Attacking the Rich?

All this talk in Washington about going after the rich to pay more taxes is just a smoke screen.  As Rick Santelli explains in the clip below, the arguments between the Democrats and Republicans are using numbers that ignore inflation & mislead the public on who they’re actually targeting with tax increases.

  • To say that the tax increases will only affect those making $250K/year is really talking about those making $165K/year (in 1993 dollars), which is a 35% miss when it comes to being honest about the actual situation our economy is facing.
  • Or worse, when they talk about only taxing the millionaires and yet begin their arguments with finding ways to tax those making $250K/year, that’s a 75% miss.

The main point is that by ignoring the inflation, these government leaders are purposely hiding their ever-increasing extortion of wealth from the middle class, not from the rich!

RT: The Empire of Debt and the Election

In this episode of Russia Today’s Capital Account, Lauren Lyster interviews Bill Bonner, author of Empire of Debt. The highlights include:

  • Do the statistics and reports generated by the government help anyone determine the real state of the economy?  GDP, CPI and Unemployment reports “mean something, but they don’t mean what they say it means.”
  • A economic system based on fiat/paper money has never lasted in the past. Ever since 1971, when Nixon closed the gold window,  the resources of the country have been used unwisely, investing in programs that destroy the country’s wealth.  In order for real economic growth, this practice must be changed so that resources are invested in initiatives that build wealth.
  • The outcome of the presidential election will not alter the current course. Instead, the election is basically a contest to determine which group of ‘zombies‘ will get government sponsorship. A Romney win will ensure the military industrial complex stays in business, while an Obama victory will further the social/welfare state.
  • The government employing stimulus as a policy to help the economy is ridiculous. Again, it doesn’t help the overall economy generate wealth, it only serves those favored cronies with close ties to those in political office.

Jim Rickards on War – Currency or Otherwise

In his book Currency Wars, Jim Rickards reveals his participation in war games sponsored by the Secretary of Defense in 2008. The objective of these particular games was to discover how nations of the world might use financial instruments to wage war on each other and to gain some perspective on their effectiveness.  In the video below, he goes a step further and hypothesizes on what events might take place between the US and China as the world economy continues to slide into the toilet.  Rickards ends the video with a probable sequence of events that will take place if we stay on the current path.

Greed, Fear, Bubbles and Market Madness

Grant Williams, of Vulpes Investment Management, provides us with a brilliant presentation explaining how greed and fear play into the making of economic bubbles.  After giving a few examples of historic bubbles of the past, Williams then goes on to describe two bubbles in the present.  Spoiler alert!

Williams presents the latter two bubbles happening today as one nearing a collapse and the other in a “sweet spot” ready to enter the hyper-inflating mania phase.

G. Edward Griffin: The Federal Reserve is a Cartel

Eighteen years ago, G. Edward Griffin wrote The Creature from Jekyll Island and exposed the Federal Reserve’s true nature.  Since that initial writing, the knowledge of the fact that the Fed is not a government institution, but a privately owned central banking cartel has expanded in public awareness. In this remarkably lucid interview with Casey Research’s Louis James, Griffin discusses:

  • The growing size of government
  • The decline of the purchasing power of the US dollar
  • The two-party political system is really a cover for a one-party system
  • The realistic expectations of public awakening prior to a collapse
  • The Fed is a cartel. Furthermore, it’s a partnership between the bankers and politicians
  • Why we have not seen hyperinflation (yet)
  • The system has changed from a free enterprise, competitive system to a politically connected, non-productive system, which will inevitably lead to totalitarianism
  • The possibilities for America to reverse course and avoid catastrophe

Nixon Shocked the Global Currency Markets

On this day, 41 years ago, Nixon shocked the world by removing gold convertibility for foreign holders of US dollars – it would be the end of the agreement made at  Bretton Woods, where it was decided that the US dollar would be pegged to gold and all other currencies would be pegged to the US dollar.  The message was so important that Nixon’s administration decided to preempt the most popular TV series, Bonanza, on Sunday evening prior to the markets opening on Monday.

What’s most aggravating is Nixon’s claim that he must save the dollar from the evil speculators trying to destroy the dollar – something we hear so much, even from modern day politicians.  Never do these con men ever mention that there wouldn’t be anything to speculate on if those in charge of the monetary system were honest and abstained from their blatant money-printing, inflationary policies.

Is More QE Coming, Or Not?

With the Fed purchasing 61% of all the US debt, it’s somewhat confusing why potential precious metals investors want to see more QE before making their move. And as the following chart from the St. Louis Fed shows, the money supply is still at uncharted, nose-bleed levels and showing no signs of decreasing.

US Dollar Money Supply

Nevertheless, analyzing a derivative of the TIPS Spread to identify when the Fed might reintroduce even more easing is what the economists over at Agora Financial have been doing.  As the chart below shows, the Fed may be waiting for the “Breakeven Inflation Rate” to drop below 2.2% prior to accelerating those printing presses.

Five-Year Forward Break-Even Inflation Rate

TIPS Spread

May 21, 2012

Below is a live graph from the St. Louis Fed showing the historical TIPS spread.  The TIPS spread is the difference between the yields of conventional Treasury securities (T-bonds) and Inflation-protected securities (TIPS).  The conventional security yield is normally higher and therefore shows on the top of the graph.  The TIPS’ yield is lower and at the bottom of the graph.

TIPS Spread

The spread between the two yields actually reveal the market’s expectation of coming inflation. If the spread widens out it means the market is expecting more inflation.  If the spread converges, then the market isn’t expecting much inflation.

The Fed has consistently sought an approximate spread of about 2%, which theoretically indicates a moderately healthy growth rate in the economy. During the crisis of 2008, the spread converged, signaling very little inflation expectation – even the threat of deflation as the conventional dropped below the TIPS.  The easing policies which the Fed embarked on had the overall affect of re-widening the spread.

