Topic: Monetary Policy
Flight Into Dollars With Dow Jones futures triggering a stock market hold that suspended trading automatically today, combined with the Dow's 300+ point drop, some hard money folks are wondering why gold and silver are doing so badly. Here's why.by Walt Thiessen
(libertarian)
Friday, October 24, 2008
This is an extraordinary time in monetary history. A major financial crisis driven by overextended mortgage lending on a global basis (no, it's not just Fannie and Freddie) has led to a set of events that is confounding many hard money advocates.
In theory, gold is where panicked investors run to historically, but as the stock market began its government-controlled plunge once again today, gold and silver prices were falling, not rising. Gold did end up on the plus side for the day, but it has a lot of gold bugs shaking their heads. Gold is down over 25% compared to its high a few months back, and silver is down 50% from its high. How could this be happening? Shouldn't their values be going up, and not down?
In order to understand, there are two critical points that must be made. First, gold is no longer a legal currency. Neither is silver. They should be, but they're not. The result is that the world's investors know that they can't be treated as currencies of last resort. They are only commodities in our crazy monetary system, and so they are behaving like the rest of the commodities markets. Investors are expecting recession and deflation, and so commodities are losing their price value.
The problem here is that the huge influxes of cash coming into the money supply from the Fed, both on its own and via the $700 billion buyout, will total roughly one to one-and-a-half trillion dollars so far, and I have no doubt that the Fed isn't done yet. This is deliberate inflation, a policy pursued by the Fed to offset the deflationary affects of banks losing so many billions of dollars in delinquent mortgages. The reason I say this is a problem is that we can be very sure that the Fed is going to put much more newly created money into the pot than the banks are losing, because Chairman Ben Bernanke, who is well known for having studied the Great Depression of the 1930s, has concluded that lack of liquidity is why that depression happened. He's partly right.
Normally, the Fed's monetary injections should have a net-inflationary impact on the money supply, and it will...eventually. However, the effects of inflation take time to manifest, and the current situation is no exception. In the meantime, stock, bond, and futures investors are trying to figure out where to put their remaining equity now. Since gold and silver are no longer legal currencies, investors are forced to choose among fiat currencies, and despite the horrendous shape that the dollar is in, it's much better off than the European currencies. Europe has been playing the over-investment game even more than the U.S. has over the past few years. This makes the dollar an attractive "safe haven" for investors right now. U.S. Treasury notes are currently in high demand, despite relatively poor yields in most cases.
I said there are two critical points. In addition to the dollar's relative strength compared to other fiat currencies in an era where gold and silver are not legally permitted to be currencies, there's also the fact that the U.S., for all its heavy indebtedness, is far better off than Europe is where national debt and mortgage debt are concerned. Two weeks ago, the New York Times ran an article entitled, "The World’s Banks Could Prove Too Big to Fail — or to Rescue." The article includes a clickable chart which shows a very interesting picture of the debt situation in the U.S. and Europe.
Briefly, what the chart shows is that the U.S.'s short-term credit problem amounts to 15% of the country's total Gross Domestic Product (GDP), and the national debt is 43% of the GDP.
By comparison, Great Britain's short-term debt problem is 156% of their GDP, and their national debt is 368% of their GDP. France's short-term debt problem is 60% of GDP and their national debt is 128% of GDP. Germany is at 60% and 167% respectively. Iceland: 211% and 480% respectively. Switzerland: 260% and 1,273% respectively, and Belgium: 285% and 367% respectively.
In other words, as bad as things are here in the U.S., Europe's finances are completely in the toilet. That's the price for all that welfare state activity they've been pursuing for decades. This leaves the dollar in a very strange place. As bad as it is, it's far stronger than the Euro, and it is holding is own against the Yen. Thus, it still maintains its place as the base currency in the global fiat money circus.
Fiat money advocates are giggling behind their hands at the glory of the dollar's relative strength. We will likely hear them crow over the next few months about how strong the dollar is. Don't believe them.
When the law is perverted to make it illegal for people to seek the safe haven of hard money, their initial inclination is to forget about hard money. Right now, prices in the U.S. aren't climbing out of control. Indeed, oil prices have dropped in half as the market calculates that global demand is going to shrink due to the global recession everyone is anticipating, but what all this is really doing is lining up the sheep for shearing. All those people who are placing their trust in U.S. Treasuries are banking on the vain hope that all that newly created money isn't going to show up as higher prices at some point. That can't happen.
It's not a question of if inflation is going to hit us. It's only a question of when, and it could take quite some time to happen. After all, the Crash of 1929 didn't lead immediately to the Great Depression. That didn't show up for another 2-3 years. Nor is it likely, given the fact that the Fed chairman is so pro-liquidity, that there will be another Great Depression II. Instead, as I've stated before, we stand on the doorway to hyperinflation.
Is hyperinflation a sure thing? No. Is inflation a sure thing? Yes. We don't (and can't) know how much inflation there is going to be. All we can be sure is that it's coming, and it's going to wreak havoc.
It's only a question of time.
