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How has reflation and greater financial risk affected gold since 2001?

Eric Janszen
December 6, 2006
Video Transcript

I got re-interested back in gold again back in early 2000, like 2001, because my observation was that the way that the central bankers were going to need to reflate the economy after the stock market collapse was to simply print more money. The world central banks couldn't stand by and allow just the U.S. to print money, because the dollar would plunge. Now they wanted to manage the dollar down because that helps the U.S. economy and they did as a group devalue it by about 20%. So what happened was that gold rose just in dollars until about 2003 and then as all the other world's central banks started to print in unison it went up in all currencies since 2003. So our readers have enjoyed that particular ride from 2001 to 2007.

The question is where do we go from here? My belief is that the price of gold is really reflecting both this reflation that we've seen since 2001 of the economy, but it's also reflecting in the words of Alan Greenspan, "a perception of increased financial risk in the global economy." The other thing that has happened in the background is that there has been a great deal of speculation and excessive growth in the debt markets and one of the side effects of that is the housing bubble, and what I call, "The junkification of U.S. corporations." This was actually mentioned in the Wall Street Journal last week, "In 1980, 30% of the S&P companies had debt that you'd rate a triple B or lower that is junk, now it's up to 70%." The problem with that is that this is a side effect of the excessive availability of credit and the use of that credit to lever up these companies. So you see bubbles in private equity, for example, as a result of that. They're able to go out and create debt through relatively exotic credit instruments like collateral backed securities and so forth, synthetic collateral backed securities, and at the moment these are all priced to perfection and the yield spreads are very low which indicates there’s a general perception in the market that the default risk is quite low. Traditionally, that's has always marked a peak in the market, actually the peak of risk in those markets. So what I believe is going to happen is that as the housing bubble continues to deflate, and the debt markets start to readjust to reflect the actual risk in the market, I call it, "going from marked to model to marked to market, right." Over the next few years, that there will be a lot of turmoil in the financial markets. Gold will then, I think, continue to rise, but only after a period of volatility where it might actually decline for a little while.

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