Money Talks, Gold Shouts

By: John Browne | Thu, Sep 10, 2009
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In the second quarter of 2008, when it became clear that bankrupted financial institutions would be bailed out by the federal government, gold did a funny thing. In the wake of a financial crisis of that magnitude, one normally would have expected asset prices, including gold, to plummet. Most observers expected the metal to dip from the $800 level down to $600, or below. Instead, gold held up well during the teeth of the crisis, and has recently increased to just over $1,000.

The biggest change in the gold market has been the unwillingness of certain governments to sell their gold. Some powerful states, such as China, are beginning to hoard gold and to become net sellers of U.S. Treasury securities. In addition, private investors are buying so many gold coins that fabrication plants are months behind on physical deliveries. In short, individuals, institutions and governments are losing faith in paper currencies, particularly the U.S. dollar. Despite the opportunity cost associated with trading interest-bearing government securities for pay-to-store bullion, they are buying gold.

Throughout much of recorded history, gold has proved to be the ultimate form of money. Due to its inherent scarcity, it has been the bane of governments who wished to spend more that they had or could borrow. Certain governments even diluted the gold content of their coins in order to dupe buyers.

The United States entered into federation with a sole reliance on gold as its legal tender. It was not until the Civil War that the U.S. government issues its first paper currency. However, this was not fiat money. All currency issued was backed by gold, and later by silver. But over the years, the backing was withdrawn as government looked to expand the money supply. By 1933, every $20 note was backed by only one ounce of gold at the Federal Reserve. That year, the Fed refused President Roosevelt's request to further dilute the gold backing of dollars. In response, Roosevelt confiscated gold from all Americans. The Fed acquiesced and printed more paper dollars.

Not content, Roosevelt devalued the U.S. dollar by 75 percent against gold the next year, unleashing a great inflation. Every American who had surrendered gold in 1933 lost 75 percent. Those who owned no gold proclaimed Roosevelt a hero.

In 1971, President Nixon broke the U.S. dollar's last link to gold, prompting the second great inflationary wave. Inflation became so bad that gold rose from $35 to $850 an ounce by 1981.

In more recent history, President Bush II and former Fed Chairman Alan Greenspan elevated the process monetary debasement into an art form, creating the largest asset boom in history and sowing the seeds of collapse in the financial system. They left the U.S. dollar so debased that the 1980 gold price of $850 is equivalent to $2,200 in today's shattered currency!

It follows that, at $1,000 an ounce, gold stands at less than half its historic peak. In a recession, when cash is scarce and price levels are falling, it is amazing that gold stands as high as it does. One can only guess where the price will go when the trillions of dollars of electronic government bailout dollars start vigorously circulating.

If we were to return to a gold standard today, each ounce of gold held at the Fed would have to back a breathtaking $39,000 dollar bills. It is a far (1,950 times) cry from the $20 for each ounce of gold of just seventy-six years ago! Is it any wonder that the euro, the currency of the nascent European Union, stands just a shade below its all time high of $1.45?

These signs of chronic monetary decay have not been lost on individual investors or governments holding U.S. dollar surpluses. The key player in this respect is China, the largest holder of U.S. Treasuries - and now the world's largest gold producer.

Recently, my friend Ambrose Evans-Pritchard reported in the London Telegraph on his interview with Mr. Cheng Siwei, Vice Chairman of China's Communist Party's Standing Committee. According to Evans-Pritchard, Mr. Siwei said, "Gold is definitely an alternative, but when we buy, the price goes up. We have to do it carefully so as not [to] stimulate the market."

This single statement should send shivers down the necks of all who believe in the paper currencies of debtor countries. Similarly, it should warm the heart of all those who already own gold. China has indeed resisted upsetting the international gold market with massive purchases. Quietly, she has merely 'diverted' part of her own production into her treasury vaults!

Also, China has sought to protect its citizens from the debasement of paper currencies by lifting restrictions on its citizens' ownership of precious metals. They can be expected to be large buyers of gold and silver ('poor man's gold,' at only $15 an ounce).

In order to protect themselves from the ravages of governments who believe in massive deficit-financed entitlements, Western citizens should think carefully about whether to trust paper currency over real money. Its an easy decision to reach.

For a more in-depth analysis of our financial problems and the inherent dangers they pose for the U.S. economy and U.S. dollar, read Peter Schiff's 2007 bestseller "Crash Proof: How to Profit from the Coming Economic Collapse" and his newest release "The Little Book of Bull Moves in Bear Markets." Click here to learn more.

More importantly, don't let the great deals pass you by. Get an inside view of Peter's playbook with his new Special Report, "Peter Schiff's Five Favorite Investment Choices for the Next Five Years." Click here to dowload the report for free. You can find more free services for global investors, and learn about the Euro Pacific advantage, at www.europac.net.

 


 

John Browne

Author: John Browne

John Browne, Senior Market Strategist
Euro Pacific Capital, Inc.

John Browne

John Browne is the Senior Economic Consultant for Euro Pacific Capital, Inc. Mr. Brown is a distinguished former member of Britain's Parliament who served on the Treasury Select Committee, as Chairman of the Conservative Small Business Committee, and as a close associate of then-Prime Minister Margaret Thatcher. Among his many notable assignments, John served as a principal advisor to Mrs. Thatcher's government on issues related to the Soviet Union, and was the first to convince Thatcher of the growing stature of then Agriculture Minister Mikhail Gorbachev. As a partial result of Brown's advocacy, Thatcher famously pronounced that Gorbachev was a man the West "could do business with." A graduate of the Royal Military Academy Sandhurst, Britain's version of West Point and retired British army major, John served as a pilot, parachutist, and communications specialist in the elite Grenadiers of the Royal Guard.

In addition to careers in British politics and the military, John has a significant background, spanning some 37 years, in finance and business. After graduating from the Harvard Business School, John joined the New York firm of Morgan Stanley & Co as an investment banker. He has also worked with such firms as Barclays Bank and Citigroup. During his career he has served on the boards of numerous banks and international corporations, with a special interest in venture capital. He is a frequent guest on CNBC's Kudlow & Co. and the former editor of NewsMax Media's Financial Intelligence Report and Moneynews.com. He holds FINRA series 7 & 63 licenses.

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