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The Moment of Truth Rapidly Approaches
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One of the most basic premises about which I have been writing
for years is about to be tested. Will we get a flight from
the dollar or will there be some other alternative? The moment
of truth is rapidly approaching.
It has been one of my basic contentions that arguments about
inflation or deflation have been misguided. Like generals
who prepare for the future by fighting the last war, those
who argue that we face inflation or deflation are looking
backwards at past events to extrapolate their vision of the
future. I see something different. I call it a flight from
the dollar.
To explain this concept, it must be recognized that
money is driven by the same fundamental, basic economic principle
that determines the market value of every good or service
- supply and demand. Arguments for inflation or deflation
focus only on the supply of money. They both ignore the demand
component, but I suppose this result is understandable. Supply
gets all of the attention.
For example, the Federal Reserve reports weekly the quantity
of dollars in circulation. M1, M2 and M3 are all measures
of the supply of money, and it is the quantity theory of money
that is taught by professors across the country. What's more,
it is the supply of money that makes the news headlines because
it has the attention of politicians. Their clamoring that
money is too "tight" is their cry to the Fed to pump up the
quantity of money. But what about the demand for money?
Economists assume that the demand for money is an unchanging
constant in the monetary equation. As population grows, so
does - according to commonly accepted economic dogma - the
demand for money grow, by anywhere from 2%-3% per annum, depending
upon which economist and which country they are imposing their
economic theories. With their economic blinders forcing them
to look narrowly at only at one-half of the monetary equation,
they believe that the demand for money today will always be
basically unchanged from the demand for money tomorrow, but
we know this simplistic axiom to be untrue. Look for example,
at what has happened in Argentina.
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The economic collapse in that country
- much like the collapse in the Great Depression in
the United States - is a result of monetary problems.
In both of these examples, the supply of money dropped,
some 30% from 1930 to 1933 and more than 20% in Argentina
over the past year. Thus, both countries have experienced
a massive deflation - a drop in the supply of money.
But look at the two very different results.
The purchasing power of the dollar increased in the
1930's while the Argentine peso has lost about 75% of
its purchasing power over the last three months. What
explains this different result from these two examples
of deflation (i.e., declines in the supply of money)?
The answer is simple - it's the demand for money, which
is different in these two deflationary episodes.
In the 1930's the dollar was defined as a weight of
gold. It was therefore sound money, and as the economic
collapse in the Great Depression worsened, the demand
for the dollar increased until eventually, the demand
for gold itself increased more rapidly than the demand
for the dollar. It was at that time that President Roosevelt
confiscated Americans' gold, rather than lay bare for
all to see the folly of using money substitutes (paper
promises to pay money) instead of money (i.e., gold)
itself. The opposite result has now occurred in Argentina.
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The peso is not sound money. It is not tied
to gold or to anything else of value. It is just some promise
to pay money, and not a very good one at that. The result
has therefore been a flight from the Argentine peso even as
the supply of pesos has decreased by 20% over the past year.
The demand for pesos is falling more rapidly than the supply
of pesos, so according to basic supply/demand analysis, the
price of the Argentine peso - which in the case of money is
called purchasing power - is falling. There is a flight from
the currency, and this is what I expect to happen to the dollar
over the next two to three years.
If there is to be a flight from the dollar, what should we
be looking for? What will be the early warning signs? The
answer is in these two charts.
These two charts present the Dow Jones Industrial Average
over the same time period (from 1979 to the present), but
measure and report the Dow in terms of two different currencies.
The top chart presents the Dow as we normally see it, as measured
in terms of US dollars. The bottom chart presents the Dow
in terms of GoldGrams. These are one gram of gold and the
currency of my company that enables the efficient circulation
of gold as currency, www.goldmoney.com
These are long-term charts, showing the Dow from January 1979,
and they basically present a similar picture. As measured
by both moneys, the Dow has been in a bull market for two
decades. But it is the last few years upon which I would like
to draw your attention. Study this recent performance carefully.
Notice first that the Dow in these two charts reached its
peak at different times. In dollars, the peak was reached
in January 2000.In GoldGrams, the peak was reached in July
1999.
It is more important to note, however, that the performance
of the Dow has been different in these two currencies since
reaching its respective peak. In dollars, the Dow has declined
18%, but in GoldGrams, the decline has been more severe -
there has been a 38% drop.Why the difference?
The answer is that the demand for dollars is declining. But
is a flight from the dollar beginning?
Since 1999, the dollar has been losing value relative to the
GoldGram. The dollar's purchasing power is declining. And
this relative difference in the Dow's performance is an important
indication of an underlying shift in the demand for dollars.To
explain this point, a comparison again of Argentina today
to the United States in the 1930's Great Depression will make
clear this shift in dollar demand.
The Dow Industrials tanked in the 1930's, falling nearly 90%
from its 1929 high. But the stock market in Argentina is soaring.
I've drawn attention to this phenomenon before. In Letter
No. 299 ("Argentina Falls Over") I quoted from The Wall
Street Journal which accurately observed that "...investors
bought [Argentine] stocks as a sort of safe haven amid
fears of future declines in the Argentine currency." Those
declines have now happened, and the currency continues to
decline. In local currency terms, the Argentine stock market
continues to soar. It is "sort of" a safe haven.
It's not the best safe haven, as investors would be much better
off if they had been holding GoldGrams rather than stocks.
But they're doing a lot better in stocks than they would be
if they were holding increasingly depreciated Argentine pesos.
Now apply this statement to the Dow Industrials today and
dollars.
The first part of this two-step analysis has fallen into place.
People are better off holding GoldGrams than owning Dow stocks.
They have more purchasing power by owning GoldGrams during
this period than if they owned the Dow. But are they better
off owning the Dow than owning dollars? Is there a flight
from the dollar? That point is still unclear, but that is
also the moment of truth that is approaching.
Here's what we should be watching for. While I could provide
a formula measuring supply and demand, it is best/easiest
to express this target in terms of the two Page 1 charts.
If the Dow in dollars climbs above the downtrend line in the
first chart while the Dow in GoldGrams falls below the uptrend
line in the second chart, then we can conclude that the flight
from the dollar is underway. The rising Dow in dollar terms
along with a falling Dow in GoldGrams terms indicates that
the Dow blue-chip stocks have become a safe-haven from bad
money, just like the blue chip stocks in Argentina has provided
the same escape.
Again, holding the Dow will not be as good as holding GoldGrams.
But you will be better off holding the Dow than holding bad
money - as the rapidly depreciating peso in Argentina has
demonstrated, and as a rapidly depreciating dollar in the
United States will also demonstrate. There will always be
a flight from the currency into safe havens to escape 'bad
money'.
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James Turk has written the Freemarket Gold & Money Report
since 1987 <www.fgmr.com>.
He is the founder of GoldMoney and inventor of digital gold
currency <www.goldmoney.com>.
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