Posts Tagged ‘Dollar’

The Real Bubbles



“It is the measure of wealth itself [the Dollar] that is overvalued, not the goods that it represents”



I’m beginning to understand what is going on. I hope this article will shed some light on a variety of issues, some of which have been fairly complicated for the common investor to digest.

I will begin with a paragraph of adages and mantras being proclaimed on Wall Street, followed by a thorough analysis of why they are either baseless or misconceived. For the sake of simplicity I won’t use references but they are all available.

Mr. Market says

“The Commodities Bubble has begin to blow over, with everything from gold to oil to potash collapsing from their artificially inflated prices to mediate norms. Much of these gains have been driven by speculator demand, from hedge funds and the like, as well as consumer demand, including China, India and Russia.

“Investors have bought in every premium into these contracts and optimism is high. Furthermore, commodities have been a very poor investment relative to stocks and bonds. Even gold has underperformed inflation. As equities recoup its gains and inflows of capital return, pushing inflation down with it, commodities will be a relic of the past.

“Recessions are times of diminishing consumer demand and this will further help in reducing prices. With much of the investing community already discounting shares due to recession we can expect a bottom in the stock market with a rally beginning just as the economy is officially in recession. Financials and Homebuilders are set to gain the most as they have been beaten down severely, looking awefully cheap from a value prospective.

“The Dollar is set to rally as stark pessimism has oversold it. Recession will strengthen the currency. This will bring in investment flow previously allocated to Euro, Yen and Gold.”

The Problems With Mr. Market and the rest of the Wall Street gang (CNBC)

1. Wrong Biases
Wall Street as we know it is not a the Mutual Fund Industry, a group Hedge Funds or even large network of multi-national corporations. It is simply the media’s opinion of the former. There are few companies that end up becoming large corporations and even fewer speculators-wanna-be-billionaire-investors who actually live up to their own aspirations.

This is due to its ill-conceived sentiment, nothing more. It has all the facts (most do at least) yet the small investor constantly fails to make the integral judgments necessary to fulfill his lifelong ambition of success, or even of financial independence. They run after Enrons, Devalued Russian Rubles and dot coms believing beyond any doubt that they have it made for themselves and they have indeed “beat the street“.

However, the only way to real gains is to bet against the crowd, to look where no one else is looking, or even better, to see past the unsound biases that have plagued investors since the Mississippi Scheme in the early 18th century.

2. Confusing Short and Long Term
This is probably the most extreme variable, one which offers the most profits to he who can see past its vile inadequacies. Many (not all) of the arguements presented in favor of the Dow 36,000 were in one way or another grounded fundamentally. The problem with the gushes of cash inflow was they were based on an economic phenomenon that was years into the future, results that we are only beginning to see today – and interestingly enough by quite a different group of influences. While investors were placing bets on Yahoo and Juno, Google wasn’t yet a public company.

3. Forgetting Premium and Discount
In addition, shares were discounted many times over yet speculators failed to realize it. Any price was a great price because in the mind of these irrational gamblers the gains were infinite it seemed. It was hard for investors themselves to understand that they were betting that the company of purchase was one of sound safety that would last, and therewith deliver on its earnings 100-1000 times over, without any interruption whatsoever.

4. Wall Street too has Seasons
There are financial equinoxes, waxing and waning over decades. Warren Buffett himself cautioned Saturday not to expect big gains from the stock market in future years. Indeed, there are periods when year after year people move from the New York Stock Exchange to the commodity pits of the Midwest in search of better returns.

5. In The Dollar We Trust
A currency is present only to act as a constant method of exchange between goods. Yet the U.S. currency is nothing of the sort. It has become a staple of growth and a signal of everlasting creditability. Unfortunately for many this will not last. Contrary to many pundits the present rally in the Dollar, however great it may seem, is a mere decoy and will be short-lived.

Even Treasury Secretary Paulson has advocated that a weak dollar is in America’s best interest. While this may or may not be a positive development, one thing may be guaranteed by any student of financial history dating back to Cicero in ancient Rome: every fiat currency has failed, frequently bringing its empire down with it.