Ron Paul on CNBC

Which presidential candidate would you be most be confident would NOT lie to you?  Here’s Ron Paul on CNBC taking up the philosophical arguments no other candidates are discussing, including one hell of a debate on gold and the debasement of the dollar with Morgan Stanley’s Stephen Roach.

Government Economic Statistics Are Misleading

Dr. Paul Craig RobertsDr. Paul Craig Roberts served as the Assistant Secretary of the Treasury under President Ronald Reagan.  He should know a thing or two about U.S. economic policy.  In this brief and simple article, he explains how government statistics on inflation, housing, employment and GDP have consistently under-reported actual data.

“In place of recovery, we have hype from politicians, Wall Street, and the presstitute media.”

2012 – Apocalypse?

December 27, 2011

The Mayans lived in what is today the Yukatán Peninsula of Mexico. Scholars are somewhat in dispute as to the dates of their civilization’s development, which ranges between 2000 BC and 900 AD.  Also in dispute is how the Mayan civilization collapsed – it seems to have come suddenly, just prior to 800 AD, when inscriptions and temple building ceased – with possible destructive mechanisms ranging from war to epidemic.

Last Page of Dresden Codex (Mayan Calendar)A few decsendents from the Maya have survived and live in areas of Mexico today. Some important artifacts have survived as well. Even though Cortez’ Christian invaders of 1519 destroyed most of the Mayan documents as blasphemous relics, four have been preserved.  One of these is known as the Dresden Codex.  After years of attempts to translate the document, the Dresden Codex was finally determined to be an astrological document, complete with predictions of lunar and solar eclipses and information on planetary movements. In addition to this, it was a long calendar of cycles dating back to August 11, 3114 BC and ending on the exact date of December 21, 2012 AD – what has become known as the Mayan Calendar.

The very last page of the Mayan Calendar shows water being poured out from the mouth of the celestial serpent, the sun, the moon and also from a pitcher held by a weird looking person with bird feet and snakes on the head. The bird-crowned chief-priest below seems to be ceremoniously resisting the oncoming deluge, but the situation looks futile.

Does this signify an all-powerful flood, destroying the earth? Or could it be some kind of global cleansing? Or perhaps the water signifies consciousness – pouring water as if to wake-up the inhabitants of the earth from their sleeping state?  It’s nearly impossible to determine exactly what the codex is trying to convey without understanding the science the Mayans used in the development of the calendar.

But it is interesting that the Mayan end-date of December 21, 2012 coincides precisely with:

  • The winter solstice
  • The sun, earth and center of the galaxy are aligned, which occurs once every 25,800 years
  • The eleven year sun-spot cycle
  • At least the dawning of the age of Aquarious, which is also associated with water being poured from a vase, as its zodiac depicts

2012 may be the year our entire financial system collapses, resulting in our lives, as we’ve known them, being dramatically altered. Just listen to Ann Barnhardt, who recently closed down her investment firm, giving her clients’ money back and telling them she no longer feels their money is safe in the financial markets any more.

Currency Wars

December 18, 2011

Currency WarsWhen the economy of a country faces economic stress, that country’s central bank usually tries to take steps to recover by adjusting or boosting inputs to GDP.  GDP is based on:

– Consumer consumption
– Investments in housing and business
– Government spending
– Net exports (Exports minus Imports)

When the country reaches a level where there is high unemployment and excessive debt, it leads to a situation where consumer consumption is weak and no one is investing in housing or business because they are uncertain about the future.  Government spending can sometimes overcome this, but it comes with higher taxes or borrowing costs which become politically unpopular.

Therefore, as a last-ditch effort to boost GDP, a country will embark on currency debasement in order to increase its net exports. The currency is devalued by inflating the money supply.  The local citizens suffer because their own money buys less goods as things become more expensive at home.

However, as a country’s currency becomes weak in relation to its trading partners’ currencies, it makes its products and services cheaper for foreigners, and thus more attractive to buyers in other countries. As foreigners buy more, the affect is a rising GDP.

But this is only a temporary situation.  Other countries begin to experience problems because their imports are rising relative to their exports.  This hits their own GDP and now they have to take similar steps – debasing their currency to remain competitive.

Rickards explains that there have been two major global currency wars already – one from 1921 to 1936 and the other from 1967 to 1987 and that we are now in the third global currency war.  This war has three main participants – the U.S., China and Europe – although many countries around the world are severely affected by the currency games being played out and make their own contributions to the overall picture as well.

Rickards also gives four possible outcomes of this currency war:

  • Multiple reserve currencies. Instead of the U.S. dollar being the preferred reserve currency of the world, countries would hold several denominations from currencies around the globe. But imagine having to deal with the policies of several central banking activities – it’s bad enough dealing with those of the Fed.
  • SDRs. Special Drawing Rights have been the instrument of the IMF. SDRs are backed by a basket of different currencies from different countries around the world. However, the SDR’s value floats – that is, it is adjusted according to global exchange rates.  Furthermore, the IMF is able to print SDRs at will. Thus, there really is no difference between any other currency of the world, except it’s worse with the SDR – the IMF controls the SDR and the people controlling the IMF are appointed, not democratically elected.
  • A return to the gold standard. Here Rickards discusses some of the things to think about prior to a return to the gold standard, like what definition of the money supply (M0, M1, M2, etc.) to use as the base money supply on which to base on the gold supply?  Additionally what ratio should be used between paper and gold? And finally, what regulations should be in place for exceptions to be made in certain circumstances?
  • Chaos. If nothing is done to stem the current path towards currency debasement, a catestrophic collapse could devistate the world as we know it.

There’s also an interesting chapter explaining how currency and capital markets have become so complex that they are quickly approaching a breaking point. Current risk models used by most firms are inadequate to account for the existing risk and thus most are unaware of the true problems underlying the system and thus are unprepared for the inevitable catastrophe.

