Consider the fate of a nation that has become obsessed with the pursuit of a money, which in the end becomes worthless. It has happened before.
WhenI talk to people about gold, I get the usual replies: "We're not on a gold standard," "You're a sadist," "You are thinking so backwards," or my favourite, "That market is dead or broken." Most of these people have already dismissed my argument before they've even considered it. The rest, a small minority, listen to my argument, cannot refute it, yet cannot find the courage of their own convictions when there is so much overwhelming momentum against them. I cannot blame them. I too have doubted my own eyes over the past few years during intermittent moments of weakness.
Recently, however, I watched an inspiring CNBC documentary called "The Great Game, a history of Wall Street," where the author claimed that, during 1928, at the acceleration point of the great bull market, a savvy (hindsight is always right) broker named Charles Merrill thought that the stock market was ridiculously overbought, but he began to doubt his own sanity when everyone else was still intent on buying up the entire market. He finally went to see a psychiatrist, who had determined that his sanity was stable and that he in fact agreed with his perspective. The next morning, they both started selling, at least a year before the market peaked the following year. My guess is that the move, as early as it was, must have been the foundation for Merrill Lynch because it gave him two years lead time on everyone else to figure out where the next big opportunity lay.
The story inspired me because I remembered that a veteran broker once told me that the difference between the long term winners and the losers in this business is ultimately, the ability to stay an independent thinker. So, until someone can reasonably refute my arguments, I will keep the courage of my own conviction! Before I go on, allow me to answer the typical objections:
We are not on a gold standard. That's debatable, but so what. If so, we haven't been on a gold standard for twenty six years, but we have been on one for nearly the last 8,000. It would be better to ask what we have accomplished since we've gotten off of the gold standard, only a short time ago, and what were the reasons that we decided to abandon it in the first place. Then, we should compare ours to other historic economic cycles that too were not supported by the value of a monetary gold reserve.
You're a sadist. I twinge at the slightest sight of a whipped dog. I just believe that there is more delusion in the financial world than ever, and through my apprenticeship in the business, have learned how to ask the right questions. As in most manias, many people are afraid to ask these questions, but in this one it almost feels as if they know the answer and don't give a damn. This is especially plausible if these people cannot see any more big market opportunities after it all unravels. I am sure, however, that the thinking was much the same in England and France in the 18th century, or the US in 1929 and 1973, or in Japan in the recent decade past. The burden of seeing through all of the bullshit may turn out to give you a head start for the opportunities that will certainly reveal themselves, and help you avoid the problems that are inevitable. I did not cause any of what may happen, and I don't wish it, but the show must go on.
Gold and gold mining is obsolete, it's like going backwards. Environmentally yes, but we are spoiled on this side of the world, with the luxury of having the capability to give the environment any thought at all. Were today's wealth not an illusion, I might agree, unfortunately, it is. It is in the wrong hands, and as Warren Buffet recently suggested, over the past few years there has been much wealth transfer, but little real wealth created. Economic need has always superseded environmental need, just look at the rest of the world. Do you think that poverty stricken third world nations would place the environment ahead of their need to eat? The history of the progress of man is three steps forward and two steps back, especially after a few drinks, so don't get too comfortable with the trend just yet.
The gold market is broken. What does this mean? This comes from the technical analyst who keeps looking at relentlessly declining price trends and charts that continue to search for a bottom. The psychology is so bearish, yet the important fundamentals (the monetary value of gold versus the value of the currency that replaced it) have been growing stronger for nearly three years now. We are probably near a significant turnaround. The gold market isn't broken, but investors' confidence is. Our system is based on a manipulation of confidence, and nothing changes that more frequently than the direction of a stock, currency, or commodity market, which is perceived to be freely traded (note that I did not say a direct manipulation of market prices). The point is that when markets finally change their primary direction, no one ever believes the first move because it looks like all the others. We have only barely gotten to that point in the gold business, but I believe that we are already at that point in the stock business. I have seen this before at big turning points. I call it the point at which the "deer freeze in the train's headlights." Take a look at the two five year charts below. Who you think that the deer are in each market?
If you think there are no deer, and still see nothing but stock bulls and gold bears, you might as well stop reading here. However, if you think that there is reason for even the slightest doubt about these popular consensuses, read on.
