Saturday, September 3, 2011
I can't believe how many inane comments I've heard about gold and the gold standard recently...
When the mainstream media begins to discuss gold as an alternative to paper money, it's a sign we're either in the midst of a massive devaluation or at a top in gold prices – or both. It's certainly a worrisome sign to see so much discussion on Fox News and CNBC about gold. Even worse, the pinheads on TV know nothing about gold, so they repeat the lies they've been told by their producers. They have no idea how stupid they sound because they've never thought about gold or studied it. I'm sure you've heard this nonsense, too...
"Gold is just another fiat currency"... "The gold standard didn't work because it limits economic growth to the availability of additional gold"... "We could never return to the gold standard because our economy is too big and there's not enough gold."
I want to dispel these falsehoods and show you why the common man should greatly prefer gold-backed money. I can imagine the groans... and envision the number of people closing this e-mail.
But I hope some of you will read this and think deeply about these ideas. I want you to know why bankers hate gold, why the government hates gold, why the mainstream media hates gold... and why you should treasure gold as your most important weapon for economic freedom.
Let's begin as Buffett's longtime partner Charlie Munger typically suggests, by "inverting" the question. Rather than starting with gold, let's start with the opposite of the gold standard – paper, fiat currencies. Let's look at how our economy and our fellow citizens have fared during the paper standard of the last 40 years. Since I spend most of my days looking at this kind of data, allow me to give you a preview...
The U.S. paper dollar standard has worked about as well as can be expected, which is to say, it has permitted debts to soar, the dollar's purchasing power to be gutted, and real wages to decline. It has left our economy with debts that can only be financed via even more inflation.
Below, you'll find a chart of the CRB index going back to the 1950s. The CRB index is a mix of basic commodities – things like base metals, oil, and food. It's not a perfect gauge of all consumer prices... But at least it's consistent over time, unlike government indexes, which are constantly "massaged" and adjusted.
Now, gold's price isn't really a measure of the metal's intrinsic value (which is almost perfectly stable). It's actually a reflection of the dollar's fundamentals. The same thing is true about the CRB index. It's not really a measure of supply and demand for commodities – it's actually a measure of the purchasing power of our currency. If you simply imagine this chart upside down, you'll get the real picture: The value of the dollar is falling. So look at the chart and then take a guess when the U.S. left the gold standard.
As you can see, prices soared (aka the value of the dollar collapsed) in 1971 when we left the gold standard. But wait a minute, you say, it looks like commodity prices fell between 1981 and 2004. Why did that happen?
Commodity prices did fall during the Volcker and Greenspan periods (1981-2006) because both Fed chairmen targeted money supply, creating a de-facto gold standard. (Volcker did so openly and publicly. Greenspan did so while only uttering totally indecipherable explanations.) As you know, this monetary discipline was tossed out the window when Bernanke took over the Fed. Since then, the monetary base has nearly tripled. As a result, commodity prices are soaring again.
Some people (like yours truly) knew a massive inflation was inevitable because of the enormous amount of credit created in the banking system from 1990-2006 – roughly $45 trillion. There's no way to finance these debts with sound money, let alone repay them. But we'll get to this part of the discussion in a minute. Let's just deal with the inflationary reality of paper money for now.
How anyone can look at that chart and not see inflation is beyond me... But as you know, several well-known economists (and even a few analysts at Stansberry Research) continue to insist that there is no inflation. When I hear that kind of baloney, it makes me want to grab those guys by the backs of their necks and push their faces into this chart. If that's not inflation, what would you call it?!
Inflation has been so prevalent for so long, most people don't even know it's not part of a normal economic system. Data on consumer prices from 1596-1971 in Britain prove conclusively that during gold-standard periods, commodity prices remain level – even over hundreds of years, during periods of massive economic growth and soaring populations.
So as should be intuitively clear to even a sixth-grader... printing more money leads to higher prices, a monetary phenomenon we call inflation. Printing money does not create real wealth or help promote economic growth. In fact, I believe printing money tends to retard production, because it interferes with prices, forcing entrepreneurs to engage in speculation (hedging) to protect margins.
We can test this hypothesis because we have an almost real-time case study – the second round of quantitative easing (QE2). QE2 began a year ago when Bernanke pledged to begin buying long-dated Treasury bonds in an effort to stimulate the economy. The funds for these purchases were created out of thin air – printed up, so to speak.
