Dow / Gold Ratio Drops to 9

Timing is everything sometimes. Since our little series on currency, gold has taken off like a shot, topping $1165 an ounce today.  The Dow hasn't been sleeping though this uptrend, moving up to 10450 today.  However, the Dow / Gold ratio has now dropped from 10 to 9 in a matter of one month.

Experts continue to tell us that the dollar will remain weak as long as the Fed continues its stimulus plan of low interest rates and printing currency.  The health care vote in the Senate this past weekend spurred gold into the latest uptrend as worries about where the money (~$1 trillion) to pay for the bill has yet to be debated.

Experts also tell us that the weakness in the dollar will turn when the Fed tightens money policy and the economy turns around.  However, when pressed for an answer on when that will occur, those experts have been hemming and hawing.  In fact no one in the government has stepped forward to even venture a guess.  In other words, the dollar will remain weak and there is no solution in sight on if or when it will strengthen again.

The gold bugs say that gold should move to $1300 with relative ease unless the government makes a policy shift.  That should push the Dow / Gold ratio down to 8 or less by spring 2010.  Commodity-based stocks should also perform well during this time frame.

A Time For Thanks, But Also For Giving

The 2009 holiday season is upon us and the lights are coming out and the annual shopping hustle and bustle has begun.  The economy has been through a lot and the experts tell us we are on the road to recovery.  Most of us have more to be thankful for this year than most. Things we took for granted the past decade now seem to have more meaning, such as a job or home or even just family.

However, this season will also be unlike any other for many.  Nearly 16 million are unemployed and nearly 750,000 families have lost homes due to foreclosures.  For them, the holidays will be quite subdued and even depressing. Therefore, I ask you please give to others in need this year to make this holiday season just a little bit brighter and give them hope for 2010.  While the government says they are helping, the true sign of American strength is people helping people, not government.  It can be a small donation, but to those receiving it this year, it can make all the difference in their lives.  Local food banks and Toys for Tots are my favorites to give to, but any charity that caters to those in need will be most appreciated.

May you and your family have a wonderful Thanksgiving.

India Chooses Gold over US Treasuries

In a stunning move today, India purchased 200 metric tons of gold from the International Monetary Fund (IMF) for $6.7 billion dollars. It is the largest single purchase of gold in nearly a decade. The move spurred gold up to a record high $1085 an ounce.

You can read more about this and its implications here:
http://www.bloomberg.com/apps/news?pid=20601012&sid=al7qXOH.bVn8

California Takes Bigger First Cut

The fallout from the budget debacle in California has two little surprises not widely publicized by the media:

Surprise #1: Income tax rates will increase by 0.25% across all income levels.

Surprise #2: Beginning November 1, California will increase the state tax withholding on your paycheck an extra 10%. For example, if the state was withholding $80 per paycheck, it now increases to $88. 

For those on tight budgets, this will only squeeze the taxpayer harder.

Read about it here:
http://www.ftb.ca.gov/aboutFTB/press/2009/Release_31.shtml

Not Too Big To Fail

Now here is a story that does not make the media headlines:

www.fdic.gov/bank/individual/failed/banklist.html

P.S. If you are more concerned with the contents of your DVR than with the contents of your IRA, you might like bread and circuses.

Doomed to Repeat History Again?

This is the twenty-second and final post in a series entitled Currency, Money and the Economy.

In the past month, you may have heard about the devastation brought about in the South Pacific by a tsunami. A tsunami is usually created by energy released by a deep undersea earthquake. This energy races unseen out in deeper waters (boats in deep water will not notice anything). However, when reaching the coast, the water recedes out and comes crashing back in, wiping out everything in its path. Unless you know an earthquake has occurred, you have no idea that a tsunami is coming until you see the tide going out. By then it is too late.

Well, the central banks of the world have created an earthquake of enormous energy with their lack of restraint in printing currency and bonds. That energy is currently traveling unseen beneath a blitz of media, Wall Street, and US government reports regarding manipulated statistics and economic recovery. We currently sit on the beach, happily counting our currency that the government has so plentifully provided us. However, by reading this series of posts, you now know that the earthquake has occurred.

