Inflating the Dream Alive

Gold and the stock market just gave their verdict on using inflation to beat deflation in housing...

"WE HAVE BEGUN the essential work of keeping the American dream alive," America's new president told the world while signing a 1,400 page spending bill no one has read, says Dan Denning of the Australian Daily Reckoning.

"I don't want to pretend that this marks the end of our economic problems. Today does mark the beginning of the end."

Truer words have never been spoken, certainly not by this President. Wall Street listened up...and then despaired. The Dow closed down 300 points at 7,552, only just above its 52-week low of 7,392 – itself pretty much an 11-year low. You have to figure, what with GM asking for another $16 billion from the American government, this could be the quarter of lower lows and lower highs.

Speaking of highs, are the governors of America's central bank smoking from the same bong as Michael Phelps? It's a question that has to be asked after a series of perplexing statements over the last 24 hours.

First is St. Louis Fed President James Bullard. In a speech he gave in New York he said, "I think we face some risk – at this point only a risk – of sustained deflation...In some ways, our current environment parallels the Japanese experience after 1990. The Japanese banking system encountered difficulties with 'troubled assets' and the intermediation system broke down.

That is an experience that neither we, nor the rest of the world's economies, want to repeat."

And exhale...

Let's be clear about what Mr. Bullard is calling deflation – falling asset prices, mostly stocks and houses. He's not suggesting that a contraction in the monetary base has led to a fall in the general price level. That's not true because the monetary base hasn't been contracting at all. It's been expanding. Rapidly.

So what is he playing at? Well, as near as we can tell, he is trying to prepare for the great inflationary swindle that the Fed plans to unleash later this year, if it can. The Fed wants you to think that the liquidation of bad investments built up in the credit boom is something else entirely – deflation! And because deflation is by definition Japanese, depressionary, and bad, it should be avoided at all costs.

And we do mean ALL costs.

The cost of avoiding what the Fed is describing as deflation is, you guessed it, inflation. But let's let Bullard do the selling and shilling:

"To avoid the risk of deflation, it is important that the Fed provide a credible nominal anchor for the economy. One way to do so is to set quantitative targets for monetary policy, beginning with the growth rate of the monetary base."

"This has several advantages. First and foremost, the monetary base is relatively easy to understand, fostering better communication about the thrust of monetary policy. Second, we can be fairly certain that rapid expansion of the monetary base will be sufficient to head off any incipient deflationary threat. Rapid base growth has been associated with inflation in a wide variety of times and places in economic history."

Did you follow that? The Fed just told you and anyone who would listen what it's going to do. And do you know what it said? Buy Gold.

The Aussie Gold Price shot A$82 higher per ounce in 24 hours. For Euro investors, the metal has risen 10% in just two weeks. If you were ranking currencies right now, the metal ones (Gold Bullion and silver), would be first and second, followed by the Japanese Yen, the US Dollar, and then a whole bunch of other, increasingly weak, paper currencies.

By the way, US Dollar strength in the face of falling US stock markets, a massive new spending program, and huge borrowing needs for 2009 is always a bit of a head scratcher. But we reckon its relative strength only. Not absolute. And for what it's worth, the six-month chart of the US Dollar index shows that the Dollar is either near a short-term high against other currencies – or may actually on the verge of a bust-out move higher.

Why would the Dollar make such a move higher? Pick a reason, any reason! But the best of them would be that serious doubts are surfacing about Europe's banking sector.

With Japan's economy doing a convincing version of hari-kari, the Euro replaces the Yen as the most desired reserve currency that is not the Dollar. But with Europe's banking sector facing serious losses from investments in Eastern Europe, the Euro finds itself in a tough spot. A very tough spot.

The Dollar may look on and laugh. But it's the reaction of Gold Investment we're interested in. Will it trudge doggedly higher? Or will it take flight?