Smith Faculty Opinion Article

By Dr. Peter Morici, Professor of International Business E-MAIL WEB SITE

September 28, 2010

Why Gold is $1300 an Ounce!

Gold is approaching $1300 an ounce for good reason. The Obama Administration has flooded the world with greenbacks and Treasuries, global investors have little confidence in the management of the U.S. economy, and investors have taken refuge in gold.

Since President Obama took the helm, the U.S. trade deficit increased 60 percent. At more than three percent of GDP, it drains off more demand for U.S. made goods and services than the President's stimulus spending has added.

America's chronic trade imbalances stem from dysfunctional energy policies imposed by Democrats in Congress, and continuing tolerance for Chinese mercantilism. As the U.S. economy recovers, oil and Chinese consumer imports rise, choking the expansion-that's why demand and economic recovery are flagging, stocks can't sustain momentum, and industry won't invest or add jobs.

Democrats in Congress insist on energy policies that limit domestic oil and gas production, and rely on higher prices that instigate conservation. Those have failed to stem dependence on imported oil, the outflow of dollars, and the chokehold Middle East investors, and now China, have attained in global capital markets and on U.S. government finances.

Cheap imports from China have chased millions of Americans from manufacturing jobs, as the U.S. purchases from the Middle Kingdom exceed sales there by more than four to one. The trade deficit with China is about $300 billion and continues growing year after year.

China has engineered this competitive conquest by keeping its yuan artificially inexpensive against the dollar and euro. Annually, it sells at deep discount about $450 billion worth of yuan for dollars, euro and other currencies in foreign exchange markets. That provides a 35 percent subsidy on Chinese exports and keeps Chinese goods deceptively cheap on U.S. store shelves.

The Bush and Obama Administrations have sought changes in China's currency policies through diplomacy but have failed-and will continue failing as long as the rhetoric of appeasement and restraint from self help are the cornerstones of American policy.

Instead of advocating strong U.S. action against Chinese mercantilism, the U.S. Treasury has tarred as protectionist those who propose substantive American responses.

The huge trade deficit must be financed by attracting foreign investment in new productive assets in the United States or by printing IOUs. Investments have only provided a small portion of the necessary cash, so each year the United States sells currency, bank deposits, Treasury securities, bonds, and the like to foreigners. Those claims on the U.S. economy now are about $7 trillion.

That floods world financial markets with U.S. dollars and paper assets that function much like U.S. dollars-what economists call liquidity. All that evokes an iron law of the universe: if a government prints too much money, it won't have any value.

Add federal budget deficits exceeding $1 trillion a year for several years to come, and an economy that can't produce enough to sustain Barack Obama's appetite to tax and spend, and investors are simply smart to short the dollar by loading up on gold.

That's why gold is $1300 an ounce!

Peter Morici is a professor at the University of Maryland School of Business and former Chief Economist at the U.S. International Trade Commission.