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A Golden Lining in a Perfect Storm

Will we ever learn the lessons of history?

Mon, Mar 16, 2009 - 3:00pm
"Nations are not ruined by one act of violence, but quite often gradually, almost imperceptibly, by the depreciation of their currency, through excessive quantity." —Nicolaus Copernicus (1473–1543) mathematician/astronomer/economist

With the world in a tumult and the global financial system on the brink, there has been one relatively steady beacon in the storm: gold. The gold price ended up 5.5% for 2008 as stock markets plunged around the world and is currently up over 4% in 2009. The S&P 500 finished down 38.5% last year and is currently down 16.5% in 2009. As a safe haven, gold set all-time highs last fall in the Euro, British Sterling, the Australian dollar, the Indian Rupee and the Russian Ruble, among others. The US dollar has also been a safe haven asset, but the longer-term fundamentals of the dollar are no match for gold.

Beyond gold's value as a safe haven store of value in these very uncertain times, the basic supply and demand fundamentals are strong as well. As gold has consistently risen in price since 2001, global gold production has actually fallen. Annual gold production is now 4% less than in 2001, when the price was under $300 per ounce. Global gold reserves in the ground are also shrinking despite concerted efforts and hundreds of millions of dollars in exploration expenditures.

Discovering Gold Is Difficult

Finding gold is not an easy chore. It is by nature a very scarce mineral, and explorers have been scouring the earth for it for thousands of years. The low-hanging gold has been found. The odds of a huge gold find are very long. This just adds to the bullish fundamentals for the long-term value of gold.

Even when a decent-sized and accessible deposit is identified, the process of bringing a mine to production can now cost hundreds of millions of dollars and last a decade or more. Unstable or unscrupulous governments can also interfere, demanding pay-offs and ever-larger slices of the golden pie. In addition, the rising costs of labor, equipment and energy have made mining a more difficult enterprise to get off the ground. It is truly impressive that approximately 2500 metric tons of gold are mined annually, given the daunting obstacles.

global gold production 1998-2007

Yardsticks of Value

Contrast those hurdles to the ease with which central banks can create vast mountains of paper money at the blink of a mouse click. Is it any wonder that gold has lasted as a store of wealth for thousands of years? On the other hand, currencies rise, fall and disappear with regularity throughout history.

Scarcity and intrinsic value will continue to drive gold prices higher over time relative to paper currencies. As the dollar and other currencies race to debase themselves during this financial crisis, the only remaining yardsticks of value remain gold and silver.

Lessons of History

History offers many lessons and guideposts that can be useful to today's leaders. Unfortunately, history also shows that prior mistakes are uniformly ignored or dismissed as irrelevant. Every generation, no matter the culture or country, believes things are different this time.

In 64 BC, Roman emperor Nero thought it clever to debase the Roman currency by putting less silver into the coins. While this allowed continued lavish spending, it built huge trade deficits with the Roman colonies and resulted in higher taxation for the wealthy. Eventually the wealthy hid their wealth or fled.

Spain looted gold from the new world becoming rich and powerful in the 1500's. Excessive consumption drained the gold supply, so Spain turned to debt to finance its consumption and wars. Decline and bankruptcy followed.

In 1716 France decided to use paper money, falling under the spell of John Law. The idea caught on eventually leading to excesses, fraud and the break down of the financial system.

In 1862 during the Civil War, President Lincoln passed the Legal Tender Act allowing the issuance of paper money backed only by government guarantees. As expected excessive money printing lead to high inflation. In 1878, the currency was again backed by gold, and inflation was once again benign until the Federal Reserve was established in 1913.

After losing WWI, Germany was held accountable for war reparations. Having little savings, it printed the money, eventually setting off the hyperinflation of 1923 and devastating the entire middle class. This of course set the stage for the rise of Adolf Hitler.

Save Us from Ourselves

It's clear that prolonged periods of excessive money creation lead to excessive speculation, debt and finally economic turmoil. It has occurred throughout the ages and is occurring today. Without the disciplining system of a gold standard, it falls on central banks to control money supply. History has shown central banks as independent in name only. They are de facto pawns of government and create whatever amount of currency that government demands.

Unfortunately, the US has squandered its hard-earned status as a creditor nation. We are now the world's largest debtor nation. Our policies are now, and will continue to be, heavily influenced by our largest creditors, particularly China. None of this would have been possible under a gold standard. The US would have been forced early on to stop deficit-spending and financing wars "off-budget." Our gold would have all been drained away by our creditors and regular citizens had we continued, which would not have been politically feasible. Politicians would have had the political cover to make the tough choices to stop spending. It would have been "out of their hands," and thus an easy decision.

More Debt, Less Freedom

Since August 1971 when the US took the dollar off the gold standard, that spending discipline has disappeared as the Fed has printed money at the government's whim. Over the last 38 years our levels of debt have mushroomed, while our purchasing power, independence and freedom have all declined. That decision, taken so lightly by the Nixon administration on August 15th, truly is a day of infamy. Its true consequences are only now unfolding.

How can citizens save for their future and plan for their retirement when what they are saving is losing value every day? It's cruel, but the silent tax of dollar devaluation through excessive currency expansion ultimately leads to dashed dreams and lowered living standards. When money continuously loses value, the hapless citizen is forced to take on more debt to maintain the same lifestyle. As the debt levels increase, freedom decreases. Over time, we all become more reliant on the government and the banks to help us survive. Does this situation sound familiar today?

Unintended Consequences Bullish for Gold?

No one knows what tomorrow or next week will bring. Never has that truism been more valid than during the volatility storms of the past year. But when most of the world's leading economies are printing unprecedented amounts of currency out of thin air, then one can feel assured that there will eventually be severe consequences. Piling debt upon debt will not solve the financial crisis. Throughout recorded history this strategy has failed every time, and why would it be different this time?

The world's central banks may succeed in holding together the threads of the global financial system, but the unintended consequences of debased currencies and many trillions in new debt will eventually play out in soaring inflation and increased global conflict. Gold and silver, precious because of their limited supplies and historical acceptance as a store of wealth, will likely become only more precious in the years ahead. History may not always repeat, but alas, human nature is set in stone.

"Unless you are willing to surrender your children and your country to galloping inflation, war and slavery, then this cause demands your support. For if human liberty is to survive in America, we must win the battle to restore honest money!" —Congressman Howard Buffett (father of Warren) Washington D.C. 1948
"Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process." —Alan Greenspan "Gold and Economic Freedom" 1966
Today's Markets

Wall Street ended slightly lower as financial stocks fizzled and investors took profits. A retreat in stocks late in the session comes after four straight sessions of gains last week. Stocks jumped more than 10 percent in the prior four sessions.

The Dow Jones Industrial Average fell 7.01 to close at 7216.97. The S&P 500 Index was down 2.66 to close at 753.89. The Nasdaq also closed lower, ending at 1404.02, down 27.48.

Crude-oil futures rose above $47 a barrel Monday to end at the highest level in 10 weeks, pacing gains in the stock market as comments from Federal Reserve Chairman Ben Bernanke raised hopes that the global economy may recover later this year.

Gold for April delivery, the most active contract, fell $8.10, or 0.9%, to end at $922 an ounce on the Comex division of the New York Mercantile Exchange. Gold had gained 3.8% over the previous three sessions, but the benchmark contract fell 1.5% on the week.

About the Author

Financial Consultant
tallison [at] puplava [dot] com ()