Money Talks but Gold Shouts

In the second quarter of 2008, when it became clear that bankrupted financial institutions would be bailed out by the federal government, gold did a funny thing.

In the wake of a financial crisis of that magnitude, one normally would have expected asset prices, including gold, to plummet. Most observers expected the metal to dip from the $800 level down to $600, or below. Instead, gold held up well during the teeth of the crisis, and has recently increased to just over $1,000.

The biggest change in the gold market has been the unwillingness of certain governments to sell their gold. Some powerful states, such as China, are beginning to hoard gold and to become net sellers of U.S. Treasury securities.

In addition, private investors are buying so many gold coins that fabrication plants are months behind on physical deliveries. In short, individuals, institutions and governments are losing faith in paper currencies, particularly the U.S. dollar. Despite the opportunity cost associated with trading interest-bearing government securities for pay-to-store bullion, they are buying gold.

Throughout much of recorded history, gold has proved to be the ultimate form of money. Due to its inherent scarcity, it has been the bane of governments who wished to spend more that they had or could borrow. Certain governments even diluted the gold content of their coins in order to dupe buyers.

The United States entered into federation with a sole reliance on gold as its legal tender. It was not until the Civil War that the U.S. government issues its first paper currency. However, this was not fiat money. All currency issued was backed by gold, and later by silver.

But over the years, the backing was withdrawn as government looked to expand the money supply. By 1933, every $20 note was backed by only one ounce of gold at the Federal Reserve. That year, the Fed refused President Roosevelt's request to further dilute the gold backing of dollars.

In response, Roosevelt confiscated gold from all Americans. The Fed acquiesced and printed more paper dollars.

Not content, Roosevelt devalued the U.S. dollar by 75 percent against gold the next year, unleashing a great inflation. Every American who had surrendered gold in 1933 lost 75 percent. Those who owned no gold proclaimed Roosevelt a hero.

In 1971, President Nixon broke the U.S. dollar's last link to gold, prompting the second great inflationary wave. Inflation became so bad that gold rose from $35 to $850 an ounce by 1981.

In more recent history, President Bush II and former Fed Chairman Alan Greenspan elevated the process monetary debasement into an art form, creating the largest asset boom in history and sowing the seeds of collapse in the financial system. They left the U.S. dollar so debased that the 1980 gold price of $850 is equivalent to $2,200 in today's shattered currency!

It follows that, at $1,000 an ounce, gold stands at less than half its historic peak. In a recession, when cash is scarce and price levels are falling, it is amazing that gold stands as high as it does. One can only guess where the price will go when the trillions of dollars of electronic government bailout dollars start vigorously circulating.

If we were to return to a gold standard today, each ounce of gold held at the Fed would have to back a breathtaking $39,000 dollar bills. It is a far (1,950 times) cry from the $20 for each ounce of gold of just seventy-six years ago! Is it any wonder that the euro, the currency of the nascent European Union, stands just a shade below its all time high of $1.45?

These signs of chronic monetary decay have not been lost on individual investors or governments holding U.S. dollar surpluses. The key player in this respect is China, the largest holder of U.S. Treasuries – and now the world's largest gold producer.

Recently, my friend Ambrose Evans-Pritchard reported in the London Telegraph on his interview with Mr. Cheng Siwei, Vice Chairman of China's Communist Party's Standing Committee. According to Evans-Pritchard, Mr. Siwei said, "Gold is definitely an alternative, but when we buy, the price goes up. We have to do it carefully so as not [to] stimulate the market."

This single statement should send shivers down the necks of all who believe in the paper currencies of debtor countries. Similarly, it should warm the heart of all those who already own gold. China has indeed resisted upsetting the international gold market with massive purchases. Quietly, she has merely 'diverted' part of her own production into her treasury vaults!

Also, China has sought to protect its citizens from the debasement of paper currencies by lifting restrictions on its citizens' ownership of precious metals. They can be expected to be large buyers of gold and silver ('poor man's gold,' at only $15 an ounce).

In order to protect themselves from the ravages of governments who believe in massive deficit-financed entitlements, Western citizens should think carefully about whether to trust paper currency over real money. Its an easy decision to reach.

Comments

[Mad Hedge F...:]

uutn Those transfixed by gold blasting through the $1,000 level have been missing the real action in silver. The white metal has soared 57% to $17 since the beginning of the year, compared to only a 22% move for the barbaric relic, an outperformance of almost three to one. I have been a raging bull on silver all year, and on May 7, grabbed you by the lapels and shook you senseless if you didn’t buy at $12.70 (click here for earlier report ). It is nothing less than owning gold with a turbocharger. Silver gives you a nice double play. Its qualities as a precious metal are giving it a major boost from the flight from the dollar, one of this year’s certainties. It is also an industrial commodity, which unlike gold, is consumed, and therefore gives you a call on the recovering economy. If you don’t think this move is real, check out the shares of the silver producers. Coeur D Alene Mines (CDE) has rocketed by 57% this month and is up 144% YTD, while Silver Wheaton (SLW), and Hecla Mining (HL) have also done well. If you want to get set up on buying silver futures, e-mail me at madhedgefundtrader@yah... and I’ll tell you how to do it. To accumulate .999 fine silver dollars for only a buck over spot, or bullion at the lowest spreads in the market, visit mileniummetals.net by clicking here. How long will it take to get to the old high of $50? The Hunt brothers must be grinding their teeth.

Sep 13 07:01 AM

[Pauly B:]

I agree with you Mad Hedge Fund trader, Silver should have been brought into this discussion too. I own gold and silver but like silver better.

Gold is tricky business and you have to be a sophisticated trader to understand it, especially the fundamentals and cycles in gold.

After reading this I am going to dig a deeper hole for my physical gold I own.

Sep 13 09:50 AM

[Ad Orientem:]

Mr. Browne,
I was pleased that you made a point often ignored by gold's detractors. People keep referring to the price of gold as being at new highs. This is of course not true for the very reason your point to (and which I have made in various forums in the past). The price of gold must be calculated against the real value of paper money. Adjusted for inflation, the price of gold would have to more than double to reach its high from the early 1980's.

This is in many respects very good news for gold investors. If gold were anywhere near its true highs I would be inclined to say it was overbought for this stage of the looming currency crisis. However given where it is and the fact that no one in Washington (or most of the other central banks) seem to have any interest in halting or even slowing the debasement of their currencies, I believe gold is a buy right now. I also concur with the view espoused by your firm and its president Mr. Schiff, that dollar denominated assets are likely to be very poor performers in the coming years. The bond market in particular I believe is very vulnerable.

Sep 13 04:26 PM

[BullnBear:]

The diversion of Chinese gold production into treasury holdings is interesting and quite informative if this can be proven to be true, this is one of those cases where I would need to see actual numbers to believe it but on the surface I wouldn’t doubt that this is possible.

I would also tend to believe that if this is actually taking place then China may be wise to do this if for nothing more than a hedge against U.S. treasury holdings but they may also have a more sinister agenda. I know that may be impossible of course keeping in mind that they are such great friends with the U.S. now and they wouldn’t do anything to hurt us would they?

I don’t know if you could call me a Gold bug but for years I’ve believed that paper based currency really doesn’t have a purpose. The most interesting thing is that the majority of people in the U.S. aren’t even aware of what Nixon did with our currency or why and the sad thing is that most couldn’t care less.

Nothing is really ever taught about monetary policy or history of such policy on a large scale so one needs to be inclined to learn about these things and again I don’t believe that it’s an accident that this isn’t part of a base education.

Nice information capture around what is possibly taking place in China, great article.

Sep 13 04:28 PM