History has shown that every time a nation or empire has attempted to maintain control by manipulating its currency, it is eventually undone by its own doing. There have been no exceptions to this rule. The United States has followed the historical playbook for ruining its currency to the letter. And unless the leaders we elect reverse their ways, which they show no signs of doing, the United States stands on the brink of etching its name on the list of civilizations that have followed the final step in the historical playbook. The only difference is that because the US dollar is used as the world’s reserve currency, they threaten to bring down every other country’s economy as well.

Who stands to lose the most? Well, not to be insensitive, but the poor are already poor, so they will not experience a significant difference. The rich know all of these facts and have already taken steps to diversify their wealth (see nineteenth post). Therefore, while their wealth will take a significant hit, they will still survive comfortably.

That leaves the middle class. The financial “experts” tell us to save for our retirements by investing in paper assets and holding them indefinitely. However, when currency is being printed non-stop, paper assets have no choice but to drop in value. When that deflationary or inflationary disaster strikes, it will be the middle class that will be wiped out because all they own is paper. As they say, “Our currency will not be worth the paper it is printed on.”

Yet for all the suffering that could come, there is opportunity. Throughout history, gold and silver have waited quietly in the wings and have watched society after society dilute their currency into oblivion. And when the people lose all faith in the currency they hold, gold and silver will welcome them back into their arms by revaluing themselves. And so the cycle will begin again…

So what will you do? Will you look out at the calm water and say, “I don’t see anything” and resume counting your currency on the beach? Or will you take precaution, gather up some essentials and head for the hills “where there be gold.” Remember, if you hang around long enough to see the tide go out, it will be too late. As Neo clearly stated in the Matrix Reloaded, “The problem is choice.”

We should continue to believe that we have control over our financial futures. However, we should also understand that we are just a speck in a dangerous universe being run by central banks playing games with the currency we take for granted.

Hopefully this series has changed the context in which you view the economy and investing. Whatever you decide to do with the information I have provided is up to you. Think about it the next time you open your wallet to pull out a dollar bill.

Further Research and References

This is the twenty-first post in a series entitled Currency, Money and the Economy.

All of the information in this series of posts may be eye-opening and overwhelming to you. It certainly caught me off guard when first reading about this myself. However, believe it or not, the information I have provided barely scratches the surface. There are many more books and websites that dive deeper into each subject we have touched upon. Below is a list of references for you to begin your own research.

Back in a previous EBFLC essay titled “The Long Road Ahead,” I gave you some general rules to guide you during the recession. Rule #1 was to assume nothing and question everything. Never take anything from a financial “expert” at face value, including myself. Always question what they are trying to tell you and come to your own conclusions on how it affects your own personal economic situation. Some of the information provided in these posts may have unnerved you. If that is the case, then I hope you will do your own research and continue the search for answers. You will find no lack of arguments for and against the data provided in these posts. Hopefully you will find answers such that you can come up with a plan that suits your economic needs.

Books
Empire of Debt: The Rise of an Epic Financial Crisis by William Bonner and Addison Wiggin
I.O.U.S.A. by Addison Wiggin and Kate Incontrera (companion to the documentary)
Guide to Investing in Gold & Silver: Protecting Your Financial Future by Michael Maloney

Documentaries
I.O.U.S.A. (available on DVD)

Websites
http://www.dailyreckoning.com/
http://www.nowandfutures.com/
http://www.usdebtclock.org/
http://www.goldsilver.com/
http://www.apmex.com/
http://www.pgpf.org/
http://www.agorafinancial.com/
http://www.fiscalaccountability.org/

The United States Dollar as the World Reserve Currency

This is the twentieth post in a series entitled Currency, Money and the Economy.

Way back in the fourth post, we established the fact that the US dollar has served as the world reserve currency since World War II. Everything that is traded internationally is denominated in US dollars. However, with all the recent financial trouble the United States have wrought on the rest of the world, some have begun to wonder if the US dollar’s days are numbered as the world reserve currency.

