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James Saft: Push for auditing Fed aids gold rally

Section: Daily Dispatches

By James Saft
Tuesday, November 24, 2009

Auditing the Federal Reserve may or may not be a good idea, but one thing seems pretty sure: just discussing it seriously will tend to drive the price of gold higher.

The U.S. House of Representatives Financial Services Committee last week voted to approve an amendment that would bring about an audit of the Fed, its monetary policy and lending programs, since when gold has gone its merry way higher, hitting an all-time high of $1,174 per ounce on Monday.

The amendment, a provision to a broader financial services reform bill that is still under consideration, was co-sponsored by Republican Representative Ron Paul, author of the book "End the Fed," and the man least likely to be found chairing a panel at Jackson Hole or Davos.

The Fed, understandably, hates the idea, saying it will compromise its hard-won independence, the administration loathes it, and really it will almost certainly never become effective in a recognizable form.

Even so, and even interpreting the vote as a populist cry of the heart against Washington and Wall Street, the fact that it has gotten this far will cause some serious people without an ideological dog in the Federal Reserve fight to buy a bit of gold, which is really a sort of anti-currency, as a hedge against increased political influence in the process of making monetary policy.

Undoubtedly many people who think keeping the Fed on a short leash attached to an elected body is a good thing also think the Federal Reserve should have been much less aggressive in creating money and risking inflation. History shows that the risks are actually skewed the other way: tighter political control of central banks more often means more inflation and a higher risk of a debased currency.

In other words, the people who support this because they think the Fed shouldn't debase the currency are probably raising the risk that the currency is debased. This just adds to the bid for gold, which is already being supported by concerns that current monetary policy and deficits put inflation and the dollar at risk. These risks are not high, they are tiny, but they are disturbingly more worth discussing now than two years ago.

Thus we are in the bizarre situation of watching the price of gold being driven higher both by people who don't trust the Federal Reserve and people who don't trust the people who don't trust the Federal Reserve.

It has to be said: The very idea of buying gold, which adds nothing to the creation of wealth or innovation and is only conceivably a hedge against bad actions of other people, is dispiriting. If you buy gold you cannot tell yourself that you are doing well by doing good, as perhaps you can with a biotech or fertilizer company. You are simply limiting the damage that can be done to you, and then only in very particular circumstances. What's more many of the people who advocate it as an asset show a disconcerting monomania; the type who if they sit next to you on a commuter train makes you consider pretending the next stop is yours.

Gold's real virtue is negative. It is not used for much industrially but there is limited supply and real physical constraint on producing more. Unlike, say dollars, you can't simply flip a switch and make more.

Dylan Grice, strategist at Societe Generale in London (who, by the way, I'd happily sit next to on a train) points out that the value of the gold held by the Fed only equals 15 percent of the U.S. monetary base and that the price would have to rise to $6,300 per ounce to make the currency fully backed by gold reserves.

Of course, gold is not just going up against the dollar, it is going up against an array of major and minor currencies, indicating that the worries are not simply about the Federal Reserve or U.S. policy but about the interplay between fiat currencies and policy around the world. A tremendous amount of debt has been created and socialized and a lot of money has been created.

Which brings us back to the Federal Reserve and the politics of monetary policy, or as perhaps we will begin to see it the politics of politics. The betting has to be that the Federal Reserve emerges with its independence intact, if not its power as a regulator. From a markets point of view the Senate confirmation hearings for Ben Bernanke's second four-year term as chairman kick off next week and offer the next opportunity for populist fireworks.

I am looking forward to having fewer conversations about gold, but I am not expecting it.


James Saft is a columnist for Reuters.

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