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Unlike the world’s currencies, gold retains its value
In a speech I recently gave at The Empire Club of Toronto , I referred
to gold as the "anti-currency." Gold is not and never has been a
currency. Gold is something entirely different and far more valuable. It is
money.
"If you're holding paper currency, you have to have some kind of
trust that the country that issued it is not just going to print its way out
of its problems. That's a real concern right now. Gold, on the other hand,
has real intrinsic value, unlike a paper currency which can be debased by its
government."
– Sacha Tihanyi, currency strategist, Scotia Capital
Currency versus
money
Most investors confuse money and currency, but they are not the same
thing. Money is defined as a medium of exchange, a unit of account and a
store of value. For centuries, money referred to coins made of rare metals
(gold and silver) with intrinsic value, and to notes backed by precious
metals.
Currency, while it is a medium of exchange, is not a store of value.
It only derives its value by arbitrary fiat - government decree and
hence the term “fiat currency”. Paper banknotes represent money
but they are not money. They are simply promissory notes whose long-term
“value” or purchasing power depends entirely on the fiscal and
monetary discipline of the government that issued them.
And therein lies the problem. In an era of massive fiat currency
expansion by profligate governments across the globe, today’s
currencies are depreciating in value faster than yesterday’s news. Fortunately
for precious metals investors, gold and precious metals have risen in value,
and will continue to rise in value against all currencies because they have
once again resumed their historical role as stores of value: money.
“When the price of gold moves, gold's price isn't moving;
rather it is the value of the currencies in which it's priced that is
changing.”
– John Tamny, economist, H.C. Wainwright Economics
The decline of
the world’s currencies
Currency debasement isn’t a recent phenomenon. For decades,
governments around the world, through their central banks, have been creating
money out of thin air to cover their excessive spending and mounting debt.
Investors have for the most part accepted this subtle form of taxation,
because it seemed to have little personal impact. But appearances are
deceiving. Investors are discovering that the value of their
dollar-denominated assets has actually declined a staggering 82 percent since
1971 (not coincidentally, the year the US cut its link to the gold standard).
Figure 1 tells the
story.
The media are
using the wrong measuring stick
Every day, the media (via currency traders) informs Canadian investors
about the latest price of the Canadian dollar in US dollar terms, while US
investors compare the US dollar to a basket of the world’s major
currencies. But this information gives investors surprisingly little
insight into the true value of their portfolios. If we started measuring
the world’s currencies against money (i.e., gold), investors would be
horrified at the stark decline in the value of all currencies. Most
investors’ portfolios are heavily weighted towards currency-denominated
financial assets (stocks and bonds), but few realize that the true value or
purchasing power of their portfolios is declining every single year because
of currency depreciation.
The rate of
currency decline is accelerating
Since 1913 (the year the US Federal Reserve was established), the US
dollar has lost over 95 percent of its value. The US and Canadian dollars
have lost 82 percent of their value since 1971, as noted earlier. But the
rate of currency decline is now accelerating.
In the past ten years alone, the US dollar, the Canadian dollar, the
UK pound and the euro have collectively fallen 70 percent in value if
measured in real (currency-debased) terms. In other words, when they are
priced in terms of gold (Figure 2).
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It’s all
about the (fiat currency) money supply
Not too long ago, all the world’s major currencies were backed
by gold because it was a universally recognized store of value. The gold
standard imposed fiscal and monetary discipline, since each country had to
hold enough gold to equal the amount of money in circulation. But not any longer.
Government spending around the world is exploding, and (fiat currency)
money supply, along with government debt in the world’s major
economies, is exploding along with it. But nowhere in the world has
spending become more out of control than the US (Figure
3), where the monetary response to last year’s financial
crisis is creating yet another bubble, and this time it will be the bubble
to end all bubbles.
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Countries are
increasingly at risk of sovereign debt default
“In the process of saving a few ‘too big to fail’
corporations and their bond holders, policymakers are greatly increasing
the risk of sovereign defaults.”
