Saturday, May 21, 2011
In today's essay, we tackle another hot button issue – gold. As you've seen, we simply can't resist these kinds of emotionally charged topics. And man, oh man, are people sensitive about the topic of gold...
Given what's happening around the world right now (monetary chaos, debt crises, soaring commodity prices, etc.), we think it's critical to understand the advantages (and drawbacks) of a gold-backed monetary system. In our view, if you don't understand gold, you probably don't understand what's happening to our money... and the world economy, as a result.
So why do free-market types (like us), libertarians, lots of wealthy people... and some kooky conspiracy theorists... spend so much time talking about gold? Why do most government types and mainstream economists seem to hate gold so much? What's the real story?
In general, people who favor more personal freedom (and responsibility), less government power, and more free markets tend to favor gold over paper (fiat) currencies, for the simple reason that gold can't be printed and its supply can't be easily manipulated by the government.
Former Federal Reserve Chairman Alan Greenspan himself explained these issues in the conclusion of his famous 1967 essay "Gold and Economic Freedom":
The ability to protect your savings with gold from inflation is the first of several significant reasons to prefer gold as a currency. People will argue there are better ways to safeguard your savings – like investing for the long term in high-quality common stocks or owning real estate. I won't argue gold is the only way to protect yourself from inflation – or even the best way. (The best way to protect yourself from inflation is to own a capital-efficient business that's able to raise prices, but doesn't have to bear many of the additional costs. That's a lesson for another day...) But I would argue gold is the best way to protect yourself with money.
Gold has retained its purchasing power for all recorded human history. It's a universally recognized and timeless store of value. Its natural properties have imbued the element with traits that humans find intrinsically valuable and well suited to use as money: It's portable, divisible, and doesn't corrode.
If I were to hide 10 gold coins today and leave them for my grandchildren, I have no doubt that in 40-50 years, my grandkids would still be able to use them to purchase something around $14,000 in value.
That certainty is gold's main appeal. It allows creditors to lend freely to debtors without having to worry about the real value of the money they'll be repaid. But in my opinion, as important as this factor is, it's not the real reason you should care about gold.
Gold-backed monetary systems accomplish two other things that are even more important to an economy and to society. I'll explain these two secret benefits to gold below. But first...
Most Americans don't realize a gold-backed currency is one of their birthrights as American citizens...
Traditionally, the United States backed its banking system with gold. It did so because during the colonial period several experiments with fiat currency collapsed. Starting around 1750, King George's government forbade the issuance of paper money and America's economy came to function almost exclusively using silver Spanish coins for small transactions and gold as bank reserves. This system remained in place, in one form or another, with only short interruptions between 1750 and 1971.
That's why the U.S. Constitution doesn't mention the Federal Reserve or fiat currency. Article 1, section 8 of the Constitution only empowers Congress: "To coin Money, regulate the value thereof, and of foreign Coin, and fix the Standard of Weights and Measures." This authority was never intended to permit the use of fiat (paper) money. It was intended to ensure that sound money – gold and silver coins whose measures would be regulated by Congress – were used.
The system worked remarkably well. Before the big devaluation of the dollar in 1933 (when FDR seized all of the private gold in the country), prices during the gold standard period were remarkably stable. For almost 200 years (1750-1933), the purchasing power of the U.S. dollar (which was defined as 1/20th an ounce of gold) was nearly unchanged.
Think about that in light of this fact: Since 2001, the value of the U.S. dollar has fallen 50% against a basket of commodities (the CRB index). Which system do you think is better for the economy: a system that holds together for nearly 200 years... or a system that loses half of its value in one decade?
The gold standard's powers shouldn't be exaggerated. A gold-backed monetary system doesn't prevent bankers from making bad loans. It won't stop investors from paying too much for lousy investments. And it doesn't work to prevent bubbles when debts outside the banking system are created, as occurred with the various trust companies prior to the Great Depression. The gold standard only works to the extent that it's enforced, just like any other standard.