6. Action and Consequence
Finally it pays dearly for the prudent investor, who has the sole initiative to first protect and only then appreciate his capital, to understand the elements of check and balance. Every action that does not act as a stimulus for long term growth but merely for short term gain will inevitably be met by an equal and opposite loss. Failing to understand this will, for the ignorant, deplete capital faster than you can say “Bear Sterns”.

Commodities will not blow over.
Long term investors understand the need for correction and rest. Things that go straight up are indeed called bubbles and we are not there yet. Like fire feeding off oxygen and fuel, so too do bubbles feed off of extreme optimism and public involvement, both of which can’t disappear over a few weeks. The perceptive analyst will look around and tell with utmost certainty there is no sign of a any euphoria. If anything the investor relies on solid fundamentals, all of which are intact, and buys when the crowds are telling him to be cautious. If he didn’t sell he is sorry but it is insignificant because a bottom is close at hand.

Has all the oil inventories been replenished with years of supply? Have investors the fear that would send each preferring a Krugerrand over a wad of hundreds? Are the cheerleaders over at CNBC telling you to buy Krugerrands and load up on more shares of Nemont Mining?

Market Norms
I have read through many books on markets, investment and financial history yet I have never seen evidence of such a thing. Everything has an intrinsic value and it either sells at a premium to that value or a discount. Professional Traders look for market “norms” in the sense that they seek a short term variable and attempt to trade within that range yet they abandon all affiliation when this trend is broken, that which all may be confident that it will.

The Real Bubble
With pundits of financially-based markets they seem to make two awfully wrong assumptions. Firstly, that the a Commodity Bubble exists in Dollar denominated form and secondly that it has been inflated by artificial and speculative demand.

The first misconception is one that one would almost fail to consider to begin with. After all, the U.S. Dollar has been on the center stage of international trade since the Bretton Woods Agreement shortly after the Great Depression in 1941. Yet since 1913 its intrinsic value relative to goods and services has fallen by over 93%. The fact that there is still any goodwill left to the Dollar at all resembles a Bubble of sorts. It is the measure of wealth itself that is overvalued, not the goods that it represents.

Thus, it is not the goods and services that rise but the Dollars that fall; their inability to maintain their value. Nevertheless instead of markets taking their natural course and correcting itself, the Government is artificially inflating the money supply whilst protecting the very economy that its currency stands for. This devaluing of the Dollar to be able to finance its debts is in no way different than if Enron was given the very ability to print its own currency to continue its business operations or pay out to its shareholders.

This explains the underlying developements we have seen in physical goods, not too different from what we experienced in the 1970s, with a dangerous undersupply of commodities, runaway deficits and financial derivatives of enormous proportions.

I ask of the conscious minded economist, “With over $500 trillion in financial promises, which now seems to be Dollar-backed and secured by the Federal Government, what meager value may be given to the price for real goods, that which feeds and sustains mankind? Furthermore, if demand for goods the world over is rising is it not reasonable to assume that prices rise with it, if not to curb demand, then to act as an incentive for the farmer to increase production? Finally, what would have offset the interest for the speculator to profit from these gains if the fundamental demand continues unabated?”

To quote Charlie Munger “We have convulsions now that make Enron look like a tea party.”

Critical Optimism
Does the financial community really believe that there is excess optimism in commodities? That gold bullion are selling off shelves? That people left and right are participating in buying goods that will benefit from real demand? On the contrary, I see that many have found an opportunity to sell the only gold that they may have in their possessions to take advantage of higher market. This denotes good business sense of buying low and selling high, but certainly not in the realm of exuberance that we have seen in previous meltdowns.

Physical vs. Fiscal
Commodities and Equities. Gold and The Dow. It is a subject that many seem to overlook from a generation-term prospective (considering that Buffett’s long term is 10 years). It is the flaw you will see in every commodity-bearish argument: “Commodities just don’t cut it relative to equities”.