Britain’s daily newspaper The Independent reported on October 6, 2009 that oil-exporting countries in the Middle East as well as China, Japan, Russia and France met in secret to begin work on a plan to replace the US dollar as the world reserve currency. Government officials from all countries denied that the story was true. The previous week, Iran had stated that it had already traded away its US dollars and was using the Euro as its reserve currency. The United Nations has released reports saying that it wants to replace the US dollar as the world reserve currency. So it is obvious there is concern about the strength of the US dollar. However, is there a reason for us to panic just yet?

The answer to this question is no. However, the reason does need some explaining. The United States has about $15 trillion in circulation that is being held by nearly every country in the world, including ourselves. If the world were to decide to replace the US dollar with something else, then there would be less of a reason to hold US dollars. That means that other countries would go to the FOREX market and exchange US dollars for either their own currency or whatever currency becomes the new standard.

With everybody selling US dollars, that would make the US dollar much weaker relative to every other currency and begin the onslaught of inflation here in the United States. However, by doing so, the other countries essentially shoot themselves in the foot two ways.

With their currencies now much stronger relative to the US dollar, other countries will discover that it is now more expensive to export to the United States. The American consumer will curb their spending with higher prices. Therefore, the export machines that these foreign countries have built will slow, stalling out their own economies.

Most countries hold US Treasury bonds. Let’s say that India purchased 10-year US Treasury notes two years ago. That means in eight years, the United States will return the US dollars back to India with interest. However, if dollars are no longer the world reserve currency and have weakened considerably because it was removed, then how valuable will that 10-year US Treasury Bond be eight years from now, even with interest? It will be a fraction of the return that India was expecting when it purchased the note initially. Every country holding US Treasury bonds would have the same problem.

Therefore, if other countries successfully removed the US dollar as the world reserve currency, they would be responsible for triggering the economic Armageddon that all central banks are trying to avoid. Since these countries are still trying to recover from this last economic downturn, I doubt they want to deliberately start another one. However, if the trend of printing endless currency does not stop soon, somewhere down the road there will be a breaking point and everyone will lose confidence in the US dollar.

Tupperware Party? Let's Throw a Gold Party Instead!

This is the nineteenth post in a series entitled Currency, Money and the Economy.

You may recently have seen advertisements in the media about the unwanted gold that you might have in a drawer somewhere and selling it for cash. In addition, these companies hold gold parties. You would attend one of these parties with some gold that you want to sell. They would weigh and judge the purity of the gold, and then pay you cash for it.

Now since we are in tough economic times, it is understandable to have the need for cash right now. Also, these companies are more interested in unwanted jewelry and other gold items, rather than bullion and coin, for meltdown value. However, knowing what you have learned in this series, ask yourself what exactly they are doing. Simply put, they are trading you a hard asset for paper! In a time where paper assets are running rampant, they are offering you more paper!

Why on earth would a company do something like this? The financial “experts” tell us that gold is speculative and could drop in price simply because at $1000, they think it is already a superbubble. Why would a company risk paying $1000 an ounce of gold if the “experts” say the price will drop? If it drops, they stand to lose a lot of capital. That is, unless they know exactly where gold is headed, which they believe is straight up. These companies are not stupid. They have done their homework and are betting that one of those disaster scenarios we previously discussed is on its way.

So who is funding these companies offering to buy your gold anyway? That’s relatively easy to speculate on. My guess is that there is a lot of private capital out there (i.e., the rich) who do not want to own any more paper assets. So they have pooled their capital together to gather in all the hard assets they can. And us middle class folk, still believing the buy and hold mantra and not knowing any better, gleefully fork over our gold for cash that we desperately need to keep up with our lifestyles. The rich fleecing the middle class again. Ahh, capitalism at its worst.

That being said, if you have some gold jewelry or other gold items that you have no real use for anymore, these companies do pay top dollar for it. However, I would hold onto any bullion or coin that you currently have.

