As somewhat of a goldbug, I can’t help but enjoy reading the following updated article (See the original gold peg call from QB Partners posted in December 2008) from Paul Brodsky and Lee Quaintance, who run investment fund QB Partners. The article is posted on Barry Ritholtz’s Big Picture.
Gold at $3K/oz would be pretty incredible for current precious metal holders. Gold at $9,000? That is hard to imagine.
Yet if history is any guide, when we start seeing gold make a serious run up and everybody starts diving into the asset class, we could easily see some unbelievable prices reached.
The rebuttal is that all of this deleveraging will result in deflation, which will take down commodities and gold. With the Fed pulling all the stops, I don’t see that happening. They’ll overshoot on monetary policy (as always) and the resultant rice in prices will mean hell to pay (to buy anything!).
In our papers last year we established that an equilibrium price of gold (our “Shadow Gold Price”) would be something north of $9000/oz today. We used simple, Bretton Woods-model math (Federal Reserve Bank liabilities divided by US official gold holdings). To save the US and European banking systems and stabilize western economies we believe the US dollar peg to gold should be implemented at a much lower conversion price than its equilibrium price. The following actions should be taken:
1)The Fed announces a public tender for any/all outstanding private gold holdings at $3,000/oz.
2)The Fed prints Federal Reserve Notes (aka US dollars) to fund these purchases
3)As once privately-held gold flows into the Fed, the Fed’s balance sheet de-levers in gold terms
4)The Fed would soon own enough gold to credibly support the newly-designated peg
5)The Fed would also purchase the “people’s gold” currently held by the Treasury Department at the $3,000/oz clearing auction price (Treasury is carrying gold on its books at $42.22/oz.)
Bang – the soundness of the dollar suddenly becomes unquestioned because it has scarcity value. Its hegemony is protected and its status as global reserve currency is solidified.
A three-fold increase in the gold price should be enough to guarantee that the “free market” would drive asset prices up to the point that all toxic and opaquely-marked paper is once more reserved by banks at ratios greater than one. The loss that JP Morgan et al would suffer in their gold/silver short positions (yes we know about those) should be more than offset by the move to Par in all their respective paper assets. In fact, given the current interest rate structure of sovereign yield curves, we would argue that most dubiously-priced paper held by banks would be valued well in excess of Par, as credit spreads would collapse to reflect sharply higher asset collateral coverage ratios.
On an ongoing basis, the Fed would hold public auctions (as a buyer/seller) to maintain the $3,000/oz. peg. The gold market would become the new outlet for the Fed’s open market operations. Other economies would have to follow suit and devalue their currencies to preserve trade relationships (particularly net exporters to the US). This would be a huge transfer of wealth to the US, particularly from China and Japan. No doubt the US would have to negotiate terms with these exporters.