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Douglas D Anderson is a native of Athens, Ga., graduating from his hometown school, the University of Georgia, in 1965 with a BA in economics. He received his MBA in finance and international business from Georgia State University in 1973. After two years as a U.S. Army officer in Germany, he... More
  • Bloomberg And Chairman Bernanke Affirm My Decision To Own Gold…And Deeper Implications For A Troubled World  0 comments
    Nov 11, 2013 4:04 PM

    (Sub-Title: Emperor Bernanke Is Wearing Fewer And Fewer Clothes)

    On October 7, 2013, Bloomberg Business News published Gold Befuddles Bernanke as Central Banks Losses at $545 Billion. Here's the opening, "Ben Bernanke, the world's most-powerful central banker, says he does not understand gold prices. If his peers had paid attention, they might have stopped expanding reserves that lost $545 billion in value since bullion peaked in 2011." So the Bloomberg writers then admonish the world's emerging market central banks for being heavy buyers of gold as the price of the shiny metal has declined from its nominal high reached in September, 2011.

    The writers then go on to establish the credentials of Chairman Bernanke and cite his statement regarding gold made before Congress in July, 2013, "Bernanke, who holds economics degrees from Harvard College and the Massachusetts Institute of Technology and led the Federal Reserve through the biggest financial disaster since the Great Depression, told the Senate Banking Committee in July that 'nobody really understands gold prices and I don't pretend to really understand them either.'"

    Did the Bloomberg "journalists" ever consider that perhaps (1) the other central banks might have good reason to accumulate gold, as many of them have accelerated their purchases since 2011 as prices have declined as much as 33%, and (2) Chairman Bernanke might be taking liberties with truthfulness in stating that "he does not understand gold prices?"

    The bottom-line is that the world's central banks, since 2009, have added thousands of metric tons of gold to their reserves. Consider the magnitude of this shift on the part of the emerging market central banks. They have seen fit to increase their holdings of gold substantially, reversing a trend over the preceding decade, which means that the percentage of their reserves held in U.S. dollars, still the predominant international currency, has fallen. Is there a message there? Are they preparing for a change, given the U.S. government's dramatic increase in sovereign debt since the 2008 financial crisis, and given that the custodian of the dollar's value, the Federal Reserve, continues potentially to debase the dollar's value further via its massive Quantitative Easing (QE) experimental monetary policy gamble?

    What befuddles me most about this attempt at journalism by the Bloomberg writers is that they go on, later in the article, to provide facts that totally destroy their own conclusions and greatly undermine the credibility of Mr. Bernanke. Here's the short paragraph that says it all in a nutshell:

    "While gold is trading below the 1980 high on an inflation-adjusted basis, it has been better than the dollar in preserving its purchasing power. A dollar bought about three quarters of a gallon of milk in 1970, a year before the peg to gold ended, and an ounce of gold 28 gallons. By the end of 2011, a dollar got you about a quarter of a gallon and an ounce of bullion 420 gallons" (bold print for emphasis).

    How can one miss the irony of this statement? I am surprised the authors did not also point out that the dollar has lost more than 97% of its purchasing power since the Federal Reserve was established in 1913! For clarity and to simplify further, the following re-statement and expansion of the paragraph above illustrate the error of the writers' negative conclusions on central banks' buying gold and the absurdity of Chairman Bernanke's assertion that he does not understand gold prices:

    1. In 1970, one dollar would buy about ¾ of a gallon of milk; therefore, a gallon of milk must have cost about $1.33. An ounce of gold at the pegged value of $35, on the other hand, would have bought 28 gallons of milk (actually 26.3).

    2. By the end of 2011, forty-one years later, one dollar would buy one-fourth of a gallon of milk (down from three-fourths), meaning that milk was priced at that time at about $4 per gallon. Yet the same ounce of gold that would buy 28 gallons of milk in 1970 would, by 2011, buy 460 gallons!