What was accomplished by these measures, which added roughly $600 billion to the U.S. monetary base? The stated purpose was to drive interest rates lower and stimulate the economy. But interest rates actually rose as the bond market began to fear inflation. Yields on U.S. 10-year bonds went from 2.5% to more than 3%. So the government bond market actually saw a decline.
And whether you owned government bonds or not, almost everyone was made poorer by the resulting inflation. Producer prices rose by nearly 6% during QE2. Oil prices, in particular, soared... moving up to more than $100 per barrel.
On the plus side... the stock market rose slightly in nominal terms. Whether or not those gains will last is another question. Even assuming the gains are permanent, all those gains would have been more than offset by the fall of the U.S. dollar over the last year (down 15%). Consider the folly of debasing the value of all U.S. assets by 15% to finance a minor increase in stock prices. That's insane.
QE2 did accomplish one thing... It led to a massive amount of new junk-bond issuance as the Fed's buying of government debt crowded out private capital, forcing it into riskier bonds. This allowed total business-sector debt to continue expanding, along with total government debt. Ever-bigger debts means more and more political pressure for inflation, something we'll discuss below.
The great advantage of paper money is supposed to be its flexibility. You can, in theory, print more of it when you need it to facilitate economic growth or forestall a crisis. But it doesn't really work. Printing money doesn't create wealth or stimulate the economy. It simply provides incentives for going into debt as people realize the money they borrow today won't be worth as much in the future.
The most important test of paper money is whether it facilitates real, per-capita economic growth. And on that score, the evidence is overwhelmingly negative. Measured in ounces of gold, per-family income in the United States has declined since 1971, retreating back to 1950s levels, despite the advent of two-income families.
Measured another way (using the government's own consumer price index as the inflation adjustment), real per-family income is essentially unchanged since 1971, again despite the fact that far more households have two wage earners today. Household earnings, in real terms, have fallen 30%-50% since the gold standard was abandoned.
Paper money works great for the rich, who can hedge their exposure to the currency and whose access to fixed-rate credit allows huge asset purchases. But it is horrible for the middle class, whose wages do not keep pace with declines in purchasing power caused by inflation. If you want to know why there's so much discrepancy in incomes and per-capita wealth in the U.S., look no further than paper money.
So that's the gold standard inverted. We can prove that paper-money systems don't work. They lead to high levels of debt, gross income inequality, and horrific economic volatility, due to both high debt levels and inflation. But what about the gold standard? How does it work?
Nathan Lewis (whose book Gold: The Once and Future Money is required reading) recently outlined the gold standard's economic performance to Forbes...
During that entire period, the U.S. was on some type of gold standard (with the notable exception of the greenback era during and immediately after the Civil War). So it's hard to take people seriously when they complain that a gold standard would hamper economic growth in America. The exact opposite is true. The gold standard helped America become the wealthiest nation in the world. Ever since we abandoned it, our debts have soared and our incomes have fallen.
How does a gold standard work? Let's go back to the greenback era after the Civil War to see how America returned to gold. Following the Civil War, it took 14 years of economic growth and steady reductions in the number of greenbacks in circulation to return the U.S. dollar to parity with gold, at the same price as before the war. By 1879, the U.S. government stood ready to exchange greenbacks for gold.
That didn't mean the U.S. government had enough gold to exchange every greenback, it simply had enough gold in reserves and had access to enough gold to make the promise. The actual gold reserve fluctuated between 10% and 40%. What mattered was the government's legal commitment to exchange its currency for gold and its financial ability to do so. This limited the government's ability to increase the money supply. And it limited the banking system's ability to create credit.
What happened next? The 1880s saw the greatest increase in per-capita GDP in American history. Unemployment fell to 2.5%, despite high immigration. Real wages rose 23% between 1879 and 1889. The country boomed, led by heavy capital investment. The amount of rail track laid, for example, grew from 2,665 miles in 1878 to 11,568 miles in 1882. The value of building permits increased by 150% between 1878 and 1883.
And here's the most fascinating part of the story... prices steadily fell from the end of the Civil War until the early 1890s, when they finally stabilized. You'd be hard-pressed to find a working economist today on Wall Street who could explain why the greatest decades of economic growth in American history could have been achieved during a period of deflation.
