ID MONSTERS, SELF-DECEPTIONS, AND $1,000 GOLD - Part I & II
By Bill Fox
February 26, 2004
Back of the Envelope
Analysis for $1,000 Gold in Five Years
Part III of XI
THE DUAL NATURE OF GOLD, and A MYSTERY
To justify my $1,000 low-end price target within five years, I need
to “run the numbers” and then explain the assumptions
behind them. Here they are:
I intend each of the above factors to be understated.
Upon reviewing my assumptions, the reader will be able to see how
gold could possibly rocket up to over $2,000 or $3,000 an ounce much
sooner than five years. But before anyone gets too excited, let us
examine each assumption in some detail.
As usual in the investment business, I have a duty up
front to warn readers that market projections are inherently risky.
There is always some chance that we could get blind sided by unforeseen
factors and that gold could behave contrary to expectations. Conversely,
it is also possible that the rise in gold could vastly exceed expectations.
Please be aware that what applies for gold in this article
also applies to silver, which closed at a $7.53 an ounce on March
19th and has enjoyed a greater bull market in the last year than gold.
I zero in on gold because it is the primary form of “natural
money” that has been the main target of manipulative efforts.
Silver, historically the second most natural form of money, has been
a secondary target in support of campaigns against the main target
INCREASE FROM CURRENT “SUPPRESSED”
MARKET PRICE BACK TO “EQUILIBRIUM”
Estimated increase factor: 5% a year
or 28% cumulative total in five years
At the March 16, 2004 intra-day market price of
$400 an ounce, gold recovered back to its 1996 level. It dipped to
a low of $252.90 in June 1999. Can we assume that gold was at a reasonable
market level in 1996, was artificially suppressed in the following
years, and that now we can expect it to catch up to the inflation-adjusted
level where it might have been without the suppression?
Gold prices in current dollars. [Source: Gold Newsletter,
Inflation-adjusted approach from a technical
or historical support base: At $400 an ounce
in 1996, gold was fifteen years into a commodities bear market and
had showed sideways technical trending evidence of “basing out.”
The inflation-adjusted gold price chart above supplied by the Gold
Newsletter suggests that gold formed a base between 1993 and 1995
at roughly $500 an ounce in today’s dollars.
In a 2001 article that looked at multiple valuation
perspectives, James Turk used CPI increases from gold’s $35
price in 1934 to determine that gold should be worth $463.
In his April 2003 article “The Gold Price,”
Paul Van Eeden extrapolated the price of gold adjusted for broad money
supply M3 growth and gold supply inflation since 1947 and came up
with a value of $700 an ounce.
Supply and demand analysis: Frank Veneroso, a
consultant to central bankers, published the Gold Book in 1998, in
which he estimated the equilibrium price of gold at $600 an ounce
for 1996. In his analysis, he looked at supply and demand inelasticity
and the likely market impact if central banks desisted from selling
off gold to fill the 1,000 tonne supply deficit in 1996. The gold
market has experienced significant supply deficits since 1987. The
decline in gold to $252.90 in June 1999 was a major historic anomaly,
given that countries tend to jealously guard their gold hoards as
strategic assets, and also given that gold supply gaps usually foster
higher prices until deficits are eliminated.
Dow/Gold Ratio vs. Tobin Q's Proxy [source: sharelynx
Gold vs. stock market valuation:
Another equilibrium approach compares gold to trough valuations of
the Dow. According to Reginald Howe in his Nov 1999 Golden Sextant
commentary, "The Dow/gold ratio moved from 1.01 in 1897 to 18.4
in 1929 before the crash, then fell to 2.01 at the bottom in 1932
(gold fixed at $20.67/oz.). From 28.26 at the Dow peak in 1966 (gold
fixed at $35/oz.), the ratio fell to about 3 at the bottom in 1974,
and to 1.04 in January 1980 at the modern peak in gold. At the Dow’s
peak in August 1999, the ratio was over 40, an all-time high.”
If we pick a ratio such as 3 from 1974, and assume a
worse case scenario 72% fall in the Dow to 3,000 within five years
from rising interest rates, this could imply $1,000 gold. This would
fit older patterns if gold continues to play “catch up”
during a continued asset price deflation credit bust cycle combined
with simultaneous consumer price inflation.
The chart above, incidentally, is very useful for another
purpose. It provides a graphic indication of the huge and ever growing
boom-bust pulse surges of credit under the fiat money and fractional
reserve banking system seen in America since the creation of the Federal
Reserve Banking System in 1913. The Tobin Q Ratio that coincides with
the Dow/Gold ratio above helps to validate this concept, since it
divides the market capitalization of all companies by their replacement
value. I will return to the topic of horrendous liquidity surges in
a fiat money system in Part VI “The Propaganda War Against Gold.”
Getting back to the inflation-adjusted Feb 2004
Gold Newsletter chart provided at the beginning of this section, if
the growing pulse surge pattern repeats itself, and gold tops its
last high in 1980, then we will likely see gold over $2,000.
650 Year Historic Gold Price [Source: Sharelynx
historical charts archive]
Gold brought forward through a Purchase
Power Parity Time Machine.
In the very long-term historical chart above, we see
a tug of war between several factors. On the one hand, we see the
price of gold drop due to a major supply shock involving gold introduced
to Europe from the New World after 1492. Lesser price declines followed
discoveries in California and South Africa. An even bigger erosive
force has come about when governments have demonetized gold by effectively
discarding various elements of a fully negotiable gold standard while
inflating in times of war, such as during the Napoleonic Wars (War
of 1812 for the US), World War I, and World War II. Conversely, gold
gained in value during the period of the international gold standard
of the 1800’s combined with the gains in wealth created by the
Industrial Revolution, when the world added wealth at a greater rate
than miners could add gold supply. The source that created this chart
claims the price of gold peaked several times at $627 an ounce during
this period in 1998 constant dollars. The gold price in constant dollars
also increased during periods of deflationary bust (the 1930’s)
and speculative demand (late 1970’s).
In Part II
of this series I described how the purchase power parity concept applies
to international trade. Here we try to put gold through a time machine.
According to economist Mark Skousan, a tailored suit cost the equivalent
of an ounce of gold or $20.67
in 1933. According to Peter Brimelow in “Gold
miners and Haberdashers” a tailored suit cost $1,260 in
1997 dollars. John Hathaway of Tocqueville Funds commented in Nov
to Alan Flusser, renowned author and designer of exclusive menswear,
a bespoke gentleman’s Saville Row suit could be purchased in
the early 1980’s for around $800. Today, the number is over
We must deal with a number of complex issues in trying
to adapt the purchase power parity concept through time. America had
stable money under a gold-plated standard until the Federal Reserve
was created in 1913. From then gold became continually marginalized
and “demonetized” in various ways as the money supply
grew rapidly. By the 1920’s the official price of $20.67 an
ounce had already become a kind of governmental and central bank “bluff”
that did not reflect underlying money supply growth realities. Because
the U.S. had gobbled up huge gold reserves from various World War
I combatants while a “neutral” trading partner, in a bizarre
way it was able to aggressively inflate the money supply and look
strong in gold at the same time. In 1933 FDR confiscated gold from
private ownership and then arbitrarily hiked the official gold price
to $35.00. In 1971 Richard Nixon removed the dollar from gold completely.
In 1974 private gold ownership rights were restored, but otherwise
to this day gold has no fixed exchange relationship with the dollar,
whose supply has been accelerating at historic rates. The price of
gold per ounce as a purchase power parity yardstick in each of these
periods has a very different meaning based on many social, political,
economic, and monetary factors, to include ways that central banks
can play with the price of gold through systematic selling and governments
can reduce its negotiability through various forms of demonetization.