    I ask you, Reader, if you could go back to 1970, would you rather have had 35 one-dollar bills to hold onto through 2011 (and through the present), or would you rather have used the $35 to acquire one ounce of gold and hold onto it for the next 41 years? The 35 dollar bills would lose 67% of their purchasing power over that time, while the ounce of gold would increase its purchasing power by 1,643%!

    It might surprise you to know that the annual rate of inflation that took the price of a gallon from $1.33 in 1970, to $4.00 in 2011, decreasing the purchasing power of the dollar by 67%, was 2.656%. This figure is only about 16 basis points above the "up to" rate of inflation the Fed says is not a concern regarding continuing its ongoing massive QE liquidity program!

    Another curious thing about the Bloomberg article is that there is no mention of China. While central banks of several other countries (Russia, Kazakhstan, South Korea, and Turkey) were cited as being part of the scramble to acquire gold, China was not listed among them. China has been nearly maniacal in its obsession to acquire gold over the past several years. On the official scorecard, last published in 2009, the U.S. still leads the world in gold ownership with just over 8,000 metric tons. Parenthetically, while that figure is "official," it is unaudited, and many pundits have expressed considerable doubt on whether the official number is real, as rumors abound of gold leasing, hypothecation, re-hypothecation, and outright sales on the part of the U.S.

    China, on the other hand, was well down the list (6th) according to the 2009 official statistics, with slightly more than 1,000 tons. But China's central bank, the Peoples Bank of China (PBOC), has been on a gold-accumulating tear since 2009. It has done so via both huge purchases of gold internationally and via China's own world-leading gold mining expansion, which is adding greatly to their gold reserves since the country prohibits exporting the metal.

    Various reports indicate that China's gold reserves are at least 2.5 times the latest official number, or up to about 2,500 metric tons (see this article). Some estimates are as high as 4,000 to 5,000 tons, which would rank China 2nd in the world, behind the U.S. There is little doubt that China is preparing for a change and that it expects gold to be an important part of the world's international currency regime at some point in the future, or, at least, that China is hedging its bets on its huge holdings of U.S. debt in the face of our country's monetary policies that threaten to debase the value of those holdings.

    U.S. Dollar's Reserve Currency Status

    While the size of the U.S. economy and strength of its military are key advantages versus other nations, a third advantage is also ultra-important - the dollar's role as the predominant currency for international trade and all other transactions requiring foreign exchange, more commonly known as the "reserve currency." Without this advantage the U.S. would likely not be able to have a debt-to-GDP ratio above 100%, nor would it be able to "print" seemingly infinite numbers of dollars via the Fed's quantitative easing (QE) program. No other country has the ability to expand its currency thusly, as they would automatically devalue their currencies against the Dollar, since they would have to convert to dollars in order to complete foreign exchange transactions.

    After World War II, representatives of the major victorious nations met in Bretton Woods, New Hampshire to decide upon a new international currency. British economist John Maynard Keynes urged the adoption of a neutral reserve currency, arguing that a sovereign currency would not be workable in the increasingly complex global economy (this after the British pound has served as the reserve currency for the previous 150 years). But after several weeks of debate, the U.S. view prevailed - that the dollar should replace the pound. In the 1960s economist Robert Triffin presented a theory (labeled the "Triffin Dilemma") that any sovereign currency would eventually fail as a reserve currency because domestic objectives and foreign exchange objectives for monetary policy often would be in direct conflict. He thereby affirmed what Keynes had argued 20 years earlier.

    While the U.S. dollar still is the predominant reserve currency, its supremacy has slipped in the past decade. The U.S. dollar percentage of total "allocated" international reserves in 2001 was 71.5% (at or near its peak). By 2012 that figure had dropped 10 percentage points to 61.4%. The Euro was the largest gainer eating into the dollar's lead in allocated reserves, defined as those where the currency composition is known.

    For unallocated reserves, the currency composition is not known. China is among those countries that choose not to reveal the composition of its reserves. But since unallocated reserves accounted for 45% of total international reserves by 2012 (up from 22% in 2001), and since China owns most of the unallocated reserves, we can see how dramatically their reserve balances have risen, regardless of their composition. (Source: IMF COFER report).