But let us look at the origins for monetary protocol: Traders bartered goods in the marketplace. With many various items coming from numerous townships it was necessary to create a measure of value, a pivot whereby difference between supply and demand may mediate; a method by which payment may be expandable without the physical presence of currency.

Thus began the credit cycle. Producer sold to seller, who bartered with traders, who retailed to the marketplace, who took home their foods from their labor and fed their families.

This “Credit”, unlike the commodity-based currencies of old, had but one restriction: the tolerance of the lender. As long as the lender would risk would the industry borrow. It is of no coincidence that this cycle of credit take years to build and then years to crumble.

The “historical trend”, if we may call it, offers fairly simple advice to the novice merchant who wishes to conserve and grow his capital:

When in times of expansion… lend, invest and do business. In times of contraction and uncertainty… Pay debts, take inventory and accumulate capital.

Recessions of Supply and Demand
It is interesting how mainstream economists will focus on something specific in great detail and fanfare and at the same time fail to see its direct opposite exposure. For instance, it is assumed that a recession diminishes demand for goods and therefore lowers prices overall, not only in the U.S. but also in China. Consequently however, a loss of demand will hurt producers who may decrease production. This will have the opposite effect and raise prices.

Furthermore, it is assumed that as we move into recession, investors have already discounted all the possible losses and write downs. At first glance this possibility seems preposterous. How can a market, however “efficient” it may be, properly and throroughly account for the very speculations that everyone from the companies to the Federal Reserve can only guess at? Besides, it’s quite humorous that Wall Street can call the middle of a recession when they can’t even call the beginning, let alone its happenstance altogether.

It goes without saying that the same case may be made for commodities, in the sense that recessionary results have already been discounted and accounted for, or that they even sell at a discount relative to post-recessionary time-tables.

Capitalism that would make Marx smile?
Capitalism works. And for he who says it doesn’t should look no further than every innovation and technological advancement since the Middle Ages. Nevertheless, it is a process and it may not be looked at point blank. There are times when the advantages of Capitalism may overextend its true worth, while there may be times that it will seem to underestimate it (much like your average share price).

For the last 28 years we have lived in a credit expansion. Yes, there have been pitfalls – the Crash of 87, LTCM, the DotCom collapse – yet we have rolled on. The world has undergone quite a change in that time and has made people sentimentally and physically wealthier than ever before. Liquidity was fluid, credit was available for anyone who needed it, lending was commercialized and industrialized allowing the investor in China to buy equity in a startup in Australia. What the lender would risk would the industry borrow.

Yet now the payments are due, and the funds we have borrowed to finance this wonderful world we have built for ourselves must be paid in full. We are not veering off a path of success, not failing at our ambitions, we are merely paying for what we have taken.

Our past actions have now brought about the future results. For years we benefited when investors fled from commodities to purchase equities and financial paper, suppressing prices through shorting, or “selling forward”, neglecting the farmers and producers. Now we must compensate those to increase supply in order to feed a larger, hungrier, wealthier, more innovated world.

Welcome the Seventies!

No, you won’t get back your Intel 4004, you won’t need to grow back that Afro, nor will you easily get a hold of some new records from the Beegees. But what you are most likely to see a heck of a lot more inflating prices of goods (your favorite dinner) and deflating financial values (your favorite stocks).

The reason why some things just don’t change, is because people don’t. After the roaring 50s and 60s, we had evolved from savers to spenders, from investors to speculators. As the markets began to deflate, the Federal Reserve, along with the help of the U.S. Government Mint, began injecting even more liquidity into the marketplace in attempt to cushion the fall of falling asset prices, such as stocks and bond ratings.

In doing so they created a giant ball of cash that was rolling nowhere since due to its gigantic size was being rejected by the average consumer in favor for safer assets, such as commodities and real estate, and eventually gold.

