Re: Theoretically the price of gold is screaming upward

First let me state that these are my thoughts (my worldview so to speak) and not necessarily absolutely correct or correctly spoken from the perspective of an economist.

The credit for the initial illustration goes to Jason Hommel.

In the previous post I was attempting to show just how much credit/money is being injected into the system at the current time and what the effects would be in a true gold standard, cash based, society. If that injection were cash (dollar bills, actual currency tied to gold) then one would expect the price of gold to have headed up as in the mathematical proposition put forth.

But this is a cash AND CREDIT system with NO GOLD BACKING AT ALL. So the illustration, while a fun and instructive exercise, does not reflect the current reality.

According to the FED as of December 2007 there was about $829 billion of currency (dollar bills) in circulation. In a strictly gold standard cash basis society with a backing of 261million ounces, the value of gold should currently be $3176/ounce.

http://www.newyorkfed.org/aboutthefe...

What was injected into the system recently was not cash (dollar bills) but credit. People still think of dollar bills as the "real thing." If you are paid in cash the debt is paid. In reality dollars themselves are paper; they too are a promise to pay.

What that payment will be is never stated because the dollar is backed by nothing. If dollars had been printed and given to the banks in the recent bailouts the populace would have been horrified as they watched the "dollar" being debased. And it would have quickly been reflected in the currency markets as the dollar would been reduced in its exchange value by virtue of there being more of them.

People perceive that there is a difference between cash and credit even though they are both promises to pay. Once a dollar bill is printed people expect it to remain in circulation forever (discounting the fact of wear and replacement). However debt is expected to be repaid. When the "debt" that was injected has been retrieved, the system is net neutral (except for any changes, positive or negative, generated by the use of the money). In other words debt is not perceived as increasing the currency in circulation and hence it should not affect the price of gold as it will eventually be netted back to neutral again. Like air blown into a balloon and sucked back out.

In extreme cases however (when people make promises to pay that CAN NEVER BE REPAID) the perceived difference disappears and bankruptcy is inevitable. The promises actually paid will be less than contracted, if any are paid at all, regardless of what form was originally owed.

Debt (as mentioned above) can be likened to air being blown into and sucked back out of a balloon. If too much is blown into it however, the balloon is compromised. Right now there is a fairly large hole in the balloon (and the debt which should be neutralized when retrieved from the balloon entrance has escaped and is gone forever). The authorities are pumping debt into the balloon as fast as they can to keep it inflated.

As long as it appears to be inflated people hope that things can return to normal. But that is not so. Much air has escaped from the balloon, these are promises which exist that cannot be paid. If and as, the balloon deflates one can easily the remaining air will not match the promises, hence the need to keep the balloon inflated.

Human nature being what it is, the more pressure there is in the balloon the faster the air will escape. I refer to graft, corruption, and misalocation of the newly injected debt.

Why can't this work? Because the price of housing is still beyond the affordability of the general public who find themselves under continually incresing and worsening pressure as the economy goes south. They will not be getting loans to buy housing until they can afford to buy the homes. Since the public's situation is deteriorating the price of the homes has to keep dropping and that aggravates the bankers situation.

Bankers can't make money by loaning that which has been given them because home prices are still unaffordable to the general public. Potential home owners can't meet the higher lending standards banks can't make any further mistakes. Businesses won't make loans to start or expand their business in a climate like this. So the balloon stays full with gov't injections so the world can't see the real situation and the banks cannot make money to repair the hole in the balloon.

As fast as the debt is injected it goes out the hole. Still the illusion of a full balloon is necessary to keep the game (and the hope of the people) going.

Rather quickly I believe, the FED and gov't will themselves not be able to borrow from foreigners to inject further debt into the balloon.

1) because so many other countries are either in trouble themselves or will have moved into full caution mode

2) they now know the extent of the U.S. monetary crisis (many are experiencing it themselves and it is worse in the U.S.)

The only way remaining to keep the balloon full is to in effect borrow the "money" from ourselves by debasing the currency and pushing the proceeds into the balloon. Here is where the number of "dollar promises" starts multiplying.

All of the foregoing (except for the last paragraph) is taking place now. The number of promises to pay keeps increasing and the ability to pay them cannot keep pace as there is a hole in the balloon which is not likely to be repaired until after the balloon has collapsed. Hopefully the inflation process will not get out of hand to the point where the balloon explodes.

The value of gold should be going up steadily but the illusion of possible success and the confusion of how much damage is being done makes people slow to respond.

When the U. S. is denied funds from foreign lenders the final step of debasing the currency openly takes place. Everyone will know the financial fate of the country is sealed and gold will skyrocket.

P.