by: Nick Barish
effMarch 17, 2010
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.
(Click to enlarge : http://static.seekingalpha.com/uploads/2010/3/17/saupload_844_thumb1.jpg )
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).
(Click to enlarge: http://static.seekingalpha.com/uploads/2010/3/17/saupload_845_thumb1.jpg
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 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.
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.
(Click to enlarge:http://static.seekingalpha.com/uploads/2010/3/17/saupload_848_thumb1.jpg)
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
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