The predictable collapse...

An Entirely Predictable Economic Dip

by John Tamny

Six weeks ago this column observed that with the price of gold having passed $1,500, the U.S. economy was already in the midst of a downturn, and that it would be foolhardy to wait for always backward looking and unreliable government statistics to reveal what gold already had. Though unemployment figures are as unreliable as the rest, Friday's anemic report points to a slowdown in economic activity that the dollar's fall in concert with gold's spike foretold.

The reason why is very basic. Contrary to the popular view among economists that currency devaluation is necessary during periods of economic hardship, debasement works against the very investment that drives company formation and job creation given the tautological reality that any returns on investment will come back in cheapened money.

Gold, the most stable constant of value known to mankind (hence its use as a money measure for thousands of years), doesn't rise or fall as much as it rises when the dollar in which it's priced declines in value, and it falls when the dollar in which it's priced increases in value. If you devalue the dollar you drive investment into hard, commoditized assets that already exist, and that are least vulnerable to devaluation.

Conversely, when currency values are maintained with stability in value paramount, investment flows into stocks and bonds of companies set to create that which doesn't yet exist. Devaluation is the proverbial blast to the past, while currency stability and strength are forward looking, and this explains why countries have never devalued their way to prosperity.

If we then look back to the most substantial economic contraction of the 20th century in 1920-21, the fact that the gold standard was unshaken amid this unsettling decline in economic activity tells why the economy rebounded so quickly. With investors confident that their delayed consumption (meaning investment) wouldn't be clipped by the monetary authorities, capital flowed to wealth enhancing activities and the economy roared.

The early ’20s offer other lessons that tell us why the economy boomed 90 years ago, but sags at present.

Indeed, contrary to the Krugmanesque view that governments must spend uncontrollably when economic spirits are down, in the early 1920s our federal government greatly reduced its spending burden on the U.S. economy. Though it spent $6.4 billion in 1920, by 1923 total spending had declined to $3.3 billion.

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http://www.realclearmarkets.com/articles/2011/06/07/an_entirely_predictable_economic_dip_99060.html