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Who's been sleeping in my bed?

Wall Street and the financial media have hijacked the children's story of Goldilocks and the Three Bears...

A RECENTLY POPULARIZED CONCEPT dubbed the “Goldilocks economy” sounds nice in theory, but sorely lacks historical precedent. Wall Street and the financial media have hijacked the children's bedtime story of Goldilocks and the Three Bears, using it as a metaphor to explain the current economic environment.

   If we take this metaphor to its logical conclusion, we see that it has big, positive implications for precious metals investors.

   Here's how the story goes...

   Fed Chairman Ben Bernanke, having broken into the three bears' house, is faced with a choice of three bowls of porridge – one “too hot”, one “just right”, and one “too cold”. His academic background gives him the knowledge to choose this “just right” bowl – a bowl characterized by low inflation and 2-3% economic growth in the US.

   Had Bernanke chosen Papa Bear's “too hot” bowl, and maintained an easy monetary policy too long, inflation would now be out of control and the US economy would be growing 5-7%. Had he chosen Mama Bear's “too cold” bowl, he would have tightened monetary policy too much, inflation would now be turning negative, and the economy would be heading into recession.

   So what is the moral of Wall Street's story, now that we are in the midst of a “just right” economy? According to the mainstream media, we should all invest in equity-index funds and watch our savings give us real returns above 10% per year all the way to retirement.

   But it's interesting how the original version of this bedtime story actually ends. Wikipedia provides a synopsis:

   “Goldilocks is still asleep in the baby's bed when the bears return home. They wake her up, and depending on the brutality of the storyteller, either kill her or scare her away. The moral of the story can differ as well; a general theme is that the privacy of others should be respected.”

   Taking this metaphor to a more plausible conclusion, the Federal Reserve has broken into the house, sat in the chairs, ate the porridge, and slept in the beds of every individual saver of US Dollars. This institution constantly injects new floods of cash into the banking system by “monetizing” government liabilities (mostly US Treasury bills). With each new Dollar created, the value of each existing Dollar held by savers declines in value.

   Will the Fed ultimately reach the same fate as Goldilocks, running away from the wrath of savers in a panic? Probably, but it will take a monetary crisis to wake savers up from their hibernation and recognize that the Fed is the primary enabler of inflation, not the “inflation fighter” that so many have come to believe.

   Meantime, the ultimate moral of Wall Street's version of this bedtime story is to buy and hold a position in gold to guard your savings from inflation.

   Wall Street's "Goldilocks" concept rests on the erroneous assumption that inflation will begin to boil over once economic growth climbs above some arbitrary threshold. But this concept exists only in the minds of academics and in economics textbooks. Real economic growth – the kind that produces “wealth” in the true sense of the word – actually exerts downward pressure on the CPI inflation index, provided that the Fed-enabled money supply remains stable.

   It's only logical to assume that a growing supply of manufactured goods and services will be forced to compete for a relatively fixed quantity of customer Dollars. The business model of Dell comes to mind. This company provides a great example of capitalism's “creative destruction”, raising every computer buyers' standard of living by passing on the incredible productivity gains of electronic component manufacturers.

   In the case of computer manufacturing, productivity gains are measured by how fast prices fall each year. Wealthy elites were the first to enjoy the benefits of personal computers back in the 1970s and '80s. But as new competition surmounted the low barriers to entering this business, PC supply accelerated, while prices and profits fell. Today, the lowest-cost producers dominate this market.

   This example runs counter to the “Goldilocks” concept. By visualizing the Dell business model, you can appreciate how complex factors of production and competition can combine to produce improving products at lower prices, while yielding profits to reward the most innovative and efficient companies along the chain of production. Why does an economy of increasing goods and services productivity require an ever-increasing money supply? The general price level would nearly always fall in a free market economy without such an out-of-control fiat currency backdrop.

   But Fed officials do not see it this way. They believe they can set the temperature of the economy as if they were preheating an oven. History shows time and again that the Fed allows the formation of credit bubbles by lowering the price of credit to artificially cheap levels. At the first sign of a credit bubble imploding under its own weight, this highly regarded institution actually compounds its original mistake, creating another bubble by lowering the price of credit yet again!

   As complex adaptive systems, economies will react differently to each bubble's aftermath. Nevertheless, it's pretty apparent that the global economy has passed the “point of no return” in terms of writing off its bad debts, rebalancing its imbalances, and beginning afresh.

   So at the top of the Fed's playbook is a plan to rescue the housing and stock markets with a heaping dose of stimulus at the first sign of real distress. Those charged with maintaining the value of paper money will follow scripted responses to each bubble's pop or hiss: cheapen money yet again.

   The future environment for gold and gold mining equities remains as bright as ever, in other words. Stay tuned for more recommendations in this sector.

Dan Amoss is managing editor for Strategic Investment, one of the world's most respected "big picture" investment advisories. He joined Agora Financial from Investment Counselors of Maryland, investment advisor for one of the top small-cap value mutual funds over the past 15 years.

Now Dan develops his investment ideas using Strategic Investment's global network of geopolitical and macroeconomic analysts. He holds the Chartered Financial Analyst designation, a professional designation widely recognized within the investment community.

See full archive of Dan Amoss articles

Please Note: All articles published here are to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events – and must be verified elsewhere – should you choose to act on it. Please review our Terms & Conditions for accessing Gold News.

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