It’s happened before in the 1970s and before that in the 1930s. Before that at the beginning of the last century. As a matter of fact, it’s been recurring about every 30 years or so, in almost identical cycles: Years of solid growth, followed by years of higher company profits trailed closely by stock prices, and then a euphoric blow-off of speculation and ill-appreciated prosperity. Then came the bust, the “credit crunch” when debts come due, loans are recalled, intrinsic values revisited. All speculative action dies along with the spirits of those who were riding it.

The primary differentiation between the “inflationary” depression of the 1970s and the “deflationary” depression of the 1930s was a simple one: Liquidity. In 1929 after stocks crashed and banks were failing by the day, there was nothing to fall back on. Man’s trust was in gold and its supply was limited. The Treasury was by no means interested in sponsoring such an event with goods of limited supply and unlimited value to those in need.

Today the story has a twist. One that has been in motion since its inception in 1944 with the Bretton Woods Agreement when the U.S. Dollar, became the unilateral global currency, “always” to be redeemable in gold. This was scrapped in 1971 with the closing of the “gold window” when these dollars became backed, not by resource of limited nature rather by the faith and credit of the people, assumed its role as the world’s global currency. This enabled the powers that be with the ability to constantly replenish the world’s liquidity in times of necessity. Unfortunately, this resulted in the same failures seen in the 30s. The rich got richer because they owned things and the poor got poorer because they owed things. Furthermore, how much you had became significantly inferior to what you had.

This being the predicament it has become quite clear in my mind that the scenario to unfold will indeed be that of an “inflationary” depression. the European Central Bank announced that it would make “unlimited” funds available to the banking sector. The Fed will, predictably, react in the same way, running the printing presses overtime.

The only way for the Fed to limit the deflationary affect of illiquidity, would be to increase real value – earnings, commodities and gold. Unfortunately, and contrary to the belief in the Federal Reserve, that’s impossible.

Billions won’t be enough to mop up this mess, but trillions. Even then chances are good that amid the panic, much of that liquidity will get misallocated to places whom those injecting it don’t desire. There is no question in my mind that the damage has been done and one way or another values must realign.

Consumer costs will rise, while stock valuations (as measured between earnings and cost per share) will fall. Debt related issues will suffer, albeit not do to deflationary pressure, rather due to inflation and interest rates.

Tomorrow marks a significant day for hedgers as the deadline for withdrawal at the end of the quarter (45 days). This was obviously discounted as the Dow fell another 200 points.

Mark my words: These days will go down in history.

China Getting Restless – Stephen Schwarzman-style

The Financial Times reports “China to buy 10% stake in Blackstone while yielding voting rights

Why we think this is huge news:

Firstly, as mentioned, this is the first time Beijing has invested its foreign reserve in a commercial transaction and is described, as should be, as a “historic event that changes the paradigm in global capital flows.”

Secondly, this may the be the first of many acquisitions that will be looked at as a monumental move to diversify their U.S. Dollar holdings, signifying a sign of action after much of the talk we’ve been hearing till now.

Thirdly it shows where China is looking – Returns. Sick of a mere 5% that would yield less than $500B over the next ten years, a boost to the 10% range would increase their holdings by over $1T in the next decade. If it were the 1990 they’d be investing in Tech stocks, if it were a few years back they would be buying up real estate and today it’s Private Equity.

So what’s next? I don’t even think the Chinese themselves know, but what I do see in the cards is a range of possibilities. And if China starts buying gold the repercussions can be huge. Nothing is certain at this point but as they say “When there is smoke there may be fire.”


Rep. Ron Paul on US Economic Awareness

U.S. Rep. Ron Paul, R-Texas, was able to read aloud for the cameras some of his prepared statement at the Feb. 15 meeting of the House Financial Services Committee. He also spoke before Federal Reserve Chairman Ben Bernanke.

Ron Paul is seeking the Republican nomination for president in 2008. He cites that the Fed should:

Begin publishing the M3 statistics again. Let us see the numbers that most accurately reveal how much new money the Fed is pumping into the world economy.

