Most cautionary tales of gold hearken back to January 1980, its last major peak. Though there are important lessons to draw from this period, I don’t think that’s the best guidance in today’s market. For one thing, the 1980 speculators were in some ways wrong. The same things that concerned investors then concern gold investors today: inflation, the size of government, and foreign competition (now from China rather than Japan).

And looking back, these worries were very real. But ultimately, things weren’t as bad as they seemed. The U.S. got its act together enough to kick the can along 30 more years until the present crisis. As a result, the valuations for gold were far too high. Knowing what we know now, gold should never have reached $850 in 1980. The country was stronger than most had expected.

What lessons can be learned from this? First we have to ask ourselves, “Can we kick the can for another 10, 20, or 30 years? This time around, it would be difficult to predict 20 or 30 more years ahead. Not only have our debt problems gotten bigger, but the baby boomer retirement wave is just around the corner. That’s not something investors had to worry about in 1980.

Furthermore, back then the Federal Reserve was under the control of sky-high interest rate chairman, Paul Volcker. Today, Bernanke is the polar opposite when it comes to rates. If inflation really begins to pick up, I don’t think that Bernanke will be able to stop it. Under the best of circumstances, I simply can’t see us pushing our problems back more than ten years without another major financial disaster.

So, while examining the past is useful, we also have to remember the simple fact that we aren’t in 1979 or 1980 any more. Our problems are much bigger, and the prospect of another 30 years of American prosperity with small intermittent recessions doesn’t seem plausible. As a result, analysis of 1980 gold prices might not be as valuable as some imagine. Perhaps if the market begins to recover strongly, gold will weaken, but I’m not sure that it would fall off a cliff again. The situation is different in a significant number of ways.

Next, Doug Hornig will give us his thoughts on the state of the union address. As you know from last week, I don’t have much interest in these addresses, but there are differing opinions on our team. Doug will have a more optimistic point of view on the address and what it could mean for investors. Then, I’ll have some comments on a recent Gallup poll on spending cuts followed by some afterthoughts.

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Everything You’ve Read about the SOTU is Wrong

By Doug Hornig

Here at Casey Research, few of us bothered to watch the State of the Union address. The expectation, as always, is of long-winded self-congratulation, interspersed with applause-generating sound bites – long on rhetoric, short on substance. It was all that but, surprisingly, much, much more. In actuality, it was one of the most brilliant pieces of political theater you’ll ever see... if that sort of thing appeals to you.

I’m more of a political junkie than many of my colleagues here, so I watch all these things. If you missed it, you can catch the instant replay on YouTube. It’s worth it. Yawn your way through all the obligatory bits: the nod to the fallen comrade (this year it is, of course, Gabbrielle Giffords); the praise for those serving in foreign wars; the proclamation that the country is still the best in the world and headed down the right track; the promise of cooperation with the other party, etc. This is boilerplate. Every president says these things.

But what both mainstream and partisan commentators seem to have missed is the subtext – and that was a stunner.

Consider the back story: here’s a guy whose policies have just been repudiated big time. The opposition is flying high, sharpening its knives. What do you do? You could play defense and argue that everything you’ve done is going to work out in the long run. But savvy politicians know that while defense may prevail in football or basketball, it never wins an election. So Obama went on the attack, and he did it so stealthily and with such a velvet glove that the GOP may not yet know what hit them… no, scratch that; they know.

Sure, Obama proposed new spending on things we can’t pay for, but he confined that to safe areas like education, infrastructure, and clean energy – things everyone’s for, even if we don’t want the government paying for them. But global warming? Zero, zip, nada. Cap and trade is as dead as ninety-nine cent gasoline.

Well and good. But that was kind of expected. What wasn’t expected is that in one short hour this paragon of liberalism suddenly, unexpectedly, got reborn as a conservative. Just have a look at this laundry list of the things he's belatedly discovered he’s all for: repealing the bad parts of the health care bill; removing unnecessary regulation from business; cutting corporate taxes; simplifying the general tax code while closing loopholes; eliminating superfluous government agencies; tort reform; and even, yes, tinkering with Social Security, the formerly untouchable third rail of Democratic politics. He actually said all that. If you don’t believe me, check it out.

Does this sound familiar? It should: Obama just stole nearly the entire Republican playbook. What're they gonna do now? They just got this big electoral swing their way, and everything they pledged to do, he's gonna preempt them and take credit for it all himself. In fact, now if the GOP doesn't get what it wants, he can blame that on them, too. Forget the pretty talk about cooperation and conciliation. This was a full-bore neutering, done in front of the world, using the other guys’ own knives.

And the thing is, it doesn’t matter if he was lying through his teeth. He’s seized the high ground that the opposition thought it had just won, and told them that they only way they can get it back is to rebuke their own selves. That is hardball. It essentially marginalized Paul Ryan’s ‘rebuttal,’ which was brief, thoughtful and on target, but was obviously written in response to a projected big government speech that didn’t really materialize. (And please, don’t even mention Michele Bachmann to me.)

I once believed there was no way in hell this guy could ever get reelected, but now I'm rethinking that. He may not know jack about economics but he sure understands politics way better than his arrogant conduct of the past two years would suggest.

I sent an abbreviated version of this text to our own Bud Conrad this morning, and he replied, “Now can we guess what legislation might actually get done and what effect this will have? My net: Nothing important. We will see deficits forever.”

True enough, the SOTU address was all about posturing, and little of substance may result. However, Obama has taken the risk of putting all this on the public record and now, if Republicans hold his feet to the fire on their favorite issues, he’ll have a lot of trouble backing away from his words.

