Gold has struggled immensely to stay above the psychological $1,800 an ounce in recent weeks, but one expert argues that $10,000 an ounce is just around the corner. Even gold bulls may have a difficult time with that forecast, but his case makes sense from a historical and mathematical perspective.
The only question is whether the gold price will behave the way it has in the past under similar conditions. It all boils down to interest rates, inflation, domestic and international scarcity of the dollar, and whether the Fed decides to keep printing money as it has done for decades.
An evasive and defensive Fed
Whenever anyone acts the way the Federal Reserve has been acting over the year or two, it's easy to say that they're being defensive. Daniel Oliver of Myrmikan Capital pointed out in a recent note that inflation was at 1.4% a year ago, and Fed economists "were whining" that it was too far below their 2% target.
However, by June, inflation had climbed to 5.3%, and the Fed's response was to use the word "transitory," claiming that high inflation was only temporary. It wasn't until November that the Fed admitted that inflation wasn't so transitory at all, but it still couldn't admit its mistake in using the word "transitory." Fed Chair Jerome Powell stated that "transitory is a word that people have had different understandings of."
Inflation is now at 7.1% -- a rate Oliver said would slash the dollar's purchasing power in half over only nine years. He added that politics requires that the Fed shift its focus to support the U.S. dollar, which would mean an end to quantitative easing, allowing the securities on the Fed's balance sheet to mature without replacing them, asset sales at an extremely difficult time, and raising interest rates.
The nominal yield on the 10-year Treasury has now jumped from 1.35% in December to 1.8%, the highest yield since before the COVID lockdowns. However, since inflation is at 7.1%, the real yield on the 10-year Treasury is -5.3%, setting a new 50-year record.
The real yield is now lower than the two low spikes in 1974 and 1980both of which lined up with what Oliver describes as "epic gold bull markets." He added that a deeper look into the drivers of gold prices is required since gold "hasn't gone parabolic yet."
The dollar as the world's reserve currency
Oliver recalled the 1970s when the U.S. dollar became the global reserve currency following World War II since the U.S. held more than 25% of the known gold in the world. The dollar became scarce because Europe overvalued their currencies to rebuild after the war. However, under Kennedy, Johnson and Nixon, the U.S. decided to relieve that scarcity through "enormous deficit spending," turning it into a glut.
According to Oliver, the need to repay the debt plus compounding interest is what anchors the value of the dollar today rather than gold. The Fed reports that its dollar-denominated debt within the U.S. is $86 trillion. Oliver estimates another $12 trillion in "Eurodollar debt."
He explained that Russia created the Eurodollar system in the late 1950s because Moscow wanted to hold U.S. dollars but not in U.S. banks. The Russians deposited their dollars in British and French banks, which operate beyond the reach of American regulators and loan those dollars to foreign borrowers.
Too much debt, too few dollars
The 2020 round of QE increased the amount of Fed liabilities from $3.7 trillion in 2019 to $8.8 trillion currently, meaning there is 11 times more debt than there are base dollars.
"If the global economy were to experience a sudden stop — as it did briefly in March of 2020 — there would be eleven debt claims for each dollar of currency," Oliver explained. "This is why the Fed had no choice but to release the floodgates in 2020, in 2008, and any other time that the debt pyramid threatens to unwind."
Due to the trade deficit, $1 trillion of the $2.3 trillion created to buy Treasury bonds to finance the deficit over the last year went overseas, not as debt. Non-U.S. earners of those dollars have to spend them buying goods, which pushes commodity prices higher, selling them for other currencies, which pushes the dollar lower, or investing them in U.S. securities. For decades, foreigners have been doing the latter, but will non-U.S. dollar holders keep buying U.S. debt when real yields are -5%?
Oliver noted that the Fed probably expects the dollar to strengthen when it raises interest rates from 0% to 1%, 2%, or 3% like it has over the last few decades due to the Eurodollar system. However, he suggests that the Eurodollar interest rate transmission could be broken because dollars are no longer scarce internationally. As a result, a 3% nominal yield is unlikely to entice international buyers when U.S. inflation is at 7%.
If hiking rates destroys the economy
Oliver questions what will happen when rising interest rates destroy the U.S. economy by slashing tax revenues and increasing federal expenditures without strengthening the U.S. dollar. In such a scenario, nominal commodity prices remain high or go higher due to the scarcity of capital, and inflation remains high or even accelerates.
In that case, the Fed will have to choose between tightening financial conditions faster to rein in inflation and abandoning the program and restarting the printing presses. If the central bank chooses to restart the money printing as it has done over the last several decades, interest rates will fall again, boosting gold to a higher trading range, just like it did after 2008 and 2020, and so would inflation. As a result, Oliver argues that owning gold is a necessity in the current environment.
"Myrmikan has always held that the end game for the dollar — what propels gold into the multi-thousands of dollars per ounce — is sharply rising rates that destroy the value of the Fed's assets and make further federal deficit spending impossible," Oliver wrote. "Without a political reason to buy the dollar, it will seek out its economic value."
Where gold prices must go
Oliver called attention to his January 2020 letter, in which he wrote about the nominal prices gold must reach to be able to back the Fed's liabilities at various percentages. He also explained why at some point, gold would reach those levels.
At the time, a gold price of $5,000 per ounce was needed to back the Fed's debt by one-third, the average amount of backing the market required that the Bank of England maintain between 1720 and 1900. Gold would have to hit $8,500 an ounce to back the Fed at 54%, the average level maintained by the central bank between 1914 and 1933. Further, the 1980 dollar panic pushed the yellow metal to 133% of the Fed's liabilities, which would have been $20,000 per ounce in 2020.
After the latest expansion of the Fed's balance sheets, those gold prices have risen to $11,090 per ounce for one-third backing, $18,150 per ounce for 54% backing, and $44,700 an ounce for a potential panic high. Oliver expects the Fed's balance sheet to continue growing, raising those numbers even more.
"It is difficult even for gold investors to imagine those prices," Oliver concluded. "Yet they are what history and math suggest are coming… The first stop of $10,000/oz is actually not that far away: investors are going to have to get used to logarithmic scales."
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