The Ultimate Store of Wealth
Gold is immune to inflation as it is a real, tangible, indestructible natural element, limited in supply and unable to be counterfeited.
Precious Metals (primarily Gold and Silver) have been the ultimate store of wealth, currency of international exchange, and sound money in its purest form for over 5000 years. Gold was the Reserve Currency of the Global Financial system until President Nixon defaulted on US International financial obligations and removed gold as backing of the US Dollar. Since 1971 the world has operated under a Fiat Currency regime where money is issued at will. In 1971 an ounce of gold cost $35 yet today it is upwards of $680 for that same ounce, a devaluation of the dollar versus Gold by over 90%. Pity those who stored their wealth in US "paper" dollars rather than precious metals.
Heavy emphasis is placed on economic and financial history in formulating my investment rationale. The 1965-1980 period in which gold rose by over 2500% is a case in point. The London Gold Pool, the Vietnam war and massive deficit spending tell a tale familiar to many observers today. Today's economic environment dwarfs the preconditions of past massive movements. More paper dollars chasing limited metal supply must send prices higher. The law of supply and demand will always prevail, eventually.
The underlying premise of my investment strategy is that there has been a rebalancing of the excessive monetary and fiscal "liquidity injections" into the US economy over the past 20 years. Subsequently, liquidity will eventually flow into sound money: gold and silver. Precious metals are presently denominated in US Dollars so the US dollar must devalue against gold and silver - there can be no other logical conclusion. Every fiat currency in human history has failed disastrously: from Kublai Khan in the 1400's; to John Law's French fiasco in the 1700's; the infamous hyperinflation of Weimar Germany in the last century; and recently the South American currency meltdown. Inflation is by definition wealth destructive, yet today we have Central Bankers creating inflation through their monetary policy with a stated target of 3%. The gap between 'official' CPI and 'experienced' inflation has lead to dramatic asset devaluation in real terms. For official statistics and public prognostications to declare that "inflation is muted" is ridiculous to the point of deceit.
Former Federal Reserve Chairman Alan Greenspan himself wrote in 1966 in his essential essay Gold and Economic Freedom:
"The abandonment of the gold standard made it possible for the welfare statists to use the banking system as a means to an unlimited expansion of credit… In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value… Deficit spending is simply a scheme for the 'hidden' confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists' antagonism toward the gold standard."
Yet under Greenspan's stewardship, the US Federal Reserve affected the greatest increase in debt via expansive monetary policy and easy credit that the world has ever seen, more than the combined legacies of every other Fed Chairman combined. The USA has fallen from the world's largest creditor in 1970 to the world's largest debtor in just 30 years. This profligate expansion of the money supply brought us the Tech Bubble of the late 1990's, the current property and equity bubble, and the massive unsustainable debtloads being carried by government and consumers globally.
As France was destroyed by Fiat currency inflation in the 1700's, Voltaire declared - "Paper money will always return to its intrinsic value. Nothing." Today's US Dollar is no exception to this rule. While monetary aggregates have exploded in the past decade, creating a credit bubble and monetary inflation of historic proportions, the Federal Reserve has recently eliminated reporting of its monetary operations. However, nothing can be more transparent than Precious Metals - you either have it or you don't.
Recently appointed Federal Reserve Chairman Ben Bernanke said in 2002 that "The US Government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many US Dollars as it wishes at essentially no cost" and that he is prepared to "throw dollars out of helicopters to fight deflation." In the current monetary environment such a historically ignorant statement appears irresponsible at best, and dangerous to wealth preservation at the very least. There can be no "strong dollar," as asserted by Treasury Secretaries Rubin, Snow and others, while ever there is no fundamental backing to such dollars. All that remains is a shrinking tax base to cover ever-increasing government expenditures and debt, and an unsubstantiated confidence that it will not fail.
"Deficits don't matter"- says Dick Cheney, the Vice President of the USA. I beg to differ. Deficits ultimately destroy the currency of any country that does not address them. Paul Volcker in 2006 said "The circumstances seem to me as dangerous and intractable as any I can remember, and I can remember quite a lot...I don't know of any country that has managed to consume and invest 6% more than it produces for long." He was chairman of the U.S. Federal Reserve from 1979-1987, when gold hit $850 an ounce, which is equivalent to $2300 per ounce in today's money. One cannot print and borrow one's way to prosperity - a historical fact that cannot be denied.
The world is awash with US dollars looking for a home. China alone owns over 1 Trillion dollars in US Government debt and is talking of Reserve diversification including increasing its gold holdings. They have accumulated these currency reserves in what has been described as a massive "vendor financing scheme." Japan, India and Russia are all operating similar schemes to transfer goods and services into precious metals via American debt. The list goes on.
The US Government has incurred more than US$50 Trillion (that's fifty thousand billion or $50,000,000,000,000) of unfunded domestic liabilities, payable in the next 15 years in the form of social benefits promised to the Baby Boomers reaching retirement age. The US' current account deficit is annually over 700 Billion dollars, growing exponentially. The apparently endless War on Terror is costing billions per month and not one spending bill has been vetoed by the current President since he has taken office. US Debt is now greater than GDP for the first time in history. How can this debt be repaid? The US Government must increase taxes, reduce spending, rely on the benevolence of its creditors or continue printing more money. Surely, the USA does not intend to default on its debt twice in 40 years.
Gold is immune to inflation as it is a real, tangible, indestructible natural element, limited in supply and unable to be counterfeited. Gold is the purest form of money and a store of wealth without comparison. Alan Greenspan himself said as recently as 2002 that "Gold will always be the financial asset of last resort." I am of the opinion that "last resort" has arrived.
The past decade has seen significant sales of physical gold by Western Central Banks, dramatically altering the supply-demand equation during this time period. Derivatives, gold leasing and forward selling exacerbate the issue, by bringing forward or front loading future supply. The underlying physical gold is now in other hands. The prospect of future official gold sales is minimal in my opinion, in fact I see a reversal of this phenomena going forward with at least one Euro zone Central Bank confirmed as a buyer last month. The political environment in central banks is resisting exposure to the risk of US dollars in favor of the stability of Gold. There are simply too many dollar holders looking to buy gold should any large chunks of metal be made available.
Conversely, global gold production is in serious decline with major producers such as South Africa, Australia, Canada and the USA all reporting significant production declines in recent years. There is less than 2600 tons of gold produced per annum with demand north of 4000 tons and rising. Global exploration has been muted over the past two decades due to low metal prices and lack of capital. Reserve replenishment will be difficult to achieve for the major mining houses without significant consolidation of the exploration sector.
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