    Can China's Yuan Overtake the U.S. Dollar?

    Not likely soon, at least not as a bona fide reserve currency, as will be explained below. But the Chinese will have a major say in the outcome of the currency battles that are beginning to intensify.

    China has made great strides in making its Yuan for usable for international trade during the preceding decade, especially over the past 3 years, as the dollar value of international trade in Yuan has gone from $34 billion per day in 2010 to more than $120 billion in 2013. The country has achieved this growth by aggressively forging currency swap agreements for trade with a growing number of countries. Here are some highlights:

    (1) Over the past two years direct trade/currency swap agreements have been forged with more than 20 sovereign states, including England, Russia, Brazil, India, Iran, Turkey, Australia, New Zealand, Argentina, and South Africa, among others. (2) Since 2010 the Yuan has gone from the seventeenth most traded currency to ninth…and is likely to continue moving up that list rapidly. (3) A major coup was pulled off recently when China reached a deal with the European Community Bank (ECB) for direct currency swap trade with entities in Eurozone countries (see Daily Pfennig: China Takes Another Step for details). In June, 2013 the Bank of England became the first European central bank to sign a similar trade deal with China. (4) China and Russia recently signed a pact for dramatically increased shipments of Russian oil to China, going from 300,000 barrels daily in 2013, to one million barrels per day by 2022 (see WSJ: The Russia-China Oil-Export Equation).

    While all of this represents great progress in use of the Yuan for international trade, and while this trend is likely to continue and increasingly erode the Dollar's reserve currency dominance, China is not likely, anytime soon, to take the additional steps required for the Yuan to become a bona fide, broadly based reserve currency. To do so would require them to institute complete currency convertibility and open the Chinese "capital account" for its citizens, allowing them the freedom to use the Yuan to make investments and conduct other financial transactions abroad.

    China has announced the establishment of "Free Trade Zones," (FTZ) in Singapore, and more recently in Shanghai, which supposedly "open things up" for complete currency convertibility. But there is a great deal of equivocation on the magnitude of the change, witness the following quote in a recent article in the digital news outlet "Quartz:"

    "...the Chinese government rigidly controls where and how Yuan are exchanged, and by whom. The result is that outside of China, Yuan are not accepted much of anywhere. True "internationalization" can't happen until that ends," says Patrick Chovanec, chief strategist at Silvercrest Capital Management and an expert on the Chinese economy.

    "The real issue with (making the Yuan international) is opening up the capital account-everything else is just window dressing," Chovanec tells Quartz. "You can do things to set the stage, but you really can't see [the Yuan] actually playing an international role until it's internationally useful."

    For greater detail see this article: (Trading In China s Currency Has Tripled In Three Years Is The Yuan Standard Finally Upon Us?):

    A New Reserve Currency?

    So what will be the eventual outcome of the reserve currency issue? I'm not sure anyone knows, but please remember Keynes' warning at Bretton Woods after World War II, with the affirming Triffin's Dilemma theory two decades afterwards -- the long term non-workability of any sovereign monetary unit (e.g., the U.S. dollar) as the international reserve currency.

    If you want real-world confirmation of Keynes' warning and Triffin's affirmation, look no further than IMF Head Christine Lagarde's admonition of Chairman Bernanke in late August, 2013, "not to 'taper' QE," warning that serious problems would result for the remainder of the world's economies, especially those in emerging markets. Mr. Bernanke's response was that the Fed would make that decision based upon what was best for the U.S. economy (see Bloomberg article). We likely will never know whether or not Ms. Lagarde's plea influenced the Chairman's decision not to taper.

    I would conclude, therefore, that a change is coming and that the dollar's supremacy will end. The question is when. Regardless of the outcome of the reserve currency change almost certain to come at some point in the future, China likely will have a prominent seat at the table. Moreover, based on their aggressive moves to accumulate gold, as well as the same pursuits by the central banks of other emerging market countries, I believe that gold will have some part in the new reserve currency regime that emerges.