In addition, the purchase power parity approach does
not necessarily factor in how the advent of new technology should
make items cheaper. As mentioned in Part
I of this series, an ounce of gold purchased twice as much in
Britain in 1914 at the end of its prolonged gold standard era compared
to ninety years earlier. Much of this gain related to production cost
reductions from the Industrial Revolution. Perhaps an ounce of gold
should buy at least two or three low end men’s suits today compared
to one a hundred years ago, whereas it may only continue to buy one
low end luxury suit on the high end. As an example, today one can
buy a low end Men’s Warehouse Suit for $400. Do we double or
triple this number to $800 or $1,200 an ounce for comparison purposes
if it reflects a substantial input of modern low cost manufacturing
methods or modern low cost logistical access to low cost Third World
labor? But then again, in the chart above, if gold reached $627 several
times during the gold standard era, and the real wealth of the world
has grown much faster than the average 2% annual supply addition to
the world gold supply during the 20th century, then why would not
gold's true international value be some multiple of $627?
ARE THE FORCES OF GOLD SUPPRESSION IN RETREAT?
The topic of gold suppression is worth covering in some
depth. This is because the degree of the effort and the extreme circumstances
required to keep gold down helps to validate its baseline value in
a negative way, much like the way a physicist who measures the force
required to compress a spring helps us understand the power of its
potential spring-back. We also need to address how gold and the dollar
may have both been manipulated simultaneously, since the dollar and
gold tend to move inversely to each other. (cf. my discussion of the
of One Price” in Part
II of this series). We also need to get a sense regarding how
these same forces for gold suppression may now be running out of ammunition
and may be in retreat, possibly allowing free market forces to push
gold towards a much higher free market equilibrium level.
I believe that gold price suppression between 1996 and
2001 involved both “lucky” short- term events for the
U.S. dollar combined with very real manipulative efforts to support
an upward dollar trend and a downward gold trend. Today what were
considered “virtuous circles” during that period have
now turned into unwinding “vicious circles.”
“LUCKY” EVENTS FOR THE U.S. DOLLAR
Paul van Eeden’s April 2003 article “The
Gold Price” describes how the dollar increased 120% from
1990 to 2000. One factor involved foreign capital pursuing America’s
1995-2000 stock market mania. Van Eeden claims that flight capital
was an important factor as various countries experienced currency
crises. As examples, from 1994-95 the Mexican peso declined 50%, from
1995-96 the Japanese yen lost 24%; from 1996-98 during the Asian crisis
the Indonesian rupiah lost 76%, the South Korean won lost 56%, the
Malaysian ringit lost 40%, and the Philippine peso was down 40%. In
1998 the Russian Ruble was down 70% and the “new” Brazilian
real collapsed. And on it went. In “Understanding
the Gold Price” written in 2000, Van Eden claims that the
Asian crisis caused various countries to sell gold to help defend
their currencies, helping to knock the gold price down from 1997-1998.
TOOLS TO HELP “LUCK” ALONG
Jim Roger’s article “For
Whom the Closing Bell Tolls” explains how loose margin,
credit, and monetary expansion policies by the Fed helped fuel the
stock market mania, which in turn attracted foreign investment and
supported the strong dollar. Loose lending practices by big money
center banks helped create major mal-investments in Asia and elsewhere
that set up many countries for crises. Hedge funds fueled by loose
speculative capital then helped trigger currency crises for their
The Clinton administration wanted the world to view
America as a safe haven, and had very powerful tools in its arsenal
to help “spin doctor” this story. I discuss in my “Amidst
Bullish Hoopla” article how the U.S. Government created
the Exchange Stabilization Fund in 1934 to help “stabilize”
currency exchange rates. Of course where “stabilization”
turns into “manipulation” few people seem to notice or
care. The U.S. Government created the “moral climate”
to manipulate currency in conjunction with other markets, to include
the stock and precious metals markets, with the creation of the Working
Group on Financial Markets following the 1987 stock market crash.
Many different factors played an important role in the
“lucky” 1990’s. The US dollar comprised about 68%
of global bank reserves. The U.S. remained the world’s last
“Global Superpower” after the collapse of the Soviet Union.
The US comprised about 25% of global GDP and presented an enticing
market for foreign exporters. Last, but not least, the US has maintained
a hegemonic relationship with two of its major trading partners, Germany
and Japan, since World War II.
The dollar and gold can have an inverse correlation
with each other whether or not there is government or central bank
intervention. Manipulation can muscle gold down a quantum level while
it continues to zig and zag in short term trading movements relative
to dollar futures. Put another way, a long term inverse correlation
between the dollar and gold does not necessarily disprove the manipulation
EVIDENCE OF OUTRIGHT MANIPULATION
James Puplava described strong evidence of dollar interventionism
in the first hour of his May 31, 2004 Financial
Sense Newshour show “Pulling a Robert Rubin.” Before
becoming Secretary of the Treasury during the Clinton Administration,
Robert Rubin had been a currency trader at Goldman Sachs and understood
the psychology of the markets. Normally central bank interventions
would buy enough dollars to arrest a dollar decline and then stop.
Beginning in 1994 under Rubin, the buying continued to drive the dollar
upwards and burned leveraged hedge funds. Puplava noted, “There
was a clear message here, and this was the beginning of the strong
dollar policy. They would sell gold and support the dollar, and that
became the central focus…This has been documented at GATA’s
web site.” On his show, Puplava frequently talks about “flag
pole” rallies in which aggressive buying in futures pits involving
index contracts are used to move markets at strategic moments.
Fraud note: It would not be out of character for American
political leaders to manipulate markets or suppress important economic
information to achieve short-term political goals. As an example,
Pat Buchanan described hubris, gross irresponsibility, and a high
level game of hot potato in his article “Bailing
Out Brazil –Or Robert Rubin?." Because the Clinton
Administration had heavily promoted the North American Free Trade
Agreement (NAFTA), it had a strong political motivation to help bail
out arch trading partner Mexico during the 1994 peso crisis. Major
US money center banks with serious Third World debt exposure liked
the way the strong dollar helped problem borrowers by encouraging
US demand for their exports.
The Bush administration has swept growing Third World
debt problems under the rug that it inherited from the Clinton administration
because, as Buchanan puts it, “No one wants to be in the pilot
house when the ship hits the reef.” Incidentally, another monstrous
debt problem that the Bush Administration is denying is the $44 trillion
Medicare and Social Security liabilities “abyss” identified
by Dr. Laurence Kotlikoff
in his “Going
Critical,” article and also on the Financial
There are all kinds of political agendas we might come
up with ranging from pork
barrel re-election strategies to longstanding Neo-Con
interventionist plans that could help explain who might benefit from
gold suppression and an artificially prolonged “feel good”
economic environment. More on motives later in this series.
There are currently three major areas that show ample
evidence of gold suppression: The first is the Blanchard suit against
Barrick and JP Morgan Chase. The second involves data related to aggressive
central bank selling of gold hoards. The third involves commodities
market manipulation. Let us briefly review each of these areas:
Blanchard & Company, the largest bullion dealer
in America, filed a $2 billion
suit in Dec 2002 against the major money center bank JP Morgan Chase
and the senior gold mining company Barrick Gold alleging substantial
client losses as a result of unlawful price manipulation, anti-trust
violations and unfair trade practices.
The Blanchard case has now moved to the discovery
phase. This is very significant for several reasons. First, it
may make public hard facts regarding unlawful collusion to drive down
gold prices. Secondly, Blanchard filed an injunction to force Barrick
to cover its massive short position. If it wins its case, efforts
by Barrick to cover its short positions could substantially move the
price of gold. Lastly, the discovery process may shed light on the
gold-derivatives related positions of JP Morgan Chase. Already JP
Morgan Chase, one of America’s largest banks, is believed by
many experts to be leveraged at over six times its capital and to
have the world’s largest gold derivatives
exposure. Many investors are worried that a sudden run up in gold
prices could detonate a meltdown similar to the Long Term Capital
Management (LTCM) fiasco in 1998.
