If my grandfather, as a young man, had gone to a Federal Reserve bank with a $20 bill, he would have received a $20 gold coin. Now worth at least $600 in paper money, that coin can buy about as much basic goods and services now as it did back then. If my father, as a young man, had gone to a Federal Reserve bank with a $20 bill, he would have received a pile of silver coins. Assuming no numismatic value, that silver would be worth about 170 paper dollars now. If I now go to a Federal Reserve bank with a $20 bill, I get a ten and two fives. The dollar has slowly but surely devalued over time. I'm talking about the paper kind, of course. A dollar is not a dollar is not a dollar.
So many of you want to know the answer to the immediate question: what should I buy/sell NOW to take advantage of the extended bull market in precious metals? That is not the point of this article. I'm not a short-term trader. Who would have thought that the gold would have gone parabolic to a peak in a seasonally weak time, in spring 2006? Not me. Back then, I read more than one article predicting that gold would hit $1000 imminently. Oops. I guess "imminent" now means at least six months. Too many short-attention-span Americans get "into" investing, want instant gratification, and then get out as soon as they get confused, lose money, or both. Too many folks delve into the details about particular asset categories, while losing sight of why they're deploying dollars. The internet makes information fast and cheap. Knowing how to think is more difficult than ever. Here, I want to change how you perceive paper money, not give you a hot tip.
Why is diversification away from the dollar important? Taking the big picture one level higher, you must understand that the money you have in your wallet, purse, and/or bank account is not real money. There is nothing tangible behind the paper dollar! It's just play money, like adult Monopoly money. That colorful $20 bill in your wallet or purse is a coupon redeemable at all locations near you. For now, anyway. Those ignorant, unconvinced folks who give me a half smile and a blank look when I tell them it's not real money will be in for a rude awakening when their belief system reveals its poor foundations. These terminal consumerists think, "Well, when I go to the mall, they accept my (paper) money, right?" They have been living with worthless paper money all their lives. They stubbornly stay in their comfort zone. They take for granted that their “money” has purchasing power while the game is going on. What happens when the game is up?
Many folks are vaguely aware that a place called Fort Knox somewhere has a lot of gold in guarded steel vaults, and that somehow that gold backs the paper money. Eeeeehhhhhhh (goes the buzzer). Wrong. You have no claim on that gold with your paper. Its function is less monetary and more strategic, like the strategic petroleum reserve. Why does there exist serious risk of a lifestyle-destroying currency crisis in your future? Most Americans take for granted that monthly bills just keep rising. They know it as "inflation” -- measured by, of course, the Consumer Price Index. What they believe is that the price of everything (except, you guessed it, consumer electronics) is going up. In reality, the value of their money is going down. Too many people know the price of everything, and the value of nothing.
Paper dollars can be printed at will by the US Treasury on behalf of the Federal Reserve bank. Check it out at www.moneyfactory.gov. Your $20 bill says “Federal Reserve Note.” A limited supply of gold doesn't regulate paper money production anymore. Not only that, but money can be created electronically by the Federal Reserve. A few mouse clicks lead to the purchase of billions of dollars worth of US Treasury debt with cash created on a memory chip. These electronic dollars don't necessarily have to be created according to the ability of a growing US economy to absorb them. They can be spontaneously generated by the financial and/or political expediency of whoever can order that certain button sequence on a computer.
The “Fed” is not part of the US government, not answerable to the public, let alone the US Treasury. It is a quasi-governmental institution of banks and bankers. The twin towers of a US federal government budget deficit and the US trade deficit require payback someday. These bring risk to dollar holders. Trying to avoid economic slump with infusions of monopoly (i.e. "fiat") money, the Federal Reserve, in cooperation with an obliging Treasury and a profligate Congress, tries to paper over the problems. But like someone on drugs, it takes more and more to get high. Postponing the withdrawal will just make it that much worse. Delay also makes a discontinuity, rather than a smooth transition, to a balance point more likely.
Only faith backs the dollar. Therein resides the truth that the powers that be don't want the middle class to know. The government won't lie to you about the paper dollar. In fact, most Americans don't WANT to know. Just look what happened when President G. W. Bush explained that there were only IOUs in the Social Security Trust Fund. Everybody put their hands over their ears! They were so busy with their own entertainment, trendy issues, crowd following behavior, and narrow thinking, that they had no room for anything that questions their previously conceived notions. Educated adults too often stop thinking independently. Not that rich people think any differently. They pay smart financial advisors to do their thinking for them, so that when some crisis erupts, the money can leave the bank/country instantly. Money, like water, always finds an exit. All the feds must do to hide the truth in plain sight is to hold a press conference before the crisis erupts.