Here’s an interview with James Rickards where his book is discussed:

And here’s an audio interview discussing the book, whether or not America needs the Fed and whether or not a gold standard is a possible answer to today’s economic issues.

Financial Repression

When a country finds itself in the same situation as that of the U.S. – too much debt – there are basically three ways to resolve the situation:

  1. Get lucky. That is, if the country is lucky enough to grow their way out of the debt by having a healthy economy with low unemployment and a steadily rising GDP, the country could easily pay its debt over time.
  2. Default. The country simply refuses to pay its debt.
  3. Financial Repression.  Inflating the country’s monetary system to the degree in which the debt becomes relatively meaningless.

So far, the U.S. economy has not shown significant improvement in employment and GDP growth, so option #1 is out. A default would be too unpopular for politicians wishing to keep their offices of power. So even though option #2 would be beneficial long-term, it’s off the table as well.

In the middle of 2011, Bill Gross, managing director of PIMCO, referenced a paper on Financial Repression written by Carmen Reinhart and revealed his fund was going short U.S. Treasuries.  Since that time, the fund has lost value due to this call because the U.S. Treasury market bubble has still not burst.  But Mr. Gross was not wrong – perhaps his timing was off.  The U.S. is indeed embarking on some form of Financial Repression in order to address its debt burden.

So, what is Financial Repression?

Simply put, the goal for the U.S. under this strategy is to sustain a modest level of inflation.  For example, if a 4% inflation level can be kept up over a period of 10 years, with compounding, half the debt can be melted away.  Of course, the U.S. Federal Reserve will not publicly state that rate, but instead declare the target of around 2%. Nevertheless, the inflation rate doesn’t have to be that high, just kept consistent over time.

According to Reinhart’s paper, there are 3 mechanisms which serve to sustain a certain level of inflation.  The first is caps on interest rates. With rates at or near zero, it’s rather obvious the Fed has been successful in keeping rates low. And in mid September, 2011, the Fed initiated Operation Twist, which rolled maturing short-term bonds into new long-term bond purchases having the affect of pushing longer term interest rates lower.

The second mechanism is to ensure there’s a market for U.S. bonds – that is, make sure someone is available to buy the securities on offer by the Treasury. With interest rates so low, this is a difficult task. The Fed was supposed to be the buyer of last resort. But recently, they’ve overtaken China as the largest holder of U.S. debt. However, during the bail-outs of 2008, the banks received a lot of money in order to keep their capital ratios up. So far, that money has been parked in accounts at the Fed earning some interest. When called upon, these banks will use that money to buy U.S. Treasuries.

The third mechanism is to have capital controls in place that ensure there is no banking competition. All the banks in the system are banks in line with the Federal Reserve System.  There can’t be any rogue banks out there deciding not to play the Treasury game as planned.

Under this strategy, the U.S. government debt can be inflated away. But there are losers in this game. First, people who save their money see their savings eaten away – they get little to no interest on their savings and as inflation rises, the value of their money decreases.  Second, those purchasing the Treasuries lose as well for the same reason – low interest rates. Understood in this manner, the inflation sought under Financial Repression is a hidden tax.

Another interesting point Reinhart makes in her paper is that in order for Financial Repression to work in the long run, investment in gold needs to be discouraged or even prohibited. Investors cannot have any alternatives, but to invest in the target securities. But thankfully, that’s not the case today.  People are able to buy gold and silver and thus protect themselves from this inflationary strategy.


How High Can Gold Go?

September 18, 2011

With gold in a 10-year bull run and the price relatively expensive, every investor must ask themselves if gold has reached its top. And with recent highs above $1,900/ounce followed by severe volativity and price plunges sometimes near $100/day, the question becomes more pertinent.

It’s interesting to recall back in January, 2010 at the Annual World Economic Forum in Davos, Switzerland, George Soros claimed “The ultimate asset bubble is gold.” At that time, the gold price was at $1,100/ounce, down from a high of $1,225/ounce a month prior.

Of course, at the time, the main-stream media only picked up on the “bubble” reference and did not take into account the context in which the reference was given. So, obviously most investors began to question their faith in the continuing rise of gold.

Soros’ reference was that asset bubbles form when interest rates are low. Easy money provided by the Fed’s policies drive people to use the money to buy all kinds of things. The more buyers there are in relation to sellers makes the prices of things rise. This is the simple logic behind all markets – supply and demand.

Gold is the “ultimate bubble” because it is the asset that serves as a barometer for the measurement of how well the central banking monetary policies are (or are not) working. In this sense, it is literally the bubble to end all bubbles. As the central banks around the world print ever more paper money without any substantial backing, gold’s price rise is sustained. Until this kind of policy is reversed, gold’s “bubble” will continue to grow.

So, back to the question, how high can we expect gold to rise? There are many different theories, some of which will be discussed below. But keep in mind that as long as gold is denominated in fiat paper money in order to establish a price, the relation with the true gold asset gradually loses its psychological connection as fiat becomes worthless and gold becomes the real money.

Using the
Consumer Price Index
to determine Gold’s Possibilities

Using the Bureau of Labor Statistics CPI inflation calculator, we can determine what something would cost in today’s dollars versus what it cost at some time in recent history (as far back as 1913, when the Fed was created).

Plugging in the average price of gold in 1913 ($18.92/oz), we get a price of $432.95/oz. That’s interesting! Is gold over-priced today at $1,800/oz? Or is there something special about gold or fishy with CPI statistics?

After President Franklin Delano Roosevelt confiscated Americans’ gold in 1933 in return for $20.67/oz, he immediately re-pegged the dollar at $35/ounce. Using the same numbers in this CPI calculator, we come up with only $25.61/oz for 1934, about $10 less than the President’s price peg. So, it is becoming evident that the CPI calculator is not historically keeping up with the price of gold.