Commodities

This is the eighteenth post in a series entitled Currency, Money and the Economy.

While we are talking about hard assets, how about investing in commodities such as oil, steel, and agriculture? Commodities are hard assets and have values associated with them. However, their value is derived from their perceived importance in the world at a particular time. For example, oil is used in everything from fuel to plastics. Therefore, a barrel of oil has value today. However, if the world develops alternative forms of energy, such as solar power and bio fuels, then the importance of oil will diminish, and so will its value. Gold and silver do not have to do anything but glitter to have value.

That being said, investing in commodities is prudent because they are still hard assets and will not suffer as badly as paper assets in an economic disaster scenario. However, you should invest in commodities that will have a high priority in a deflationary or inflationary environment. Food and energy (traditional or clean) would be two such commodities. Not coincidentally, those are the two commodities that the US government likes to either manipulate or omit when reporting inflation numbers today.

Precious Jewels

This is the seventeenth post in a series entitled Currency, Money and the Economy.

Who says that precious metals are the only thing of value? How about precious jewels, such as diamonds and emeralds? Similar to platinum and palladium, the supply of precious jewels is erratic and not dependable. For example, unless you are a professional dealer, you cannot simply trade diamonds and rubies like stocks. South Africa controls the supply of diamonds to the rest of the world and thus can dictate the price. It is rumored that if DeBeers released all the diamonds stored in their vaults, they price of diamonds would fall by over 50%.

The quality of precious jewels is also erratic. As many know when shopping for a diamond ring, the price depends on clarity and color of the stone, not just weight. Gold and silver, on the other hand, can always be readily obtained in their purest form (although there are lesser qualities out there in jewelry form).

In addition, technology has begun to create synthetic jewels. These are not fakes, but real diamonds and other jewels created through artificial processes of heat and pressure. If man can create something on a replica scale, it limits the value the object has. Gold and silver cannot be recreated, although the legends and myths of alchemy continue to persist.

Platinum and Palladium

This is the sixteenth post in a series entitled Currency, Money and the Economy.

If gold and silver hold their value, how about other materials? Platinum and palladium bullion is available for purchase as well. Platinum is currently priced more than gold and palladium is currently priced more than silver. Therefore, how come they are not also involved in our primary arguments when talking about precious metals? There are a couple of reasons.

The first reason is availability. Gold and silver have been readily available since the dawn of civilization. Therefore, every person knows that these two metals have inherent value. Platinum and palladium, however, are not readily available. Because they are rarer, perhaps they should be more valuable. However, because not every person knows what these two metals are or has access to them, they do not carry the same amount of importance as gold and silver.

The second reason is accessibility. Gold and silver can be mined in all parts of the world. However, approximately 75% of platinum and palladium mined comes from South Africa and Russia. Since the production is concentrated in certain corners of the world, the supply can be subjected to manipulation. Whereas gold and silver values are dictated by market forces, platinum and palladium values are dictated by those who control the supply.

That is not to say owning some platinum and palladium is not prudent. However, these two materials should not be the precious metals of choice to protect the value of your assets.

A House Made of Silver

This is the fifteenth post in a series entitled Currency, Money and the Economy.

For those of you who are struggling to figure out how to purchase a home, here is an interesting exercise. In previous posts, we created a ratio between the Dow and gold and found a pattern. We are now going to create a new ratio called the Home Price in Silver. For this exercise, we take the average median home price in the United States starting in 1970 and divide it by the price of silver. In 1971, the price of a median home was $27,500 and the price of silver was $1.39 an ounce. This means you could buy a house for 20,000 pieces of silver. Inflation took hold and by 1980, the median home price increased to $58,800, but the price of silver rocketed to $52.50 an ounce. Therefore, it only took 1100 pieces of silver to buy a home. Growth took off again and in 2003, the median home price was $179,000 and the price of silver was $4.88 an ounce. Therefore, it took whopping 36,700 pieces of silver to buy a home. With the housing bubble now burst, housing prices are returning to historical norms. In 2008, the median home price was $199,000 and the price of silver was $14.99 an ounce. That means a median house today will cost 13,300 pieces of silver and the ratio is falling.