In the meantime, what should gold bugs and silver investors do? Strange as it may sound, they should stay in dollars as much as possible for now. Eventually, we'll get to the point when overall prices start going up again. When that happens, it'll be a good time to look for bargain prices in gold and silver.
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Posted By: Jake, the champion of the constitution
Date: 2008-10-24 22:24:04
Walt -
Thumbs up, I have been hoping some other columnists here would offer criticism of my increasingly militant pro-gold articles, but it appears they may be too militant :)
I do have a challenge for you. You start off with a statement I wholeheartedly agree with "This is an extraordinary time in monetary history." Unless we go back to the Feudal Age, this is unlike anything that has happened in my brief lifetime at least.
Then you conclude with the advice that "Strange as it may sound, they should stay in dollars as much as possible for now. Eventually, we'll get to the point when overall prices start going up again."
In recent times, the price of gold has plummetted by 25% in USD terms, although just 8% in Euro terms. In fact as I wrote last week, even as it plummets, gold has hit new highs in 5 major currencies. Terrorist Completes Ultramarathon! And Gold Hits New Highs!
With this volatility, its best to be cautious and not "expend all your powder", but hey, in terms of the gold price we are in a time warp to the land before time (Oct 2007), before Lehman Bros, before Bear Stearns, before Freddie&Fannie back to when the Dow was at 14000 and most people thought a housing crash would never happen.
Why buy gold (or silver) in the first place? Not because you want to get rich, but as a form of insurance. And since its a currency. And the currency factor is have somewhat factored in (no clue how much) - about 25% of the demand for the ~2500 tons of gold mined annually are consumed by investors. So I think you advice to wait and see is completely not valid for those who have no gold or silver to speak of.
One last point on your advice is that it even overlooks the recent performance of gold. On September 18th, 2008, the price of gold leaped 10% in a single day. Is that recent enough for you? Maybe not.
Let's look at October 24, 2008. Gold started the day at $713 and finished at $728. No big deal right? But look at the range, it fell to $682 then rocketed to $744 before falling again. Again, we are talking 10%. That's a lot of volatility! So how can you rule out gold shooting up 20%, 30% in a single day? I do not think this can be ruled out.
So waiting and seeing might not be best for those who hold no gold and silver, or feel they do not have enough. Even if the (paper spot) price of gold drops another $100, no big deal. Just buy more - if you can find it. For those of us goldbugs who already have some, its just a cost-benefit problem based on everyone's individual circumstances.
Go drive around your city and tell me if you can even FIND 3 kilos of physical gold (almost 100 oz). My point is, regardless of the dollar movements, the law of supply and demand is broken for both gold and silver.
Anyways, thats why I focus on grams not its dollar value. When you buy gold, just think of that, not its dollar value. And it will always be worth something. Citibank stock, even the Dow Jones go to, or approach, zero, but gold will always have value unless society completely breaks into pieces. Then you need to find food to eat and a gun :)
One final thought as I frantically jet around Asia for my company - I have no idea how businesses are going to figure out if they are actually making any money in this free floating exchange environment. The Dollar-Euro movements alone should be enough to make most businessmen throw their hands into the air in despair. How are we supposed to plan? How do you know if you make a profit?
YOUR WRONG!
i.e. Germany's total debt is 65% GDP; The euro zone is mandated to keep member budget deficit to under 3% of GDP.
The US may have a budget deficit of 1.5 trillion this year, over 10% of its GDP. Total US debt will surpass 11 trillion this year, about 79% of its GDP(around 14 trillion). Get your facts checked, the US dollar may be the next bubble to burst.
Posted By: Walt Thiessen
Date: 2008-10-25 03:39:06
Giz: my source is the New York Times. Check out the link I supplied in the article. What's your source?
Jake: I agree that gold did rise...briefly. However, you're wrong about gold being a legal currency. It's not. Rather, there are some investors who treat it as if it were a legal currency, while the majority of investors treat it as if it is not a legal currency. That's the whole root of gold's behavior.
I agree that gold is a good buy in the long run, but not in the short run. Next week's stock market is looking pretty bearish. If I were in the market for gold or silver, I'd wait until the stock market bottoms out before buying.
You mention dollars as a comparatively safe haven. Could it also be that over-leveraged owners have resorted to selling their metals to generate funds to cover other commitments?
Thought I would jump in here and clear up a few things.
1st, per our constitution, Article 1 section 8, clause 5:,
“To coin Money, regulate the Value thereof, and of foreign Coin, and fix the Standard of Weights and Measures”. [1]
“Article I, Section 10, Clause 1: No State shall... coin Money; emit Bills of Credit; make any Thing but gold and silver Coin a Tender in Payment of Debt.” [2]
It is the fiat money we call "dollars" that are illegal per the constitution.
Secondly, Jake is right about trying to "find" gold (and silver) these days. The coin dealers are out, premiums have risen for what they do have, one of the larger ones, Fidelitrade limits a person to 10 American Eagle's, and they have no Krugerrands or silver coins. Completely out.
