Gold Price to Soar When Crack-Up Boom Hits US Market

The other day, a residential real estate developer in Vancouver, BC - one of the hottest markets still remaining in North America –– said to me, “Ed, We’ll never see a boom like this again in our life time.”

The remark jogged loose a memory I had long forgotten.  The year was 1989 – two years after the stock market crash of 1987. It was my first day on the job as a full-fledged stockbroker. During a lull in the trading day, one of the old-timers started reminiscing about the good old days, before the crash. “It was easy making money back then,” he sighed. “But we’ll never see a stock market boom like that again in our lifetimes.”

The old trader was dead-wrong, of course. A few months later, the Dow was soaring past the highs of 1987, and a few years after that the Internet/dot.com mania spurred an epic stock market bubble.

So what about the current real estate crisis? Will it turn into a barely perceptible blip in the historical record, hardly worth discussing…as did the stock crash of 1987? Will the veteran real estate developer in Vancouver be as wrong about his industry as the old time stockbroker was about his?

No one can see the future, of course, but we can all see the past. And the recent history of financial crises suggests that real estate prices could go much higher within a few years, but only because the value of the dollars in your pocket will go much lower. In other words, as the dollar loses value, the prices of tangible assets like real estate will go up. We call this phenomenon “inflation” and it doesn’t make anyone richer.

The US Federal Reserve has signalled its intention to pump as many dollars into the US monetary system as necessary to “maintain liquidity”. No one really knows what “liquidity” is exactly, but like Supreme Court Justice Potter Stewart once said about pornography, “I know it when I see it”…and we will see it too (liquidity, that is).

We will see this liquidity in the form of inflation, perhaps even hyper-inflation. Most Americans think of inflation as the gentle – and harmless – increase in the cost of goods and services over time. The 5-cent Coca-cola, for example, is now US$1.50…and no one seems to mind. But they should mind.

Fundamentally, inflation is an across-the-board drop in the value of money.  Ludwig von Mises, a deceased economist of some repute, called the culmination of hyper-inflation the “crack up boom” – something that appears when “the masses wake up…[and] become suddenly aware of the fact that inflation is a deliberate policy and will go on endlessly. A breakdown occurs. The crack-up boom appears. If a thing has to be used as a medium of exchange, public opinion must not believe that the quantity of this thing will increase beyond all bounds.”

If we are talking about something as serious as a crack-up boom occurring here in the US, or something at least as serious as 1970’s-style inflation, we are talking about a precipitous drop in confidence in the dollar.

And let’s be clear; if a serious crack-up boom occurred in the US, an ice cream cone on a hot day would retain its value better than a dollar. Under such a scenario, the Dow may go to 30,000 – or to 300,000 – but only because the dollar had lost value in relation to stocks. But not because of all the reasons the bulls talk about – like productivity and real gains in earnings.

Assets like gold tend to gain the most when the market sniffs a crack-up boom. (Curiously, gold jumped to a new one-year high of US$714.00 last week – just US$15 shy of a new 27-year high! Maybe the “yellow dog” is sniffing something already).

It is instructive to note that the aggregate price gains of the stock and real estate market during the 20th century can be almost completely explained by the debasement of the dollar.

Compare, for example, the US median home price in nominal terms to the median home price “after inflation,” also know as the “real” price. Why did home prices go up so much since 1975? One word: Inflation. At least 80% of the gain in prices for the median new single family home since 1975 can be attributed to monetary devaluation.

Looked at another way, the median home price in nominal dollars costs about six times as much now as it did 30 years ago, but not even twice as much in real dollars. I’m no fan of the CPI because I think it understates actual inflation rate. But even an “understated” CPI shows the surprising extent to which rising asset prices over time can be attributed to monetary abuse. (Incidentally, in gold terms, the median single family home in the US would cost roughly the same today as it did in 1973 – about 350 ounces).

Expect inflation to continue…if not accelerate.

The Fed will meet today’s credit crisis head-on with every imaginable form of “monetary stimulus” – which is just an elegant term for “money printing”. Bernanke is trapped in a commitment to an inflationary policy. Therefore, ANY asset that is sounder than a dollar will be a better asset to own than a dollar…even a house.

The current downturn in the homebuilding business may take a few years to work itself out. But make no mistake; this bust could eventually lead to an even bigger boom…sort of. Prices might rise, but only because dollars have become less valuable. As the cheapening of the dollar accelerates, the dollar-based prices of every hard asset will soar…especially hard assets like gold.

The next boom might be a real crack-up, but only gold investors will be laughing.

Ed Bugos
for The Daily Reckoning Australia

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