If we extrapolate the trend similar to what we did with the Dow/gold ratio, at some point the cost of a median home will drop to 1100 pieces of silver again. 1100 ounces of silver currently costs $19,000.

In scenario #1, the price of silver rose to $100 using a conservative silver/gold ratio of 10. 1100 ounces of silver at $100 will be priced at $110,000. Since we are in a deflation scenario, house prices dropping 50% would not be implausible. Therefore, you could buy a house for 1000 pieces of silver.

In scenario #2, the price of silver rose to $600 using a conservative silver/gold ratio of 10. 1100 ounces of silver at $600 will be priced at $660,000. Since we are in a stagflation scenario, house prices will essentially stay flat at $200,000. Therefore, you could buy a house for 350 pieces of silver.

In scenario #3, the price of silver rose to $3000 using a conservative silver/gold ratio of 10. 1100 ounces of silver at $3000 will be priced at $3,300,000. Since we are in an inflation scenario, house prices will rise. However, even if the median house price rose by a factor of five, it would still cost “only” $1,000,000. Therefore, you could buy a house for 350 pieces of silver.

Imagine putting away just $20,000 right now in silver (1100 ounces) into a vault or safety deposit box. If any of the three disaster scenario strikes, you would be able to sell the silver and purchase a home outright, without a mortgage. For those of you with a home already, you could pay off the mortgage. In fact, in the last two scenarios, that $20,000 could actually buy you two houses (one residence and one rental property). Now that is something worth contemplating. And that was just using the conservative silver/gold ratio.

Now those who live in the San Francisco Bay Area know that the median home price is just a “tad” higher than elsewhere. Therefore, simply readjust the figures to see how much silver you would need to pay for your dream house.

Also, for those parents with small children trying to figure out a way to pay for college costs that are already spiraling out of control, a similar exercise can be performed.

Disaster Scenarios, Part Deux

This is the fourteenth post in a series entitled Currency, Money and the Economy.

Let’s re-examine our three disaster scenarios discussed in the eleventh post, this time adding silver to the equation. In addition, let’s use both a conservative ratio of 10 and an aggressive ratio of 4 and observe the results.

Scenario #1: Deflation
The Dow crashes to 2000. Gold remains at $1000 an ounce. To reach a ratio of 10, silver rises to $100 an ounce. To reach a ratio of 4, silver rises to $250 an ounce.

Summary: Paper assets: -80%, Costs: -50%, Gold: 350%, Silver (C): 2000%, Silver (A): 5000%
Winner: Silver

Scenario #2: Stagflation
The Dow stagnates at 12,000. Gold rises to $6000 an ounce. To reach a ratio of 10, silver rises to $600 an ounce. To reach a ratio of 4, silver rises to $1500 an ounce.

Summary: Paper assets: 0%, Costs: 50%, Gold: 2150%, Silver (C): 12,000%, Silver (A): 30,000%
Winner: Silver

Scenario #3: Inflation
The Dow surges to 60,000. Gold rises to $30,000 an ounce. To reach a ratio of 10, silver rises to $3000 an ounce. To reach a ratio of 4, silver rises to $7500 an ounce.

Summary: Paper assets: 500%, Costs: 1000%, Gold: 10,800%, Silver (C): 60,000%, Silver (A): 150,000%
Winner: Silver

In each of our scenarios, silver outpaces everything else, even using a conservative estimate. So while gold shines bright and gets all the glamour and publicity, it is silver that has the most potential to outperform.

Now let’s say you have $2000 to invest right now. You have the choice of buying 110 ounces of silver or 4 shares of Google. Before we began this series of posts, I would be willing to bet that most of you would have chosen Google. Now knowing what you have learned, which is more likely to double first, silver (moving from $18 to $36 an ounce) or Google (moving from $500 to $1000 a share)? Remember, since 2000, the Dow has dropped 17% (price only, not value), but gold and silver have both increased 350%. It’s not so clear cut anymore, is it? Welcome to your new reality.