Furthermore, after 1933 citizens were prohibited from owning gold bullion. So, there wasn’t a free market available to establish a real gold price. It wasn’t until 1975, after President Gerald Ford signed a bill legalizing private ownership, was gold put back into a free market.

In 1975, the average price of gold was $160.86. Using this CPI calculator, the price in 1975 should be only $102.82/oz, again under-stating the price of gold by about 38%.

From an historical perspective, then, it seems this CPI calculator cannot be used to determine the price of gold. In fact, the tool is geared to specific data points, like those of this table, which excludes any precious metal.

Further still, the CPI measurement methods themselves keep changing. The reason for the constant changes is because CPI attempts to sustain the strength of the dollar and reduce the claims agains unfunded liabilities like social security. If the government can show that inflation is not rising as much as it is, they don’t have to increase pay-outs to social security recipients. Of course, this ends up hurting those individuals dependent on their ss checks because they’re getting hit harder at the grocery stores and their income isn’t increasing enough to compensate.

The CPI calculation method, therefore, is more of a tool to prop up the value of the dollar rather than to accurately measure the price of a commodity such as gold.

Using the
Currency/Gold Ratio
to determine Gold’s Possibilities

As this Seeking Alpha article from April 25, 2011 explains, the Gold Standard Act of 1900 tied the value of a dollar to 1/20th of an ounce of gold. This meant that the U.S. treasury needed to keep one ounce of gold in their vaults for every $20 of currency in circulation. (Note: Precise value was $20.67.)

Back in the early years of the 20th century, if one were to divide the amount of U.S. dollars in circulation by the ounces of gold held in reserves, one would consistently arrive at a value close to $20. But as the century progressed, with economic depressions, wars and central bank interference, the value fluctuated both up and down. But as shown in the table in the article, the ratio has historically tended to be an accurate predictor of the higher prices that eventually came to pass.

As the article goes on to describe, the currency supply of the U.S. has been inflating at the average rate of 8.5%/year between 1913 and 1971, and an accelerated 11.5%/year since 1971. As of April, 2011, there was about $949 billion worth of currency floating around. This is the M0 money supply, which represents all the paper bills and coins in circulation. Note: it is reported by the government not as M0, but as the column headed “Currency(1)” in the Components of M1 table on this page.

Next, this M0 amount must be compared with the reserves of physical gold held by the U.S. Treasury. According to The World Gold Council via Wiki, the U.S. currently has 8,133.5 tonnes (approximately 261 million troy ounces) of gold in its reserves.

So, using the currency/gold ratio for April, 2011, we have $949 billion divided by 261 million ounces = $3,636/oz.

Using the
1980 Peak of $850/oz
to determine Gold’s Possibilities

In January of 1980, gold hit a record price of $850/oz. Granted, the peak of 1980 concluded with a huge price drop back down to the $300’s because of the responsible actions taken by the Chairman of the Federal Reserve, Paul Volcker – he raised interest rates as necessary to reduce the easy money available, thus taming inflation and bringing the gold price down. But we see no such effort by those in power today. They’re faced with a declining world economy, making it difficult to make the unpopular decision to raise rates. Indeed, our current chairman, Mr. Bernanke has told us to expect interest rates to remain near zero through mid 2013.

Today, with gold over $1,800, one can say that we’ve already surpassed the 1980 peak. But this would not take inflation into account.

Now, we’ve already dismissed the Bureau of Labor Statistics CPI calculator above as a valid tool for establishing the price of many assets because it showed a tendency to under-state inflation, hence under-state prices. However, using that calculator and the government’s own data for measuring inflation, we see that it correlates the 1980 peak of $850/oz with a price of $2,336.93/oz today. As of this writing, we have not yet achieved such a price, thus the peak of 1980 still holds in even the weakest inflation-adjusted terms.

But is there another source of inflation data which describes the inflation situation better than CPI. In fact, there is such information available, thanks to John Williams’ ShadowStats. Data from ShadowStats indicates that CPI inflation measurements have traditionally under-stated inflation significantly. “The problem lies in biased and often-manipulated government reporting.”

This site also has an inflation calculator, which compares inflation adjusted prices using both governmental CPI and ShadowStats measures. Unfortunately it’s subscriber protected. However, here’s a Bullion Vault article from January, 2011 that references ShadowStats data and indicates that gold would need to reach $5,467/oz in order to match the 1980 peak! And here’s an older “Flash Update” from Mr. Williams in November, 2007 stating that the “Peak Gold Price is $6,030/oz.”

Using the
Run-up to the 1980 Peak
to determine Gold’s Possibilities

Again, using this list of annual average gold prices it can be seen that in 1971 the price of gold was at a low of $40.62/oz. After 1971, the price began to surge to its peak in 1980. The average price for 1980 was $615/oz. That represents a 1,414% increase.

On this current bull-run that started in 2001 when the average price was $271.04, in order to achieve a similar 1,414% gain, the price would have to climb to $3,833/oz.

Using the actual bottom-to-top numbers ($37.39/oz in 1971 to $850/oz in 1980), the percentage gain was a whopping 2,173%. The absolute low of 2001 was $255.95/oz. A 2,173% increase from that low would be $5,563/oz.

Comparing the
U.S. Gold Reserves Versus U.S. Monetary Base
to determine Gold’s Possibilities

Here’s an interesting “chart-of-the-day” from Bloomberg. This method tries to establish a “fair value” for gold by mapping U.S. gold reserves against the M1 monetary base. The theory tries to map every dollar in existence – currency, checks, certificates & any other instrument exchangeable for currency such as traveler’s checks – to the amount of gold held in U.S. reserves that could possibly provide backing for the currency.

