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Elizabeth Warren's Misguided Currency Plan Would Cause Gold Prices to Rally

The Street logo The Street 6 days ago Simon Constable
a group of people playing instruments and performing on a stage: Elizabeth Warren's Misguided Currency Plan Would Cause Gold Prices to Rally© TheStreet Elizabeth Warren's Misguided Currency Plan Would Cause Gold Prices to Rally

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Gold investors should love presidential hopeful Elizabeth Warren.

Her plan to lower the value of the dollar will likely cause inflation, capital flight, and a currency war -- any of which have the potential to boost gold prices. And if all happen together, then bullion will do even better.

If Warren eventually gets elected to the White House and then enacts that policy, investors should consider adding a large helping of gold bars to their portfolio. Alternatively, try buying the SPDR Gold Shares exchange-traded fund which tracks the price of the metal.

The U.S. Senator from Massachusetts says "managing" the value of the U.S. dollar could help boost exports.

Warren isn't alone. President Donald Trump has spoken about the topic also.

Underlying her plan is the idea that a lower value of the dollar would make U.S. goods cheaper on the world market and so help boost sales to foreign countries. The theory also says that the rise in exports would help slim down the trade deficit, which measures how much U.S. imports exceed exports.

Out of the Dustbin and Into the White House?

Still, the theory is nonsense because it doesn't work in practice.

It's an idea that most students of economic history have assigned to the dustbin as almost entirely harmful and ineffective. Nevertheless, Warren wants to recycle it, no doubt due to a lack of understanding on her part.

"For any politician to suggest we can solve our trade balance issues with a lower dollar is to suggest they have no idea what is driving both economics and financial markets," says Jeff Christian, managing director of New York-based commodities consulting firm CPM Group.

But Warren's misunderstanding could be to your benefit because her policy will almost certainly cause one or all of the following problems:

1. Inflation

By definition, inflation means that the dollar in your pocket buys less than it had previously. Think of it like so: A lower value for the dollar means that anything you import from the world market will now be more expensive. Energy will be more expensive, as will foodstuffs and materials.

When inflation takes hold, then the value of gold tends to rise. In the 1970s, the U.S. saw massive levels of inflation, sometimes in the double digits. That period also coincided with a rally in the price of bullion from $35 a troy ounce in 1971 to $850 in 1980. That's more than a twenty-fold price increase.

2. Currency War

The next issue, which is no less problematic, is that pushing down the value of the dollar would likely prompt a currency war. They are like trade wars, only worse.

In simple terms, a currency war works like so: if one country devalues its currency so it can boost its exports, then the other countries will follow suit by doing the same, says David Ranson, director of research at financial research firm HCWE & Co.

"Competitive devaluations get you into a vicious cycle," he says. Or put another way, there is quickly a race to the bottom for the value of every currency.

Such tit-for-tat devaluations are more harmful than trade wars because in trade wars companies can shift their supply chains, Ranson says. Currency wars tend to be more pervasive and so envelop the entire global economy.

In such times, investors head for safe-haven assets.

"If the vicious cycle takes off, then the only winners are owners of hard assets like gold," says Ranson.

3. Capital Flight

The key to growing an economy is in attracting capital rather than scaring it away.

But rising inflation (a.k.a. a dollar devaluation) increases the so-called "cost of capital." That's a technical term that refers to the level of returns that investors demand before putting their money to work.

When devaluations are large and persistent, then the cost of capital can skyrocket. That tends to result in investors taking away their money. In other words, they won't want to invest in new factories or cutting-edge technologies.

Instead, they will seek alternative investments that have a history of maintaining their purchasing power.

"A weaker dollar is going to move people into better stores of value like gold and out of the stock market," says Robert E. Wright, professor of political economy at Augustana University in Sioux Falls, South Dakota.

This article was originally published by TheStreet.

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