Here’s one more fact to consider. If a superbubble forms over the precious metals market, the primary target will be gold, since it gets all the publicity. Something similar happened during the Great Depression. In order to preserve the gold it had on reserve, the United States made it illegal for a US citizen to own gold. From 1933-1974, a United States citizen could not purchase gold or redeem dollars for gold, even though the dollar was backed by gold.

If there is another superbubble, there is no reason that the United States cannot pull the same trick and close the gold window again. What better way to attempt to stop a bubble than by making the demand side of the supply/demand equation illegal! After all, the Federal Reserve is currently the master of currency manipulation. If that happens, where will people turn to protect the value of their assets? You guessed it, silver.

So what kind of silver/gold ratio should one have in his/her portfolio? Using an actual supply/demand ratio of 4, this would be a realistic conservative ratio. If you really want to be aggressive and bet hard on silver, than you may want to move your ratio up to 10. Remember an ounce of gold is $1000. Ten ounces of silver is still less than $200. So a ratio of 10 is not that much of a burden financially (although physical weight becomes a factor).

Gold versus Silver

This is the thirteenth post in a series entitled Currency, Money and the Economy.

In previous posts, we have been examining precious metals. However, the discussion focused around gold. As we move away from the comparison of precious metals to paper assets, let’s examine the relationship between gold and silver.

Throughout history, silver has always followed gold in preference of precious metals. The reason for this is that silver has been more abundant to mine than gold. Therefore, gold always had more value than silver because it was rarer. In ancient times, the value of gold was approximately ten times the value of silver. Is this ratio appropriate today, though?

Estimates through history put the amount of gold mined at 4 billion ounces. For silver, estimate of mined quantities is 40 billion ounces. So a price ratio of ten seems to be realistic. However, that ratio may no longer be appropriate.

The advent of technology in the 20th century has affected the quantities of silver available. Beginning with photographic film, silver began having an importance in various industries. Today, everything from batteries to cell phones to solar panels uses silver. Since these items are discarded after a time, the silver is consumed and no longer recoverable. On the other hand, due the high price of gold, most gold has remained intact in the form of bullion and jewelry.

Estimates of gold remaining in the world is 3.5 billion ounces, or 88% of that mined. Estimates of silver remaining in the world is 14 billion ounces, or only 35% of that mined. The rest has been consumed. In addition, the number of technological devices continues to grow, which means that more and more silver is being consumed.

Similar to the peak oil theory, it is getting harder and harder to find both gold and silver reserves that are economically viable to be mined. In fact, only 25% of the silver mined today comes from pure silver mining operations. The rest comes from byproducts of other mining operations, such as copper, nickel and zinc. The bottom line is that silver is becoming rarer and is being consumed at a much faster rate than at any other time in history.

Therefore, returning to our ratio, a more realistic ratio maybe for 4 instead of 10. However, let’s keep both ratios in our heads and see what impact they have. The current price of gold is $1000 an ounce. The current price of silver is $18 an ounce. Therefore, the current price ratio is 56, way higher than either of the two ratios we have come up with. This means that either gold is either way overpriced or silver is way underpriced. Given the current economic conditions we have discussed in previous posts, the gold price is probably more accurate. Therefore, the price of silver is way lower than it should be from a supply/demand standpoint.

There are two possible explanations for this discrepancy. One is that because it is treated more as an industrial metal like copper, it is priced as such. The problem is that silver is much rarer than copper and nickel. The only industrial metals rarer than silver are platinum and palladium (we will cover those two in a later post). The second reason is that it does not get the publicity it should. For example, when you hear gold break to new levels, no one ever mentions or cares about the price of silver.

However, if history has taught us anything, it tells us that when supply and demand get out of whack, a severe correction is waiting in the wings. What does that mean? That means that one day soon, the world will wake up and realize that silver has been undervalued for too long and the ratio will plummet to levels that match more accurate supply/demand estimates. Let’s see how that can work to our advantage in the next post.

All That Glitters...

