Monday, August 23, 2004

Kitco.com: Gold - the Instinctive Protection of Wealth By Barry Downs and Bill Matlack

Gold - the Instinctive Protection of Wealth
By Barry Downs and Bill Matlack
August 18, 2004
Kitco.com
Nowhere in the mainstream conventional-wisdom discussion of economics is there any concern shown for the cumulative negative impact on society of the past many decades of inflation. In fact, Federal Reserve inflation has become institutionalized to the point where, if inflation prospects lessen or deflation threatens, the Fed becomes quite aggressive to bring back inflation. We have seen this happen over the past three years. Aside from the minute group of economists and investment managers concerned with the unsound nature of the money credit system, the masses at this time remain blissfully ignorant, complacent, and unprotected; and still see gold as only relevant for baubles and bangles.

Dollar inflation (i.e., the loss of purchasing power) has grown in intensity since the establishment of the Federal Reserve in 1913. By year-end 2003, based on CPI inflation, the dollar had lost 96% of its purchasing power. In the period from the early 1940s to 2003, 91% of that loss occurred. Since President Nixon closed the gold window to foreigners in 1971, ending any tie to gold, the dollar by year-end 2003 had lost 78% of its purchasing power.

One has to ask how long the inflating can go on before a serious breakdown in the money credit system occurs, perhaps sending the dollar shuffling off to the dust bin of money history or, as some would say, to money heaven. History has shown that, in the world of defunct currencies, past French inflations, as an example, have lasted around six decades or until the currency had lost 99 1/2 % of its value. On that timetable, the US dollar's day of reckoning may be fast approaching. Fed governor Ben Bernanke minced no words over a year ago when he stated that when threatened with falling costs and prices, money printing could reach the point where there could be helicopter dollar distributions. A panicky Fed is quite capable of anything!

The French provide a very good example of a society with an inborn instinct when it comes to surviving monetary turmoil. It's standing French folklore that every French peasant has some savings in gold coins under the mattress or in the floorboards, and that in past generations gold has enabled survival amongst a succession of great disasters under various forms of government. In a little over two centuries the French had to survive a profligate king and John Law's Mississippi bubble, which ended in a worthless currency; a few decades later, it was the guillotine for a tyrannical government and again worthless paper; Napoleon's war and nation building brought hardship and monetary turmoil to the country; the French were defeated twice in the 1800s; there was a succession of weak and vacillating governments including a monarchy and several republics; and finally, two destructive world wars were both won, but the aftermath still produced economic disaster.

Throughout European history, there have been similar instances where a gold hoard has been the difference between financial survival and ruination. The reichsmark at the end of WWI was exchanged for the dollar at the rate of one hundred to one, but by the fall of 1923 it went to one trillion to one, wiping out the savings of Germans or any other holders of the currency.

There has never been a fiat paper money system which has survived. The US dollar, through its circulated Federal Reserve notes, represents a fiat paper money cut loose from the discipline of gold money over 30 years ago. The reserve currency concept was sold to the rest of the world on the presumption that a paper money, issued by a country as successful as the US, must be sound. Confidence has been built around the full faith and credit of the US, but as America has lived beyond its means and leveraged itself to the hilt, confidence in America's eventual solvency is eroding.

Unfortunately, US finances have been so mismanaged by the Keynesian and Monetarist micro managers that the country sits with record trade and budget deficits, beholden to foreigners for financing with a total credit market debt pyramid of over 300% of GDP and coming off a period of unprecedented debt stimulus where $4 is being spent to get a miserly $1 of growth. Added to US financial woes is the $45 trillion of unfounded liabilities looming in the period not far ahead, and the war against America and its way of life being waged by the Islamic Fundamentalist world. The cost of a prolonged terrorist war could alone bankrupt the country.

The cumulative dollar inflation since WW II has wiped out 90% of the dollar's purchasing power and trillions of dollars of savings of Americans, but few Americans so far seem to realize what has happened to their store-of-value money, and even fewer have contemplated how the inflation eventually ends.

Americans had a brief encounter with gold in the late 1970s, which took the dollar price per ounce to $600 for a short time in 1980. But for more than 20 years, the flood of paper by the Federal Reserve and the focus on paper assets have mesmerized the general public, causing them to forget about the importance for a sound money credit system. The 8,000% plus increase in NYSE average volume since the 1970s and the 18,000% increase in NASDAQ volume over the same period illuminate the interest in paper assets in roughly 30 years. A very small percentage of Americans from time to time will speculate in gold via the futures market or in paper gold, or will speculate in a limited way in gold stocks. But as far as holding physical gold for monetary reasons as the rest of the world holds gold, there is virtually no interest, at least at this time.

The belief that the dollar and the debt-based paper wealth surrounding it are somehow blessed with some special spiritual permanent protection is residing in a fool's paradise. The world has always been a crime and punishment place, and the Federal Reserve has created the ultimate financial crime, which has been the orchestrated destruction of wealth through inflation. The punishment ultimately will be dished out by the market place to the dollar and its holders. Market forces in the final analysis will also likely dictate the return of paper money tied to gold, but not until bitter lessons have been learned.

Human instinct to seek protection in gold seems likely to explode when the time comes, probably first among Europeans and Asians where gold to this day has its tradition. If history has taught us anything, interest in gold and indirect investments in gold will eventually spread to the US as well, adding to the demand for something in very limited supply and sending gold prices soaring.

The gathering economic storm and approaching money/credit inflection point is providing holders of wealth, dominated in the dollar or any other fiat paper money, a chance to secure protection in the gold arena at historically low price levels. Whether it be a position in the physical metal (the ultimate) or gold in the ground via a well-chosen portfolio of gold mining stocks, or both, some significant diversification away from a world of pure paper fiat money has never been more appropriate.

Those with wealth centered only in paper assets, including real estate, should perhaps begin to ask themselves if they will end up having been as smart as a French peasant.

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