I think there will be some deficit reduction – not enough, but some. Obama has to deal with Paul Ryan, the new chair of the House Budget Committee and personally my second favorite choice for president in 2012 after Gary Johnson. Ryan is a real deficit hawk, and the only politician to propose an actual roadmap designed to balance the budget. Workable or not, it’s out there, and there’s no competitive plan. So you can count on Ryan pushing it, or at least parts of it.

In addition, Obama publicly admitted what everyone already knows – the budget cannot be balanced by cutting discretionary spending alone. Social Security must be repaired as well. Apart from being emphatic that he wouldn’t allow SS to depend on the vagaries of the stock market, Obama didn’t offer anything concrete. The shocker is that he mentioned it at all. Democrats don’t do that. It could be phony baloney, since it would mean bucking a big segment of his own party (although, come to think of it, that might not be a bad reelection strategy). But no matter who likes it or doesn’t, changes to SS must be made and we’ve now been signaled that they’re on the way. The parties will fight over what to do and when, but we’re going to get something.

Bud’s vision of deficits forever is right on, but they will start to shrink. There will be cuts to the military budget, and some money will be saved as we stand down in Iraq and, hopefully, Afghanistan, although that’s far from a done deal. Any reduction in business regulation that he proposes will cruise on through, and have a positive effect. Consolidation and cuts in bureaucracy will be cheered by everyone, and will help. The health care bill will be dissected from A to Z, and reformed, saving some money.

The key, though, is tax reform. Neither party has wanted to face this since forever. But the president is finally admitting that spending cuts alone aren’t enough, no matter how drastic. You also have to raise revenues. So how do you that without raising taxes? Actually, it’s not that hard. If he’s not lying about reducing the corporate tax rate, that one’ll sail through Congress and it’ll have an immediate and very positive effect, not only bolstering the economy, but increasing tax revenues as private sector confidence improves and new ventures are launched. The other way is by closing tax loopholes, which he also promised. Efforts to further soak the rich with higher rates have gained little traction, so Obama has shifted focus. Now he apparently favors merely making everyone pay their “fair share” – no deductions, no accounting legerdemain – and if he follows through that would increase revenues dramatically. That one, of course, would face very tough sledding, as every lobbyist in D.C. cranks up the heat. But it’d be hugely popular with the public, so we shall see. It could happen.

Finally, what if anything does all this mean to investors? Well, if Obama does back the larger part of the Republican agenda, that’s very business-friendly. Which in turn means that the stock market should do very well.

And there’s one other thing that directly affects us hard money folk, something of a throwaway line during Obama’s backpedaling on the health care bill. The president said he’s realized that there are a lot of things in there that should come out, including one section that is unduly burdensome on businesses. This, I think, can only refer to the onerous requirement that 1099s be submitted for all transactions over $600. That’s gotten huge negative press and it looks like he got the message. I wouldn’t call it a sure thing, but it’s close. The GOP hates this so much that I think they’ll push through a repeal of that section, even if they get nothing else. That is very good news for all of us who like to keep our precious metals buying private.

In the end, will there be any substantive change? History suggests we’d best not hold our breath. Meanwhile, the mountain of debt continues to grow, and nothing anyone envisions can prevent it from hitting the wall some day soon. Still, the real problems will start to be addressed and some first, fumbling attempts will be made to deal with them. The executive branch and Congress will cooperate, not because they want to but because they kind of have to. Obama will need to grit his teeth and abandon his dreams of a government that fixes all things if he wants a second term; the GOP will have to grit theirs and accept that they may have to concede the White House in order to get what they want. For a political junkie, it's gonna be an interesting two years.

Americans Not Willing to Cut Any Significant Programs

Gallup released a discouraging new poll last week, copied below:

This should be disheartening for our readers, and frankly for any investor. So, foreign aid is the only thing that we can agree to cut? Yeah, that’ll solve our problems. The poll goes deeper in to the topic by identifying responses by political affiliation. Surely the Republicans will support more cuts:

And here are the Republicans to the rescue: 56% want to cut funding for the arts and sciences. Good thing too – the Smithsonian is really edging the U.S. toward default. Ironically, 54% of Democrats favor cutting military and defense spending, which is the only large spending program with a majority on the list. Reductions there could actually make a difference. And it’s something that America should consider for its own national security. The strategy of dropping a million-dollar bomb from a billion-dollar jet on a guy with a $300 AK-47 doesn’t make sense for a long-run war. And unfortunately, we’ll run out of money much sooner than the terrorists will run out of crazy bastards willing to blow themselves up.

Some Thoughts on Tax Loopholes

Doug had some interesting thoughts in today’s article, and I feel the need to comment on taxes. I’m personally not against “tax loopholes.” In fact, they shouldn’t even be called loopholes in my opinion. The government writes the tax laws, and some people make a profession of reading the fine print and finding ways to reduce tax bills legally. If the government created the law, I don’t see where the “loophole” comes in.

If the government makes the speed limit on a street 50 mph, but realizes that it actually intended it to be 40 mph, can one blame drivers for driving 50 anyway? Ultimately the drivers are just following the law. Similarly, citizens who use loopholes are following the tax laws as written. Furthermore, what exactly qualifies as a “loophole”? Folks, we live in a country with progressive taxation, where the top 50% of workers pay 97% of the income taxes. In the context of this fact, talking about “loopholes” and “fair share” seems almost absurd.

In his article, Doug makes the point that higher taxes may be needed to close the deficit. While the government has plenty of programs worth cutting, political reality may result in higher taxes. As the recent Gallup poll showed, the majority doesn’t want to cut almost anything. That leaves Congress with only one option to reduce the deficit: higher taxes. So, whether we like it or not, I wouldn’t be surprised to see a great deal of tax loopholes disappear.

That’s it for today.