– Puru Saxena, editor/publisher, Money Matters
The risk of massive and widespread sovereign debt default has never
been higher. “Official” US government debt has soared to 90
percent of GDP, while multi-trillion-dollar budget deficits for the next
several years will send that number soaring. Japan, the world’s
second-largest economy, was recently put on credit watch. Its debt is twice
total GDP, yet its newly elected government has announced much higher
spending for 2010. The UK’s 2009 budget deficit will be over 14
percent of GDP, adding to a net debt that will reach 56 percent of GDP this
year, 65 percent in 2010 and 78 percent by 2015.
Spain, Italy and Portugal are facing major fiscal deficits, as is
Eastern Europe. Dubai is billions in debt and its prize jewel, Dubai World,
is bankrupt. Greece's credit rating has been slashed, and its debt is
forecast to reach 130 percent of GDP. And then there is Iceland, whose debt
had exploded to seven times GDP before the global meltdown. The
country’s banking system has now collapsed, its currency is deeply
devalued, its real estate market has imploded and the country is in a
full-blown economic depression.
The incredible
shrinking dollar
As the world’s reserve currency, the US dollar is a proxy for
the rest of the world’s currencies. The dollar’s decline is a
direct reflection of America’s deepening financial troubles,
exacerbated by a ravaged banking system that, by 2010, may see over one
thousand banks insolvent. In 2009, the US incurred a budget deficit of $1.4
trillion, and its debt rose by $1.9 trillion due to off-budget
expenditures. These off-budget expenditures alone were more than the 2008
budget deficit. At the end of 2009, America’s total debt was over 100
percent of GDP.
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In their attempt to reflate the bubble-driven economy, President
Barack Obama, Fed Chairman Ben Bernanke and Treasury Secretary Tim Geithner
have decided to add to this financial house of cards. Instead of raising
taxes or cutting expenditures, they have decided to borrow their way out of
the problem and have the Fed create money out of thin air, which will
almost certainly create another bubble. This bubble will make the others
pale by comparison and will help destroy the US dollar. The dollar may be
the world’s reserve currency, but China and other countries are not
only questioning its status, but also actively campaigning for greater use
of alternative currencies.
Investors are
demanding real money
Where are most investors putting their cash? It should no longer be
in stocks. Key stock indices like the Dow Jones Industrial Average have
been flat to negative in nominal terms since the end of the last century.
But if the Dow is priced in gold (in other words, money) as opposed to
depreciating dollars (in other words, fiat currency), its decline is far
more dramatic. As Figure 4 shows, the Dow:Gold
Ratio is not only in a downtrend, the downtrend is steepening which
is a continuing indicator to move from equities to bullion.
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Global creditors who currently hold trillions of dollars’
worth of dollar-denominated financial assets are dumping them to preserve
their wealth. That is why gold bullion, along with its precious metals
cousins, silver and platinum bullion, have been consistently keeping their
value against financial assets (Figure 5).
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Central banks
are buying gold bullion
"We have a market-friendly Fed injecting a lot of liquidity in
the system which will set us up for another bubble economy. Excessive monetary
accommodation just takes us from bubble to bubble to bubble."
– Stephen Roach, chief economist, Morgan Stanley
India recently bought 200 metric tonnes of gold bullion from the International
Monetary Fund for $6.7 billion. Russia has recently added 120 tonnes of
bullion to its reserves, while China has steadily (and surreptitiously)
increased its gold bullion reserves from 600 tonnes in 2003 to 1,054 tonnes
today. China is even urging its people to put five percent of their savings
into gold and silver because it is so worried about the dollar. And because
trillions of dollars of its reserves remain in US dollar-denominated
assets, China’s central bank will be diversifying into gold for many
years to come.
The world’s central banks know that gold is primarily a
monetary asset, not a commodity. That’s why a growing number of them
are quietly diversifying out of US dollars and adding to their 29,000
tonnes of gold reserves.
In its 2010 Precious Metals Outlook, Scotiabank noted that
“seeing the value of the dollar steadily erode must be a nightmare
for large US creditors such as China, Japan, South Korea, Russia, the oil
producing countries and Sovereign Wealth Funds (SWF)...