Jay Taylor, who publishes J.
Taylor’s Gold and Technology Stocks, interviewed Blanchard
& Co. CEO Donald W. Doyle for his 15
Dec 2003 issue. According to Doyle, JP Morgan Chase acquired a
significant ownership position in Barrick through a third company
called TrizecHahn. Barrick arranged an incredible deal where it can
massively short gold without any margin requirements for a fifteen
year term. On top of this, it can roll over its contracts indefinitely.
According to Doyle, at its height, Barrick accumulated
a 23 million ounce short position, which amounted to five times the
global investment demand for gold for 2000 and 2001 combined. This
is also equal to the combined annual output of every gold mine in
the world’s two largest gold producing countries (the US and
South Africa), or 80 times the speculative limits set by the COMEX
(Commodities Exchange). Doyle claims that all of this was more than
adequate to manipulate gold prices downward. Barrick allegedly treated
its short positions as off-balance sheet assets and did not feel compelled
to include fair market value changes in its current earning statements.
It did, however, report $2.2 billion in additional revenue from its
short sales. It also reported sixty consecutive profitable quarters
of short-selling activity. An unbroken profit record like this is
virtually unheard of in the volatile commodities trading world.
Significantly, Barrick unsuccessfully tried to get the
case dismissed under the sovereign immunity theory claiming that central
banks were involved. This points a finger at the Fed. Also, Doyle
said that he thinks a price for gold of $750 an ounce is a reasonable
inflation-adjusted number if the suppression had not taken place,
particularly given that Barrick began hedging operations back in 1987.
CENTRAL BANK MANIPULATION
Central bank manipulation of the gold markets is an
old story that goes back in recent history to the London
Gold Pool episode of the 1960’s. While promoting a guns-and-butter
policy that involved simultaneously funding the Vietnam War and his
Great Society social welfare programs, Lyndon Johnson wanted to avoid
raising taxes at all costs. His administration created fiat money
out of thin air and pawned off on foreigners over half the cost of
the Vietnam War. (cf. the Mises Institute lecture:
."Presidential Money Mismanagement from FDR to Nixon” by
Dr. Joseph Solerno). To artificially suppress gold as a barometer
of inflation in order to encourage foreigners to continue accepting
dollars as a global reserve currency, Johnson sold off America’s
gold reserves through the London market.
America lost so much gold during Johnson’s gold
suppression scheme that later in 1971 Nixon decided to close the gold
redemption window for foreigners at $35 an ounce rather than devalue
the dollar or rein in imports. Within a decade after the Federal Government
took the lid off, gold soared to a high of around $850 in 1980 at
the height of double-digit inflation.
Fraud note: James Turk
reports strong circumstantial evidence that Lyndon Johnson may have
vastly more of America’s official gold reserves than has been
officially disclosed. If true, this would suggest an interesting “the
best defense is a good offense” strategy to get other central
banks to disgorge their gold in the 1990’s as part of a possible
“national security” bureaucratic rationalization to cover
up spendthrift recklessness and arrogant unaccountability. Former
Swiss Rothschild banker Ferdinand Lips wrote in 2001 in his excellent
Wars: The Battle Against Sound Money as Seen From a Swiss
Perspective (footnote 75 to Chapter VII “Betrayal of Switzerland”)
that, “Recently, there has been growing doubt whether the U.S.
is still in possession of its 261.5 million ounces it declared to
be held in trust in the Department of the Treasury. Firstly, there
has never been an independent audit of the U.S. gold reserve since
1955. Secondly, in September 2000 a strange reclassification was made
in the Treasury Report. Over 54 million ounces of gold were switched
from the category of `Gold Bullion Reserve' to `Custodial Gold Bullion'
without as much as an explanation. Even more mysterious is the May
2001 Treasury Report where `Reserve’ and `Custodial’ gold
have been entirely eliminated and are now labeled as `Deep Storage
Gold.' Thus far, the Secretary of the Treasury, Mr. Paul H. O’Neill,
has not responded to any questions put to him about the matter by
politicians and citizens.” According to William Greider in his
classic work Secrets
of the Temple: How the Federal Reserve Runs the Country, the Fed
has never been subjected to external audit either. Some Treasury watchers
think “deep storage” means the US no longer owns this
gold. In the case of gold stored at West Point and other sites, it
may now belong to foreigners due to gold
swap deals. In footnote 20 to Chapter VII, Mr. Lips writes in
regard to the decision by Swiss bankers to dramatically reduce their
gold reserves in the late 1990’s: “At the time, I was
still naïve enough to believe that the Swiss central bankers
were motivated by a patriotic interest in the value of the nation’s
money. I was wrong. All they wanted was to debase the currency. Throughout
the world, central banks are engines of inflation, and they have very
little interest in sound money. In fact, and especially in the U.S.,
the central bank is the creature of the banks. They conceived it,
they lobbied for it and, de facto, control it. The purpose of the
central bank is not to protect the currency, but to protect the banking
According to Gold Anti-Trust Action Committee (GATA),
in the 1990’s central banks sold or loaned out over half their
reserves to fill the supply deficit in gold that has existed since
1987. The deficit became 1,000 tonnes a year by 1996, and according
to GATA head Bill Murphy, now stands at around 1,400 tonnes. In the
introduction to his 1998 Gold Book, Frank Veneroso commented: “Statements
by Eddy George, Governor of the Bank of England, and Dale Henderson,
staff director of the U.S. Fed have disparaged gold as a reserve asset.
The prospect of a never-ending crushing supply of official gold now
terrifies all the bullish advocates of gold and makes the bears supremely
An important part of the intellectual cover for the
gold sales was the trend by various European countries to form a European
Central Bank by 1998 and merge their currencies into the euro.
Obviously if the German Mark, French Franc, Dutch Guilder, and other
expressions of nationalism were things of the past, then various European
central banks required less gold to help defend domestic finances.
Ferdinand Lips describes in his book Gold Wars how various
international organizations used a variety of measures to help knock
the Swiss off their former Constitutional gold standard and encourage
them to sell their gold reserves in the late 1990’s. The measures
included propaganda that gold is obsolete, veiled threats against
Swiss overseas banking interests, initiatives to feed the world’s
hungry with gold sales, and complaints over fifty years after the
end of World War II that the Swiss harbored “Nazi gold.”
Mr. Lips feels that the latter charges were unjust, and claims that
during the 1950’s the Swiss bent over backwards to identify,
compensate, and otherwise help Holocaust victims.
Bill Murphy of GATA claimed in a May 31, 2003 interview
with James Puplava that he thinks the Fed has even arranged payments
to foreign central banks at prices for gold that are way above current
market prices in order to get them to disgorge more gold into the
market at below market prices to help keep the price of gold suppressed.
FUN AND GAMES IN THE COMMODITIES MARKETS
Bill Murphy, Ted
Butler, David Morgan,
Puplava, and many other experts who closely follow futures exchanges
have frequently commented on supply deficits and overhangs of short
positions and derivatives contracts for both gold and silver. Currently
total short silver positions that have helped to suppress rising silver
prices have grown to 534
million ounces, a decade-long high, or roughly equal to the annual
mining supply. Although paper long positions are equal to this, David
Morgan claimed on the March 13, 2004 Financial Sense Newshour
only about 10% of this sum consists of “registered” physical
silver in warehouses available for guaranteed immediate delivery.
