[rt]

I’m reading Michael Maloney’s book “Guide to Investing in Gold and Silver”. In one chart of the price of gold, there’s a large drop in the 1980s. What was the reason? And could such a drop occur again in the future?

[jmherbener]

Fed monetary inflation in the late 1970s created a bubble in gold late in 1979 and into 1980. When Paul Volker at the Fed slowed monetary inflation to break the double-digit price inflation, the bubble popped.

http://www.kitco.com/charts/historicalgold.html

(You must construct the chart by selecting the relevant years.)

Only time will tell if the run up in gold from 2000 to 2013 will prove to be a bubble.

http://www.kitco.com/charts/historicalgold.html

(You must construct the chart by selecting the relevant years.)

What moderated the price of gold in the 1980s and 1990s was an increase in world demand to hold dollars, which moderated price inflation. Price inflation has remained moderate through the 2000-2013 period and the run up in gold has occurred during a bust instead of before the bust as in the 1980s. What’s the same for the two periods is the expansionary monetary policy of the Fed. We’ll see soon enough if investors have over- or under-estimated the effect of such policy on the purchasing power of the dollar and the price of gold.

[rt]

Thanks. Do I understand this correctly: During the inflationary period of the 1970s demand for gold increased, in part because of price inflation. Then the Fed let interest rates rise and slowed down monetary inflation. Therefore price inflation was moderate throughout the 1980s. You mentioned that the price of gold in the 1980s stayed moderate but when the bubble burst, the decline was pretty sharp. Did this fall occur because demand for Gold collapsed and demand for dollars increased simultaneously?

Obviously a bubble in gold is different from a housing bubble. The former cannot be explained by ABCT correct? What is then exactly a bubble in gold?

In order for the price of gold to fall, the Fed would have to let interest rates rise, demand for dollars would have to increase and demand for gold would have to fall, correct? Is this very likely? If interest rates rose, the government would have to pay more interest on its debt, banks would become insolvent because demand for T-Bonds at lower rates would collapse. The economy would perform very badly. I don’t think people would buy dollars in such circumstances. Am I missing something here? What would have to happen for a drop in the price of gold to occur? Do you have a personal opinion regarding investing in gold?

Thanks again so much for your time and effort! It’s greatly appreciated!

[jmherbener]

The monetary inflation and price inflation of the 1970s led investors to buy gold as an investment hedge against further inflation. (This, by the way, is what Bernanke is trying to replicate: inflate the money stock sufficiently so that price start to rise leading people to form expectations that prices will rise further leading them to buy goods across the economy now and drive prices up now. The higher prices, he thinks, will stimulate production across the economy.)

Just like the last ten years, investors bought gold because they expect more rapid price inflation in the future. When the Fed tightens, investors may change their expectations and sell gold, popping the bubble. This is what happened in 1980. The gold price collapsed for a year and stayed at a new level for several years thereafter, higher than that of the mid-1970s but lower than that of early 1980.

The reason that price inflation was moderate for the rest of the 1980s and through the 1990s was that even though the Fed kept the money stock inflating briskly, the demand to hold money increased as well.

Bubbles can arise in any market where investors borrow credit created by banks during the process of monetary inflation, housing, autos, land, gold, and so on. These bubbles are a secondary, not primary feature of the boom-bust. The primary feature of the boom-bust is the artificial lengthening of the capital structure beyond what is supported by people’s time preferences.

For the price of gold to fall now, investors would have to lower their expectations about future price inflation in which case investors would sell gold and buy other other goods or hold more money. Of course, there are other reasons why demand for gold has been increasing and therefore, other reasons why the demand for gold might fall in the future.

We live in an age of inflation so generally, in the abstract, holding gold seems prudent. As to timing of buying and selling and portfolio allocation and so on, I render no opinion. I’m only a humble economist, not, alas, an entrepreneur.

[Joshua.Jaouli]

Sons, the gold bubbles most often pop during periods of real interest rates of +2%.

However, never again will we have real interest rates. Every 1% move in interest rates adds $160B to interest expense on the national debt, which, thanks to Clinton and Rubin, now has an average maturity of under 3 years.

In a few years time, when inflation is clearly at 12-15%, it would require someone raising interest rates ahead of the inflation in order to tame the beast, but that would require interest rates of let’s say 17%.

Assume the US has a debt of $20T by then, it would mean an annual interest expense of $3T+ if we roll over the entire debt stock over the course of 3 years at the new rates.

And with our extremely overleveraged, consumer debt driven economy, you’re right to think we would be in a real mess with rising interest rates. Credit card rates would spike up, meaning people would be doing everything they could to pay down balances instead of racking them up. This would lead to poor retail sales, leading to layoffs and decreases in state and local tax revenue, less federal revenue, rising unemployment, so on and so forth.

In other words, hold on to your gold and silver and prepare for a monetary meltdown. There can be no end to quantitative easing, stimulus or the like. The U.S. balance sheet is beyond repair and Bernanke will monetize and monetize until he can monetize no more.

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