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Inflation without Gold - the Record
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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: |
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Years |
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1900 - $1,000 |
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*1913 - $1,159 |
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1925 - $2,045 |
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1950 - $2,858 |
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1975 - $5,915 |
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2000 - $19,950 |
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2003 - $21,088 |
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* 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
bmatlack@aegiscap.com
*****
**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,
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Order 2001.
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