This is the twelfth post in a series entitled Currency, Money and the Economy.

Going back to our original question in the ninth post: Is there any hope for the individual investor? The question is now simple to answer. Yes, if you protect the value of your portfolio with precious metals. If you had $100,000 in the stock market in 2000 and just did the buy and hold, you would still have $100,000 today. However, if you had put that $100,000 into gold, you would have $350,000 today.

The pundits on Wall Street and at the Federal Reserve will dismiss these facts with a wave of their hand and tell you that investing in precious metals is speculative and should only be used as a mild hedge against inflation. They will continue to stress not to panic and to stick with the tried and true method of buy and hold. However, if the last few posts should tell you anything, is that every investment has a cycle with historical patterns, and that the next positive precious metal cycle has already begun. And based on the amount of debt the United States has accumulated, it may be the last cycle.

How much of your portfolio you should allocate to precious metals depends on your needs, but diversification of your assets should include gold and silver. Just remember, the Dow/gold ratio right now is 10 and falling. Most value is gained before the superbubble is formed. If you wait until the Dow/gold ratio drops to 3 or 4, it will be too late to take advantage of the situation. By then, everybody will be scrambling and the price will be too high (historical playbook, step 7). And like the last two superbubbles we have seen in the last decade, the later one gets into the bubble, the more likely one will take the most loss when it goes bust.

Disaster Scenarios

This is the eleventh post in a series entitled Currency, Money and the Economy.

In the last post, we identified a trend between the Dow and gold. In order to understand how to take advantage of that trend, we need to examine each scenario and see how each asset performs. Note that each scenario is measured from the peak of the Dow in 2000, from which the current economic cycle began.

Scenario #1: Deflation
Prices fall like a rock. Gold will hold steady at $1000 an ounce, but in order to reach the 2-ounce ratio, the Dow will crash to 2000. From the 2000 high, that is a loss of 83%. Think that is impossible? In the Great Depression, the Dow dropped 89%. The Japanese Nikkei index was 39,000 in 1989. Today it stands at 9700, a loss of 75%. Well, if gold doesn’t increase in price, how does that help me? It will because the price of everything else will drop, making things much cheaper to buy. Cars will cost $15,000 instead of $30,000 and house prices will also drop by 50%. Yet gold will still be the same price.

Summary: Paper assets: -80%, Costs: -50%, Gold: 350%
Winner: Gold

Scenario #2: Stagflation
This is the scenario that Ben Bernanke envisions as the one he wants to fight. As he indicated, if the Federal Reserve starts to see signs of deflation, they will pump as much money as they can into the system to make sure it does not go down. In the best case scenario, the Dow will stagnate at 12,000. In order to reach the 2-ounce ratio, that means the price of gold will increase to $6000. However, pumping more currency into the system will cause inflation, though not at extreme levels. Costs will increase gradually, but it will make things more expensive, probably 50% over a five-year period.

Summary: Paper assets: 0%, Costs: 50%, Gold: 2150%
Winner: Gold

Scenario #3: Inflation
If the powers that be lose control of scenario #2, then prices will rocket out of control due to runaway inflation. The Dow will surge from 12,000 to 60,000. However, the cost of goods and services will increase 10-fold, stripping away any gains the Dow makes. In order to reach the 2-ounce ratio, that means the price of gold will increase to an unheard of $30,000 an ounce!

Summary: Paper assets: 500%, Costs: 1000%, Gold: 10,800%
Winner: Gold

In every possible scenario, gold outpaces costs, which outpaces paper assets. You may doubt the 10,800% number as unrealistic. However, during the last half century of the Roman Empire, the price of gold rose 4,240,000%! In the final years of the Weimar Republic of Post World War I Germany, the price of gold increased 87,000,000,000,000% (87 trillion)! Therefore, the scenario #3 that we postulated can be considered a “conservative” estimate of inflation. Remember that every empire in history that has battled scenario #3 has lost.

Identifying the Trend

This is the tenth post in a series entitled Currency, Money and the Economy.

