GOLD AND WAR: A SECOND LOOK, by Raymond J. Nize
April 9, 2003
[linked previously, but insightful, so here at length]
In light of a military victory close at hand for combined United States/British forces in the War in Iraq, gold prices continue to slide. Gold is now trading nearly $70 per ounce off of its 52 week high.
The immediate explanation for the drop in the gold price is that war is bullish for gold and that therefore, since an end to war is near, there is no reason for a war premium for gold. Indeed, we would argue that it is this knee-jerk thinking which has pushed the gold price lower.
However, peeling away at the “War is bullish for gold.” axiom, one must reach the conclusion that the immediate prospects for gold are quite bullish and that the current pull-back is perhaps the last great buying opportunity for gold under $350 per ounce.
The war is bullish for gold axiom is based on the simple premise that wars are expensive. Further, throughout history governments have turned to the printing presses to pay for war. Of course, governments, that turn to the printing presses to help pay for war, create enormous new liquidity in an economy and therefore create new inflation which ultimately results in a rising gold price. Given this scenario, the end of war is naturally often a blessing on the economic front as the expense of war is eliminated.
However, the, soon to be, end to the war in Iraq will not result in a “Peace Dividend.” Indeed, United States government expenditures are likely to rise after the war has ended. The United States is not coming home after this war. Iraq will become an occupied territory of the United States. The most optimistic projections suggest that the occupation will last at least 18 months. More pessimistic projections anticipate 5 years of United States occupation. Whether it be 18 months or 5 years, it will be expensive. In addition to the cost of maintaining the occupying force itself, there will have to be huge payments made to various Iraqi factions. To keep the Kurds from fighting the Sunni and to keep them both from battling the Shia, big time money will have to flow to all these groups.
At the same time the United States will be spending enormous sums in occupied Iraq, other parts of the Middle East will grow increasingly unstable. Rumblings from some parts of the Bush Administration suggest that some believe the regimes of both Syria and Iran must be changed. And while some suggest that such regime changes will not require military force, in all likelihood it will be the prospect of United States dollars that will inspire those in Syria and Iran to attempt internal regime changes. It’s another great expense ahead for the United States, irregardless of whether United States troops are part of the equation. Troops may not be part of the equation but, be assured, United States dollar bills will be part of the equation.
All these additional costs, from the occupation of Iraq to the potentially expensive support for regime changes in Iran and Syria, must be further looked at in the context of the current domestic situation in the United States.
The federal government itself faces budget deficits as far as the eye can see. Tax revenues are down and expenditures, even without the war in Iraq, are out of sight. Moreover, Congress may cut taxes, guided by Keynesian and supply-side notions that tax cuts always promote economic expansion and thereby generate additional tax revenues. This notion is sure to be tested. In the current sluggish, near-stagflation economy, it is unlikely that tax cuts will have a strong enough impact at the margin to significantly raise tax revenues, if indeed tax revenues increase at all.
However, in any case, tax cut or not, the Federal Reserve continues aggressive money expansion. At the start of April, M2 money growth climbed year-over-year at a rate of 6.9%. Total Fed credit is expanding at a 9.6% rate. This type of money growth is always an ominous sign of potential inflation ahead, particularly since this money growth is multi-year growth.
Massive amounts of imports have been keeping a lid on consumer prices. In 2002 Americans imported about $500 billion more than they exported, that is, they consumed more than they produced, financing the deficits with U.S. dollars, most of which remained abroad or were invested in U.S. government obligations. The question remains how long will this dollar over hang remain overseas. Trade deficits and foreign dollar holdings exert powerful exchange-rate pressures on the dollar which in recent months have already resulted in a decline in the dollar of more than 20 percent versus the euro. Further U.S. dollar weakness will reduce American imports, increase exports, and result in higher United States domestic prices.
War or no war, the United States was likely heading towards much greater inflation. Any costs of Iraqi occupation and support for regime change in Syria and Iran that exceed revenues, that the Unites States is able to siphon off from the sale of Iraqi oil, will only add to a bill that is already extremely high. Those who have sold gold based on the end of war should perhaps re-think their analysis and re-position themselves before it is too late. Aggressive Fed money expansion, growing budget deficits, and dollar overhang are not going away, regardless of how many bunker buster bombs are dropped on Saddam Hussein and his regime.
Raymond J. Nize is an occasional contributor to GlobalStockAlert.com and the president of RJN Partners. |
