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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
Stephen Roach,
the chief economist at Morgan Stanley, said:
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.
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:
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
Lou Jiwei, a
Chairman of China Investment Corporation, said:
Both China and
America are addressing bubbles by creating more bubbles and we’re just
taking advantage of that.
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.
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.
Disclosure: No
positions
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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