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On March 14, 1900, the
Congress of the United States passed the Gold Standard Act.
This placed our nation on an official gold standard and
mandated that the issuance of “greenbacks”,
or Treasury notes, could only occur if they were backed
by gold. Further, Congress created a gold reserve of $150
million that was to be expressly used for the redemption
of gold-backed greenbacks. Henceforth, under the gold standard,
our politicians were to be limited in the ability to issue
new banknotes by the amount of physical gold that was set
aside to redeem them.
When dollar creation was governed by this
law, the dollar’s strength or weakness was determined
by the health of our economy, interest rates and our monetary
gold stock. The stronger that our country appeared to the
rest of the world, the more desirous was our dollar. During
this era, the gold standard acted as a self-regulating mechanism
by dictating the size of our money supply. The larger our
gold stock, the greater the amount of notes that our country
could issue. Conversely, if our nation’s gold supply
dwindled, it was forced to reduce our money in circulation.
Further, the gold standard functioned to moderate and control
the expansion and contraction of the business cycle.
In 1934, President Roosevelt revalued gold
from its earlier official price of $20.67 to $35 an ounce.
When that occurred the gold standard redefined the dollar
as being worth 1/35th of an ounce of gold. Because the government
could only create as many dollars as their gold stock would
provide, this “official” rise in the gold price
simultaneously allowed our leaders to “legally”
increase our money supply. Our then current store of gold
would support a far greater dollar amount of paper money.
In effect, they devalued the dollar by reducing the quantity
of gold that was necessary to redeem it. This allowed our
politicians to increase our money supply with the hope that
it would help our country extricate itself from the throes
of the Great Depression
The gold standard formed the foundation of
a sound domestic monetary system. It prevented government
officials from arbitrarily increasing the dollars in circulation
as it limited their ability to create money from “thin
air”. This fostered greater confidence for our trading
partners in holding our dollars, as they knew that their
value was stable and that they could redeem them for gold.
The gold standard also facilitated smooth
business transactions between foreign nations. When the
gold standard was adhered to by our trading partners, gold
was used to settle balance of payments deficits between
countries. When one nation, the debtor, bought more goods
and services from another than it sold to it, the creditor,
the former incurred a balance of payments deficit. The net
effect was the return of the debtor country’s money
and a transfer of some of its gold stock to its creditor.
A growing American economy generates greater
wealth for both our domestic companies and our citizens.
Further, this condition increases the desire of foreigners
to purchase and invest in our nation. They are more confident
in holding our currency and they see value in doing business
with us. During periods when both our dollar was widely
desired and our economy was strong, U.S. companies imported
greater quantities of foreign goods than they sold. This
was the result of our citizens and enterprises using some
of their increased income to purchase more products from
beyond our borders.
Under these circumstances dollars left our
shores and accumulated in foreign lands. As this process
continued a point was reached when we created a U.S. Balance
of Payments deficit. As stated earlier under the Gold Standard,
if a foreign nation desired to redeem their acquired dollars
they could receive gold in exchange. When this occurred,
the transfer of gold from the U.S. caused a decrease in
our gold stock, and forced a simultaneous reduction in our
money supply. Thus, the dollar’s increased value would
make our goods progressively more expensive in other currencies.
This acted to curtail foreign purchases in the U.S. The
resultant decline in foreign demand, and our reduced money
supply, would act as a brake to slow the economic expansion.
It would also act to reign in any inflationary pressures
that were fostered by our strong economy.
In contrast, during periods of weak U.S. business
conditions the dollar fell in value, and U.S. consumption
of foreign goods declined. The weakened dollar raised the
price of alien goods to Americans. Eventually, the cheaper
dollar and the greater bargains that our products represented
encouraged foreigners to consume a relatively greater amount
of U.S. goods and services. This caused a U.S. Balance of
Payments surplus as our trading partners acquired more of
our products than they sold us. When this occurred their
accumulated currencies were exchanged for gold by our country.
The result was a net increase in our governments’s
gold stock. This in turn would generate a rise in our money
supply which would stimulate business, help end the recession,
and the process would repeat itself.
THE REMOVAL OF THE LAST
RESTRAINTS
UPON MONETARY CREATION
In 1944, the Bretton Woods Agreement was signed
by the U.S. and 43 other nations. This created the gold
exchange standard. Under this accord, these countries agreed
to treat the dollar as a substitute for gold in settling
their Balance of Payments deficits; both gold and the dollar
could be used interchangeably. Under the earlier gold standard
these foreign nations also utilized their gold hoards in
determining the size of their individual money supplies.
The gold exchange standard opened the door
for excessive world monetary creation and the inflation
that it inevitably produced. No longer would the money supplies
of the major countries be controlled by the amount of gold
in their depositories. Now, they could increase their local
money stocks by issuing additional amounts of their native
currencies based upon both their U.S. dollar holdings and
their gold reserves.
Finally, in August, 1971, President Richard
M. Nixon closed the gold window. This removed the last vestige
of gold backing from our currency and the final restraint
on our politician’s ability to arbitrarily create
money. Thus, the era of fiat money entered its heyday, and
the dollar became doomed.