Another 13% is “eligible” but requires more paperwork
for actual delivery. A market that becomes this thin on physical delivery
becomes particularly vulnerable when parties such as the Hunt
Brothers in the 1970’s or Warren
Buffett in 1997 demand substantial physical delivery, which can
cause silver prices to skyrocket. Morgan stated in his March 20th
update he can see a possible eventual silver price well above
$150 an ounce. He cited such factors as severely dwindled above ground
silver inventories after a 15 year supply deficit, rising demand for
physical delivery, and an eventual reversion of the price ratio of
gold to silver to somewhere near its 1:15 incidence in nature. (On
March 21, 2004, with $412.12 gold and $7.53 silver, the ratio was
|Gold and Silver Production
Deficits and Cumulative Supply Deficits.
cf. James Puplava & Eric King's "Believe
It!" to use "click to enlarge" feature]
Most futures contracts roll over rather than settle
for delivery, allowing interventionists to paper over demand and drive
down prices so long as physical supply and demand for physical delivery
do not get too far out of alignment. In Gold Wars (Part IV, p. 81),
Ferdinand Lips wrote: “As far as the gold market is concerned,
it is estimated that the `paper gold’ market in 1999 is many
times larger than the actual physical market. Estimates range from
a minimum of 90 to an excess of 100 paper-ounce contracts being written
for every ounce of physical gold that changes hands. This is not only
mind-boggling, or a Frankenstein monster as James Dines calls it,
but a king-size horror trip.”
According to GATA, the Fed has the ability to indirectly
manipulate both the stock and commodities markets by feeding Wall
Street firms money through the repurchase agreement pool. This is
about $40 billion in size. The Fed and US Treasury can add another
$30 to $40 billion from the Exchange Stabilization Fund totaling $80
billion. Major Wall Street firms can borrow billions of dollars for
up to 28 days. The Fed can keep rolling all of this over, as if making
a permanent loan. Wall Street firms are free to use this money any
way they please, to include using futures contracts at strategic moments
to move markets. They can make really big money by following the Fed’s
“body language.” Last, but not least, they are highly
motivated to remain loyal and sensitive as Fed “team players”
in case they some day need an LTCM-style bail-out.
FROM GOLD PRICE SUPPRESSION TO REAR GUARD ACTION
The artificially strong US dollar policy could not go
on forever. The dollar has been in decline for the last two years.
The initial phase of the US bear market in stocks that ran from March
2000 to March 2003 began to shatter the confidence of foreign investors,
whose earlier capital inflows played an important role in maintaining
the strong dollar.
Low bond interest rates created by the Fed to prop up
the asset bubbles are discouraging additional short-selling in gold.
Speculators used to pay .5 to 1% to borrow and then sell gold from
central banks, and then invest the proceeds in bonds. Bond rates are
now so low that there is no longer a profitable spread. Furthermore,
the trend of rising gold prices has made short selling more dangerous.
This trend also discourages gold producers from hedging. If anything,
the recent trend among producers has been to unwind their hedges.
Even if gold leasing remained profitable for short-sellers,
central banks cannot keep selling forever to fill the current approximate
1,400 tonne per year supply deficit. According to Bill Murphy, they
may be down to only 10,000 or 15,000 tonnes in reserves. At some point
central banks will run out of gold, and world gold prices will skyrocket,
making the central banks look even more foolish than they already
appear for having disgorged gold well below current market prices
in the late 1990’s. In addition, one might ask what might happen
if they get rid of all of their gold, and the world goes back to a
Despite Barrick’s aforementioned alleged sweetheart
deal that allows it to continually roll over its short positions,
we can not necessarily assume that all the gold that has been leased
out by central banks will be contractually converted into gold sales
at lower prices as gold prices continue to move up, or that derivative
insurance against rising gold prices will be adequate in turbulent
markets. According to John Embry of Sprott Asset Management, “Strong
evidence suggests that between 10,000 and 16,000 tonnes (30-50% of
all Central Bank gold) is currently in the market. This is owed to
the Central Banks by the bullion banks, which are the counter party
in the transactions.” Even a very small fraction of short covering
in this area could be explosive.
Politically, the European economic integration trend
behind the creation of the euro that helped justify gold selling is
unraveling. Many countries have balked at taking the last steps towards
full integration, and many members of the EU are becoming increasingly
restive over their inability to follow independent economic policies.
As Mises Institute senior fellow Dr. Hans-Hermann Hoppe points out,
the EU has often simply added increasing layers of regulation rather
than helped to simplify and standardize regulations throughout Europe.
Friction created by Third World immigration and other issues that
fuel nationalism could motivate EU members to recreate their own currencies
and other tools of national sovereignty.
Rising global gold demand is also putting gold suppression on the
defensive. Russia has been accumulating gold, and according to John
Embry there are rumors that far eastern central banks are quietly
buying gold as well. Countries with large US dollar trade surpluses
can do better buying gold (short of running up the gold price) than
buying US bonds. US debt instruments can lose market value two ways
for foreigners if the dollar continues to decline and if interest
rates start moving back up. Both trends are highly likely.
Last, but not least, the strong bull market in commodities
fed by Asian demand over the last two years appears to be pulling
gold and silver along with it. On his web site Le Metropole Cafe and
in his 6 March 2004 interview with James Puplava, Bill Murphy of the
Gold Anti Trust Action Committee has been banging the table for silver,
claiming that physical above ground inventories of silver are very
nearly exhausted. He claims that there is evidence that China has
contracted for 75% of annual silver production in 2005. Explosive
upward movements in silver could help fuel speculative demand for
DETERMINING THE INCREASE FACTOR FOR THIS SECTION:
If we apply a 5% a year or 28% total increase factor
to $400 gold, that brings us to $512 an ounce for gold at the end
of five years. This returns us to the technical support base shown
in the Gold Newsletter chart for 1993-1995. Frankly I think it is
highly likely that we will see $512 gold within one to two years,
not to mention five years, but I am trying to be conservative here.
The Gold Newsletter price scale is probably conservative to the extent
that it uses understated official CPI numbers.
IMPACT OF CONTINUED DOLLAR SLIDE
AND GLOBAL INFLATION
Estimated increase factor: 5% a year
or 28% cumulative total in five years
The U.S. is still running balance of trade deficits of around 5% of
GDP. This has historically marked the danger zone for a currency crisis.
Chinese and Japanese central bankers could easily sink the dollar
overnight by simply conducting “business as usual” in
global currency markets, that is, by simply selling off their huge
trade surplus holdings. Instead, the dollar has made a gradual decline
over the last two years only because of their active intervention.
This is putting an increasing strain on their economies while rapidly
growing trade within the Australia-Asia area provides an increasingly
attractive alternative. As an example, Japan spent the equivalent
of $180 billion buying depreciating dollars to protect companies against
a rising yen in 2003. This was twice Japan’s trade merchandise
surplus and about 50% more than what Japan has received for its exports
to the U.S. in each of last two years. In mid-March of this year Japan
signaled that it might dramatically reduce support for the dollar.
As I discuss in Part II, the rise in the price of gold
in dollars against the dollar decline over the last two years has
actually been more of a dollar bear market than a gold bull market.
But as China and various First World countries continue to inflate
their currencies to help maintain export competitiveness to the U.S.,
this may create a global inflationary bull market for gold as well
as undermine the ability of the US to correct its balance of trade
problems. We could wind up with a global inflationary bull market
for gold on top of a continuing dollar decline bull market for gold.
Professor Tim Congdon’s 2002 World Gold Council
research report describes how the US would need to convert 5% of GDP
to exports just to stabilize its current account deficit growth with
GDP growth. He cites several independent research reports that predicted
a 25-50% dollar slide necessary to begin to find equilibrium. He presents
formulas that describe how achieving equilibrium is positively correlated
with GDP growth and negatively correlated with debt size and interest
rates. Since we still have a 5% deficit despite the dollar decline
in the last two years, the 25-50% decline projection may still be
a valid forward-looking estimate.