In speaking about the Gold story, we need to understand that the structure of that market has beenshaken down to the bone. The only visible and meaningful buyers of real gold today, are consumers, and the only reason they buy is to decorate their wardrobes. Even though this demand alone has consistently exceeded the annual new production of gold for years, prices keep falling from the weight of central bank selling, producer hedging, and from the weight of speculators selling the borrowed metal for a stake in the New Economy. In my view, all of these sellers are short, not off. My view is based partly on my study of the history of money, and partly on philosophical fact.
The story of gold is an 8,000 year story. The story of technology is not new, it is almost as long. The story of a paper rich empire built on a pyramid of credit and greed, is only thirty years long, but has frequented many different societies through time. Through the eyes of history, these instances are seen as financial delusions, or manias, but in the heat of the moment they are always rationalized. It's easy to see why. Thirty years is a whole generation of people who have no experience with the value of gold in the first place.
Traditionally, there are two important camps of buyers, whose confidence today has been all but obliterated by the very global, but American led, monetary experiment, and the long absence of inflation, which is the natural result of an agenda has always been built upon a strong Dollar policy. The genius of putting your country in a position where the whole world desperately needs to support your currency in order to survive, almost equals the potential consequences. Ironically, history's greatest owners of gold, and undoubtedly its most missed supporters, are today, its greatest enemy. It is an enemy which has arrived at times like this, throughout history to inject a stagnant economy with a creative new monetary solution to growth. This is not the first prosperous period in history that has ever come about because of creative monetary theories. This is also not the first time in history that the consensus believes that we are too dynamic and sophisticated to make a really big mistake, or become subject to mass delusion. This is not the first time in history that we have stretched and jeopardized the monetary fabric that makes a free market system work so bloody well in the first place. In short, this is not the first time we have killed a golden goose.
The Great American Monetary Experiment was born in 1945, collapsed in 1973, and reborn in 1982
This whole process started in the United States in 1945, after the war, when the economy was faced with ballooning government war debts, which had to be paid down before real growth could resume. The Dollar based Bretton Woods solution was invented, a system where the US Dollar was fixed against the price of gold and every other currency in the world was pegged against the US Dollar. An official description of the system, by the Federal Reserve Bank of Cleveland, and its ultimate collapse is provided on the page after next.
In my view, the Bretton Woods System was invented to exploit a global esteem that the US had recently won after two world wars, and it was conveniently preferable to paying down growth inhibiting and "Dollar threatening" government debt. The USA did not hesitate in claiming its reward in the name of virtue. The war inflated the Government's obligations, and the economic stimulus from the war began to disappear. Under the agreement, however, the Dollar was fixed in terms of gold, as if to suggest that it was as good as gold, and all other currencies were fixed in terms of the Dollar. In effect, it helped fix the Dollar at an unsustainable level. Before the system collapsed in 1973, the economic elite in the United States got a taste of the real economic benefits derived from a strong currency. The period between 1945 to 1973, was the longest and prosperous secular economic expansion of the century, at the time, and came about by a misguided manipulation of the gold market vis a vis the Dollar.
However, as has always been the case in any fixed currency regime, imbalances inevitably accumulated and finally became irreversible without a violent currency adjustment. When this moment of truth finally came, in 1973, the Dollar appeared on the road to collapse (against gold), and it became a toss as to what was the biggest influence on the inflation of the seventies: Oil shocks or a breakdown in the Dollar based Bretton Woods system. Nevertheless, Paul Volcker came in with some tough medicine and did what he could to kill inflation and defend the integrity of the Dollar system. At the time, he was hated, but the victory placed the Dollar back on its pedestal as an international currency reserve, a feat which he was recently acknowledged with. At around this time, new monetary thought about the cause of crashes and collapses came to dominate policy and just so happened to help accelerate the growing dependency of the global economy on a US Dollar based global monetary system. In fact, the dependency was to get so strong that major foreign powers would continue to support the Dollar's leadership role, and even exacerbate it, in order to survive, themselves. The plan was to flood the world with Dollars, and force its status by virtue of sheer presence and vested interests. In the promotion business, they call this "getting everyone long."