Major investors
are diversifying into gold
“Both China and America are addressing bubbles by
creating more bubbles and we’re just taking advantage of that.”
– Lou Jiwei, Chairman, China Investment Corporation
It is not just governments that are dumping dollars for bullion. A
rapidly growing number of sovereign wealth funds (including China
Investment Corporation) are participating, as are major institutional
investors. Hedge fund manager John Paulson, who made $3 billion in 2008 by
shorting subprime mortgages, recently took a multi-billion-dollar position
in gold as a hedge against inflation. Northwestern Mutual Life Co.’s
CEO Edward Zore said his company purchased $400 million in gold (the first
time in its 152-year history) because “the downside risk is limited,
but the upside is large. We have stocks in our portfolio that lost 95
percent. Gold is not going down to $90."
Hedge fund manager David Einhorn, through his Greenlight Capital
fund, has sold gold ETFs in order to invest in longer-term and lower-risk
gold bullion because of current US economic policy. Lone Pine Capital
significantly increased its stake in gold this year. Perhaps of even
greater interest to the unwary investor is a survey of US hedge fund
managers by London-based Moonraker Fund Management: 90 percent (20 of the
22) of the hedge fund managers surveyed admitted they had bought physical
gold for personal investment. These sophisticated investors know something
that the average investor doesn’t: that the global policy response to
the financial crisis will not only devalue the world’s major
currencies, it will decimate the US dollar.
Many investors
still view gold as a commodity
Individual investors are not so farsighted – yet. Because most
of them have only experienced one kind of market – a 25-year bull
market in stocks – many still think gold is just a commodity like
copper, zinc or pork bellies. But gold is far more than that. It has a
3,000 year history as money; for much of that time, it was the universal
medium of exchange because of its divisibility, portability, rarity,
beauty, malleability and indestructibility. Despite today’s negative
sentiment, gold is not a speculation or a barbaric relic. Gold is money.
Gold retains its purchasing power year after year, as
Figure 6 shows.
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Forty years ago it took 66 ounces of gold to buy a compact car.
Today it takes only 14 ounces. If you had put your money in gold instead of
dollars, the same car would actually be 79 percent cheaper, because gold
keeps its value. Houses, stocks and virtually every other asset on earth
would also be cheaper if bought with physical gold.
The more investors learn about bullion, the better for their
portfolios. If you are already a bullion investor, now is the time to add
to your portfolio. If you are new to investing in bullion, now is the time
to start dollar-cost-averaging into bullion. I encourage investors to learn
as much as they can about bullion and about the markets in general. A good
place to begin is the Learning Centre section of our website (www.bmgbullion.com). It offers a
comprehensive look at the economy, money, markets and bullion investing,
and provides a variety of thought-provoking articles written by experts in
the field of gold and precious metals.
Gold is money
Gold is money because it cannot be created out of thin air by
government decree. Unlike bonds, gold does not represent someone
else’s liability and, unlike stocks, gold does not rely on someone
else’s promise of performance. Gold is money because, unlike
currencies, impatient monetary policymakers cannot change its value. The
rising gold prices we have experienced for the last eight years do not
signal a bull market in precious metals, but rather a vote of decreasing
confidence in the future value of paper currencies.
Currency-denominated financial assets are a disaster waiting to
happen. The current economic rebound is a mirage, being entirely dependent
on something artificial and unsustainable: massive government spending. A
new crisis is building out of unprecedented fiscal and monetary
mismanagement. Fortunately, smart investors can protect their wealth from
the coming storm. The true level of risk has not been priced into the
markets. The time to shelter your wealth from the storm is now. And there
is no safer investment on earth than bullion, because bullion is and always
will be money.
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Nick Barisheff
Bullion
Management Group
Nick Barisheff is the co-founder and President of Bullion Marketing
Services Inc., which was established to create and manage The Millennium
BullionFund. The fund is Canada’s first and only RRSP eligible open-end
Mutual Fund Trust that holds physical Gold, Silver and Platinum bullion www.bmsinc.ca
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