Over the past week, the prices of stocks as well as precious metals have taken quite a tumble. It has been reported that stocks tumbled because of inflation worries, however, gold has also taken a steep dive even though it is viewed as a hedge against inflation.
Anybody who has been watching the precious metals charts knows that they were starting to head up in a straight line which is never a good sign. A health correction was needed but I have been surprised by the steepness of the decline.
The rise in gold prices from $250 per ounce in 2001 to over $600 today has drawn investors and speculators into the precious metals market. Though many already have made handsome profits, buying gold per se should not be touted as a good investment. After all, gold earns no interest and its quality never changes. It’s static, and does not grow as sound investments should.
It’s more accurate to say that one might invest in a gold or silver mining company, where management, labor costs, and the nature of new discoveries all play a vital role in determining the quality of the investment and the profits made.
Buying gold and holding it is somewhat analogous to converting one’s savings into one hundred dollar bills and hiding them under the mattress– yet not exactly the same. Both gold and dollars are considered money, and holding money does not qualify as an investment. There’s a big difference between the two however, since by holding paper money one loses purchasing power. The purchasing power of commodity money, i.e. gold, however, goes up if the government devalues the circulating fiat currency.
Holding gold is protection or insurance against government’s proclivity to debase its currency. The purchasing power of gold goes up not because it’s a so-called good investment; it goes up in value only because the paper currency goes down in value. In our current situation, that means the dollar.
One of the characteristics of commodity money– one that originated naturally in the marketplace– is that it must serve as a store of value. Gold and silver meet that test– paper does not. Because of this profound difference, the incentive and wisdom of holding emergency funds in the form of gold becomes attractive when the official currency is being devalued. It’s more attractive than trying to save wealth in the form of a fiat currency, even when earning some nominal interest. The lack of earned interest on gold is not a problem once people realize the purchasing power of their currency is declining faster than the interest rates they might earn. The purchasing power of gold can rise even faster than increases in the cost of living.
The point is that most who buy gold do so to protect against a depreciating currency rather than as an investment in the classical sense. Americans understand this less than citizens of other countries; some nations have suffered from severe monetary inflation that literally led to the destruction of their national currency. Though our inflation– i.e. the depreciation of the U.S. dollar– has been insidious, average Americans are unaware of how this occurs. For instance, few Americans know nor seem concerned that the 1913 pre-Federal Reserve dollar is now worth only four cents. Officially, our central bankers and our politicians express no fear that the course on which we are set is fraught with great danger to our economy and our political system. The belief that money created out of thin air can work economic miracles, if only properly “managed,” is pervasive in D.C. [boldface added]
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Many central bankers in the last 15 years became so confident they had achieved this milestone [turning paper into sound money] that they sold off large hoards of their gold reserves. At other times they tried to prove that paper works better than gold by artificially propping up the dollar by suppressing market gold prices. This recent deception failed just as it did in the 1960s, when our government tried to hold gold artificially low at $35 an ounce. But since they could not truly repeal the economic laws regarding money, just as many central bankers sold, others bought. It’s fascinating that the European central banks sold gold while Asian central banks bought it over the last several years.
Since gold has proven to be the real money of the ages, we see once again a shift in wealth from the West to the East, just as we saw a loss of our industrial base in the same direction. Though Treasury officials deny any U.S. sales or loans of our official gold holdings, no audits are permitted so no one can be certain.
The special nature of the dollar as the reserve currency of the world has allowed this game to last longer than it would have otherwise. But the fact that gold has gone from $252 per ounce to over $600 means there is concern about the future of the dollar. The higher the price for gold, the greater the concern for the dollar. Instead of dwelling on the dollar price of gold, we should be talking about the depreciation of the dollar. In 1934 a dollar was worth 1/20th of an ounce of gold; $20 bought an ounce of gold. Today a dollar is worth 1/600th of an ounce of gold, meaning it takes $600 to buy one ounce of gold.
The number of dollars created by the Federal Reserve, and through the fractional reserve banking system, is crucial in determining how the market assesses the relationship of the dollar and gold. Though there’s a strong correlation, it’s not instantaneous or perfectly predictable. There are many variables to consider, but in the long term the dollar price of gold represents past inflation of the money supply. Equally important, it represents the anticipation of how much new money will be created in the future. This introduces the factor of trust and confidence in our monetary authorities and our politicians. And these days the American people are casting a vote of “no confidence” in this regard, and for good reasons.
The incentive for central bankers to create new money out of thin air is twofold. One is to practice central economic planning through the manipulation of interest rates. The second is to monetize the escalating federal debt politicians create and thrive on.
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There’s no single measurement that reveals what the Fed has done in the recent past or tells us exactly what it’s about to do in the future. Forget about the lip service given to transparency by new Fed Chairman Bernanke. Not only is this administration one of the most secretive across the board in our history, the current Fed firmly supports denying the most important measurement of current monetary policy to Congress, the financial community, and the American public. Because of a lack of interest and poor understanding of monetary policy, Congress has expressed essentially no concern about the significant change in reporting statistics on the money supply.
Beginning in March, though planned before Bernanke arrived at the Fed, the central bank discontinued compiling and reporting the monetary aggregate known as M3. M3 is the best description of how quickly the Fed is creating new money and credit. Common sense tells us that a government central bank creating new money out of thin air depreciates the value of each dollar in circulation. Yet this report is no longer available to us and Congress makes no demands to receive it.
