Special Report

There can be no doubt that the US faces a serious deflationary threat. Over $4 trillion has been lost in the stock market and regardless of how you spin the numbers, that money is gone. Even though Greenspan has been inflating the money supply at a staggering rate, it pales in comparison to the stock market carnage and the downturn in the stock market hasn't even really begun yet. The Dow Jones Industrial Average is still within reach of its all-time high. If the Dow declines as much as I think it's going to, another $4 to $8 trillion dollars could go to "money-heaven". This, coupled to the slow-down in the US economy, which is having a ripple effect throughout the world, is undoubtedly deflationary. Deflation is an increase in the relative value of money and hence should be detrimental to the gold price. Forget about the Great Depression, the price of gold was set by decree and hence one cannot compare the movement in the price of gold then to the price of gold now.

On the other hand, Greenspan has shown us the way. He has unequivocally shown that he intends to raise the money supply in order to fend off a recession (depression?) and if we should continue to face deflationary pressures, it appears very likely that he will continue to increase the money supply. Ultimately this could lead to very substantial inflation, which in turn could prove to be much more difficult to control since the money would already have been created. Inflation should also cause the gold price to rise and the dollar to fall.

In the short term then, the question is whether we will see deflation before the inflation kicks in or whether the growth in money supply will circumvent deflation and lead us straight to inflation. Either way the end result is the same, inflation - and that should translate directly into a lower dollar and a higher gold price. Since the market is forward looking it is also quite possible that even if we do have deflation within the US, the increase in money supply could put severe downward pressure on the dollar exchange rate and that should lead to a higher US denominated gold price in spite of the deflation.

The recent activity in the gold market and the currency markets suggest that this may already be happening. This week the dollar came under pressure and the gold price increased. I believe that the gold price is a leading indicator for both inflation and the value of the dollar; the two are inextricably linked. The gold price is telling us to be very, very careful of the dollar and as I've said many times before, if the gold price rallies without a decline in the dollar, the gold price is likely to fall back again. However, it also appears that the dollar is under pressure and one of these days the gold price is going to run and the dollar is going to drop. When that happens the roof could blow off the top of the gold price.

I expect the dollar could drop as much as 30% and that should cause the gold price to return to around $400 an ounce. Of course the short position in gold could cause the gold price to spike substantially higher than that.

Another possibility is that the financial markets lose faith in all fiat currencies, as they should have long ago. This could cause the gold price to sustain a price level far in excess of $400 an ounce since now gold would increase across the spectrum of currencies, not just against the dollar.

The World Gold Council has recently published a report that calls for a return to gold-pegged currencies. I could not agree more. I am personally not only in favor of gold-pegged currencies but a return to a strict gold standard so that the meddling politicians won't have the power to defraud us with fiat money.

Capitalism is not to blame for the rich getting richer and the poor getting poorer, it is inflation. Rich people have excess capital to invest in real assets that protect them against the ravishes of inflation. Poor people live from hand to mouth and do not have excess capital to invest. Inflation increases their cost of living while their income almost never keeps pace with inflation.

The gold market is acting very bullish although I admit that I am biased. Nonetheless, recent activity in the gold market indicates that something is afoot. My guess is that the party in the US is over but the guests haven't gone home yet. Paul van Eeden

Paul van Eeden
Paul van Eeden is a widely respected financial analyst who has written extensively about the relationship between the U.S. dollar and the price of gold. For more information, please visit Paul's website at: http://www.pve.net/.

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