Mainstream economists all believe prices ought to only fall during economic depressions because they've become so blinded by paper money. But I can explain what happened in the 1880s easily: With real money in place, investors were willing to make long-term investments.
The result was an economy led by capital investments – not consumption. It was an economy fueled by real savings – not foreign loans. There was no need for a central bank to set interest rate policies or to "safeguard" us from inflation because the gold standard insured parity and fairness between borrowers and lenders. This all led to big increases in productivity and production – and wealth for the entire economy, not just the rich.
And therein lies the secret to our story...
Any reasonable study of paper-money systems versus gold-backed monetary systems demonstrates the superiority of gold immediately. So... why does almost every modern government choose paper? The answer is because paper money allows the wealthy and powerful vested interests in our economy to manipulate interest rates, prices, the money supply, and credit to their exclusive advantage.
Think about this for a second. Imagine how much productivity in our economy has increased since 1971. There's been a complete revolution in technology that has caused massive increases to productivity. You can see it all around you. I'd estimate productivity has increased by 4%-6% per year since 1971.
Where did all that wealth go? It didn't end up boosting the value of our currency, as you'd normally expect. Prices never fell. Instead, all those productivity gains were consumed by the issuance of more and more money – by inflation. Therefore, average wages, in real terms, have declined. And all these productivity gains – all that wealth – was consumed by the financial sector, the government, debtors... all the people who benefit from inflation.
As a result, we've been left with a heavily indebted economy that's still led by consumption. Our system rewards debtors and punishes savers. It makes long-term capital investment nearly impossible because of economic volatility and financial risks caused by inflation. Worst of all, our system requires everyone become a speculator because there's no other way to safeguard savings.
You see, what the gold standard really does is ensure a level playing field for all economic actors – borrowers, lenders, and even governments. That's why bankers (who are always highly leveraged), media barons (who constantly borrow to buy more properties), and governments (which can never balance their budgets) all abhor gold. To maintain their power, they all need paper money. The system we have now and those who profit from it would not survive a transition back to the gold standard.
Here's just one example of how this all works out in practice, not just in theory. Take a look at Rupert Murdoch's balance sheet. News Corp. is totally a product of the paper-money system. Murdoch always has access to credit, thanks to his government connections. He can always borrow heavily to buy his media properties – and he always does. News Corp. currently has a debt-to-equity ratio of 53. (That's not a typo. You can check the number yourself here on the News Corp. website.)
Murdoch recently borrowed $60 billion to buy the Wall Street Journal. Under a gold standard, there's no way Rupert could finance these debts. News Corp. would go bankrupt if the dollar was sound.
So do you think the Wall Street Journal is going to come out publicly for gold? What about the U.S. government? Do you think it wants to give up the power it has today – the ability to legally print money to pay its debts? No way. It'll never happen – not willingly. And how do you bet Rupert's and the government's debts will be paid back? In sound money? Or through inflation? What do you think that inflation will do to the value of your wages?
Do you see how the game works now?
One more point... you'll frequently hear that we don't have enough gold to support a gold standard and other such nonsense. Those comments are ignorant. The U.S. is the world's largest holder of gold. We have plenty of domestic gold mines – Nevada is one of the richest gold-mining areas in the world. A return to gold is possible.
The timetable for doing so and the impact it would have on the world economy would depend on what price level was set for gold. Setting a target date in the future – say 10 years from now – would allow the market to reach the appropriate price level in an orderly fashion. There wouldn't need to be any real economic adjustment – except for folks who are currently heavily in debt. Sound money would make it much more difficult to refinance risky loans.
I'm sure there would have to be a significant restructuring of our existing debts. And that would mean the end of our debt-led financial system. But after those debts were restructured, the gold standard would lead to massive economic growth and ensure the benefits of that growth are spread equally across the economy.
The next time you hear someone in the media talking about the gold standard as though it's some kind of insane idea... listen carefully. You'll hear nothing but lies and propaganda. There's no legitimate reason to oppose the gold standard. It's the safest and most efficient way to run a monetary system, as has been proven time and time again. Paper, on the other hand, always fails.
Date Range:8/25/2011 to 9/1/2011
Date Range:8/25/2011 to 9/1/2011