Precious Metals — When Financial Repression Fails

Financial repression may prove to be the policy that triggers the inevitable return to fair value in precious metals. The failure of this academic policy, originally deployed in the 1950’s,adds to the list of possible scenarios triggering the failure of the manipulative price suppression that has been observed in the precious metals futures markets.

For example, the price of monetary metals like silver and gold should rise as growing debt concerns and an ongoing U.S. Dollar devaluation policy set the stage for a new American currency or even a global currency that will be backed by assets of true intrinsic value like gold and silver.

Furthermore, at a minimum, gold and silver would remain highly valuable as off-the-market hard currencies in barter transactions.

A Precious Metals Rally in the Face of Financial Repression

Even as long as the futures market-led price suppression continues to operate — and as long as debt and inflation do not become serious problems — then the price of gold and silver should continue to rise over longer investment time frames.

A reasonable estimate for this anticipated rise is that it should proceed at roughly the rate of inflation plus an annual return premium for the amount of gold and silver that are consumed by industrial uses — never to be recovered or recycled.

Financial Repression — Old Solution Applied to a Much Bigger Problem

Financial repression is an old solution that worked well in the past by controlling interest rates, creating low inflation, while relying on a small engine of growth to melt away debt and spark a recovery. Nevertheless, financial repression will probably fail to work in the future for the following reasons:

(1) No Growth – Despite an ever-growing national debt, there has been zero growth in the U.S. economy. Periods of zero growth, and even negative growth, creates a scenario in which the relative value of the debt the county is incurring is actually growing beyond what Congress actually spends each year.

(2) No Inflation Yet – While inflation has been fluctuating up and down on a month-to-month basis, the Federal Reserve has not been able to create steady inflation, in part because what determines inflation today is mostly speculative interests. Speculative purchases of oil may send up the price of oil, but when investors take profits, the upward price pressure is relieved and the price declines. Meanwhile, companies are cutting costs to help reduce the price of their products to make them affordable to consumers with less expendable income, so the official measured inflation level is not rising. Furthermore, the national debt is growing far faster than inflation.

(3) The Legality of Holding Metals – One can currently look back at how precious metal prices performed during a time frame in which U.S. investors could not own gold and silver legally and also at times when they could purchase gold legally, but they could not do so easily. Making spurious laws that force U.S. investors to avoid natural inflation hedges like the precious metals allows the U.S. government to force inflation through the markets without a revolt, or much of one at least. No choice exists for investors in such a legal environment but to buy low-yielding Treasury debt instruments, which typically provide negative real returns.

(4) Hostile Debt Purchases – Historically, the nations involved in purchasing U.S. Treasury securities were friendly, and the United States had the ability to influence their policies. Nevertheless, the same cannot be said today, since China is a major holder of U.S. debt and hardly cares what the United States thinks about its Treasury purchases or internal policies. Also, given recent events — like the Japan-China island dispute and Mitt Romney's declaration that he will re-instate the “currency manipulator” label with respect to China, which will force the U.S. Commerce Department to impose countervailing duties if the Chinese do not allow their currency to move quickly to fair value versus the U.S. Dollar — the long term picture looks rather bleak with respect to U.S. relations with China.

Basically, financial repression is the wrong tool being used in the wrong time, so look for higher metal prices over the long term as this questionable policy of devaluing the U.S. Dollar and Treasury debt begins to unwind and spin out of control.

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