Tell us exactly what the President’s Working Group on Financial Markets does and why.

Explain how interest rates are set. Conservatives profess to support free markets, without wage and price controls. Yet the most important price of all, the price of money as determined by interest rates, is set arbitrarily in secret by the Fed rather than by markets! Why is this policy written in stone? Why is there no congressional input at least?

Change legal tender laws to allow constitutional legal tender (commodity money) to compete domestically with the dollar.

His full speech can be found here.

February 21, 2007


Questions on Gold and Money
I just read through a long thread comments on the previous post found at the link given therein.

I don’t suggest reading through all 76 some comments, but I did write a synopsis in question and answer form.

Correction: In the previous post we mentioned that Gold did not compete with Inflation, citing the chart of M3. This may be incorrect as Gold does indeed act as a sufficient hedge over long periods of time. (As cited below M2 Prime may be a better measure).


What is Gold?
Gold is a commodity just like any other.

What is Money?
“Money” per se is anything of value to anyone in exchange for any other commodity, i.e., rare Sea Shells, Manual Labor or abundant pieces of cotton-paper.

Is Gold money?
Gold has attained it’s status historically as a monetary medium due to its physical and sentimental values (durability, scarcity, divisibility rare color). It has thus been fairly adequate for safe, abundant and enduring accumulation.

Is Gold a decent hedge for Inflation?
If you want to buy a Coke you’ll need some greenbacks. You want to be able to buy that same Hugo Boss suit in 40 years from now? Use an ounce of Gold.

Will Baby Boomers/ Retirees buy Gold?
They’ll buy whatever hands over the most return for any “safe” asset. First it was Bonds, then Real Estate, gold seems to be next.

Will Gold ever be confiscated?
Possible, but not probable. Gold’s market is too small and insignificant to chase after with the Law. Even if it was, few would hand it over. Many in 1933 just hid it under the mattress. As I recall, not one arrest was ever made on the matter.

Is Gold a Good Investment?
Well, if gold is just another asset class then looking at the Dow/Gold ratio should give us our answer, as one of the commentators mentioned. In terms of Gold the Dow is still overvalued by historical standards. Over the next few years Gold should continue to outperform.

Does Gold offer Interest or Dividends?
No. That’s the price you pay for “Tranquility”.

Does the Federal Reserve care about Gold?
Based on their statements I’d say they do and very much. Even Ben Bernanke has mentioned his concern for the rising gold price and will be watching it closely.

Gold ETF or Gold Bullion?
If you’re buying to “make money” then buy the ETF – easy to buy and no storage. If you’re buying to secure wealth (like the Indians are) then buy Bars.

Will Silver outperform Gold?
Technically, the ratio has been between 1:10 to 1:100, currently at 1:48. Fundamentally though, the consuming supply of silver may be dwindling faster than that of gold.

Should we calculate Inflation with M2 prime instead of M3?
IMHO, Definitely!

If Gold is worth so much – sentimentally – why then do Hedge Funds, Institutions and Governments still deal in Fiat Currencies?
This is because they are the ones who make it. They can’t increase the supply of gold but today they could create billions of dollars with a stroke on the keyboard.

This is no conspiracy. It happened in Rome, Spain and Greece. No Fiat currency has ever survived but if that’s all that is legal tender its what we’re forced to use. We get used to it – they get used to it – We all forget about Gold and the days when wealth was defined by how many cattle you owned or how many fields you had. Not in valueless IOUs.

Do I own Gold?
Yes, but I will own (stocks in) companies become cheaper to own – circa P/E ratios of 8-10 and when they attain a greater Margin of Safety.

Final Words:
Rule #1. Don’t Lose Money. Rule #2. Don’t Forget Rule #1.


Is Gold Really An Inflation Hedge?

Look on any mainstream investing newsletter or any economic market guide and they’ll most probably tell you that Gold is a hedge or insurance against inflation. But is that true?

