continue to inflict, untold damage on the economy. Negative real rates deny investors a secure economic repository for their cash. In reaction, many have used gold as an alternative to replace bank deposits. This added demand has boosted the marginal prices of gold and silver.

Today, precious metals appear to track stock markets. When stock markets rise, investors tend to hold their accumulated cash not in zero interest bank deposits, but in precious metals, driving prices upwards. When stocks fall in price, investors sell precious metals to raise cash to meet normal cash requirements including redemptions and margin calls, adding enormously to the marginal price volatility of precious metals. However, this volatility does not foreclose on gold's ability to retain its value when confronted with additional rounds of currency debasement.

Second, precious metals are not merely a hedge against inflation. They are insurance also against financial catastrophe. With quantitative easing likely to be the recommended panacea for recession, we may face economic recession accompanied by financial inflation and a threat to the fiat monetary system. If this disaster transpires, one major safe haven could be precious metals. As a result, Fed inspired short-term price volatility should not deter investors accumulating positions on price dips.

In short, the current news from both sides of the Atlantic should provide further reasons to feel comfortable with precious metals.

It is time for investors to hope for the best but to plan on the worst. Part of this plan should involve greater care for portfolio currency selection, which is examined in greater detail in a report recently put out by Euro Pacific Capital.

Subscribe to Euro Pacific's Weekly Digest: Receive all commentaries by Peter Schiff, Michael Pento, and John Browne delivered to your inbox every Monday.

By John Browne
Euro Pacific Capital
http://www.europac.net/

More importantly make sure to protect your wealth and preserve your purchasing power before it's too late. Discover the best way to buy gold at www.goldyoucanfold.com , download my free research report on the powerful case for investing in foreign equities available at www.researchreportone.com , and subscribe to my free, on-line investment newsletter at http://www.europac.net/newsletter/newsletter.asp

John Browne is the Senior Market Strategist for Euro Pacific Capital, Inc.  Mr. Brown is a distinguished former member of Britain's Parliament who served on the Treasury Select Committee, as Chairman of the Conservative Small Business Committee, and as a close associate of then-Prime Minister Margaret Thatcher. Among his many notable assignments, John served as a principal advisor to Mrs. Thatcher's government on issues related to the Soviet Union, and was the first to convince Thatcher of the growing stature of then Agriculture Minister Mikhail Gorbachev. As a partial result of Brown's advocacy, Thatcher famously pronounced that Gorbachev was a man the West "could do business with."  A graduate of the Royal Military Academy Sandhurst, Britain's version of West Point and retired British army major, John served as a pilot, parachutist, and communications specialist in the elite Grenadiers of the Royal Guard.

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