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Ben’s Blather: What’s the Truth? | By Patrick A. Heller – June 28, 2011

American economist, and the current Chairman of the Federal Reserve
American economist, and the current Chairman of the Federal Reserve

In my Numismaster column two weeks ago I addressed the question of whether there was likely to be one more major drop in gold and silver prices before the overall long-term bull market resumed its general trend toward higher prices.

I could not give a definite prediction that there would or would not be one more round of a significant price decline. However, I did state, “the financial markets have lots of sizable potential disasters waiting to explode. If one or more of these were to erupt, then we could see a concerted effort to suppress precious metals prices.” My projection was that another significant price drop would be more politically orchestrated rather than occur solely as a response to economic and financial developments.

Negative political events of the past week have limited the options of the U.S. government. The dilemma is largely caused by past actions of the U.S. government. In my judgment, forcing a decline in commodity prices, especially gold, silver and petroleum seemed to be the only option that could temporarily delay having to actually try to fix the problems.

Well, that is exactly what is happening. From a mid-week high last week, the price of gold has fallen over 4 percent and silver dropped at one point almost 10 percent. This round of falling prices has not necessarily reached bottom yet.

The nexus of the problem is that the current round of U.S. government inflation of the money supply (known as Quantitative Easing 2) expires this Thursday. As expected, this dilution of the value of the U.S. dollar (done in the name of stimulating the U.S. economy) had two huge negative results: 1) more aggressive efforts by foreign holders of U.S. dollars and U.S. Treasury debt (including Fannie Mae and Freddie Mac bonds as well) to sell off these assets, and 2) sharply higher U.S. consumer prices.

To avoid further trashing, the value of the U.S. dollar, the administration needed to appear to be opposed to a continuation of inflating the money supply after June 30. Several regional Federal Reserve presidents made speeches in the past six weeks stating either that quantitative easing did not need to be continued or that it should not carry on past June 30.

The latest information I saw was that the Federal Reserve has been forced to purchase about 85 percent of all new long-term Treasury debt and about 70 percent of Treasury debt of all maturities. If the Fed had to mostly stop buying this debt after the end of quantitative easing, that would present a real problem. Unfortunately, the political reality is that a cessation of inflating the money supply would force the U.S. government to pay higher interest rates in order to attract buyers of U.S. government debt that would be rolled over on maturity. Higher interest rates would force up mortgage interest rates, putting further downward pressure on home prices. There would be myriad other problems beyond increasing the federal budget deficit and further hurting the residential real estate market.

The dilemma facing the U.S. government is that it will be forced (out of political considerations) to continue “quantitative easing” while trying to appear that it is not doing so, at least not under that terminology.

Upon the conclusion of the latest Federal Open Market Committee meeting last week, a statement was issued. Shortly thereafter, Federal Reserve Chair Ben Bernanke held his second press conference. Between the FOMC statement and Bernanke’s press conference, the administration conceded that the alleged economic recovery was not really happening and that the FOMC and Bernanke did not understand why the economy was doing so poorly. Despite not knowing why the economy was in the poor condition that it was, Bernanke confidently claimed that the weak conditions were only temporary.

Huh? If you admit you don’t understand what is going on, how can you then be confident that what is happening will only be temporary?

Bernanke supported his contention with two pieces of information. First, he expects the economic fallout from the March earthquake and tsunami that hit northern Japan to disappear quickly. Sorry, but the Japanese catastrophe had such a small impact on the U.S. that it is not accurate to describe it as a major contributor to the recent weakness in the U.S. economy. Also, the recovery will take years rather than months.

Bernanke also stated that the rise in the price of petroleum was a temporary blip in recent “core” consumer price increases and that this problem would be resolved as petroleum prices declined in the near future. Apparently, Bernanke “forgot” that energy costs have long been defined as not being part of U.S. government-reported core consumer prices. Therefore, any drop in petroleum prices would have no direct impact on this statistic.

