Marketwatch (Aug 29) by Matthew Lynn — What would gold be priced at if it reclaimed its role at the center of the monetary system? There are plenty of predictions out there but the truth is no one really knows.

The interesting point is this, however.

Markets are anticipatory. They are always trying to get ahead of the game. It doesn’t take an actual return to the gold standard to send the price soaring. Just the debate should be more than enough.

The strains are showing. The dollar is in long-term decline as the U.S. shrinks in relative importance. Central banks are frantically printing more paper money but having little impact on the real economy. Asset markets are getting ever more unhinged. It is hardly surprising that people look at the mess and start to ask hard questions about whether the monetary system is really working.

What would the price of gold be if the U.S. did return to the gold standard? No one really knows. The London-based research firm Capital Economics estimated in a study last week that it would be around $10,000 an ounce, or more than five times its current price.

The chances are, however, that so long as there were speculation about a return to the gold standard that would be very good for the precious metal. Investors would pile into the asset in anticipation of massive central bank buying. The price would go up and up.

Will we ever go back to a gold standard? It is too early to say. But is certainly true that the existing monetary system is a mess, and the discussion is under way.

And that can only be bullish for the metal.

[Source]

In my opinion, QE3 is a huge distraction and a short term consideration that takes away from the real reasons why the gold price might rise in the years to come. After all, how much of QE2 has fed through to prices thus far? Little to none — yet gold has risen significantly. Most of the money printing has gone to fill some very large holes in the economy thus far, though it should be kept in mind that money printing, according to Friedmanite analysis, can take up to three to five years to wend its way through the economy and result in price inflation. That would make this year and next key to confirming whether or not the inflationary fires have been lit, and there certainly are some signs that we may be in for a round of inflation. (We should all remember though that gold, to the surprise of many, has made this phenomenal move during disinflationary times — something else that often gets lost in the reams of discussion on the markets.)

Gold’s long-term future, in my view, is more wrapped up in

a) the burgeoning demand from central banks

b) consistent global private investor demand, particularly that emanating from the East

c) hedge fund demand led by stalwarts like Soros, Einhorn and Paulson. (They aren’t buying for short term speculation, but because they need a hedge just like the small private investor needs a hedge.)

d) contractual use of gold as collateral by financial institutions

e) global production being tied up at the national level by countries more interested in channeling it directly to national coffers instead of liquidating it on the open market for more dollar or euro reserves

With those factors underpinning the market, a successful QE policy, i.e., one that actually kick-started the economy and induced price inflation, would become so much icing on the cake and potentially launch an explosive rally in the price. But that said, QE3 is just one ingredient in a complex recipe. In short the recipe looks so good, it might not need any icing. Add the icing though and it would amount to having your cake and eating it too.

Times have changed. . . .This is not the gold market of the 1970s. . .

All of this is covered in some detail in the new third edition of “The ABCs of Gold Investing: How to Protect and Build Your Wealth with Gold” which can be ordered at this link.

Overlooked in the discussion about a new rendition of QE3 is the fact that government bond auctions continue to be oversubscribed with aggressive interest from both domestic and foreign buyers. The discussion on the QE3 issue over the past few weeks has been endless but I have yet to see any of the so called “Fed Watchers” dealing with this straightfoward quandary, if there is such a thing as a straightforward quandary.

The commercial banks in the United States are much more interested in buying government debt than they are lending money to their customers. They see it as the safer alternative as they stand precariously poised on their slippery slope. Foreign banks and financial institutions don’t have much in the way of options. Euro based debt is a bit risky at the moment. Japan is paying zero. Switzerland is discouraging investment. Go down the checklist and the United States looks to be the best option despite concerns about the so-called fiscal cliff and whatever else is rattling around out there in the U.S. bond market.

So what’s a Fed chairman to do if there is literally no U.S. government debt available for purchase? Ask the federal government to create so much debt the world can’t buy it thus forcing the Fed into the picture? Compete with all the other buyers to get their hands on some of those precious debt instruments?.

Well, the whole thing is quite a quandary, and a pretty big one, for the Fed chairman. He might opt for more MBS purchases — a backdoor kind of monetization that hasn’t seemed to do much good for the overall economy. The better choice would be to issue what I would call the QUANDARY DIRECTIVE (QD) — a kind of official order to the banking system that it must loan out a certain percentage of its reserves over a designated and hopefully short period of time. That might actually help the economy. If not that, perhaps QUANDARY DIRECTIVE II (QD2) – Direct Injections….launch the literal helicopters, congregate the people, and let the currency fall from the sky. That would certainly get results.

Jokes aside, the options are limited, so he is likely to do nothing except offer up some sort of a palliative — to keep Wall Street from open rebellion. With Romney ready to pull the rug from under Bernanke (should he come out victorious in November), it doesn’t look like the Fed could print Obama into a second term even if it wanted to.

What’s a Fed chairman to do??