The interesting thing about this theory is not that the fair value for an ounce of gold last June was $10,000/oz, but that as a percentage of the monetary base, gold is sitting at historic lows – 18%. Even during the $850/oz peak of 1980, the U.S. had such a relatively small M1 monetary base that if everyone who had any form of an exchangeable dollar instrument suddenly demanded an ounce of gold for it, the U.S. would be able to cover it – no problem! At that time, as a percentage of the U.S. monetary base, U.S. gold reserves amounted to 120%. But now, due to the ever-increasing monetary inflation, the U.S. would be completely drained of its gold and still have 82% of its dollars outstanding with absolutley no backing!

If you didn’t get that last paragraph…. it’s an eye-opener, so go back and try again!

Gold & Silver Rising

What’s causing the Rise in Gold & Silver?

March 12, 2011

Precious metals such as gold and silver have been on the move lately. The one-word answer as to why this is happening is “inflation.” But that could be said about all commodities like oil and food, which are also going up in price. To fully comprehend why the precious metals are soaring, we need to understand the following:

  • What is money?
  • Why have people around the world respected
    the US dollar?
  • What has the US Federal Reserve been doing
    to destroy the value of the dollar?
  • What has the US government been doing to
    destroy the value of the dollar?
  • What has the US consumer been doing to aid
    in the destruction of the dollar?
  • What is the magnitude of the US dollar’s
  • Are other currencies around the world having
    similar problems?
  • Has this all happened before in human history?

Once we understand all these things, it will be easy to answer the ultimate question:

  • Why do gold and silver preserve wealth and thus make for a sound investment in these times of crisis?

By reviewing these questions we hope to attain speculative intelligence and investment insight. We hope to understand why precious metals such as gold and silver provide financial protection in these economic times of turmoil. So let’s tackle each of these items one by one….

Understanding the concept of ‘Money’

It may seem like common sense, but it is worth asking yourself about the concept of ‘money.’ For example, why is it that people readily take the dollar in exchange for goods and services? What is it about the dollar bill that makes it have value in this manner? After all, it’s just a piece of paper, right?

Yes, money makes the world go around, as the saying goes. It provides an easy mechanism by which goods and services can be exchanged, without resorting to a cumbersome barter system of direct trade. If a carpenter wants a chicken for dinner, he doesn’t have to wait until the farmer needs a new barn built – he can use money.

But we still have not answered the question. What gives money its value? Today, in America, this is a question which has an answer that is different from what the answer would have been 100 years ago. Back then, there was something behind the American dollar that gave it value. Each dollar represented 1/20 of an ounce of gold. If desired, a person could even receive bullion by trading in their paper dollars – gold certificates could be exchanged for gold and silver certificates for silver.

But as we shall see, this is not the case today. The only thing that gives value to the US dollar today is the faith that people have in the US government and its financial institutions. What kinds of things might cause that faith to fade and what would be the consequences?

The Mighty US Dollar

The US dollar was not always recognized as a global power currency. Prior to World War II, Great Britain had enjoyed having the world’s strongest currency – the pound sterling. But in 1931, Britain had to begin devaluing its currency in order to pay for debts accumulated fighting and financing war with Germany. After World War II, the US dollar became the world’s leading currency and as we shall see, the US is now coincidentally undertaking similar devaluation strategies because of its debt.

Many people talk about how bad the Great Depression was, which started with the stock market crash of 1929. As part of the effort to bring financial strength back to the American economy, in 1933 Franklin D. Roosevelt confiscated almost every ounce of gold bullion from U.S. citizens, paying them $20.67/ounce. After all the gold was acquired, the government revalued gold at $35/ounce, thus immediately solving the impending national monetary crisis – the U.S. government simply inflated its way out of the problem because they could now print more money to represent the gold in their vaults. But worse, gold redemption and bullion ownership by the private American citizen was outlawed. (The only way to legally own more than $100 of gold was in the form of rare coins and jewelry that were said to be worth more than the gold itself. It wasn’t until 1974, when President Ford signed a bill that made ownership of gold as a commodity legal again.)

In 1937 this confiscated gold was placed into a new bullion depository at Fort Knox. The gold was immediately used to stabilize the U.S. dollar against foreign currencies – funding the Exchange Stabilization Fund (ESF), a tool used by the treasury to ‘control’ the value of the dollar in relation to foreign currencies. Essentially, this means that as foreign countries acquired U.S. dollars by selling their products to the American consumer, those foreign nationals were able to redeem those dollars and receive gold back from the US Treasury’s ESF. (Even though, strange as it may seem, it was still illegal for the U.S. citizen to exchange his paper money for gold from his own government.)

In 1945, after the war, the allied nations got together and instituted a foreign exchange policy, mandating that each member country tie their respective currencies to the US dollar, while the dollar would be directly tied to the price of gold. This was made possible, not just because the US was victorious in the war, but because prior to US involvement, through international trade with the European war parties, the US had accumulated most of the world’s gold reserves. This policy agreement is known as Bretton Woods. The policy allowed the US dollar to become the world’s preferred trading currency – because it was pegged at $35 per ounce of gold, it inspired confidence among foreign nations. In fact, oil and other commodities were denominated in US dollars and transactions between other nations occurred in dollars, rather than either of their own respective currencies. This resulted in a steady increase of US dollars being held in foreign countries’ national reserves and thus began the steady recognition of the mighty US dollar around the world.

This situation would last until 1971, when the U.S. had reached a critical point in its accumulation of debt. In addition to the U.S military activity in Vietnam, it had developed a trend of buying more stuff from foreign countries than it sells. This meant that foreign countries were acquiring more U.S. dollars at a faster pace. So, as foreign nations began to recognize that the U.S. may not be able to make good on its dollar promises, the U.S. gold supply was threatened to be over-run. This is why, in 1971, Nixon stopped all convertibility and prohibited the foreign exchange of U.S. dollars for gold, thus killing any remnant that was left of a gold standard for the US dollar. And as for Bretton Woods – it’s also dead. Member countries now need to be content holding U.S. paper in their reserves in lieu of any gold promises. And worse, the US Federal Reserve is now free to print as many dollars as it sees necessary because there isn’t any tie between the US dollar and any amount of gold or silver.