By 1987, the US Balance of Payments deficit started to become a real Dollar burden again and it came to a head on the weekend before the 1987 stock market crash. This time Greenspan saved the day in what some would consider his debut to glory. With the speed of a determined Kamikaze, he pumped liquidity, and therefore confidence, back into the financial system by pushing down on the interest rate lever and consummating his fateful relationship to Wall Street, and perhaps to Mr. Rubin, who at the time was a highly respected currency trader at Goldman Sachs. This set the stage for what was to be a monetary extreme in the low "goods/commodity" inflation 1990's. The new economic thought that had fancied American leaders, came through the conclusions of Milton Friedman in the late 1960's, who concluded that it is the change in money supply that causes inflation or deflation, and expansion or contraction. Whew, just in time to rationalize the beginning of the greatest credit cycle (read ponzi-scheme) there ever was. The problem is that the real growth in money would come in the lower end of the quality barrel, and through a process of credit creation. The irony is that the structure of FED policy is not set up to control money supply, but rather interest rate targets. Money supply is dictated largely by the economy's (read stock market's) needs, where Greenspan has no control over it. And we all know that you don't need real quality money to buy stocks today. The hypocracy is that due to the fact that the definitions of money supply have become too complex to quantify, it has suddenly become less important. Inflation rate monetary targets have now become another way to justify the money spigot.
The Bretton Woods System of Money by The Federal Reserve Bank of Cleveland
Under the Bretton Woods system, the International Monetary Fund (IMF) charter stipulated that the price of the U.S. dollar was fixed in terms of gold (initially at $35 per ounce) and that all other currencies were pegged to the U.S. dollar. Unless a country developed a "fundamental disequilibrium" in its balance of payments (usually interpreted as a "large and persistent" deficit or surplus) and obtained IMF approval to change the pegged value of its currency, the nation would have to maintain the exchange rate through purchases or sales of U.S. dollars, the reserve currency. The creation of the World Bank and its affiliates to make longer-term loans is also considered part of the Bretton Woods system. Shorter-term loans were available from the IMF. The destabilizing effects of speculation and the persistent U.S. balance-of-payments deficit were seen as the immediate causes of the system's demise in 1973. Because the U.S. dollar was the key reserve currency, the United States was reluctant to devalue despite persistent deficits. At the same time, surplus countries chose to add to their dollar holdings rather than to revalue. As U.S. deficits persisted, the stock of U.S. dollars held abroad ballooned relative to the need for a reserve currency. Some countries viewed the United States as abusing its privilege to issue reserve currency and as forcing other countries to finance persistent U.S. deficits. Eventual increases in the dollar price of gold and the refusal of Germany and Japan to revalue their currencies were the final blows. However, the fundamental flaw in the system was that international liquidity considerations encouraged foreign central banks to hold U.S. dollars, but also hindered other nations from revaluing their currencies to eliminate their balance-of-payments surpluses. Ultimately, confidence in the dollar as a reserve currency had to suffer.
The transition of a monetary system back to gold has usually arrived, according to history, not when the government or bank has finished selling, but when the monetary experiment breaks down. This point of transition obviously happens when the experiment results in forces out of their control, and this has always been coincident with a meteoric, unsustainable expansion in low quality money and credit. The point at which a credit cycle becomes unsustainable is the point at which enormously irreversible imbalances in the global financial and economic infrastructure begin to weigh on growth, and cannot be justified with REAL incomes. It is at this moment, when the monetary system becomes vulnerable to collapse, yet it is at this moment when most people are most likely to be in denial. We are unquestionably at this moment, and contrary to popular consensus, the case for remonetizing gold has only grown stronger than ever.
Why did the gold market fizzle out in 1987?
In 1987, the Bretton Woods descendent was barely born and the euphoria in the stock market proved to be generally containable. At the time, only one quarter of US households had exposure to equity, though valuations were still stretched to historic proportion relative to what has been known thus far. However, the stock market was still smaller than the overall economy, and the real trade in goods and services had a much larger influence on the Dollar than it does today. Today, by far, the largest influence on the currency is speculative capital flow, not trade. The credit cycle was mature, but not yet vulnerable to collapse. If only there were a way to debase the currency without anyone noticing or caring. Alas, since the consumer was out of business, what better time to flood the system with liquidity without causing goods inflation.The nineties ushered in an era of unprecedented monetary inflation, which was able to grow without rekindling inflation because the government and consumers were still hung over with debt from the eighties, and was eventually to grow enough to debase this debt hangover. That is the new economy, if anything is. From creative monetary policy to creative government accounting policies, the private sector got its cue. People were ready to believe what they wanted to, as always. A true pessimist might view this as a financial extortion upon a world who has become increasingly dependent on the prosperity of the United States of America. Unfortunately, US prosperity has become increasingly dependent on paper creation and the stock market outcome.