In my Oct 29, 2003 article: “Templeton Trepidations,
Buffet Battle Stations” I discuss why Warren Buffett divested
his firm of $9 billion in US Treasuries and made massive purchases
of foreign currencies, and why John Templeton has remained out of
US bonds and invested in Canadian, New Zealand, and Australian bonds.
Templeton believes the dollar is likely to slide further, although
he is unwilling to quantify his views and comment on an Economist
Magazine special report that expects a 50% dollar decline.
There are two major issues involved with a sharp decline
in the dollar. One is that America has lost so much of its manufacturing
base that it may take much longer than in the past for it to overcome
its structural problems and benefit from cheaper export prices. An
even more serious concern is the possibility that a rapidly declining
dollar could lead to many out of control vicious circles.
A rapidly declining dollar might scare foreigners, who
may in turn accelerate their disinvestment in American bonds and stocks,
accelerating a dollar decline even further. To lure foreign investors
back, who buy about half of the Federal debt, the Fed will be forced
to raise interest rates. This can cause the stock market to decline
further, scaring away even more foreign investors, and putting even
more downward pressure on the dollar. In essence, America could experience
a crisis involving a plummeting currency, skyrocketing interest rates,
and crashing securities markets. This sort of macroeconomic behavior
has been an all too familiar pattern with many spendthrift Latin American
countries in the past few decades.
To add insult to injury, any sharp dislocations of the
currency markets or other markets might trigger another crisis similar
to the Long Term Capital Management (LTCM) meltdown in 1998. Robert
Moriarity of 321gold.com commented in his March 13th Korelin interview
that global debt now stands at $100 trillion, more than twice the
world economy of $45 trillion. Even worse, the Bank of International
Settlements (BIS) reports total derivatives at $207 trillion, or a
little under five times the global economy. They have grown from zero
in 1971 when Nixon completely de linked the dollar from gold. Derivatives
help institutions hedge currency risk (previously dealt with through
the simple use of gold) and also allow them to pawn off risk, leverage
speculative positions, and avoid regulatory obstacles in building
loan volume. Adding further to instability, we now have record bankruptcies
in America in a supposedly benign environment with record low interest
rates. Moriarity observed that since Bush was elected, America has
lost three million jobs, and the countervailing gain of 750,000 jobs
has been almost entirely in the public sector. If interest rates start
moving up, and if we also see increasing instability between markets,
this could help trigger a broad economic crisis and a derivatives
meltdown far too big for the Fed or any other central bank to contain.
DETERMINING THE INCREASE FACTOR FOR THIS SECTION:
In choosing a dollar decline factor, I have selected
the low end of Dr. Congdon’s research and am using a factor
of 5% a year or 1.28% total over five yerars. In this case it may
be more reasonable to be conservative, since there may be overlapping,
interactive effects with the 28% factor that I use for M3 growth that
I describe next.
IMPACT OF CONTINUING M3 GROWTH
AND ACCELERATING PRICE INFLATION
Estimated increase factor: 5% a year
or 28% cumulative total in five years
In the long run price inflation is a function of money
supply growth in excess of productivity growth. The Fed has been increasing
the money supply 8-10% a year over the last
five years. This is about the same rate as during the Lyndon Johnson
and Richard Nixon eras which directly preceded the double-digit price
inflation of the late 1970’s. Real productivity growth has been in decline over
the last few decades and now stands around the .75% to 1.5% area.
America now requires
five dollars of increased debt to grow a dollar of GDP, and savings
(the traditional basis of capital formation) is at record lows.
Aggressive price inflation is already here. Congressman
Ron Paul noted in a recent press release that broad indexes show commodities
have risen 49%
since last spring, and that government CPI figures under-report inflation
by focusing on rent figures softened by displaced demand for housing
stimulated by artificially low interest rates while ignoring rising
housing prices. Al Korelin noted in his March
6, 2004 Korelin Economics Report interview with Bill Murphy
that so far in this commodities bull market steel is up 160%, aluminum
up 50%, copper up 120%, and lumber is up 93%. Murphy noted that oil
appears headed for $40 a barrel. He added that while the indices are
screaming inflation every place, the administration comes out and
says there is no inflation, and people accept it. “It is ludicrous,
inflation is roaring, and Ron Paul is correct…In the CPI there are
things they say they do not count such as food, energy, and then we
have housing. So if you do not live any place, eat, or drive any where,
then there is no inflation.”
Aggressive money supply growth is a longstanding trend
likely to continue. In his June 16, 2000 article “Lies, Damned
Lies, and the CPI.,” Adam Hamilton explains how M3 has grown at
a 7.9% compounded rate since 1959 vs. 4.4% for the CPI. Fed Governor
Ben S. Bernanke remarked in Nov
2002 that the Fed is prepared to inflate without limit if necessary.
Total Federal, state, and local government spending
continues to grow four
times as fast as the economy, especially now that the Federal
government is running fiscal deficits that are approximately 5% of
GDP to help fund its global war on terrorism. This absorbs additional
global savings on top of America’s other “twin” deficit –the balance
of trade deficit.
We are also likely to see aggressive M3 growth to handle
other rising costs. These other costs may include rising energy prices
(discussed again in a later section) and increased costs related to
Rising oil and gas prices are an increased cost on the
American consumer. They typically reflect a combination of increased
taxes to the government and increased transfers of wealth to foreigners,
since a little over two thirds of our oil is imported.
We are likely to see rising protectionism as a political
reaction to continued job loss to China and other Asian countries.
America has lost half its manufacturing jobs in the last three decades.
Unfortunately both the timing and the nature of the new “protectionism”
will likely increase drag on the economy, putting more pressure on
the Fed and US Government to create even more money to try to make
up for shortfalls.
Fraud note: The “free trade” vs. “fair trade”
national media debate regarding protectionism usually glosses over
the most important issues, namely taxation and self-determination.
Instead, the debate tends to pay homage to liberal internationalist
ideology or pork politics. Protectionism means more tariffs, which
at root are nothing more than sales taxes on foreign goods. All taxes
are bad, to the extent that they wind up picking the pockets of the
productive, real job-creating private sector and transferring wealth
to the often wasteful, economically incompetent, and politically warped
public sector. It is true that tariffs can be a least bad
form of taxation and can comprise an important tool to steer business
and reinvestment towards local industry while creating barriers towards
countries considered too alien, duplicitous, or otherwise threatening
for full social and economic integration. But despite all of this,
tariffs remain costly. The Federal Government may wind up raising
overall costs to society for the wrong reasons while it is already
over-indebted and financially stressed.
In terms of raising revenues, the government has little
room left to raise taxes to fund its runaway spending and massive
debt obligations without throttling the taxpayer goose that provides
the tax eggs. Total federal and state taxes on the average American
are about 50% of income.
Cutting government expenditures is getting politically
tougher. About 60% of Federal spending involves non-discretionary
transfer payments and social entitlements. Although the official national
debt at around $7
trillion currently stands at around 70% of GDP, this does not
take into account over $44 trillion in un funded current liabilities
for Social Security and Medicare that will start becoming a cash drain
on the system once the first wave of baby boomers begin to retire
in a few years. Demagogic politicians are likely to try to raise taxes
anyway, just as they did in the 1930’s to “spread the wealth.” They
are likely to seriously undermine the capital formation process needed
to create more jobs and wealth, just as they did during the Depression.
And of course if they see that their policies are not working, their
answer to everything is usually always to print more money.
The Fed is not only creating money out of thin air to
support runaway government spending, but it is also fueling credit
growth with historically low interest rates to try to prevent collapsing
bubbles in the bond, stock, and housing markets. It uses open market
operations to buy bonds to help keep interest rates artificially low,
monetize debt, and inject more money into the system to help keep
the asset bubbles inflated. All of this also causes consumer prices
to continually rise.
