Serious challenges: price strength of gold relays important financial information.

Author:Hummel, John
Position:Financial analysis

When financial assets, bonds and stocks are rising relative to gold, it is a positive environment for the economy and financial markets generally. However, when gold is rising in price relative to financial assets, as it has been since 2001, it may be signaling potential financial concerns, and/or heightened inflation expectations.

Given the absolute and relative rise in gold prices since the beginning of this decade, it behooves investors to ask serious questions about its significance to their investment strategy.

Changes in gold prices may simply be an adjustment to supply and demand as total world gold supply has not increased as fast as other assets or liabilities of the world financial system.

A signal?

But the price also may be signaling a serious future financial dilemma facing the United States. In the three plus decades since the dollar became a fiat currency, three disturbing trends have emerged:

  1. Aggregate debt has increased faster than economic growth.

  2. We have become increasingly dependent on foreigners to finance our debt.

  3. The contingent level of liabilities (in addition to actual current liabilities) has potentially become an unmanageable number for our economy.

These liabilities include the future cost of social programs ranging from Medicare/Medicaid and Social Security to whatever else may need to be bailed out before the current financial crisis is put behind us.

It is estimated that a 100 percent tax on all personal and corporate income would not finance the total estimated cost of the social programs. The actual cost of the financial bailouts could range from modestly manageable, if economic growth and price levels rise sufficiently, to catastrophic if economic stagnation sets in.

Because the United States now absorbs 85 percent of world savings to finance its deficit, it is unlikely that we can continue to rely on foreigners to finance our extravagance. The growing deficit will have to be financed domestically through Treasury borrowings, crowding out the private sector's need for...

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