Briefly, let's consider some of the results of this monetary experiment so far, with a particular emphasis on important economic imbalances that have grown since 1973, and especially since 1990. Maybe I'm just imagining all of these things:
1945 - 1971; Notice the moderate debt growth under Bretton Woods?
1971 - Present; New theory born, Yee..ha, here we go!
Look at that, it has gone on so long without consequence that
we don't even have to save money in the new economy.
If you do not yet believe that we are at or near an enormous turning point in our economic history, then it will be important for you to watch how the US economy, and especially the Dollar, absorbs the inevitable stock market decline. You will have to ask the following questions:
- Over the past five years, what single factor has been the primary influence on the Dollar?
- What is likely to happen faster, a quick fix to the nation's trade deficit or a quick adjustment to the US Dollar?
- Will the FED be able to lower interest rates to defend the stock market, at a key ignition point for inflation, and with a potential test of the Dollar's status as a reserve currency on the horizon?
- Will employees continue to accept, increasingly out-of-the-money stock options instead of cash for their remuneration?
- Can the alleged budget surplus grow without the benefit of capital gains tax revenues?
- Can the National Savings Rate rise without affecting money supply and economic growth?
- How much can corporate earnings really rise without including profits from the sale of other stock, with an extended paper rich consumer that pulls in his horns, and with the likelihood that companies will have to pay their employees with cash instead of stock options?
- How much excess and leverage is really built into the stock market's valuations?
- Has the US, and the global, economy become dependent on the stock market's continued prosperity?
- Has there really been any meaningful wealth "creation," or has it just been churned and transferred? Maybe offshore?
- Does every action cause an equal and opposite reaction, or is it different this time? Do markets only overshoot on the upside from now on?
- What happens to speculators who have borrowed gold, and sold it, for a stake in the American dream, when the dream begins to look like a nightmare?
- What happens to the weight of US obligations to foreign interests in an environment of declining Dollar values?
- What will happen to the supply channel of gold production, if gold prices spike and force solvency problems at major gold producers to shut down or sell their mines?
- In an environment of declining US asset values, an eroding Dollar value, and rising gold prices, what will foreign bankers do with their enormously unprecedented Dollar positions?
- Are we really off a gold standard, or do we just think we are? What then would be the reason for limiting European gold lending activity if not to head off a potential imbalance in the Dollar market?
- Without the ability to lower interest rates at their disposal or the ability to further debase the currency, what else can the government do to defend stock prices?
The value of the stock market has grown from representing only a quarter of the value of the US economy to a whopping $17 Trillion, or two times the size of the economy, in just 17 years. It is just not possible to print enough money, without affecting interest rates or further debasing the Dollar, to defend this monster. In 1987, the value of the market was only 85% the size of the economy, and only one out of every four households owned stock. Today, nearly three out of five own stock, which by the way, puts us way in uncharted historical territory. Not the kind of market we could call "dynamic."
Let's face it, were this process to begin to unravel, the United States government would have to sell every gold bar it owns, just to satisfy the short interest in the Gold market, but that would only transfer the short position from the private sector onto the government. Talk about taxpayers bailing out the morons again.
Whatever happens, do not get fooled by the recent rise in the value of the Dollar and its further accumulation by the ECB. When a central bank buys or sells a reserve currency, it isn't for investment purposes, it is to make a market. If foreigners saw this stock market dip as a true opportunity, we would likely not see such a dramatic contraction in money supply growth rates over the past couple of months. It is more plausible that they are helping their financial pillars wind down their Dollar exposure, or that they have learnt a few tricks from their American friends and forcing large American speculators, like George Soros, pay a premium to sell their Euro-holdings. And do not be fooled by the final shakeout in the gold market IF it comes, especially as a result of this illusion of a strong Dollar.
So, in light of the strong historical relationship between gold and our current monetary/currency regime, what kind of a discussion of fundamentals does not include the integrity of the US Dollar? The kind that comes from analysts that have no way of quantifying, or timing these kinds of dramatic changes in the supply and demand outlook for gold, or the sea change in public confidence, and/or preference.
That is the job of a speculator, whose keen sense of reason should get rewarded for effectively smoothing these kinds of changes not exacerbating them. No market can work right without this kind of "dynamic" player. The gold rally that began in the late 1970's was only postponed long enough for an illusory prosperity to take over the promised land. What we are about to see, is a long lasting return to economic power for real money and common sense. Let's hope it is s-m-o-o-t-h.
GOLD $2000 in the Year 2000 !
Has a nice ring to it, though it may actually be the year 2001.