This fascinating article by Mish on his blog intriguingly attempts, once again, to disprove the conventional logic. I have been contemplating this concept for some time and it’s a pleasure to find most of my research done. In addition, I have been questioning how well gold does in times of deflation. Apparently, very well.

Here are his final thoughts:

Gold in many time frames is not much of an inflation hedge.
In terms of real price, gold is a better deflation hedge than an inflation hedge. The reasons…

1. Gold is money. Proof of that statement can be found in the market behavior of gold. The markets treat gold as if it was money (not only now but on a historical basis). On that basis gold must be considered money regardless what the central banks say.

2. Money is worth more in terms of other goods and services during periods of deflation. During periods of disinflation “cash is trash” and that helps explain why gold dropped from over 800 to 250 even though we had a positive (although falling) rate of inflation for much of that time frame.

3. Gold is stateless and has no liabilities attached to it. It is the only money that won’t be touched by whatever measures the authorities decide to take to combat deflation.

In addition to being a deflation hedge, gold may also play a role in a panic flight to safety scenario. For example: If the US dollar were to suddenly collapse and/or if fiat currencies were totally repudiated in general, gold would be a huge beneficiary.

Given the current underlying conditions, with increasing chances of a deflationary credit implosion related to housing, along with some chances of a collapse in the dollar, Yen, or fiat currencies in general, the incentive to store wealth in the form of gold is massive.

Full Article

Mish also points out that Silver not only shares the “accumulation” qualities inherent in money, but in addition is an “industrial” commodity as well. Thus, diminishing its above ground supplies, increasing its scarcity, and hence its value.

We have in the past posted a number of articles emphasizing the possibilities of silver competing or even replacing gold as the primary medium of monetary value.

Over the past 22 years, while M3 – the primary adviser of total dollars in circulation – has been rising continuously while gold as an asset has fallen.

Is Gold An Inflation Hedge?
Mike Shedlock
February 20, 2007


The Stock Market’s 1959 Top

Peter Eliades, editor of the Stockmarket Cycles newsletter points out, that stocks have just reached another high… in the NYSE Advance/Decline ratio, attaining levels not seen since 1959.

The big question, of course, is does an indicator remember where it was almost 50 years ago and does it make any difference if it does or not. An even larger question might be whether the ever-growing number of interest rate related issues on the New York Stock Exchange has somehow distorted the historical accuracy of this indicator.

We do not claim to have the answers to those questions but based on all the other technical information at our disposal, it would not surprise us to see the cumulative advance/decline ratio stall at these levels.

Will they pass these highs and what does it all mean? Eliades is not sure. Looking through my folder of charts I noticed a few things.

1) The year 1959 was dead in middle in of a long Bull market that ran until 1966 taking the Dow from 600 to over 1000. By contrast we are in the midst of a Bear market – off from one of the longest and largest Bull markets in just about every definition a bull market may be attained, i.e., earnings, P/E ratios, credit, interest rates, etc.

2) This is easily demonstrated in the ratios of Dow/Gold or Dow/Silver, both of which confine stocks as an asset class to a definite ongoing decline. The Dow/Gold ratio currently stands at 19, down from its 2000 high of 41, the highest ratio in over a century including 1929. In the Dow/Silver ratio, currently at 915 down from its 200 high of 2,545, we see that the Dow remains in fairly overvalued territory. Each high above 1000 since the year 1800 has resulted in a decline of over 40% in value.

3) In 1959 the S&P500 was valued at only 14 times earnings destined to reach just 20 times earnings in 1965. By contrast the S&P currently supports prices 18.5 times earnings and has been declining ever since its 2000 highs of over 30.

4) In regard to asset classes of the times, in 1959 we saw stabilizing Real Estate prices since its highs in 1947 surge after WWII. In 2006 we see an already threatened market that has surged by over 50% nationwide just over the past 6 years (after great stock gains and easy credit?). Similarly commodities and gold were in a bear market in the late 50s while today they seem to be in a strong bullish trend due to supply and demand factors as well as a bearish stance on the US Dollar.