    China now has the world's second largest economy. Based upon current growth trends (high for China and low-to-non-existent for others in the top 5), China likely will overtake the U.S. as the world's economic super-power within the next few years. It is no secret that China is increasingly unhappy with the U.S.'s stewardship of the dollar as the world's reserve currency. This has been obvious for some time, but China is getting more aggressive in expressing its discontent - see this recent LA Times article citing China's strongest yet "shot across the bow" regarding the need for a "de-Americanized world."

    And let's not forget that China holds more than $1.2 Trillion of U.S. Treasury securities, giving them even more leverage.

    Concluding Comments

    I concur wholeheartedly with former Congressman Dr. Ron Paul that gold is the only real money. Why? Gold, along with silver, are the only mediums of exchange that provide assurance to a payee of value retention. How could anyone doubt this contention, given the "gallons of milk" illustration at the beginning of this article, and given the fact that our fiat dollar has lost 67% of its value since 1970? I believe further that gold and silver, the physical metals, not "paper" futures contracts, will resume their roles in providing discipline for world monetary policy, which in my opinion is totally out of control in "developed" world countries (U.S., Eurozone, and Japan). The new currency regime almost certain to evolve, again in my opinion, likely will include a role for gold and silver, whether it be a full-fledged precious metal "standard" or partial backing for the new currency.

    Our country and our world are in serious trouble. Here are the major reasons I feel this so strongly, some of them based on fact, some laced with opinion:

    1. There are mounting threats to the dollar's reserve currency supremacy, as elaborated upon above. As these threats continue to erode U.S. control of the reserve currency, increasingly the U.S. will be unable to continue "papering over" its problems.

    2. The U.S. is the most profligate spender in the history of our planet, both in absolute terms and in relation to its means (i.e., revenue).

    3. The U.S.'s unprecedented "peace time" sovereign debt level at more than 100% of GDP, not counting, of course, the unfunded liabilities (notably Social Security, Medicare, and Medicaid) that would increase the debt by many times. If we applied the same accounting standards to our country that are applied to U.S. businesses, the U.S. would be bankrupt.

    4. The U.S. economy simply is not growing. We are well into the 5th year of a so-called "recovery" from the Great Recession and have not come close to attaining escape velocity. The anemic growth our government reports likely has gone negative, in reality. Final Q2 2013 GDP growth cited by the Bureau of Economic Analysis (BEA) at 2½% was really minus .5% without the conveniently-timed July, 2013, accounting change that added 3% to GDP (see this WSJ article).

    5. The U.S. unemployment rate is nearly 14% when the percentages of (1) people whose unemployment insurance has expired and have left the labor force, and (2) part-time workers desiring and needing full-time employment, many of whom were previously working full-time, are added to the headline number.

    6. The U.S. middle-class is being eviscerated by (1) lay-offs and the lack of re-placement jobs, (2) declining real income for those who are working, a huge percentage of them part-time, (3) the Fed's "zero interest rate policy" (ZIRP) that penalizes savers, and (4) required dipping into savings in order to live. And Wall Street, government leaders, and the Federal Reserve appear to be oblivious to this huge issue which soon could be disastrous for the U.S. economy. Chairman Bernanke even claims that his "Wealth Effect" strategy for QE is as much for "Main Street" as it is for "Wall Street," which is far, far from the truth (more on this below).

    7. The governmental gridlock in Washington due to our totally dysfunctional legislative and executive branches, which are unable to enact needed fiscal policies to promote growth…even within the system as it has existed for decades (rife with corruption, crony capitalism, and legislation drafted by lobbies), much less any attempt at real reform of our broken system.