Subsequent to President Nixon’s refusal
to exchange gold for foreign U.S. dollar claims, the dollar
became the primary item that was used to back the currencies
of the world. Under the gold exchange standard our trading
partners gained great confidence in the dollar. This was
the result of the long period in which they could confidently
exchange it for gold. It is the prime reason that the U.S.
was able to convince the world to move from the gold standard
to a system which allowed a dollar substitute. This placed
the U.S. in an enviable position, and allowed it to wield
great power. It provided our country with the ability to
settle our balance of payments deficits with dollars that
the Federal Reserve could create at will. They no longer
had to back the dollar with gold. Had our leaders acted
responsibly to limit the creation of dollars, we would not
be in the precarious condition that the U.S. and the balance
of the world now finds itself.
During the ensuing four decades after the
dollar replaced gold, the U.S. has registered an enormous
cumulative balance of payments deficit. These dollars left
our country to acquire valuable goods and service which
were gladly sold to us. Many of these dollar credits then
returned to the U.S. and were invested in U.S. Treasuries
which helped reduce our interest rates. A substantial number
of the dollars that went overseas found their way into the
coffers of the various central banks. This kept them out
of our money supply and reduced pressure on our prices,
thereby limiting domestic inflation. Simultaneously, the
dollar build up in foreign lands fostered large increases
in the money supplies of those nations.
All of these factors worked well for quite
some time. In the U.S., it allowed our citizens to lead
a far better lifestyle and enjoy a higher standard of living
than would have otherwise been the case. We did not have
to sacrifice our precious gold hoard, as we would have under
the gold standard, in order to settle our balance of payments
deficits. We not only weren’t forced to reduce our
money supply, but were able to expand it. Foreigners continued
to treat the dollar as if it remained as good as gold. We
simply transferred electronic dollar credits to pay for
our foreign purchases. Additionally, the abrogation of the
gold standard forestalled a serious economic decline that
would have been mandatory under its rule. Each time our
economy has contracted the Fed effortlessly expanded the
money supply and reduced interest rates. Even today this
method appears to be working. However, the time will come
when the piper will have to be paid, and time may be running
out.
The other nations are beginning to recognize
the trap into which they have fallen. They see the dollar
declining and gold rising in value and have heard from the
lips of Fed Chairman Alan Greenspan and Fed Governor Ben
Bernanke that the U.S. has the ability to create dollars
at will. Large foreign dollar holdings have been converted
into euros and some into gold. Further, there is talk of
not only repricing oil in euros but in the creation of new
gold backed currencies. Either of these events will play
havoc on the dollar as its usefulness to the rest of the
world will decline, and with it both the dollar’s
desirability and worth. For these reasons, I believe that
the dollar is destined to gradually lose its global importance.
Additionally, Japan is aggressively purchasing
dollars with newly created yen credits. They are attempting
to support the dollar in an effort to maintain their competitive
trade advantage. This is acting to limit an increase in
the U.S. money supply because the dollars purchased are
removed from our domestic measures of money. Instead, the
dollars are used by Japan to acquire U.S. Treasuries. This
is likely the primary reason for our surprisingly strong
bond market.
At some juncture I believe that it is
inevitable that the U.S. will be forced to again back the
dollar with gold. It will not likely occur until the dollar
appears to be in the process of or loses its status as the
world’s reserve currency. Or, if this is preempted
by an economic accident. That is likely the only fashion
in which the dollar will have the opportunity to again become
universally desirable. This will not occur overnight! Until
that time comes, gold and secondarily silver and gold and
silver stocks, as well as tangibles, will be the prime beneficiaries
of the termination of the gold standard.
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I publish Financial Insights. It is a
monthly newsletter in which I discuss gold, the financial
markets, as well as various junior resource stocks that
I believe offer great price appreciation potential.
Please visit my website www.financialinsights.org
where you will be able to view previous issues of Financial
Insights, as well as the companies that I am presently following.
You will also be able to learn about me and about a special
subscription offer.
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CAVEAT
I expect to have positions in many of the stocks
that I discuss in these letters, and I will always
disclose them to you. In essence, I will be putting my money
where my mouth is! However, if this troubles you please
avoid those that I own! I will attempt wherever possible,
to offer stocks that I believe will allow my subscribers
to participate without unduly affecting the stock price.
It is my desire for my subscribers to purchase their stock
as cheaply as possible. I would also suggest to beginning
purchasers of these stocks, the following: always place
limit orders when making purchases. If you don't, you run
the risk of paying too much because you may inadvertently
and unnecessarily raise the price. It may take a little
patience, but in the long run you will save yourself a significant
sum of money. In order to have a chance for success in this
market, you must spread your risk among several companies.
To that end, you should divide your available risk
money into equal increments. These are
all speculations! Never invest any money in these
stocks that you could not afford to lose all of.
Please call the companies regularly. They are
controlling your investments.
FINANCIAL INSIGHTS is written and published by Dr. Richard
Appel and is made available for informational purposes only.
Dr. Appel pledges to disclose if he directly or indirectly
has a position in any of the securities mentioned. He will
make every effort to obtain information from sources believed
to be reliable, but its accuracy and completeness cannot
be guaranteed. Dr. Appel encourages your letters and emails,
but cannot respond personally. Be assured that all letters
will be read and considered for response in future letters.
It is in your best interest to contact any company in which
you consider investing, regarding their financial statements
and corporate information. Further, you should thoroughly
research and consult with a professional investment advisor
before making any equity investments. Use of any information
contained herein is at the risk of the reader without responsibility
on our part. Past performance does not guarantee future
results. © 2003 by Dr. Richard S. Appel. All rights
are reserved. Parts of this newsletter may be reproduced
in context, for inclusion in other publications if the publisher's
name and address are also included for credit.
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