Gold thrives on political and economic uncertainty . . . and we've got plenty of that following the Republican victories this week and the Fed's Wednesday afternoon announcement that it is embarking on another large dose of monetary stimulus.

We reiterate our long-term forecast that gold prices will rise to $2,000 an ounce, then $3,000, and possibly higher over the next few years. Certainly, this week's U.S. Congressional election and the policy decisions just announced by the Fed only reinforce our confidence in gold's bullish prospects.


Now that the Republicans have overwhelmingly seized control over the U.S. House of Representatives, there will be plenty of rhetoric from Congressional leadership and the Obama Administration about "working together" to solve America's economic problems.

But, in the end, unbridgeable philosophic differences on the role of government suggest that the ship of state will remain rudderless -- at least with respect to fiscal policy -- until the next federal elections in two year.

Not only will the new Republican majority in the House confront a liberal Administration, but there could also be a titanic struggle for control within the Republican Party between its now-more-powerful conservative wing and party moderates and within the conservative wing between the traditionalists and the unconventional Tea Party bloc that has now won a seat at the head table.

It's hard to imagine we won't be faced with more gridlock and more acrimony on Capitol Hill -- in short, a dysfunctional government that is incapable of dealing effectively with America's serious economic problems.


One of the first big indicators of future fiscal policy -- or lack thereof -- will be the decision taken to extend or let expire the Bush tax cuts that run through the end of this calendar year -- or just possibly accept some sensible compromise that would extend the cuts another year or two for all but the wealthiest few percent of tax payers.

Rather than pursue what some consider appropriate counter-cyclical fiscal policy, failure to extend the Bush tax cuts will raise taxes at just the wrong time, taking money and spending power out of the household and small-business sectors.

Others argue the expiration of the Bush tax cuts is just the right medicine to reign in our outsized Federal budget deficit and borrowing requirement, a first step toward restoring confidence in the U.S. dollar both at home and overseas -- but fiscal restraint at this juncture could easily backfire, reversing or slowing the hoped-for economic recovery.

In any event, neither course -- raising taxes enough to achieve a quick and significant reduction in the Federal budget deficit, nor cutting taxes enough to greatly stimulate a sluggish economy is politically feasible given the deep divisions in Washington DC.

How this controversial fiscal-policy issue unfolds and its long-term effect on the health of our economy -- will be one of the big issues affecting gold and other world financial markets, not only in the weeks ahead but possibly for years to come.

Another important fiscal policy issue that will soon capture more attention on Capitol Hill and in the financial press is the insolvency of many state and local government entities across the nation. With the new, more conservative, majority in the House of Representatives the hoped-for bailouts from Washington may not be forthcoming.

Many states operating in the red (including California, Texas, New York, Michigan and others) must balance their budgets -- meaning further belt-tightening, service cuts, more layoffs of public employees (including teachers, policy, firefighters and office workers) and higher local taxes, all of which will be a further drag on the national economy.


With the Obama Administration and a more conservative Congress at loggerheads, it is likely that America's central bank will, by necessity, be the only agency capable of acting forcefully in the face of a continuing recession-like economic performance. And, all the Fed can do is print more money -- what economists and financial journalists call "quantitative easing" or simply "QE." The Fed accomplishes this magic trick by purchasing securities, usually Treasury notes or bonds, in the open market but pays via an electronic debit entry on its balance sheet.

Indeed, perhaps more important than this week's election outcome for the short-term direction of gold and other financial markets will be the decisions taken at this week's meeting of the Federal Open Market Committee (FOMC), the Fed's policy-setting forum.

In its policy statement released following Wednesday's FOMC meeting, the Fed stated it will buy $600 billion more in longer-term Treasury securities over the next two quarters -- or about $75 billion each month -- but the Fed has left the door open to make adjustments up or down in response to the unfolding economic indicators.

Fed Chairman Ben Bernanke may be doing the right thing by adopting more aggressive monetary stimulus. Without more action now, the economy will sink further, new job creation will slow or grind to a halt, and unemployment will surely rise.

Even with this new commitment to more aggressive monetary stimulus, I believe recession-like conditions with persistently high unemployment will continue for another few years -- and that additional tranches of quantitative easing by the central bank could raise the cumulative size of the Fed's monetary stimulus to two or three trillion dollars.


Printing more money may raise the hackles of sound-money advocates and surely won't be appreciated by foreigners holding U.S. debt -- but inflation may be just the potion that could ultimately restore economic equilibrium by devaluing our debt in real terms and reducing its burden the economy expands more quickly in nominal terms, reflecting not only real growth but also inflation. And, if wages rise with prices, a few years of moderate inflation here at home could be politically palatable.

Although the Fed is actually targeting a small rise in consumer price inflation, I believe they are well aware of the much greater inflationary potential arising from their program of quantitative easing.

The stagflation of the 1970s -- a period of sluggish economic growth and high unemployment -- demonstrates that inflation, led by a falling dollar and rising commodity prices, can take hold even with a high degree of economic slack and low rates of capacity utilization.

It's especially relevant to today's investors to remember that this was also a period of rapidly rising gold prices!


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