FOREIGNERS ARE ALREADY BEGINNING TO BAIL
Foreigners are beginning to ditch dollar reserves. Washing
dollars back at the US can only add to price inflation. Half of the
$18 trillion in global US dollars are held outside the US . About
68% of global central bank reserves consist of dollars. According
to a Lehman
Brothers analysis, in the last half of 2003 as much as $133 billion
of foreign exchange reserves in non-Japan Asia out of $2 trillion
total left the dollar for stronger, higher-yielding currencies such
as the euro, pound, and Australian dollar. Asian banks financed half
the current account and fiscal debt last year.
Vladimir Putin met with German Chancellor Gerhard Schroeder
in Oct 2003 to discuss switching oil sales from dollars to euros.
James Turk claims that OPEC countries are already
tacitly pricing in euros. Many Islamic countries have threatened
to convert to a gold-based Dinar in protest against America’s interventionist
policies in the Middle East and also as a defense against the declining
value of dollar reserves.
The next shoe to drop will probably take place when
foreigners cut back their purchases of America’s fiscal debt issues
and stop supporting its current account deficit. At that point the
Fed will need to start raising interest rates to help lure foreign
investment back. It will also need to print even more money to handle
rising interests costs on the national debt. In addition, it will
need to monetize portions of its own debt that foreigners and other
investors are no longer willing to purchase. The Fed will likely repeat
the same pattern of behavior that it showed in the stagflationary
1970’s, in which it was slow to hike interest rates to head off inflation
that got into the double digits. This created a real negative interest
rate environment that lasted nearly a decade.
As discussed in Part
II to this series, gold tends to perform particularly well in
a negative interest rate environment. We are likely to experience
double-digit inflation, if not hyperinflation, within this kind of
environment some time over the next five years.
DETERMINING THE INCREASE FACTOR FOR THIS SECTION:
I think that it is likely the Fed will continue to grow
the money supply by at least 10% a year for the next five years. 10%
compounded over five years gives us an increase factor of 61%. To
be conservative, I have used under half that number, or 28%, suggesting
a 5% average annual compounding rate. This is lower than the historic
M3 growth rate of 7.9% identified by Adam Hamilton since 1959. However,
in the long run M3 growth and the dollar decline factor discussed
in the prior section have a high correlation, so a lower multiplier
factor intuitively helps to adjust for the overlap between these two
IMPACT OF DECLINING MINING PRODUCTION
Estimated increase factor: 2% a year
or a 10% cumulative total in five years
Newmont President Pierre Lassonde commented in his July
7, 2002 interview with Tim Wood of Mineweb.com that, “…Further,
gold production is expected to decline by about 2-4% a year through
2010. Most ‘marginal’ projects have already been factored into the
supply and demand balance. In addition, with exploration expenditure
levels at record lows during the last five years, there are very few
projects of any size that are ‘sitting on the shelf’ waiting to be
developed. What we are seeing now is the logical result of the exploration
budget cuts over the last five years - a dearth of new projects awaiting
John Embry, President and Portfolio Manager of the top-performing
Canadian Sprott Gold and Precious Minerals Fund, stated in the Sept
20, 2003 update of his Fundamental
Reasons to Own Gold, “…Mine supply will contract in the next
several years, irrespective of gold prices, due to a dearth of exploration
in the post Bre-X era, a shift away from the high grading which was
necessary for survival in the sub economic gold price environment
of the past five years and the natural exhaustion of existing mines.”
Lastly, a Nov 2002 Worth
Magazine article reported that the World Gold Council estimates
mine supply is likely to decline 3 to 5% over the next few years,
and noted that the average mine has a life of 10 to 15 years. Government
permitting, community negotiation, feasibility studies, engineering
reports, and environmental procedures often stretch out mining projects
as long as 5-7 years from discovery until production.
DETERMINING THE INCREASE FACTOR FOR THIS SECTION:
If we factor in the impact of the lack of new exploration
over the last five years, as well as the impact of delays in permitting
over the next five years, and add on to this the impact of a substantial
decline in mining production due to normal mining life span expirations
over the next five to ten years, it seems conservative to use a 2%
annual gold price appreciation factor for a cumulative five year total
INCREASING ASIAN AND OTHER GENERAL
INVESTMENT DEMAND FOR GOLD AND COMMODITIES
Estimated increase factor: 3% a year
or a 16% cumulative total in five years
As previously mentioned, the Commodities Research Bureau (CRB) index,
composed of 17 different commodities, is up over 42
% since Oct 2001. Gold and silver tend to participate with broad
moves in commodities, as they did in the stagflationary 1970’s. Recently
the charts show commodities and gold moving together.
Growing demand for industrial goods by China, India,
and other Asian countries has been putting upward pressure on a wide
variety of commodities, to include copper, zinc, and iron. China claims
its growth rate
reached 9% in 2003, and its raw material demand is tying up 25%
of global bulk shipping capacity.
In regard to investment capital, excess liquidity from
the Fed and other central bank stimulus is flowing out of paper assets
and into commodities, particularly in a negative interest rate environment.
On top of this, China has opened a National Gold Exchange. Gold demand
in China among its 1.2 billion people could reach 500 tonnes
in the next few years.
Global investment demand may be enhanced in the years
ahead on an individual investor level by the creation of easier ways
to buy and sell gold through such means as stock
exchanges and online
accounts. In addition, rising gold prices can help to stimulate
new demand from momentum investors and investors who feel that rising
prices enhance gold’s aura as an investment vehicle and as a natural
form of money.
More high-level policy makers are talking about remonetizing
gold. According to John Embry,”Islamic
nations are investigating a currency backed by gold (the Gold Dinar),
the new President of Argentina proposed, during his campaign, a gold-backed
peso as an antidote for the financial catastrophe which his country
experienced and Russia is talking about a fully convertible currency
with gold backing.”
Rising energy prices have a double impact. They help
boost commodity price indices, which can help drag gold and silver
along. As mentioned earlier, they also increase costs to Americans,
and put pressure on the Fed to monetize debt to handle Federal tax
revenue shortfalls as taxpayers get squeezed. There is a chance that
oil prices could climb as high as $50 a barrel within a year or two.
Chinese and Indian demand remains in a steady up trend. Meanwhile
on the supply side, Saudi Arabia, which has been the world’s largest
producer, is beginning to show signs of maturing production,
to include increased water shows in its wells. OPEC members inflated
their reserve numbers in the 1980’s in an effort to increase their
export quotas and may be at peak capacity and facing decline curves
sooner than expected. America passed the point where it can find new
reserves to replace current production in the 1970’s. The U.S. now
imports around two thirds
of its oil. Technical data collected by industry veteran Jean Laherrčre
suggests that proven and probable world oil reserves are on a decline curve.
DETERMINING THE INCREASE FACTOR FOR THIS SECTION:
Investment guru Doug Casey thinks that the trend of
steady growth in Chinese demand could see some near term retrenchment.
China claims it has a Non Performing Loan (NPL) problem in its banking
sector. In contrast, goldinsider.com editor John
Over the long run both remain very bullish on China. A factor of 15%,
reflecting a little under 3% growth a year, seems conservative, all
considering. This may be especially true if we factor in possible
rising demand from momentum investors if gold maintains its upward
IMPACT OF INCREASING CRISIS INSTABILITY
Estimated increase factor: 2% a year
or 10% cumulative total in five years
This is the most difficult factor to assess, since it
is based on a subjective assessment of the likelihood that any of
a growing variety of “accidents-waiting-to-happen” will in fact take
SOME POTENTIAL POWDER KEGS
Both gold bullion and gold
stocks comprise relatively thinly traded markets that could skyrocket
with sudden massive investment demand.
