Paper Currencies - Trampoline Jumping

By: Adam Brochert | Wed, Dec 16, 2009
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Watching the national paper fiat currencies rising and falling relative to one another can be interesting, but it is misleading for many of those who take it seriously. When the U.S. Dollar Index is rising, Americans are gaining in their standard of living as it takes fewer dollars to buy things, right? Not necessarily

The currency pairs or currency indices that people follow simply measure one piece of paper versus another. If I created a calculators to televisions price ratio and called it a currency pair, there may be traders out there interested in guessing the next move in this ratio as a casino play. Traders trade. But is this a valuable metric of inflation, deflation or price strength? Only in a very limited sense. In other words, it is true that a rising U.S. Dollar Index means that the U.S. Dollar paper note can generally buy a greater number of paper Euro notes (at least given the way the U.S. Dollar Index is currently constructed).

The rise and fall of paper currency notes relative to one another in the current economic setting reminds me of a seesaw - one currency goes up, then it goes down while its pair currency does the opposite. One currency may rise a little more in net terms over a period of time or vice versa based on various factors.

But what if that seesaw (or perhaps a trampoline with paper currency contestants trying to out jump each other?) is tightly tied to a 5,000 pound anchor that has just been tossed out of an airplane? Do these up and down movements of paper notes relative to each other actually have significant meaning relative to the downward plunge both are experiencing? The answer to this question, of course, depends on one's time horizon and goals.

This seesaw/trampoline analogy is not a minor matter of importance to me. For this is our current international monetary system and this system is hurtling towards disaster at a somewhat frightening pace. Whether the U.S. Dollar Index rises a few more percent before dropping again or not is not as important as realizing that the fundamental underpinnings of the U.S Dollar are being destroyed by the federal government and its non-federal, for profit, central bank corporation known as the federal reserve. Piling unpayable debt on top of unpayable debt just because one can is quintessential depravity. The consequences will not be minor. The maddening thing is that nearly every other major nation in the world is happy to follow suit and some are in an even worse financial position than the United States. How can this end well?

I started my economic educational journey with eyes wide shut and now find them open, aware and already jaundiced. From inflation to deflation to hyperinflation and back again, I now find these terms only vaguely helpful to describe what we have been and are going to continue to go through. No period in history is identical to its predecessor, despite the rhymes that make market and economic history relevant.

Some things history and my education to date have taught me:

*No currency system has survived intact for more than 40-50 years or so, whether Gold-backed or not. If Gold backed, the Gold backing will be revoked or watered down at the first sign of trouble. If not Gold backed, the currency will be debased into oblivion by those addicted to the magical printing/debt press. When currency "events" occur, Gold is a reliable way to protect your savings and come out ahead on the other side.

*A heavily over-indebted nation with no savings is not going to see its currency rise to astronomical new heights in some Prechterite deflationary miracle. The U.S. is a heavy debtor nation, not a creditor nation like it was in the 1930s and not a nation with savings like Japan in the 1990s. A brief short squeeze in the Dollar can occur, just like in 2008, but a sustained bull market in a severely damaged paper debt instrument that no longer holds the world's confidence (like, ummmm, the U.S. Dollar?) is unlikely. In fact, I would wager that such a scenario is about as likely right now as a sustained new secular bull market in subprime mortgage debt, which now [not] coincidentally backs the U.S. Dollar thanks to the policies of the private federal reserve corporation.

*Gold is a great hedge against government insanity and instability and we are in a secular cycle of government insanity and instability right now. Gold is not a simple asset class (as the ignorant commentators shouting "barbarous relic" would have you believe), it is not a consistent inflation or deflation hedge, and it is not just an anti-Dollar play.

*Every asset class has its day in the sun. It is Gold's turn in the sun and Gold's secular bull market is not close to being over. Sometimes bull markets go up just because they've been going up and the momentum and capital concentration begin to take over in a display of primal herding behavior that can persist for much longer than seems rational. We first need to see a visible public Gold rush/mania to match the preceding paper mania in internet stocks and real estate before this Gold bull is over. This means your paperbug, CNBC-watching neighbors, co-workers and/or friends with any money left to invest are comparing notes on where to buy physical Gold coins and bars (that's buying Gold, not selling Gold jewelry to pay the rent) and how to participate in junior Gold mining stock IPOs. I vividly remember a day in 1999, not long after I first started "investing," when a janitor where I used to work started talking to me about internet stocks after he noticed I was checking stock quotes online. We barely knew each other, but I sure felt envious of his stock picking prowess and he of mine by the time our ten minute conversation ended. I hope he made out better than I did once the internet bubble burst a few months later. Does anyone without an axe to grind against Gold really think we're at this type of mania stage right now? When a reality show called "Flip that Krugerrand" hits my local cable network, then I'll start getting worried.

*Gold brings out some very strange emotions in people - the extremes are represented by paperbugs and goldbugs. Emotions often get people (including me) into trouble when investing. Paperbugs will miss out on the Gold bull market until the very end stages as they bash Gold and try top calling on Gold unsuccessfully the whole way up. Goldbugs will lose much of their hard-earned profits by failing to realize that Gold will not be the "go to" asset class forever (I'm assuming the goal here is to make money rather than a political statement). If one doesn't sell high, then one may well take the round trip back to low again if history is a decent guide. At some point in the next decade, Gold will become expensive and stocks and real estate will become cheap (we're not likely to be close to this point until the Dow to Gold ratio hits 2).

*Gold mining is a hard, capital intensive business. Gold miners provide leverage to the price of Gold, but that leverage is not guaranteed, not consistent and it comes with added risk (i.e. leverage cuts both ways).

Those calling for the collapse of Gold here are the same ones who yelled from the rooftops last fall that Gold was no safe haven and the fall 2008 crash proved it because Gold sank in the chaos. Of course, no thoughtful comments were made by these same folks when Gold was back at $1000/oz in February of 2009 while the stock market slithered to even lower and essentially unthinkable depths. These folks also said Gold was only making new highs in U.S. Dollar terms early this fall when Gold began its breakout, ignoring the new highs in many major currencies for Gold in early 2009 and again a few weeks ago.

You can listen to these folks if you want, but I think we are at a strong buying point for Gold and most Gold mining stocks. I think Gold and major Gold stock indices are going to make new highs soon (likely before January is over, though I don't know exactly when). I am not focused on the paper debt notes moving up and down on their seesaws or trampolines, I am focused on the anchor pulling all these notes rapidly down towards the earth due to shattered confidence and irrational fiscal and monetary policies around the globe that even a 3rd grader knows are harmful. The decline in value of all paper debt instruments (i.e. all current national currencies and their derivatives) will cause a continued rise in Gold, as people will seek out the currency and wealth protector of last resort.



Adam Brochert

Author: Adam Brochert

Adam Brochert

Markets and cycles are my new hobby. I've seen the writing on the wall for the U.S. and the global economy and I am seeking financial salvation for myself (and anyone else who cares to listen) while Rome burns around us.

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