What about the secret advantages to gold-backed monetary systems? The first little-understood advantage is that gold-backed monetary systems are almost completely immune from any large-scale boom or bust. That's because the supply of credit is strictly regulated by the size of the economy. Bankers are limited by their gold reserves from making too many loans.
Let me show you what this means... In the U.S., under the various forms of the gold standard we used from the 1750s until 1971, you'll notice a curious coincidence. The total debt-to-GDP ratio in our country was remarkably – almost perfectly – stable.
Yes, there are some exceptions, like during World War II. But except for these temporary anomalies, the ratio of debt (both public and private) to GDP was remarkably stable at around 1.6 times GDP throughout most of U.S. history. Why? The size of our gold reserves limited our debt burdens. Reserves could only grow in correlation with the overall economy. Bankers couldn't build up onerous amounts of debt.
That all changed in August 1971. Rather than cut the government's spending and raise interest rates to slow demands from our trading partners for bullion, President Nixon took us off the gold standard. From that point, our creditors had no legal claim to our gold reserves. And the banking system had nothing but the Federal Reserve to limit the creation of additional credit and money.
Check out the charts below to see what happened next – debt began to explode.
David Stockman, the director of the White House Office of Management and Budget under Ronald Reagan, explained why credit exploded in February at Jim Grant's conference in London:
Freed from any requirement to acquire new reserves through industry or trade, the size of our banking system exploded. By 1990, the total debt-to-GDP ratio in the U.S. had grown substantially to 2.6 times GDP. It reached 3.6 times by 2007 – even before the financial crisis. Today, total debt in the United States stands at $56 trillion – 3.8 times GDP.
That equals $180,000 in debt for every man, woman, and child in the United States. That's nearly $700,000 of debt per family in the United States. The interest on these debts is more than $3.5 trillion per year. To give you some idea of how much money we're spending on interest alone, just consider... the total budget of the U.S. federal government is also $3.5 trillion. Again, $3.5 trillion just covers the interest.
These debts are completely unaffordable. How many families in America do you know that can afford to finance and repay $700,000 in debt? Not many... certainly not the "average" family. And that means the value of our currency is now in peril because, to politicians, the only way out of this crisis is to print trillions of new dollars, something that's underway right now at the Federal Reserve.
This will greatly devalue our currency... and, sooner or later, lead to an even bigger debt burden. (Ironically, this cycle of debt, devaluation, inflation, and then more debt is exactly why the King of England finally forbade fiat currencies in the American colonies in 1750.)
A stable credit environment over the long-term isn't the only poorly understood benefit. There's one more big advantage to gold that's almost been completely forgotten. I don't recall these ideas being written anywhere else. (That means most of you will simply think I've lost my mind and made up this part...)
Paper currency systems – with their inevitable booms, busts, inflations, and devaluations – discourage the public from saving. Instead, they inspire consumption and speculation. One of the main reasons the housing boom got so bad was people learned from the inflation of the 1970s and 1980s that buying a home (using a fixed-rate mortgage) was a "great investment."
Most people didn't account for the fact that much of the rise in home prices during this period was attributable to inflation. People just knew if they'd kept the money in the bank, they wouldn't have done as well. This kind of steady inflation leads people to prefer spending over saving. It also leads to more speculation. People realize they can't trust paper money, so they're willing to take more financial risks, consume, and borrow.
Now imagine if our money was sound. Imagine if instead of feeling like you better buy something or make an investment in something right away, you knew you could hold on to your money for decades and it would be worth at least as much as it is right now. Your perspective on risk and investing would change overnight. You'd be more willing to save and more cautious with your investment choices. You'd have the option of merely saving for retirement. You won't have to worry about trying to invest for retirement.
As our current monetary system collapses from taking on too much debt and printing trillions of U.S. dollars, there will be many discussions about what should replace the dollar. As part of my Project to Restore America (you can see our website here and visit us on Facebook here), I'm lobbying for a Constitutional amendment that will require banks and the U.S. Treasury to keep their reserves in gold. Believe me, you are going to hear all kinds of rhetoric about why this is a terrible idea, how it's not feasible, etc.