..The total world gold supply is 4.75 billion ounces. At $400
an ounce, is worth $1.9 trillion. This is only 20% of America’s GDP,
and worth only 10.5% of the estimated $18 billion dollars in existence
at home and abroad. The total market capitalization of all the gold
mining companies in the world combined is somewhere close to $100 billion.
This is less than half of the current market cap of Microsoft.
The derivatives market has
swollen to an estimated $207 trillion and is vulnerable to system
failure. Nothing has changed since the Long Term
Capital Management melt-down in 1998, except that the total quantity
of unregulated derivatives has multiplied. Warren Buffett has called
derivatives “Weapons of Mass Financial Destruction.” The ability of
major investment firms to clear their derivatives positions could
be imperiled by a crisis that changes the liquidity characteristics
of financial markets. In addition, major financial institutions are
more leveraged today than ever before. If a major institution such
as JP Morgan Chase goes under, the Fed may have to hyper inflate to
provide a back up.
America has increased its
open-ended military commitment that could lead to new quantum increases
in expenditures. The U.S. Government has already
experienced a quantum increase in expenditures since 9/11 that rule
out a balanced budget and show no light at
the end of the tunnel. Anti-American
forces in the Middle East may become more
effective in inflicting escalating costs. Any of a number of incidents,
such as the possibility that Pakistan (which has nukes) or Saudi Arabia
(which has the largest oil reserves) could fall into unacceptably
hostile hands might cause further military interventions. Throughout
history, war has often lead to unintended consequences and unexpectedly
long campaigns that have in turn led to ruinous hyperinflation.
Foreign creditors can force
a major crisis simply by pulling the plug. As
discussed previously, the US trade deficit at 5% of GDP has reached
the point that normally triggers a currency crisis. Foreigners can
increasingly deliver shocks to America through passive resistance
rather than active measures, to include repudiating the dollar as
a reserve asset. Unfortunately current trends may create vicious circles
in this area. In his Dec 8, 2003 editorial “Paper
Chase,” James Sinclair noted that the Patriot II Act, which does
not require due process for the US to seize foreign assets, is already
inducing foreigners to start pulling their money out of the US. As
America loses more jobs overseas, this increases pressure on politicians
to promote forms of protectionism that could risk provoking devastating
forms of trade or investment retaliation. A financial crisis could
easily force the Fed to hyper inflate.
Failure to turn around deteriorating
macroeconomic trends. Time has become America’s
enemy rather than its friend so long as America continues to show
that it is incapable of turning around serious deteriorative trends.
Its real un funded liabilities (to include Social Security and Medicare)
are over five times GDP, well over the 120% of GDP threshold often
seen as a liquidity trap tripwire. Rising interest rates could trigger
a compounding effect that could make total bankruptcy inevitable.
DETERMINING THE INCREASE FACTOR FOR THIS SECTION:
The 2% a year or 10% cumulative five year value I assigned
is meant to be a minimal “marker” value to give this factor some visibility.
Over the next five years the impact of this factor could range from
zero to a figure well over 200%. No one knows. However, even if none
of the aforementioned accidents waiting to happen take place, growing
levels of vulnerability and instability could nevertheless increase
investor anxiety, which in turn could increase the value of gold as
an alternative investment vehicle.
|Self-sufficient attitudes in 1836.
Volunteers from Tennessee, South Carolina, Mississippi and elsewhere
in America help Texans achieve greater local autonomy without
Federal government or central bank intervention.
LOOKING OUT BEYOND FIVE YEARS
WILL CERTAIN "ANACHRONISMS" RETURN TO
The biggest boost to gold prices might come
about if gold were remonetized, that is, all or part of America were
to return to a gold standard reminiscent of the 1800’s. We have already
seen some small but important steps in this direction with such examples
as the development of online GoldMoney, or the recent
introduction by New Hampshire State representative Henry McElroy of
the Sound Money Bill (HB
1342) that would allow people to transact with the state government
using US-minted gold and silver coin.
As I explain later in this series, the decline of gold
and silver as money has had an interesting inverse correlation with
the steady growth of Federal monopoly power since 1861. Perhaps we
can call this period a 150+ year bull market in “government” (Federal
and state). This federal and state government bull market has expanded
its share of GDP from less than 5% in 1861 to over 42% today. In my
opinion, much of this has to unravel on many different levels, to
include various social, political, and ideological levels, in order
to see a full remonetization of gold and silver.
If in fact government hits a financial wall and a huge
unraveling process does in fact take place, Americans may be forced
on a local level to return to many of the self-sufficient, pro-hard
money, and anti-centrist attitudes and values held by the pioneers
who once created the Lone Star Republic in Texas, the Grizzly Bear
Republic in California, and the provisional government of the Oregon
Territory. Come to think of it, this may not be such a bad thing.
Under the gold standard, the dollar appreciated 50% by 1900 compared
to 1800, despite the inflationary Civil War, and America enjoyed noteworthy
periods of economic growth, innovation, rising living standards, and
declining interest rates.
It is interesting to try to compare data from the
gold standard era to today. According to Franklin Sanders,
in 1861 an ammunition plant supervisor in Memphis, TN made 11.3198
ounces of gold a year. At $400/oz gold, that is $4,527 a year today.
In 1997, the average small arms ammunition plant production worker
made $31,914 a year.
Even if we assume living standards have gone up let’s say about
two and a half times, that still leaves gold room to triple from
here, particularly if gold is remonetized.
It is also interesting to note how debauched the dollar
has become since the creation of the Federal Reserve in 1913. According
to Dr. Murray Rothbard’s book America’s Great Depression,
(page 91), the total money supply in America on June 30, 1921 was
$45.3 billion. This was roughly twice what it had been in 1913 as
a result of World War I inflation. The expansion from a monetary base
somewhere around $20-$30 billion dollars in 1913 to around $16 trillion
global M3 dollars today might represent a staggering increase of perhaps
as much as 400 times. In contrast, gold at $400 is up only 19.4 times
from its $20.67 peg under the old gold standard. (I provide these
numbers for rough comparison purposes, since “total money supply”
for mostly domestic use in 1921 may have had a very different meaning
than globalized “M3” today).
Imagine if we were to try to go back to a 40% reserve
policy similar to the 1800’s, and if we were to use a gold price of
$400 to try to figure out how many ounces we need as reserves in America’s
.......40% * $18 trillion
.......------------------- ......= ....18 billion
oz gold needed as reserves.
We have a problem here. There are only 4.75 billion
ounces in existence above ground on the planet. Obviously we would
have to drop our reserve ratio and/or increase the price of gold dramatically.
Let’s say we could get our hands on every ounce of gold
on the planet. We would then need to raise the gold price 3.78 times
to $1,516 an ounce to back up 40% of existing dollars.
Let’s say the US Government decides to back up just
20% of its dollars with gold. Then, lets say that it gets its hands
on 10% of the world’s total 4.75 billion ounces of gold as a back
up, even though America currently has an approximate 25% share of
global GDP. Here is what the calculation would look like:
.......20% * $18 trillion
.......... .. ......... .= . ...$7,579 an oz.
.......4.75 billion oz global gold * 10% for
This calculation is meant simply to aid the reader’s
intuition about how almost any feasible assumptions that we apply
to a model regarding remonetization of gold is likely to see a whopping
increase in the gold price.
There are obviously other complicating factors that
could apply in the real world. As one example, if other countries
around the world adopt a 100% gold standard, the world market price
for gold could skyrocket above our theoretical reserve price and help
dictate to America a price reflecting a 100% reserve ratio. On the
other hand, all things being equal, we might be able to afford a lower
reserve ratio for gold if we introduce other forms of commodity money
such as silver that could compete with gold-related money.