So, Mr. DiFalco, should I cash out and buy gold and silver? Stop that, I say! Think before you act. Problem is, precious metals can get overextended in price relative to other things (which amazingly can include the paper dollar at times) due to market manias. If you panic and buy in at the wrong time, like 1980, or maybe in another spike a few years from now, you might die before you ever see a profit. Markets can be erratic, illogical, and overcompensating. Knowing the big picture about currency--which is broader than a long term view of a particular market--helps prevent panic buying. Also, gold is less liquid than paper dollars, requires safe storage, and earns no interest since it’s only a store of value. That’s precisely the point! The idea that paper cash is trash frees me to think of alternatives of which to take advantage when the opportunity presents itself. More than just bullion coins, they include gold exchange traded funds, commodity ETFs, foreign currency CDs, international bond funds, foreign bank accounts, and even 90 day Treasury bills. Derivatives such as options, and equities such as mining stock mutual funds, are different than simply stores of value, and are beyond the scope of this topic. What I'm telling you to do is to reshape your head before you reallocate your portfolio. Why is a more important question than what. Monopoly money does not retain its value.
The average American either refuses to listen to what I'm communicating, or believes I'm unpatriotic for questioning the foundation of the greatest economic engine in the world. If you want to be patriotic, consider US one ounce gold and silver bullion coins. The "uncirculated," as opposed to the "proof" versions, sell for near the price of the metal and have no numismatic (“collectible”) premium. They are real money. As long as there has been civilization, gold and silver coinage has been the foundation of a stable monetary system. The US Mint (ironically part of the US Treasury) has been making "American Eagle" bullion coins for the last 20 years. Where have you been? If you need them, they are right in front of you. The choices in your monetary toolbox are many. Be resourceful. Don't be average.
Oh, but Mr. DiFalco, what do I do with my money today? Foreign currencies? If you're still asking these questions, you're still not in position to survive wild gyrations in the purchasing power of the US dollar, let alone profit from them. That requires opening your mind. In fact, we did have a soft devaluation in the 1970s. That was a decade when the US government cut the final link of gold to the dollar, and when silver coinage disappeared from circulation. Double digit, economy-crunching interest rates stopped that spiral. I hope we don’t see that 70s show again. It's not that paper currencies outside the US are intrinsically more valuable. Most are just better managed by their institutions. Paper money not denominated in US dollars suffers the same fundamental flaw. People should view foreign currencies as investment tools in the toolbox, ready to be used if needed, not as safe havens.
Does my pounding the table about the worthlessness of paper money mean that I think all roads lead to hyperinflation? It's not that simple. Don't get stuck in the typical American rut of "binary thinking"--gold/paper, inflation/deflation, buy/sell, happy/panic, good/bad, home team/visitors, cold/hot, north/south, us/them, yes/no, black/white, left/right. As there are more points of view in 3-dimensional space that just two, you need to rise above lazy mindedness. Betting all your chips on red or black, even if you hedge your bets, you might still lose. The markets love to frustrate conventional thinking. Double 0 green, you lose! Laser focusing on one investment or one theme is gambling.
Perhaps there will be a series of inflation waves culminating in the “big one.” However, a pernicious combination of inflation and deflation in rapid succession would catch many market literate people off guard. For example, wrapped around a US dollar crisis in the global markets, the middle class shrinks as a sudden jump (i.e. tens of percent in less than a year) in prices segues into a do-or-die dollar defense with double digit interest rates. Or in reverse order, an economic shock leads to a cascade of credit defaults, deflation, and a desperate printing of money, followed quickly by inflation. Same impoverishing result. Paper--and now electronic--dollars allow these whipsaw scenarios unfolding much more quickly than before. Gold retains its purchasing power over extended periods of time. However, since there could be huge spikes versus paper dollars in both directions, like in 1980 and 1982, precious metals might only work well temporarily. Although the date and time of a dollar crisis is unknowable, timescales could be quite short once the tsunami starts. The whole point here is to make you think outside the package mail box and safety deposit box. Only then can you begin to research all the non-paper dollar options available to you.
Once the epiphany strikes like lightening, you will reorient how you think about money. For example, you might measure your wealth in terms of ounces of gold rather than dollars. I hold only enough dollars in the bank to pay my bills and taxes. To me, it’s a convenience service, like a currency exchange booth at an international airport. Hopefully, your mental conversion will occur long before any crisis hits.
Copyright © 2006 by Chuck DiFalco
