Copper and Oil and Gold, oh my!

Over the past four years or so, we in America are witnessing something that last occured about 30 years ago: the dramatic rise in commodity prices. Analysts can chalk this up to many things including greed, demand, etc., and while they might be correct, one thing is certain.

These, as well as most commodities, are priced in US dollars. As the price of the US dollar versus a basket of currencies rises, the prices of these commodities falls. And as the price of the US dollar falls, the prices of these commodities rises. The bottom line is that the actual value of these commodities does not rise or fall. It is a function of the currency.

In general, commodity prices fell from the early 1980's, through the early 2000's. This period was also marked by an historic rise in the value of the dollar relative to other currencies. As evidence of this, the price of gasoline barely rose from 1982 through 2002. Most of the rise we did experience was solely a function of inflation, but less so than most countries.

Now, fast forward to 11 September. The country is more or less in a recession that was forseen as early as January 2000. A massive revenue decline resulting from a significant decrease in capital gains payments in 1999 and 2000 left a Congress with budget shortfalls. This has not been uncommon in the course of our recent history, but had temporarily been alleviated by massive capital gains taxes in the late 1990s. Classic (Keynsian) economic theory states that during a recession, you do one or two things on the fiscal policy side to end the suffering: cut taxes and/or raise government spending. The course that our President and Congress took was both. While this will certainly create budget deficits, the theory stipulates that this policy only be undertaken during a recession. Once a recession ends, you can raise taxes and/or cut government spending. I am not saying this is sound economic policy, only classic policy.

Unfortunately, this Congress, which controls the purse strings, did neither. In fact, perhaps because of 11 September, Congress has increased tax cuts and government spending.

It was roughly from this time that commodity prices (once again, priced in US dollars) began to rise. Crude oil was trading around $17 per barrell, prior to 11 September. Gold was at this point trading at approximately $250 per ounce. As of Friday, crude oil traded over $70 per barrell and the price of gold closed at approximately $710 per ounce. If you'd like to know the market's perspective of our fiscal and even monetary (interest rates) policy, look no further. What this means is that, despite the value of commodities does not rise, only their prices, American can purchase significantly less (by approximately 2/3) of gold. The dollar has fallen this much, largely due to our fiscal situation.

As of this writing, the situation looks only like it will get worse. Baby boomers (far and away, the largest generation our country has ever seen) are beginning to retire, and soon, will begin collecting their entitlements that they have been promised since birth. If we can't balance our budget now, what will happen say in 10 years, when entitlement spending doubles? Either Congress will need to enact massive tax increases or dramatically cut spending. Each year we let pass will only make the situation get worse. Unfortunately, Congress is only elected for a finite period of time, and by the time this bomb drops, most are likely to be long gone.

So America, it is up to you. Either implore your Congressman to dramatically cut spending and raise taxes, or buy lots of gold. Choose wisely.