Walt is right that eventually the tides will turn. Jake is right that we buy gold (and silver) as insurance. Things happened quickly in Iceland and Argentina. There is plenty of historical precedence to get gold and silver now.
Dollar cost averaging in each of the next few months should get you a great overall price...and coins since there aren't too many to find. Ireland, Austria, France, England, Canada, you name it...they are all struggling with supply or out of coins.
My friend who works for one of the large coin dealers (we worked together in the business for a stint) keeps me up to date on supply. Even the numismatics are taking off because there's no supply!
Good article as anyone who promotes gold gets a thumbs up from me. Jake, I'll have to go back and read some of your posts! Been busy writing..
Posted By: Jake, the champion of the constitution
Date: 2008-10-26 02:09:11
Walt -
I don't recall ever writing that gold is a "legal" currency. I maintain it is a currency, and can be used as a medium of indirect exchange, though nearly not wildly used as paper banknotes, I grant you that! We do have gold coins issued by some major nations, usually with a joke of a fiat amount, but also stamped with the weight, which is what the currency actually is.
I am sure we both agree with Doug that its constitutionally legal at least.
Think for a second about your logic though. If gold is NOT "legal" currency, why do the central banks hold so much of it? They might as well just dump it all if its just the same as iron, zinc, or copper. Heck that might not be a bad thing :)
Posted By: Walt Thiessen
Date: 2008-10-26 04:08:00
Jake: to answer your question, the reason central banks hold so much gold is because it is an easily traded commodity that takes very little space and holds its value in the long run. It also provides a good form of "reserve" for their lending activities. They don't hold it because they think it's currency; they don't think of gold as currency at all.
I'm not questioning the fact that gold and silver are hard to find these days, but in the face of declining prices in gold and silver, due to the overall market collapse and flight to fiat cast, that's not terribly relevant. It will become very relevant once the overall price structure starts to rise again due to the Fed's inflationary practices lately, but not before then.
Posted By: Walt Thiessen
Date: 2008-10-26 04:13:45
Doug: I agree about the Constitutionality of gold vs. fiat, but the harsh fact is that Congress has long disregarded the Constitution, and anything that is not "legal tender" is illegal as currency under Federal law. Unless the courts suddenly get strict-interpretation "religion" and start enforcing it, I see no reason to believe this state of affairs will change anytime soon.
Walt: They will do it to themselves. Just give them time. Unfortunately they have the laws on their side to remedy the situation by confiscating our gold "or anything else." But to do that they'll have to eliminate the 2nd amendment first! I wanted to go to the "Gold Standard" conference at Mises Univeristy this weekend, but couldn't swing it. Hope they have the videos for it on the website. Ron Paul is going to be there.
Posted By: Jake, the champion of the constitution
Date: 2008-10-27 06:57:22
Walt: I hear you, this is the public line the central banks toe - that gold is an asset, not a currency. Its still a currency though just seldom used at the moment. I proved it on the streets today, but thats a story for another day....
(grumble, grumble...if Walt's so smart and right, why don't the central banks keep platinum in their vaults, that's dense and holds a relative value, though its a specialty industrial metal.?.. or diamonds, or Rembrandts... the central banks selected and picked gold for a reason and that's because its freaking money and the currency of the entire planet just 75 years ago, just 37 if you count the Nixon window debacle.... grumble, grunt... back to the cave....)
Posted By: Jake, the champion of the constitution
Date: 2008-10-27 07:01:40
Walt - you know what would be a cool idea, and thats if you (as in not the author) could click a box when you leave a comment to receive an email if someone else leaves a comment, if you want that is.
Sorry Walt. I read again what I posted and wasn't exactly clear. The Fed will do it to themselves meaning they will, by their past, current and future actions, destroy themselves.
It is difficult for me to remember which posts I commented on or would like to follow my comments. I'd probably post more comments if it was in a forum where comments could be made on various articles.
Something like, "Feel free to discuss or see what others have commented on this article in our forum by clicking here" type thing at the end of each article...
Posted By: Walt Thiessen
Date: 2008-10-28 07:22:52
Jake: no, I'm not talking about what the banks say. I'm talking about what the U.S. Code says.
Under 18 U.S.C. § 486, it is a Federal crime to utter or pass, or attempt to utter or pass, any coins of gold or silver intended for use as current money except as authorized by law. That definition is cast as follows by the code:
Whoever, except as authorized by law, makes or utters or passes, or attempts to utter or pass, any coins of gold or silver or other metal, or alloys of metals, intended for use as current money, whether in the resemblance of coins of the United States or of foreign countries, or of original design, shall be fined under this title or imprisoned not more than five years, or both.
So legally speaking, anyone who uses gold or silver as currency are breaking the law. This is an evil law, but it is still the law nonetheless. That this law serves the banks' interest is undisputed, but claiming that it is merely spin (as you are suggesting) simply isn't true.
Posted By: Jake, the champion of the constitution
Date: 2008-10-30 05:54:21
Walt -
You are a treasure trove of information, wasnt aware of this law., thanks Looks like NORFED's Liberty Dollar ran afoul of it too, had to issue their coins with a disclaimer.
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