Return to Prosperity

I recently wrote a post about the decline in the gold price.  I said that it could mean one of two things.  The first scenario is that it is a temporary downturn before we see another big run in the gold price.  The other possible scenario is that we are headed into another recession.

In response to this, I received the following comment:

"In general I agree with your expectation for gold to rise in price.  But I note that there is a 3rd possibility... that we are emerging from the deflationary recession depression and in the early stages of a return to prosperity.  If that is the case gold could be on the express elevator ride to the basement.  Remember the 80's and 90's."

He is technically correct that this third possibility exists.  But I give it no more than a 1% chance.  The only way I see this happening is if we have some major technological breakthrough in tandem with Congress finding fiscal discipline.  Perhaps I should say that I give it no more than a .01% chance.

So what is my reasoning for this?  First and foremost, the Federal Reserve has more than tripled the monetary base since 2008.  It is on its way to being quadrupled.  This is unprecedented.

We had a major recession in 2008 and the federal government, along with the Fed, did not allow the full liquidation to take place.  Instead, it propped up failing companies, tried to prop up housing, and has continued to bail out banks and create massive amounts of new money out of thin air.  We are actually in a worse situation now than we were in 2007, at least in terms of distortions in the economy.

All of this massive malinvestment will have to be corrected at some point.  If it is not, then our living standards will decline immensely.  Until we see a shakeout of all of the misaligned resources, we are not going to return to prosperity.  We may see false prosperity in terms of higher housing prices and higher stock prices, but that is only because of the massive monetary inflation that has taken place and continues to take place.

The last sentence in the comment above is: "Remember the 80's and 90's."  But this is a perfect example of why we will not return to real prosperity any time soon.  This can't be like the 80's and 90's.  If anything, we are in the early 70's right now.  It would not surprise me to see us advance into something like the late 70's with high price inflation and high unemployment.

While a part of the boom of the 80's and 90's was false prosperity from a loose monetary policy, it was, at least relatively speaking, good economic times.  But the reason we were able to have good times is because we took the right medicine before that.  Paul Volcker came in at the Fed and halted the printing presses.  He allowed interest rates to rise to what would be unthinkable levels today.  With no more monetary inflation to prop things up, he essentially saved the dollar, which also resulted in severe recessionary conditions in the early 80's.  We went through the pain of the correction.  Resources realigned to better uses and we saw a new wave of investment and productivity.  We were only able to return to prosperity when the malinvestment was flushed out.

We have not taken the right medicine yet today.  Instead, Bernanke and friends keep putting poison in our bodies.  Sometime the poison has an illusion of masking the painful symptoms, but it is actually making us sicker.  Until we stop taking the poison and start taking the medicine (while experiencing some pain), we are not going to return to prosperity.