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Inflation without Gold - the Record


By Barry Downs             Printer Friendly Version
and Bill Matlack

August 04, 2004

Research CommentPrecious Metals

It is hard to find a government economist, central banker, or private mainstream economist in any country today, who shows the slightest concern for the most vital function of money, which is its store-of-value aspect. The disregard of governments for money’s store-of-value and the resulting reduction in purchasing power is illuminated by comparing the cost of a typical market basket of goods and services over the past century in terms of the 1900 US dollar.

Cost of a $1000 market basket of Goods and Services
(based on CPI) in 1900 US dollar terms:
  1900 - $1,000  
  *1913 - $1,159  
  1925 - $2,045  
  1950 - $2,858  
  1975 - $5,915  
  2000 - $19,950  
  2003 - $21,088  
* US Federal Reserve System Established

Cumulative inflation in the dollar over the past century has been staggering, especially the surge in the inflation rate from the 1970s to the present. The progression of inflation has clearly coincided with the staged elimination of gold and its discipline from the monetary system, which was completed over a 70-year period, begun early in the 20th century:

• William Jennings Bryan, a three time Democratic presidential candidate, in his famous 1896 Democratic Convention speech, set the mood towards gold for the next 100 years. Bryan condemned the idea of a Gold Standard, warning that, “You shall not crucify mankind upon a cross of gold.” However, gold’s place remained in the system, and four years later the US moved from a bimetallic standard to a pure Gold Standard.

•The bankers and politicians, who formed the Federal Reserve System in 1913, represented the first major official negative influence on gold. In 1925, the Gold Standard was replaced with the Gold Exchange Standard whereby only dollars and pound sterling were redeemable into gold. All other currencies were redeemable in sterling, which was then redeemable in dollars.

• John Maynard Keynes’ new economics, introduced in the 1930s, had a profound negative influence on the idea of a Gold Standard, which Keynes deemed a “barbarous relic.” Keynes thought it ridiculous to dig gold out of the ground in South Africa or elsewhere and put it back in the ground at Fort Knox.

• The attack on gold reached a new level when Roosevelt banned US citizens’ ownership in 1933, but still allowed foreigners to redeem dollars for gold. The restriction on US citizens lasted 41 years, until after the gold window had been closed also to foreigners in 1971. Oddly enough, until 1945, the Federal Reserve was required to hold gold reserves equal to 40% of its notes outstanding and 35% of its deposit liabilities. In 1968, what reserve requirements were left were dropped altogether, and a two-tier gold system was put in place with an official gold price and a free-market price. The official US government gold price, which began in 1797 at $19.75 an ounce, was bumped up to $35.00 in 1934, then to $38.00 in 1972, and finally to $42.22 in 1973. Each increase has represented a devaluation of the dollar.

• By 1971, ballooning trade and balance-of-payments deficits eroded faith in the dollar and Washington’s influence abroad. Nixon, realizing the US couldn’t cover its foreign liabilities, feared a European run on the dollar by international currency speculators. Thus, he closed the gold window to foreigners, placed a 10% surcharge on imports, and imposed wage and price controls. The Administration needed an agreement to revalue world currencies, and in December 1971, the dollar was devalued 9% by raising the gold price to $38 an ounce. Nixon declared himself a complete Keynesian, and from 1971 to this day the dollar has been devoid of all ties to gold.

• In the mid 1970s, William Simon, Secretary of the Treasury, devised a program of US Treasury gold auctions, which coincided with slightly later IMF gold sales. Inflation had begun to pick up, the free-market gold price was rising, and the authorities wanted to squelch interest in gold. Official gold sales drove the free-market gold price from $200 an ounce in 1975 to $103.50 in August of 1976. Bankers and economists were so convinced gold was finished that Walter Wriston, head of Citibank and anti-gold, forecasted publicly that the free-market gold price would be driven back to $35 an ounce or lower. Gold bugs at the time joked that they had been “Simonized.” But from out of the ashes like the Phoenix, gold rose from the $103.50 low to over $600 an ounce by January, 1980, creating a windfall for gold and gold share investors. Gold then entered a long protracted 20-year bear market, during which time paper assets flourished. It was not until July 1999 that gold bottomed at $253.30 in London; in February 2001, a double bottom occurred at $256.25. On April 01, 2004, gold in London hit $427.25.

• The 1990s central bank gold sales and forward-selling programs by the mining industry suppressed gold. Following the 1999 low, gold has been working its way higher.

