As published in Money Magazine March 2010
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).
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.
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.
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.
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).
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.
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.
1 Gold Outlook for 2010
Gold Resuming its Historical Monetary Role - as the Anti-Currency
http://bmgbullion.com/document/648