This left foreign countries little choice in what to do with the US dollars they were accumulating in their reserves. The only constructive thing they could do was to buy US Treasury bonds – America’s debt. The US pays interest to foreign countries owning these bonds, which, as we will see, is becoming an unbearable problem.

Federal Reserve (Fed) – Easy money policies

The concept of having an American centralized banking system has been the subject of many heated debates among many of America’s forefathers. Whether or not the institution serves us well could be the subject of an entirely different discussion, yet today we have the Federal Reserve (Fed).

The Fed has been busy recently – very busy. The following chart is from the Federal Reserve Bank of St. Louis. (Note that since this article was first published in March of 2011, the money creation has marched even higher.)

This chart illustrates how much money the Fed has been creating since inception. Instituted in 1913, the Fed’s monetary creation remained relatively mild up until Nixon removed the last remaining thread of the gold standard in 1971. At this point, since there doesn’t have to be any gold backing the paper currency, there is nothing to stop the Fed from printing as much money as it needs for anything it desires. On the chart, one can also easily pick out the relatively tiny blip from the 9/11 disaster. But the thing that should really grab your attention is the unprecedented money creation that started with the ‘crisis’ of 2008! This monetary build-up has dwarfed everything up to that point.

So what caused this sudden spike in money creation?

If you recall, back in 2008, the US Treasury, Federal Reserve and leaders of about 10 of the biggest banking institutions had secret ’emergency’ meetings and pledged what they then said was $700 billion to stave off disastrous peril of our banking system. Turns out more than $3 trillion was actually thrown at the situation (and we aren’t even close to having solved any of the problems). Here are some of the articles that give more information about these bail-outs: Bloomberg, Washington Post and the Wall Street Journal.

Reading those articles, one can see at least two things that may be a bit surprising. First, the institutions getting emergency aid were not limited to the U.S. – there were plenty of foreign banks and institutions getting money from the Fed. Second, it wasn’t limited to banks, but included some large companies too, like General Electric and Harley Davidson. Apparently, US leadership bought into the idea that letting Harley Davidson Motorcycles go bankrupt would contribute to a disastrous peril of our banking system.

While it is true that many of the firms have now paid back the initial bailout funds, it should be noted that the Fed did not fully disclose all the information necessary to gain a complete picture of what happened. They did not indicate what each institution was putting up as collateral for this easy, low/no-interest money. This is probably because it was either toxic or non-existent. And all of that crap is still out there on the books, even though, according to those accounting rules instituted in early 2009, the books do not have to reveal the current market value (=0), but can mark them as what they would be worth if there were buyers and the economy was in good shape. If the truth were known, we’d have a full-on panic right now.

This leads us to the Quantitative Easing strategy the Fed has been employing.

QE-1) Soon after those bail-outs, from the end of 2008 to the beginning of 2010, the Fed purchased Treasuries and mortgage-backed securities to prop up Fannie Mae and Freddie Mac to the tune of approximately $1.5 trillion.

QE-2) On December 5th, in a 60 Minutes interview, Fed Chairman, Ben Bernanke said that he will keep printing money as he currently sees no other way out of this ‘economic slow-down.’ QE-2 is now underway, and if you think it will be limited to the $600 billion figure he’s mentioned, think again….. it will end up being much more! Here’s the 60 Minutes interview in case you missed it: Part 1 & Extended 2. He discusses deflation as being a real risk, which is heavily misleading. The Fed officially uses flawed techniques and data for measuring inflation (on purpose, of course), and deflation is actually a great thing for people who save their money. But the banks end up the losers in a deflationary economy and since the members of the ‘inner circle elite’ own all the banks, Bernanke will strive to protect them. In order to protect against deflation, the Fed is going to step in and buy U.S. Treasury bonds to the tune of $600 billion in the next 6 months, and probably continue afterwards. This, the Fed hopes, will keep interest rates down because as fewer foreigners are showing up to buy our ridiculous debt at these Treasury auctions, someone else has to step in and buy in order to keep those interest rates from climbing. (China, for example is becoming less willing to accept such low interest on US bonds, especially at such high risk due to the growing level of un-payable US debt.) Interestingly, this intended strategy has back-fired as interest on these bonds have been rising recently, indicating more problems ahead.

(By the way, if you like Jon Stewart, his take on this matter is highly entertaining – probably more so if you’re already somewhat hedged with your share of gold or silver.)

QE-3) We should expect to see at some point in the future a state and municipal bail-out package from the Fed. American cities and states are in a similar situation as that of the European community and will need to be bailed out soon.

QE-4) It is likely that the real-estate collapse will continue, so we might expect to see a bail-out specifically to prevent the banks from taking huge losses on un-sellable properties they’ve taken over. Once the ‘paper-work’ issues of the foreclosure crisis gets cleaned up, property seizures will most likely resume its rapid pace.

Concluding from all of this, the chart above has not yet finished it’s upward spike because, as already noted above, Bernanke is at this moment cranking up the printing presses again with QE-2 and will probably continue well beyond that point with QE-3, 4, …., n.

Most of the public hears these huge amounts of trillions of dollars and doesn’t even realize what is being discussed. But this page gives a nice representation of what a trillion dollars would look like if you were to have the physical cash stacked up in a huge warehouse somewhere. Yet the Fed acts as if all this cash is simply Monopoly money by its seemingly unending printing activities.

US Government – Deficit spending

After reviewing the Fed, some may wonder why we are now having a separate discussion on the government, as it may seem somewhat redundant. But contrary to popular belief, the Fed is not controlled by the US government. Rather, it’s an independent institution within the government. The Quantitative Easing strategies discussed above are separate from stimulus actions launched by congress.

