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Resource Investor: Miners have bought as much gold sold by central banks
By Richard S. Appel
Financial Insights
November 4, 2004
Many investors and traders who have a keen desire
for higher gold complex prices believe that it will be
wonderful when gold finally breaks free from the
shackles that have long restrained it and soars
wildly higher in price. Some of these individuals
believe that gold is headed toward $600, while others
can barely contain their emotions believing that the
sky's the limit.
Many of these excited souls ponder the extent of their
future wealth when the noble metal ultimately surpasses
its earlier $875 high set in 1980 and soars to the $2,000,
$3,000, or even $4,000 level that certain conditions may
ultimately justify.
Unfortunately, few direct their thoughts to even remotely
consider the events that must first unfold in order to propel
gold to these mind-boggling prices. Further, far fewer have
any understanding of the consequences to our great
nation and its citizenry, themselves included, that will result
if these underlying driving forces truly play out and propel
the eternal metal to the untold heights that they believe are
its fate.
I feel that the majority of gold community members who
believe that the yellow metal is destined to greatly rise
subscribe to the belief that the dollar will sharply fall in
parity against the currencies of our international trading
partners. They rightly recognize that our current account,
balance of payments, and fiscal deficits cannot be
sustained, and will one day prove damaging to our nation.
They give lip service to the recognition that at some point
other countries will demand a real form of payment for the
valuable goods and services purchased by our country,
rather than continue to solely accept declining dollar
credits. Yet these gold community members avoid
believing what they see when they gaze into the future.
It has been incredibly beneficial for America to possess
the world's reserve currency. Our officials learned long
ago how to use this condition to their advantage. It
provided our Federal Reserve with the ability to literally
create dollars at will, without the need for our inhabitants
to be similarly productive as did all of those who supplied
us with their wares. Heretofore, controlling the reserve
currency came with the responsibility to maintain its
integrity and value. This was the case for decades
because it benefited international trade and fostered both
a strong American economy and financial system.
Unfortunately, for various reasons this goal has been
abandoned. At the forefront of these, is that possessing
the world's primary currency allowed our country to
become supported by the sweat and efforts of those
toiling in faraway lands without our giving them anything
of value in return. All that was necessary was to create
dollar credits literally from thin air, and use them to pay
for our foreign purchases. Sadly, this state has caused
America to become accustomed to living far beyond its
means. This, without the knowledge, recognition or
understanding of this true underlying reason by most
of our fellow citizens.
The enormous and increasing U.S. budget deficits, on
the other hand, are similarly unsustainable. To date,
countries such as Japan and China along with the
European Union members have helped fund these
deficits. They acquired Treasuries with the expectation
that the dollar would maintain its value, and gladly
purchased our bills, notes, and bonds with the belief
that they made a wise investment. History taught them
that when they desired to sell these assets they would
not only receive a similar or greater amount of their own
currency in return, but would also gain interest on their
holdings in the interim to boot.
They were in for a shock.
I believe that gold is quite undervalued. To my mind the
purchasing power of an ounce of gold is far greater than
the current $425 for which it sells. However, in order for
gold to trade far in excess of the $600 or so that I feel
conditions currently warrant, a number of events must
first transpire.
The United States has been riding the crest of a growing
tidal wave since 1971. This began when President Richard
M. Nixon "closed the gold window." That infamous day
occurred in August when I was honeymooning in Europe.
During the ensuing week or so after the announcement I
could not exchange more than a $20 bill or traveler's
check for any local currency. It was that fateful
announcement that removed the final vestige of gold
backing from the dollar. This opened the door to an
unconstrained issuance of paper money, and later
electronic dollar credits, by our Federal Reserve
System.
Throughout the subsequent period our country became
increasingly dependent on the rest of the world's
generosity, or, some say, naivete. Initially, they
bought our Treasury paper with the expatriated dollars
that flowed from our land in exchange for their products.
This helped fill the gap and largely paid for our
government's chronic fiscal deficits. Later, our ever-kind
trading allies gladly accepted our readily produced dollars
in exchange for their valuable services and goods. They
were thrilled when the dollar soared in value on
international markets between 1995 and 2001, and
barely batted an eye when the greenback reversed
course and began its present descending path.
