Bush Tax Cuts to Drive Inflation and Gold Higher - Dollar Lower

It never made sense to me how you could stimulate the economy with money borrowed from taxpayers and then raise taxes on the very taxpayers you just put further in debt.I guess they finally came to the same conclusion as Bush tax cuts have been extended for two years.So, now what happens to the economy?What happens to Gold prices?

The very purpose of stimulus and tax cuts is to heat up the economy.As you do, rising inflation is a byproduct of those efforts.That's right!Rising inflation is not a matter of "if", it's a matter of "how high".With inflation, then comes upward pressure on gold prices as gold has long been recognized as an inflation hedge.

As news of the extension of Bush tax cuts navigated its way to the far east, gold prices rallied overnight with China trading.If anyone is sensitive to U.S. inflation and a weaker dollar it is the Chinese.A weaker dollar means less profit for those from whom we buy imported goods.Hence, it becomes prudent for people like the Chinese to own an asset that hedges against dollar debasement and inflation.Gold is that asset!

Of late, foreign demand for gold by governments and central banks has been well chronicled.Especially China!Their demand for gold is going through the roof as they may have the most at risk if the dollar weakens beyond recognition.

Last night may be evidence of that fact as gold prices rallied near $1430 an ounce with the announcement that Bush tax cuts would be extended.As domestic markets awakened, profit taking ensued and prices have settled.

Commenting on the extension, Edward Meir, MF Global metals analyst, said in a street.com article, "It remains to be seen whether these cuts will have the desired impactof stimulating the economy, but they most certainly will grow thedeficit and weaken the dollar, and this is perhaps what is behind thesizable advance we are seeing today."

In a recent interview on CBS' 60 Minutes, Fed Chairman Ben Bernanke made it clear the current stimulus program could be extended.He also said it could be years before unemployment levels return to a normal around 5%.To me that indicates, the practice of stimulus (printing money) could be with us for just as long.

That said, as long as there is stimulus, gold prices have no reason to head lower except for periods of profit-taking like we are seeing today.

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