It's certain the government and the bankers will oppose gold with all their might. Under a gold-backed system, they will lose tremendous power. They won't be able to create credit with a computer or a printing press. They won't be able to control the money supply. They won't be able to tax with unlimited power through inflation. (If you like these ideas, please join our Project to Restore America e-mail list... We'll keep you updated on our plans and progress to move these ideas forward.)
The foes of sound money will argue – as they always do – there isn't enough gold to back the currency. That's complete nonsense. The U.S. government is the largest holder of gold in the world (or at least it claims to be). We have 263 million troy ounces. The Fed's monetary base is $1.7 trillion and will soon be $2 trillion. Divide $2 trillion by 263 million ounces... and you get a gold price of $7,604 to have a currency that's 100% backed by gold. It's that easy.
Now... there's one last part of all of this that might greatly interest you. Because the U.S. dollar has seen so much of its value wiped out over the last decade, it has become unreliable as an arbiter of prices. If you look at the price of stocks as measured in gold, instead of as measured in dollars, you will have an entirely different outlook on the real trend in stocks. See for yourself.
Does this look like a bull market to you? The above chart shows stocks have steadily lost ground to gold over the last 10 years. The reason why is obvious: Our currency is falling apart. But not one investor in 100 understands what this chart means or how to use it to make great trades.
The inherent unreliability of the dollar led some speculators (like me and Steve Sjuggerud) to develop alternative methods for tracking stocks, bonds, currencies, and commodities. Around the office, we call what we do "ratio" trading. The bottom line is, rather than using U.S. dollars to analyze the world's markets, we use other related commodities or ratios. This gives us a huge advantage over other traders who can't see the market the way we do.
If you'd like to see the work we've done or review the dozens of profitable trading systems we've built using this unique way to look at the world's markets, I invite you to become a charter subscriber of our newest publication at Stansberry Research – True Wealth Systems.
Steve Sjuggerud has compiled all our secret ratio strategies – trading systems we've built over the last 15 years – into one monthly advisory. Using a custom computer system and hundreds of thousands of dollars worth of programming and data, Steve can scan the markets constantly, looking through the lens of dozens of different ratios – not just U.S. dollars. When he sees prices that are proven to be statistically reliable indicators, he'll put on a trade.
I have more confidence in this new trading service than I do in any other speculative advisory we've ever published. I'm sure you think I'm only saying that because I want you to buy a subscription, but really, I honestly don't care if you do or not.
I publish several newsletters I know few people will buy – like True Income and Extreme Value. They're expensive (but worth it). They use sophisticated strategies that most people will never understand no matter how many times we explain the concepts. And year after year, they wind up on top of Stansberry Research's annual Report Card, where we publish our results.
Believe it or not, I don't publish these letters to make money – compared to our other products, they're bad businesses. I publish them because I'm extremely proud of the quality of the products. I can't tell you how many people have told me True Income is the best newsletter they've ever read.... or said the same about Extreme Value. I expect True Wealth Systems to be in the same league.
Most people will never grasp the intellectual elegance... the beauty... of how these ratio trades work. But I love looking at the markets this way. I urged Steve to develop these systems because I'd used several myself, privately. We're taking the major fault of the global financial system – the inherent unreliability of the U.S. dollar – and using it to make extremely profitable, low-risk trades. In my mind, there's nothing better.
Does it really work? The systems Steve's built produced profitable trades almost 70% of the time. The average annualized return was greater than 35%. And the duration of these trades was long – 210 days. These systems work with large amounts of capital. This isn't day trading. It's for real investors and real money. To me, these ratio trades are like knowing the most valuable secret in the world: What things are really worth. Now imagine you'd figured that out and after you told people about it... they ignored you. Would that bother you? Not at all.
The most unique part of this advisory is Steve is willing to show you the systems he's built. He explains why they work. Then he alerts you whenever one of them "triggers" a trade. If you're interested in seeing what Steve has done, you can sign up now here.