Near Zero Interest Rates? Gold is Antidote for Treasury Trap

by | Aug 10, 2011

Last week Fed Chairman Bernanke raised eyebrows and denied history when he asserted in front of Congress that gold doesn’t qualify as money. Yesterday he took the unprecedented step of announcing that the Federal Reserve would keep interest rates near zero for at least the next two years. In very short order thereafter it required […]

Last week Fed Chairman Bernanke raised eyebrows and denied history when he asserted in front of Congress that gold doesn’t qualify as money. Yesterday he took the unprecedented step of announcing that the Federal Reserve would keep interest rates near zero for at least the next two years. In very short order thereafter it required much more of the money that he believes in (U.S. dollars) to buy the money that he doesn’t believe in (gold).

In any event, it was beyond unusual for the Fed to make such an explicit time commitment on monetary policy. To underscore this fact, three voting members of the Federal Open Market Committee came out against the policy. Such dissent within the Fed’s ranks has not been seen in decades. But Bernanke’s shameless appeasement of market fears did interrupt, if only for a few hours, the free fall on Wall Street. Wiser investors, understanding how a more activist Federal Reserve will destroy the value of the dollar, moved to gold, pushing the metal up to north of $1,750 per ounce.

The economic forecast contained in the Fed statement was far gloomier than earlier pronouncements. Bernanke sees continued sluggish growth for the U.S. economy and subdued inflation. Normally under such conditions gold should be expected to fall. However, as we have said consistently, these times are far from normal.

Readers will know already that we believe that the U.S. Treasury market is a gigantic wealth trap. Even before the Fed’s statement, investors seeking safety from European debt fears and staggering losses and unnerving volatility in the equities markets had flooded into U.S. Treasury securities. Nevertheless, this week has thus far seen a stampede into Treasury securities, causing yields to plummet. One-month Treasuries now yield 0.02 percent, making them no better than cash; the 5-year yields 0.93 percent, 10-year 2.17 percent and the 30-year 3.56 percent. Assuming a Consumer Price Inflation rate of 3.2 percent, all new investors in U.S. Treasury securities with a maturity of less than 30 years are losing ‘real’ money. In addition, with little prospect of further interest rate reductions the possibility of capital gains through Treasury investments are essentially nil.

These negative returns will eventually act as a pressure for funds to drift away from the bloated bond market into the beaten down equity market. But the total size of the global bond market is more than twice the size of the global equities markets, so these fund flows, when they occur, may make an outsize impact on equity prices.

In addition, the Fed is debasing the U.S. dollar at an increasing rate. Despite the fact that other nations are following suit to protect their exports, the dollar is set to fall further. Indeed in criticizing the S&P downgrade last week, Former Fed Chairman Greenspan said that the Fed need not be concerned about debt service because it can just “print more money!”

Facing negative real yields, the prospect of further credit rating downgrades and a falling dollar, investors in U.S. Treasuries are setting themselves up to be plundered.

On the other hand, despite recession fears, the upward march of gold continues, with many mainstream investment firms now setting price targets north of $2,000 per ounce. But skepticism remains, with some analysts pointing out that the price of gold is in “record” territory and is therefore highly speculative. However today’s gold price of $1,760 is still about 30 percent below the inflation adjusted high set in 1980 when gold struck $850 per ounce. From my perspective, with a sovereign debt crisis threatening, a currency collapse looming, and a chronically persistent low interest rate regime, gold looks positively cheap.

John Browne is the Senior Market Strategist at Euro Pacific Capital.

The views expressed above represent those of the author and do not necessarily represent the views of the editors and publishers of Capitalism Magazine. Capitalism Magazine sometimes publishes articles we disagree with because we think the article provides information, or a contrasting point of view, that may be of value to our readers.

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