In the early 1800’s Americans used silver certificates
and silver coin as much, if not more, than gold. In his series “What Has Government Done to
our Money?” Dr. Murray Rothbard suggested pegging the dollar to
gold, while simultaneously allowing silver and other forms of commodity
money to “float” with the free market rather than get pegged in a
specific exchange ratio to gold and the dollar.
How much reserve back up would we need?
There is no one right answer. As a historical reference
point, while America was on a “gold-plated” standard in the 1800’s,
banks were required to back up 40% of their
currency with gold. The same was true of most countries around the
world during that era. Switzerland used a 40% reserve ratio until
it dropped its gold standard in the late 1990’s. As I describe in
a later part of this series on the history of gold in America, within
a decade after the Federal Reserve Banking system was created in America
in 1913, the gold reserve ratios in banks across the country plummeted
down to the single digit level. Faith in back-up by the “Fed” replaced
faith in a gold “back up.”
The equation above shows that the lower the reserve
ratio we try to use, the lower the price of gold that we can set.
However, the lower we try to set a reserve ratio, the more we increase
the risk that any particular run on the financial system could quickly
deplete all the gold reserves. So this is really a situation involving
trade-offs between intangibles. On the one hand we balance “confidence”
in the overall integrity of the banking, financial and economic system
against the depth of our gold reserves to endure a run on our currency
should people begin to lose confidence.
There is a paradox here similar to spending on national
defense. Theoretically, the more a country invests in gold reserves
and spends on national defense, the less likely it will be that it
will ever need either for defensive purposes.
What percentage of the world
gold supply would the U.S. need?
Let us first look at the current official U.S. gold
reserve situation. According to the World Gold Council, the U.S. as
of Dec 2003 had 8,135
tonnes of official reserves. This comprised 58.22% of official
world gold reserves and 5.5% of the 147,800
tonnes of above ground global gold existing (Goldfields,
end of 2002). If we use 5% of world gold as a reserve for 20% of 18
trillion in global dollars, that means that we would need to set the
gold price at $15,157 an ounce.
There are a number of factors that make a calculation
of an appropriate percentage of total gold that would be necessary
to back up the dollar really tricky. Intuitively it would seem that
if the US has 25% of global GNP, it should obtain about 25% of the
world’s gold. However, 25% of world gold seems totally beyond the
pale given circumstantial
evidence described by James Turk that the US may not even have
even a small fraction of the 5.5% of the world gold supply that it
claims it has. Given the thinness of gold markets, if in fact the
U.S. is out of gold, making purchases just to get back to 5% could
be a nightmare.
The ultimate focus should be on restoring the
free market and taking money out of the hands of government, not the
particular dollar peg price for gold.
In Part VI titled “The Propaganda War Against Gold”
I describe Dr. Murray Rothbard’s argument
that it does not matter what particular price is used as a peg for
gold under a gold standard as long as it reflects an equilibrium free
market price for gold and a reasonable relationship between the supply
of gold held in reserve and the supply of dollars. Once the dollar
gets fixed against gold, it becomes “as good as gold,” and the system
can function just as effectively if a dollar reflects .00025 ounces
as if it were to reflect a different ratio that has more decimal places.
The main concern is that the system is created with sound free market
pricing relationships to begin with.
The biggest issue involves creating and maintaining
a stable monetary system out of the hands of politicians. It also
involves creating fairly constant monetary reference points that become
the basis of a “galaxy of prices” that aid entrepreneurial calculation
and help avoid economic imbalances. More on all this later in this
IS REMONETIZATION OF GOLD EVEN
POSSIBLE IN OUR LIFE TIME?
I agree with Texas Congressman Ron Paul
that there is a strong likelihood that the United States Government
will eventually hit a financial wall. Although this probably will
not happen tomorrow morning, it is possible that it could happen as
soon as within the next five to ten years. There are increasing numbers
of wild cards in the hands of foreigners that make the near term odds
I originally thought it would most likely happen at
the end of the next likely credit bust cycle, say around the years
2030-2040, by extrapolating from the Dow/Gold ratio chart near the
beginning of this article. Given current demographic trends, the 2030-2040
era might mark a tipping point where most Baby Boomers have died off
and America becomes an extremely unstable hodgepodge of disparate,
inassimilable, and majority “Third World” peoples, as envisioned in
Peter Brimelow’s classic work Alien
Nation. However, the ability of Bush, Greenspan,
Neo-Cons, & Associates to fast-forward the imperial overstretch,
profligate spending, and alienation process has impressed me enough
to revise forward my estimates.
To gain some insights into a “terminal drop” process
that took a seemingly monolithic system by surprise, in the year 2003
Lew Rockwell, Director of the
Mises Institute, invited former
Soviet leader Mikhail Gorbachev as a speaker. (cf. Rockwell’s talk
“How States Fall and Liberty
Triumphs”). Rockwell claims that Gorbachev really tried to save
the old Soviet system. He tried to give the appearance of leading
reform rather than reacting to it. As Rockwell puts it, before violent
oppression by Gorbachev became a viable option to maintain the old
system, he was “run over by history and out of a job.”
In Part XI of this series I will try to examine various scenarios
in which remonetization of gold and silver could take place alongside
various possible restructurings of the social and political order
in America in the event that such 20th century institutions as America’s
central bank and its ever-expanding fiat money and credit creation
system get run over by history.
The remainder of this series is still
Please stay tuned...
Bill Fox is VP/Investment Strategist and private
client money manager, America First Trust. Bill welcomes phone calls
and responses to this article. His web site: www.amfir.com. Address:
VP, America First Trust, Reg. Rep., Sammons Securities Co., LLC P.O.
Box 820669, Vancouver, WA 98682, telephone: 360-882-5369, toll free:
866-945-5369 (866-WILL FOX), email: firstname.lastname@example.org. Securities
offered through Sammons Securities Co LLC, member NASD and SIPC. ©
2004 Bill Fox. Additional Disclaimer: Not all views referenced in
this report are necessarily those of the author, America First Trust
Financial Services, or Sammons Securities Co., LLC. Sometimes the
author provides opposing viewpoints to give the reader a greater sense
of perspective. This report is intended for informational purposes
only and should not be considered specific investment advice. It is
not intended to be a recommendation to buy or sell securities in the
absence of specific knowledge regarding the financial situation and
suitability requirements of a reader. The information has been obtained
from sources believed to be reliable but whose accuracy cannot be
guaranteed. Past performance is no guarantee of future results. There
can be no guarantee that the market will perform according to the
author's opinion or that his investment ideas will be effective under
all market conditions. His opinion can change without notice. Investment
returns will fluctuate and the value of an investor's positions may
be worth more or less than the original cost when redeemed. Market
data presented here is subject to change daily. Sammons Securities
Co., LLC is a member of the National Association of Securities Dealers
(NASD) and the Securities Investor Protection Corporation (SIPC).
DISCLAIMER: Not all views referenced in this report
are necessarily those of the author, America First Trust Financial
Services, or Sammons Securities Co., LLC. Sometimes the author
provides opposing viewpoints to give the reader a greater sense of
perspective. This report is intended for informational purposes only
and should not be considered specific investment advice. It is not
intended to be a recommendation to buy or sell securities in the absence
of specific knowledge regarding the financial situation and suitability
requirements of a reader. The information has been obtained from sources
believed to be reliable but whose accuracy can not be guaranteed.
Past performance is no guarantee of future results. There can be no
guarantee that the market will perform according to the author's opinion
or that his investment ideas will be effective under all market conditions.
His opinion can change without notice. Investment returns will fluctuate
and the value of an investor's shares may be worth more or less than
the original cost when redeemed. Market data presented here is subject
to change daily. Sammons Securities Co., LLC is a member of the National
Association of Securities Dealers (NASD) and the Securities Investor
Protection Corporation (SIPC).
2004 Bill Fox All rights reserved.