So what does this mean for stocks? No one seems to be sure, but what many are sure is that regardless of how you cut it lower stock prices seem in the cards… unlike 1959.


The Stock Market’s 1959 Top
Peter Eliades
February 16, 2007

The Value of the Dollar

I remember hearing from my uncle who had gone to a concert with a very wealthy individual, who runs a very successful business in Real Estate developments near and around the Disney area, as well as in family vacation packages. This guy, David, didn’t really seem all that interested. I guess your modern-day Reggae concert just wasn’t his thing.

As they got their tickets, it occurred to David that he was holding VIP passes to front row seats. Seeing all the fans waiting eagerly around him to get in, he immediately turned to an excited fan and asked if he was interested in buying a VIP pass. Here is a man, my uncle thought, worth millions of dollars, looking for a buyer of his two passes. Incredible! This man got where he is today not by simply “Buying and holding”, but by selling what he had to someone who obviously wanted it more. He understood full right the “value of the Dollar”.

Robert Kiyosaki, in an artcle titles “Go for Gold and Silver” said it best, “One of the reasons why we have this enormous gap between the world’s haves and have-nots is because the have-nots value money – they work for it, save it, cling to it, and lose it.”

The value of the dollar, per se, equals no more than the cotton-paper its written on. Its merely a symbol. An IOU, a promise. A credit labeled as legal tender explaining how any Bank will accept it as a medium of currency.

But what is money? Money is no more than an exchange of service or goods, an Interest. I give you, you give me, nothing more and nothing less. The “haves” spend their lives working for a higher worth of goods or service, while the “have nots” hide their wealth under their mattress while its “time value” deteriorates slowly but surely.

The laws of supply and demand apply to a dollar bill the exact same way they apply to any commodity or asset. This is by definition the power the Fed supposedly has to control the US currency market through Interest Rates. By driving up or down the return on the dollar, the holding of cash becomes more or less attractive.

In this way, when a country is doing well it needs not worry about the amount of dollars – or any medium of exchange – in circulation. People want goods and services, not money. When the interest for these wither, such as in a time of economic recession on contraction, then money will become more valuable.

This, nevertheless, is not always that easy to predict. Many times a government will under or overestimate the proper status of the money supply or the demand thereof. In this case running the printing press too long could result in a financial crisis, similar to what Germany went through after WWI, sending the economy into a tailspin of hyperinflation, (people were using German marks as firewood because it was cheaper).

It isn’t getting better. The United States now has a second problem as well, with a trade deficit in the trillions. Although many don’t seem to find it to be a problem, it spells clean-out financial trouble. Like Spain in the 16th Century, we no longer have any major exports. Instead Spain just used their enormous gold holdings to buy their imports from other countries. When the gold ran out they were doomed. Nothing to sell and with nothing to buy.

Today our money is no longer backed by gold. It’s backed simply by the faith and confidence of the world, since a huge chunk of US dollar holdings are now in foreign lands. If that trust is breached, or if those countries simply find another asset to be of better or safer value it could cause a run on the dollar, causing a major inflationary crisis, sending interest rates through the roof (anyone remember 17% rates in the 70s?) and driving a prosperous country into severe recession.

Could this happen? Well, as we speak countries holding extremely large amounts of US assets have indicated diversifying away from the dollar. China, Japan, Russia and Iran have all mentioned that they may move part of their assets into other holdings such as the Euro or gold.

What to do? The best way to hedge oneself against such events is to buy gold and silver. These have been considered money, by all, for thousands of years. The novelty of an unbacked currency goes back only 35 years to 1971 when, with the Bretton Woods agreement, many countries agreed to peg their currency against the dollar, instead of with gold.

Historic records show however, that no currency unbacked by any hard asset has ever survived. Not in Spain, England or even ancient Rome.