For the past year, I have been telling my readers about the deterioration in the U.S. economy that has now come to pass. If it was so obvious to me, it is difficult for me to believe that Bernanke was telling the truth when he stated that he does not know why the U.S. economy is now in such a mess. But, if Bernanke is not as incompetent as he claimed, that means he is a liar. Or, possibly, he is both incompetent and a liar.

Given the poor state of the U.S. economy, what can the administration do now?

What has unfolded in the past week makes me suspicious about the strategy that the administration has chosen to pursue.

First, it has been standard operating procedure for years that the prices of precious metals need to be suppressed when the Federal Open Market Committee is meeting and issuing their statement. Second, the U.S. government does not want gold and silver prices to rise after a top official, such as Bernanke, make a major address.

Precious metals prices did not fall last Wednesday. Instead, gold closed on the COMEX at $1,553, its third highest gold close ever (ignoring inflation), just $4 below its record high close on May 2, 2011. Silver jumped to a multi-week high close of $36.73. Both metals were building momentum to surge higher.

The next day, the U.S. government announced that it would be releasing 30 million barrels of oil from the fed’s Strategic Petroleum Reserve. In addition, it was announced that another 30 million barrels of oil would be added to the product stream from other nations over the next month. The reserve theoretically is being held only for use in national emergencies. The price of petroleum had actually fallen significantly in the weeks before this news, so there was no national emergency reason to justify this release. Therefore, the release was politically motivated rather than for economic purposes.

The announcement of this relatively modest release of oil had the desired effect of pushing down oil, gold and silver prices. It also had the effect of knocking down the prices of many other commodities.

Aha. Falling commodity prices now creates the specter of deflation, where consumer prices fall. Deflation would be a boon for consumers, but a nightmare for the U.S. government. The U.S. government needs the value of the dollar to decline in order to repay its mountain of debt at a lower cost. Deflation would have the side effect of making the U.S. dollar more valuable. For political survival, the administration cannot allow that to happen.

However, if deflation is allegedly happening (even if it really is not), the U.S. government can proclaim all the fiscal problems that it would cause. So, the government would need to do something to keep the effects of deflation at bay. One of the ways to do this would be to start a new round of inflating the money supply. You can be sure, if this comes to pass, that it will be disguised by calling it something different than quantitative easing. To make the politicians breathe easier, this continuation of inflation of the money supply will appear to be for a different purpose than the first two rounds of quantitative easing, which makes it alright for the government to be “forced” to do this.

There you have it. The U.S. government can make a stand against the evil of quantitative easing, while at the same time engaging in that very same activity that, on the surface, seems to be needed to forestall a brand new problem. In the process of doing so, the price of gold gets suppressed for a time, which as one of its functions serves as a report card on the strength of the U.S. dollar. This perfect scenario, in terms of the U.S. government, makes me suspicious that this may be what is really going on behind the scenes now.

The eruption of this fiscal crisis is the reason why precious metals prices have been crushed over the past several days.

Looking forward, what does this all mean for the precious metals markets? Right now, buyers have a bonus buying opportunity at lower price levels than I expect to see in the not-too-distant future. The ability of the U.S. government and its trading partners and allies to push down gold and silver prices has weakened in the past year, apparently because of the lack of physical metal that could be surreptitiously sneaked onto the market.

This time around, it looks like there has to be some actual gold showing up on the exchanges. Yesterday, the rates for gold leases with maturities from one month through one year all dropped significantly and are now all negative. That’s right, there is so much physical gold on the market that would-be borrowers can now be paid to lease gold rather than having to pay a fee to do so.

The further destruction of the value of the U.S. dollar is already baked into the plans of the U.S. government. You need to protect yourself with assets like gold and silver if you have not yet done so.

Patrick A. Heller owns Liberty Coin Service and Premier Coins & Collectibles in Lansing, Mich., and writes “Liberty’s Outlook,” a monthly newsletter on rare coins and precious metals subjects. His radio show “Things You ‘Know’ That Just Aren’t So, And Important News You Need To Know” can be heard at 8:45 a.m. Wednesday mornings on 1320-AM WILS in Lansing (which streams live and becomes part of the audio and text archives posted at