The following chart is taken from, and was generated from US Treasury data. It gives a graphical view of the historical amount of US national debt since 1950.

How, in the name of God, did we allow our national debt to get to this ridiculous level? To understand what led us to this debt burden, we’ll now look at the wonderful world of politics and how it generates a perpetual cycle of government spending more than it receives in tax revenues.

Politicians rely on democracy to attain and retain their jobs. That is, to get elected, they must get the votes. To get the votes, they make promises. Candidates have been notorious for making promises to benefit a certain demographic or a certain group or organization.

In order to get elected, candidates avoid the difficult questions like those put to them about the fate of Social Security or Medicare, which face revenue declines and beneficiary recipient increases. They know that the demographic relying on continued benefits from these programs do not want to hear that those life-lines may be cut. So, they remain silent.

To make matters even worse, some organizations sponsor certain candidates by donating money to their election campaign funds. And in early 2010, there was new legislation passed that allows unlimited funding in this manner. In turn, this sometimes makes the elected officials somewhat beholden to those organizations and they are easily swayed by lobbyists – another tool used by organizations to subvert US lawmaking.

The result of all these kinds of politics is that candidates do not think long-term. They only concentrate on what will keep them in office in the near term. They avoid discussing the real cuts that are necessary to reduce the deficits, because they would be too painful for many citizens, which in turn, would not be good for their political careers. So they spend money the government doesn’t really have in order to satisfy the voters – they borrow from the future, believing that by the time the debt comes due, either it will be someone else’s problem or there will be some other distraction to avoid attention and extend debts even further.

To understand this political impact on the US national debt, let’s examine some of the recent programs and stimulus packages that have been launched by the US government.

Emergency Economic Stabilization Act of 2008: Under President George W. Bush near the end of 2008, this was a $700 billion dollar package initiated in response to the subprime mortgage crisis that threatened to bring down the banking system, as already described above, under the Fed’s action to bail-out the financial sector. (Included in this action was the Troubled Asset Relief Program – TARP – which was set up to take toxic assets off the banks’ books.)

American Recovery and Reinvestment Act of 2009: Under President Barak Obama in early 2009, this was a package of nearly $800 billion to stimulate the economy. The US consumer was tempted by ‘cash for clunkers’ (=$3 billion) and home buyers tax credits (=$22 billion). Jobless benefits were also extended due to the seemingly never-ending unemployment outlook (=$319 billion).

Patient Protection and Affordable Care Act: With a democratically-dominated congress, this health care reform bill was passed and signed into law by President Obama at the end of March, 2010. The package has been estimated to be a cost of $1 trillion over the next 10 years. It is still unclear where this money will come from because there are still legal battles being fought over the finer points of the measure.

Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010: Again under President Obama, this package extends the tax cuts initiated under President Bush and has an estimated price tag of $858 billion. Tax cuts are usually welcomed by citizens, but can we afford it?

Here’s a neat page that shows the US national debt in real-time. As you can see it is now over $14 trillion. [Note: Written in 2011] But as the page also shows, that’s only our so-called discretionary spending. If you were to include unfunded, mandatory spending (interest payments on the existing debt, Social Security, Medicare, state and municipal debt, etc.) the US national debt has a number closer to $50 trillion! This is a deep hole to dig ourselves out of, considering the annual budget projections for 2011:

$2.6 trillion
$3.8 trillion
$1.2 trillion

It’s getting a bit absurd, isn’t it? The US is already slated to spend $1.2 trillion more than it has for 2011 on top of an existing published debt of nearly $14 trillion. Until the politicians are willing to face this reality and stop acting solely on their own concern for future votes to remain in office, they will never be able to make the difficult decisions to reduce the deficit enough to pay down this debt. Tax cuts and welfare benefits are nice, but if drastic spending cuts are not made, the only way to pay for these nice things is to debase the dollar further by printing more money.

American Consumers Increased their Personal Debt

The economies of the world have been increasing their dependence on debt. As we have seen, the US has been leading the way. The policies employed by the US Fed, keeping interest rates at record lows, and the government, passing stimulus packages, have been relying on the consumer to keep the economy running by spending their money – money they don’t really have – on new cars, new houses, new appliances, etc. They are hoping that this spending will counteract the recent downturn in the economy. But most consumers are either waking up to the fact that they are already stretched too thin or the banks have become more restrictive in their lending due to their own balance-sheet problems.

Since the turn of the century, the Fed’s policies have made the acquisition of credit extremely easy, which meant more people could buy expensive homes at inflated prices. It wasn’t until the sub-prime mortgage crisis started to hit in 2007 that people started to realize that the large increases in home values were basically an illusion. Real-estate prices had been going higher simply because the banks were willing to lend ever increasing sums of money to people, many of whom had questionable credit worthiness. At some point, this so-called housing bubble had to burst, which it has and will probably take a while to correct.

As a result of this mess, more consumers are finding that they are too far in debt and struggling with their finances. The chart below is from NPR. Immediately below is the historical household debt for the US consumer, which has been steadily rising, but has begun to taper off in recent years. This may indicate that the consumer is either unable or unwilling to take on new debt.

The consumer is not spending at the rate they had been in the past. And their savings rate, although seemingly on the rise in recent years, is still far below overall average historical savings rate of 8% of disposable income. It should be noted that there is little encouragement coming from the Fed and banking institutions – they are not providing the incentives to motivate people to save. Interest rates on savings accounts are averaging only about 1.1%.

All this, combined with the poor unemployment outlook, reveals the real reason why the Fed and the US government have subsequently accelerated their monetary expansion in the last few years – they must replace the consumer as the primary economic engine by spending enough to close the gap. In fact, the slight (and temporary) positive affects in the economic data recently are solely attributable to government growth, not growth of any significance in the private sector.