We have all heard the euphemism that "the U.S.
pretended to pay foreigners with dollars and they
pretended to be paid." In truth, it became a symbiotic
relationship. The U.S. government found a way to
finance its growing deficit-spending propensity, and our
trading partners required an eager outlet to sell their
goods and services. This in turn helped improve their
economies, their employment rates, and the standard
of living for their citizens. It also helped keep their
leaders in power.
The result was an unprecedented explosion in both
global economic growth and the creation of U.S. dollar
credits. Unfortunately, just as it appears that we are
in the twilight of the world's greatest economic boom,
we are also at the dawn of what will likely become the
demise of the heretofore almighty dollar.
At some point, one by one, our trading partners will balk
at being reimbursed with dollars for delivering their goods
onto U.S. soil. The likely trigger for such an event will be
the declining parity of the dollar. The question is the level
of pain that each country can withstand -- that is, the
extent to which the dollar must fall against their local
monetary units, before they rebel.
What few people recognize or care to consider are the
events that will unfold when this time arrives. True, gold
will be at a far higher dollar price. But what economic and
social price will be its cost?
When people around the world begin to reject the dollar,
they will sell their accumulated U.S. Treasuries. They will
no longer desire these vehicles to act as a store for their
dollar holdings. This will cause a sharp increase in
domestic interest rates as their Treasury paper is sold
into the market. Our earlier loyal trading partners will then
take their received dollars and sell them for their own
currencies. This will act to further depress the dollar's
value on the world market. Further, the Federal Reserve,
which will be the ultimate redeemer of the Treasuries, will
be forced to issue new dollar credits. This will create a
flood of dollars entering our monetary system, balloon our
money supply, and threaten a serious outbreak of domestic
inflation.
The combination of increasing interest rates, a falling dollar,
and a sharply rising money supply will produce a second
series of events. The higher rates will damage the balance
sheets of our country's businesses and will threaten the
housing market. Further, the monthly interest payments
on our already highly debt-burdened populace will soar.
Stocks will weaken and single family home sales will
decline. This will drive consumers to limit their purchases.
These damaging events will be amplified when the "wealth
effect" begins to wear off and Americans experience a triple
whammy. Stocks will plummet, homes values will fall, and
the news of layoffs will fill the airwaves. This will act to
further restrict consumer spending and will foster a sharp
decline in business activity.
Additionally, the falling dollar will increase the price of
imported goods entering our markets. This, combined with
the sharply rising money supply, will not only add to the
cost of living but will promote the threat of inflation. Further,
foreigners will reduce their U.S. stockholdings for fear of
additional currency and stock market losses.
Consumers, already reeling from their increased cost of
living, the fear of additional stock and home equity losses,
and the threat of reduced incomes or their own
unemployment, will further retard their spending. This will
add to the damage sustained by our fragile economy and
place still more workers on the unemployment rolls. These
will swell while personal and business bankruptcies soar,
and the cycle will feed upon itself and spiral lower.
Of course the Federal Reserve will attempt to counteract
these forces. We have already been comforted by
statements from Alan Greenspan and Ben Bernanke, a
Fed governor, that they will create dollars at will if needed
through various schemes to circumvent a catastrophe.
However, if they execute their methods they will only
worsen the outcome. Yes, the Fed's machinations will
likely temporarily forestall a severe economic downdraft
and may indeed avoid a derivative meltdown, but at what
cost? If they aggressively act in this fashion their deeds
will only further damage the integrity and value of the
dollar, drive gold far higher in price, and likely precipitate
a damaging inflationary event. In fact, we may be forced
to endure the worst of all worlds where our domestic
prices are soaring while business is stagnating or
collapsing.
I have not painted a pretty picture of the potential
outcome when the world ultimately refuses to accept
the dollar. I have done this with the desire to warn readers
to protect themselves. "Forewarned is forearmed." I would
highly recommend that you greatly reduce all forms of
debt. Further, I believe that you should not only increase
the percentage of your gold and gold share holdings but
that Americans should also add to their cash positions
and hold them in the form of short-term U.S. Treasuries.
I hope that our leaders have prepared for such an event
and are successful in the execution of their contingency
plans. However, for those who will continue to anticipate
a joyous and happy ending to soaring gold and gold
equity prices remember, be careful for what you wish.
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http://www.minersmanual.com/minernews.html
http://www.a1-guide-to-gold-investments.com/euro-vs-dollar.html
http://www.investmentrarities.com
http://www.kuik.com/KH/KH.html
(Korelin Business Report -- audio)
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Ted Butler silver commentary archive:
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----------------------------------------------------
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