Though M3 is the most helpful statistic to track Fed activity, it by no means tells us everything we need to know about trends in monetary policy. Total bank credit, still available to us, gives us indirect information reflecting the Fed’s inflationary policies. But ultimately the markets will figure out exactly what the Fed is up to, and then individuals, financial institutions, governments, and other central bankers will act accordingly. The fact that our money supply is rising significantly cannot be hidden from the markets.
The response in time will drive the dollar down, while driving interest rates and commodity prices up. Already we see this trend developing, which surely will accelerate in the not too distant future. Part of this reaction will be from those who seek a haven to protect their wealth– not invest– by treating gold and silver as universal and historic money. This means holding fewer dollars that are decreasing in value while holding gold as it increases in value.
A soaring gold price is a vote of “no confidence” in the central bank and the dollar. This certainly was the case in 1979 and 1980. Today, gold prices reflect a growing restlessness with the increasing money supply, our budgetary and trade deficits, our unfunded liabilities, and the inability of Congress and the administration to reign in runaway spending.
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Foreign policy plays a significant role in the economy and the value of the dollar. A foreign policy of militarism and empire building cannot be supported through direct taxation. The American people would never tolerate the taxes required to pay immediately for overseas wars, under the discipline of a gold standard. Borrowing and creating new money is much more politically palatable. It hides and delays the real costs of war, and the people are lulled into complacency– especially since the wars we fight are couched in terms of patriotism, spreading the ideas of freedom, and stamping out terrorism. Unnecessary wars and fiat currencies go hand-in-hand, while a gold standard encourages a sensible foreign policy.
The cost of war is enormously detrimental; it significantly contributes to the economic instability of the nation by boosting spending, deficits, and inflation. Funds used for war are funds that could have remained in the productive economy to raise the standard of living of Americans now unemployed, underemployed, or barely living on the margin.
Yet even these costs may be preferable to paying for war with huge tax increases. This is because although fiat dollars are theoretically worthless, value is imbued by the trust placed in them by the world’s financial community. Subjective trust in a currency can override objective knowledge about government policies, but only for a limited time.
Economic strength and military power contribute to the trust in a currency; in today’s world trust in the U.S. dollar is not earned and therefore fragile. The history of the dollar, being as good as gold up until 1971, is helpful in maintaining an artificially higher value for the dollar than deserved.
Foreign policy contributes to the crisis when the spending to maintain our worldwide military commitments becomes prohibitive, and inflationary pressures accelerate. But the real crisis hits when the world realizes the king has no clothes, in that the dollar has no backing, and we face a military setback even greater than we already are experiencing in Iraq. Our token friends may quickly transform into vocal enemies once the attack on the dollar begins.
False trust placed in the dollar once was helpful to us, but panic and rejection of the dollar will develop into a real financial crisis. Then we will have no other option but to tighten our belts, go back to work, stop borrowing, start saving, and rebuild our industrial base, while adjusting to a lower standard of living for most Americans.
Counterfeiting the nation’s money is a serious offense. The founders were especially adamant about avoiding the chaos, inflation, and destruction associated with the Continental dollar. That’s why the Constitution is clear that only gold and silver should be legal tender in the United States. In 1792 the Coinage Act authorized the death penalty for any private citizen who counterfeited the currency. Too bad they weren’t explicit that counterfeiting by government officials is just as detrimental to the economy and the value of the dollar.
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Particular things to remember:
If one endorses small government and maximum liberty, one must support commodity money.
One of the strongest restraints against unnecessary war is a gold standard.
Deficit financing by government is severely restricted by sound money.
The harmful effects of the business cycle are virtually eliminated with an honest gold standard.
Saving and thrift are encouraged by a gold standard; and discouraged by paper money.
Price inflation, with generally rising price levels, is characteristic of paper money. Reports that the consumer price index and the producer price index are rising are distractions: the real cause of inflation is the Fed’s creation of new money.
Interest rate manipulation by central bank helps the rich, the banks, the government, and the politicians.
Paper money permits the regressive inflation tax to be passed off on the poor and the middle class.
Speculative financial bubbles are characteristic of paper money– not gold.
Paper money encourages economic and political chaos, which subsequently causes a search for scapegoats rather than blaming the central bank.
Dangerous protectionist measures frequently are implemented to compensate for the dislocations caused by fiat money.
Paper money, inflation, and the conditions they create contribute to the problems of illegal immigration.
The value of gold is remarkably stable.
The dollar price of gold reflects dollar depreciation.
Holding gold helps preserve and store wealth, but technically gold is not a true investment.
Since 2001 the dollar has been devalued by 60%.
In 1934 FDR devalued the dollar by 41%.
In 1971 Nixon devalued the dollar by 7.9%.
In 1973 Nixon devalued the dollar by 10%.
These were momentous monetary events, and every knowledgeable person worldwide paid close attention. Major changes were endured in 1979 and 1980 to save the dollar from disintegration. This involved a severe recession, interest rates over 21%, and general price inflation of 15%.
Today we face a 60% devaluation and counting, yet no one seems to care. It’s of greater significance than the three events mentioned above. And yet the one measurement that best reflects the degree of inflation, the Fed and our government deny us. Since March, M3 reporting has been discontinued. For starters, I’d like to see Congress demand that this report be resumed. I fully believe the American people and Congress are entitled to this information. Will we one day complain about false intelligence, as we have with the Iraq war? Will we complain about not having enough information to address monetary policy after it’s too late?
If ever there was a time to get a handle on what sound money is and what it means, that time is today.