Inflation Gradually Destroys the Value of the Dollar

With the Fed repeatedly going to the printing press to gin out more paper money, the government’s unwillingness to divert from its deficit spending sprees, and the average citizen unable to balance personal spending with adequate savings, one has to wonder what all of this is doing to the value of the dollar.

This chart shows what has happened to the US dollar’s purchasing power since the Fed’s inception in 1913. Using the US government’s measure for inflation – the Consumer Price Index (CPI) – the dollar has lost 96% of its value over the last 100 years. And with all that has been discussed above, it looks like this trend will continue until the dollar debasement is complete.

Other Countries’ Currencies are in the same Boat

The US dollar is definitely in decline, as should be obvious by now. But it’s not alone. At this time, all major currencies around the globe have departed from the gold-standard and adopted fiat currencies, with no backing other than the trust in their respective governments (with the possible exception of Malaysia, now experimenting with new gold and silver currencies).

A government subscribes to the use of fiat currencies in order to be able to spend money it doesn’t have. It simply prints up money when it needs to expand governmental programs or go to war. The governments will be successful in this effort as long as the public ‘trusts’ their leaders to be fiscally responsible. But citizens all over the world are waking up to see that their leaders are corrupting and debasing their currencies by printing too much paper money.

Case in point: Europe. Recently, starting with Greece, the European Union has been struggling with too much debt among some of its weaker member states. The so-called PIIGS countries (Portugal, Ireland, Italy, Greece and Spain) are so far in debt, that it has caused genuine concern that their debt problems might end up breaking up the union and throw the Euro, that relatively new currency of the European bloc, to the garbage bin. So the EU along with the International Monetary Fund (IMF) launched a $1 trillion package to save the union and the Euro. And, by the way, the US and other countries around the world contributed to that bail-out package via the IMF.

Unfortunately, this $1 trillion dollar European bail-out package is not sufficient to save all the EU countries in trouble. First, the fund really isn’t as big as $1 trillion, because the member countries contributing to the bail-out fund include the countries being bailed out! (How can a country that doesn’t have any money make any contributions to help pull itself or another country out of the crisis?) Second, Greece and Ireland have now taken approximately $250 billion out of the EU package. It’s estimated that Portugal will take out another $100 billion. Then, once Spain and Italy start down the same path, the fund will need to be increased because the expectations there are $450 billion and $1 trillion, respectively. Because of the US banking industry’s exposure to European debt, the US may once again be asked to join with the IMF to help prevent the European Union from collapsing by giving more monetary aid. The IMF, in fact, has already suggested an increase in the bail-out fund in anticipation of Spain’s debt problems.

Sound familiar? It’s the same story, just different geography.

By printing more money to resolve their debt problems, countries are actually temporarily benefiting themselves because their weaker currencies enable
stronger exports
. But again, this is only temporary. As other countries recognize this trade impact, they too will take actions to devalue their own currencies to improve their trading and economic activity. The net result is a global currency war – a race among all nations to devalue their currencies against each other. In such a global economic environment, all individuals who keep their wealth in financial instruments denominated in fiat currencies will suffer the biggest losses. On the other hand, owners of hard assets such as gold and silver are able to preserve their wealth.

Historical Similarities to Current Political and Monetary Policies

As Rome began to fall, there were similar things happening that we see today in our modern society. There was a kind of welfare system, allowing for the dispensing of free bread to those that qualified. Additionally, the Roman republic had a tax system. Included in that system was a taxation of farmers where a certain percentage of crops had to be given for the purposes of feeding the civil servants and soldiers. As this tax percentage increased due to these welfare programs and war activity, farmers began to feel the pinch and decided it was better just to grow a small amount for their own family, and perhaps a bit more for the sake of the government. But soon, the laws were changed so that a farmer had to give a certain tax percentage according to the size of the land the farmer had – so it forced them to work even harder – and for less return on their labor. As this continued, farmers were walking off their land, giving it up and moving away – expatriating.

In addition, the Roman currency, the dinar, was similarly devalued over the course of the empire’s history. At first, Rome used 4.5 grams of pure silver as their coins’ material base. But as the empire grew, so did the debasement of their coinage. Nero decreased the silver content to 3.8 grams – a debasement of about 15%. About 215 AD, a new coin was introduced with only 60% silver content (a 40% debasement). As the empire’s wars went on, the coin’s debasement continued and by 260 AD it was down to 20-40% silver content (a 60-80% debasement). It got worse – they
started issuing bronze coins with silver plating by the millions. In 301 AD the coins issued were only 2% pure silver (a 98% debasement).

In Germany, during the Weimer Republic, the German mark was similarly debased and even resulted in hyperinflation. In 1914, it only took 5 marks to equal one US
dollar. But by 1923, the Weimer government had printed so much paper money that the mark hyper-inflated to a level of more than a trillion marks to the dollar!

There are numerous other examples in history of nations inflating their currencies to death: the French assignate during the French Revolution; the Chinese yuan during the period after 1934; and just recently during the years between 2003 and 2008 in Zimbabwe.

In view of all these monetary fatalities, it seems many of today’s nations are on the same path using similar currency practices and political policies, with the US leading the way with the debasement of the dollar.

Conclusion: Precious Metals like Gold and Silver Provide Protection

After understanding the issues above, one does not need to be an economic genius to see that the price movement of gold and silver is not due to the changing values of those metals. Rather, it’s the value of the dollar and all other fiat currencies that are collapsing! Precious metals act as a hedge against inflation and the destruction of a fiat currency.

In our current world economic situation, it really is a necessity to own physical gold and silver. However, it is not suggested that one rush out and buy these precious metals at any price. Nothing ever goes up or down in a straight line. There will be inevitable corrections, which should be utilized by the intelligent investor to add to existing holdings. Given that the fundamentals discussed above do not change (and at this point, there is little chance of the kind of changes necessary to turn things around), in the intermediate to long term, the value of these precious metals will continue to rise in relation to the world’s baseless fiat currencies.