Here’s one more thought to ponder. The US government reserves officially hold (although many believe unverified) about 200 Million ounces of gold. In April the government ceased its announcements of M3 – the amount of US dollars in circulation – claiming that it was an unimportant report. M3 is thus estimated at approximately $10.5 Trillion dollars. A dollar used to represent one silver dollar and 1/16 oz. of gold. Whats 10.5 Trillion divided by 200 Million? Answer: $52,500. Divided by 16 would still equal $3,281. Even if we were to exaggerate the sums of each more benevolently we would still be facing a shocking number.

This means that either the dollar must come down to 1/3000-th of its value or gold must rise to $3000. Of course they will most likely land somewhere in between. As a matter of fact, these fundamentals have already begun their move. The dollar has already shrunk to 13-year lows against other major currencies (like the Pound and the Euro), while gold has more than doubled in its nominal value.

I would say that we still have plenty of time before gold (and silver) attains the status that it so rightfully held for centuries before. This could take time, with many small corrections in the gold price, but it’s still far safer than cash.

I’m even more Bullish on Silver than on gold, but more on that in a later article.

The Dow/Dollar Ratio
For some long-term perspective, today’s chart illustrates the Dow adjusted for inflation since 1925. There are several points of interest. For one, when adjusted for inflation, the bear market that concluded in the early 1980s was almost as severe as the one that concluded in the early 1930s. It is also interesting to note that the inflation-adjusted Dow is now a touch less than three times higher than where was in 1929 and a little over double where it was in 1965. Not that spectacular of a performance considering the time frames involved. However, the magnitude of the bull market of 1982 to 1999 (even when adjusted for inflation) was truly of historic proportions. While the Dow has recently been making new record highs on a non-inflation-adjusted basis, today’s chart does illustrate that on an inflation-adjusted basis the Dow still trades below its 1999 peak. Further proof that time is money.

What more can I say other than “I think it’s about time to start thinking about commodities…at least for the next 10-15 years”. An economic slowdown (which the short-term-minded world is so speculative about) would last about a year, even considering the most bearish predictions. This bull market in commodities however should last for over a decade. When you see stocks trending towards the green line, you’ll know to get out.


China says it long has had a dollar diversification plan. Do You?

Zhou Xiaochuan, governor of the People’s Bank of China, said at a conference in Frankfurt that China has very clear plans to diversify its reserves, which now stand at more than $1 trillion. A wide range of instruments are under consideration, Zhou added.

Central Banks seem to be thinking the same way.

The instruments mentioned are possibly currency diversification into the Euro, oil or even gold. Gold which stood for about 60% of total international reserves in 1980, has since diminished to just 9% in 2005. This leaves immense possibility for gold as an option for Central Banks.

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Is this the demise of the Dollar?

The Theory of Relativity

The theory that Albert Einstein has established has, over the course of decades, answered questions and disputes that have been active for centuries. In the field of science for example: Does the earth revolve around the sun or vice versa? According to Albert, it’s impossible to tell since all planets are theoretically in constant motion!

In economics we have a very similar scenario. What is does money revolve around? I have seen many posts on so many websites and blogs recently discussing the topic, primarily on Big Picture.

We are constantly at odds as to what constitutes as money. Gold? The US Dollar? The Euro? Corn?

“It’s all relative”

There is truly no way of developing an undistorted measure by which value can be described, especially since any resemblance of the traditional Gold Standard has been in practice.

Nevertheless, I would say that regardless of what the current outlook may be, I would say that when we are in true doubt we should use history as an example. If Gold has been a currency, worldwide, as far back as we can trace the history of money, there should thus be a solid assessment that it will provide that security in the future.

Recently even Gold has become speculative. It’s not just gold though. It’s a simple “religious” sway between those who chose to believe in the ink-on-paper-and-cotton currency they own with the power of the same government that enacted the “freedom of the press”, and those who strongly desire a tangible wealth asset that they can hold in their bare hands.

The way I see it it’s relatively simple. If you back your wealth with assets of real value – commodities – you will at least have food on the table if there is a currency meltdown.

Remember, I advocate only by Margin-of-safety.