    8. Europe and Japan are potential disasters waiting to manifest themselves. In Europe the ECB is insisting on austerity while its economies need growth, stock markets are levitating on little more than Mr. Draghi's words, Spain is one of their recovery "poster boy" examples of progress with unemployment recently dipping below 27%, Italy and France are not far behind, and Greece has been on life support for at least two years (see this on Europe's "recovery"). Japan is a tinderbox with its QE to the nth degree, awaiting a spark from the under-collateralized derivatives world (with the same collateral used multiple times) to ignite a world-wide credit collapse that could dwarf the '08 crisis.

    Finally, in my own case, I am neither trader nor investor in owning gold. I own gold as an insurance policy for what I believe will be, via one set of events or another, a major devaluation of the dollar. It may happen next month, or it could be five years from now, but I firmly believe that such a devaluation is inevitable based upon the issues outlined in the preceding paragraph, among others.

    As for my claim that Chairman Bernanke is taking liberties with the truth in saying that he is befuddled by the price of gold, does it really, really matter? Can there be any doubt that most, if not all, public figures, including Dr. Bernanke, are guilty of stretching the truth a bit from time to time? And most of the time it matters very little.

    But when such falsehoods obscure deeper, more urgent truths…ones that the world's citizens need to know… then exposing the untruths takes on far greater importance. Well, the lies, or more politely the severely misleading statements, by Chairman Bernanke profiled in this article, and the one at my Seeking Alpha blog (Open Letter to Chairman Bernanke Please Tell Us the Truth), fit squarely into this latter category.

    The "Open Letter" article, linked in the preceding paragraph, gets right to the evisceration of the middle-class cited in point 6 listed above. I urge you to read that short article. Chairman Bernanke appears to want us to believe that he does not understand the difference between "average" wealth and "median" wealth when he uses average American wealth recovery to argue that his QE Wealth Effect strategy is as much for Main Street America as for Wall Street America. More to the point, he appears to think that we do not know the difference. The article presents compelling evidence that median (Main Street) American wealth is much lower than pre-Great Recession levels (down 35% by 2011) and continues to decline. At the same time, average American wealth - including (1) Wall Street executives, (2) crony capitalists, (3) major corporate executives, as well as (4) many other more legitimately ultra-wealthy Americans not directly benefiting from the government/Federal Reserve largesse that is directly helping the first three categories - has indeed recovered and is considerably higher than pre-recession levels.

    It takes a very short leap of faith, or only an obvious application of logic, to conclude the reason - Chairman Bernanke's Wealth Effect strategy, largely manifesting itself in developed world stock markets that are up more than 150% since early 2009, has benefited the upper 1% of Americans, notably the upper one tenth of one percent, on a hugely disproportionate basis. The result has been a sizable transfer of wealth from Main Street America to the ultra-wealthy; hence use of the term evisceration of the middle-class. How is this so critically important, and damaging, to prospects for economic growth, which is 70% dependent upon consumer spending? Consider this simple, symbolic statement - not nearly enough of that transferred wealth to the upper echelons of U.S. society likely will find its way into Wall*Mart, and the eviscerated middle-class will have less and less to spend there!

    Regarding the befuddlement issue, Chairman Bernanke knows that the purchasing power of the dollar has declined by 67% since 1970. Likewise he knows that the purchasing power of gold (and hence its value) has increased, measured in U.S. dollars, by more than 1,600% over than same time period. Rather than being befuddled by gold, in my opinion he is bedeviled by it. What should befuddle him is why the "market" price of gold is not much, much higher. Gold is the dollar's nemesis, as is the case for all fiat currencies. Gold is the only relevant monetary measuring stick against which fiat currencies can realistically be compared, and their comparative values consistently come up lacking. He simply cannot be truthful with the American and world public on this issue because his fiat currency would collapse.

    So I, for one, will continue to monitor Chairman Bernanke's statements, especially his answers to the few meaningful questions allowed to be asked publicly. Regarding his performance in this regard so far, I conclude that Emperor Bernanke Is Wearing Fewer and Fewer Clothes.

    Disclosure: I am long UVXY.

    Additional disclosure: I am long gold and silver.

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