The accelerated debasement of the dollar, especially over the past quarter century, has left the long-term reserve currency status of the dollar in question. Created literally out of thin air by the trillions, the dollar has defaulted as a store-of-value on US citizens, who have worked for and saved dollars for a rainy day. Moreover, the US dollar has become the cornerstone of what amounts to a global fiat paper money system. History is strewn with worthless defunct paper monies. History buffs will recall the US experience with the Continental dollar, created by the Continental Congress to support the Revolution. The inflated currency rapidly became worthless, and to this day the expression goes, “not worth a continental.” France, during the French Revolution, saw its currency, the assignat, become worthless, and the Germans saw their reichsmarks become worthless in 1923.

Confidence in irredeemable paper money is very much a state of mind. Benjamin Disraeli described confidence in money as suspicion asleep. Once suspicion has been awakened, it doesn’t go back to sleep. In periods of sound money, confidence in paper has been maintained by a gold backing; however, not only the US, but the entire world, has outright abandoned the natural stability of a gold-backed currency. A look back in monetary history would conclude that a breakdown in paper money, including the dollar, can’t be avoided at some point ahead.

In the move to substitute paper for gold, the Federal Reserve became a prisoner of its own expansionism early on. Its expansionist policies have created domestic political demands for perpetual economic growth regardless of the additional debt created. Consequently, total credit-market debt has ballooned disproportionately relative to the size of the US economy, to the point now where over $4.00 of new debt stimulus produces only $1.00 of GDP growth. Like trees that can’t grow to the sky, a debt pyramid can only grow so much before imploding. Inflationary forces are now causing the Federal Reserve to raise short-term rates from recent 45-year lows, and pressure has begun to build on the overall debt structure.

The US has saddled itself with record budget and trade deficits, is dependent on foreign sources of financing, and is mired in debt with both the government and its citizens living far beyond their means. The final solution is likely to be the re-association of paper money with gold money, albeit, perhaps only after a monetary catastrophe.

In the interim, drawing from the history of how inflation-riddled paper monies have eventually fared, private citizens should be able to see the handwriting on the wall for the US Federal Reserve note as well as the whole global paper money system. The end impact on history’s best enduring money, which is gold, should prove to be extraordinary. For gold investors, will it be dé-jâ-vu?

Research CommentPrecious Metals

Barry Downs** (775) 852-3875

Bill Matlack** (201) 217-5680


**Barry Downs and Bill Matlack are stockbrokers specializing in gold and mining equities with Aegis Capital Corporation, a registered broker/dealer, in New York, New York.

Company Risk Disclosure
In addition to the risks involved in investing in commodities generally, we also highlight the following risks that pertain to this commodity. Gold is highly levered to the relative strength of the U.S. dollar, the U.S. balance of trade, and inflation generally, as well as to political and economic stability worldwide.

Analyst’s Certification
We, Barry Downs and William Matlack, hereby certify that the views expressed in this report accurately reflect our personal views about the subject commodity. We also certify that we have not, are not, and will not receive, directly or indirectly, compensation for expressing the specific recommendations or views in this report.

General Disclosure
The research analysts (or their household members) who prepared this research beneficially own gold securities and physical gold. Aegis Capital Corporation (“Aegis”) or an affiliate expects to receive and intends to seek compensation for investment banking services from gold equity issuers within the next 3 months. The analysts who prepared this research report may be compensated based upon (among other factors) investment banking services.

The opinions, estimates and projections contained herein are those of Aegis as of the date hereof and are subject to change without notice. Aegis makes every effort to ensure that the contents have been compiled or derived from sources believed reliable and contain information and opinions, which are accurate and complete. However, Aegis makes no representation or warranty, express or implied, in respect thereof, takes no responsibility for any errors and omissions which may be contained herein and accepts no liability whatsoever for any loss arising from any use of or reliance on this report or its contents. Information may be available to Aegis or its affiliates, which is not reflected herein. This report is not to be construed as an offer to sell, or solicitation for, or an offer to buy, any securities. Aegis, its affiliates and/or their respective officers, directors or employees may from time to time acquire, hold or sell securities mentioned herein as principal or agent. Aegis may act as financial advisor and/or underwriter for certain of the corporations mentioned herein and may receive remuneration for same. TO U.K. RESIDENTS: The contents hereof are intended solely for the use of, and may only be issued or passed onto, persons described in Part VI of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2001.