What did the example in the previous post demonstrate, besides the fact we missed the boat on making a killing (provided we had been alive since 1903)? It demonstrates that in times of extreme deflation or inflation, precious metals will hold their value. So, now knowing the lessons of the past, how does that help us for the future? Let’s return to our example and start from the year 2000.

As stated in the last post, in 2000, you could buy the Dow for 42 ounces of gold, an all-time high. In 2007, the Dow hit an all-time high of 14164, but gold had risen to $695 an ounce. That meant it only took 20 ounces of gold to buy the Dow. Therefore, even though the Dow had retraced its dot-com high and made new ones, the value of the stock market dropped by 51% in just 7 years.  This is not some measure like the Consumer Price Index (CPI) the United States government loves to manipulate and quote in order to tell the public that inflation is under control. This is a measure of a hard asset against a paper asset.

Right now, the Dow is at about 10000 and gold is at $1000 an ounce, meaning it only takes 10 ounces to buy the Dow.  The value of the stock market has dropped 76% since 2000 and very few people know it!  Compare this number with the 80% reduction in buying power of the US dollar stated in the eighth post.

If we put all of the information we have learned in the last two posts into a table, we get this:

Time Frame	Dow low / Gold	Dow high / Gold	Dow low / Gold	Economic Period
1903-1929	1.5	19	-	Growth
1929-1932	-	19	2	Deflation
1932-1966	2	29	-	Growth
1966-1980	-	29	1.2	Inflation
1980-2000	1.2	42	-	Growth
2000-Present		42	10 and falling	???

All of a sudden, the trend becomes clear as a bell. This table clearly identifies cycles between growth and pain, and the relationship between the Dow and Gold during those cycles.

Now let’s project these trends out into the future. Based on historic cycles, we will expect that the value of the Dow will continue to fall until you can once again buy the Dow for about 2 ounces of gold. But how does that help us if we do not know if the economic period will be deflation, inflation, or something in between? Let’s examine all of them in the next post.

A Glimmer of Hope

This is the ninth post in a series entitled Currency, Money and the Economy.

The end of the last post was extremely depressing, so let’s change the focus and ask a simple question: If the sun does set on the American Empire, is there any hope for the individual investor? The answer is yes, if you quit blindly following the dogma of Wall Street and open up your eyes and mind to other possibilities.

Let’s take the “perfect” investing example provided to us by Michael Maloney.

In 1903, the Dow stood at 30 points and gold stood at $20 an ounce. Therefore you could buy the Dow for 1.5 ounces of gold. So let’s buy one share of the Dow for 1.5 ounces of gold. Now let’s move ahead to 1929 before the crash. The Dow now stands at 380 points, but since currency is still tied to gold, gold is still $20 an ounce. Therefore, it now takes 19 ounces of gold to buy the Dow. Let’s say we have a miracle vision and decide to sell our one share of the Dow and take the 19 ounces of gold.

The Great Depression takes hold and a deflationary period sets in. Three years later, the Dow bottoms out at 40 points. Gold is still $20 an ounce, so it only takes 2 ounces of gold to buy the Dow again. Let’s apply our 19 ounces of gold and buy 9.5 shares of the Dow. The United States production booms from the end of World War II until 1966, when the Dow hits 1000 for the first time. Gold is now selling for $35 an ounce. This means that you can buy the Dow for 29 ounces of gold. We decide to sell our shares in the Dow again and receive 276 ounces of gold.

Now, thanks to Presidents Johnson and Nixon, inflation rages throughout the 1970’s. In 1980, the Dow still sits at 1000, but gold sits at a whopping $850 an ounce. This means we purchase the Dow for just over 1 ounce of gold. President Reagan takes office and says that he will fundamentally restructure the economy. We believe him and we put our 276 ounces of gold back to work and buy 235 shares of the Dow. Fast forward to the year 2000 and we are nearing the end of the dot com boom. The Dow sits at 11,700 while gold has dropped to $279 an ounce. At this point, it takes 42 ounces of gold to buy the Dow.

Now, let’s say that we followed the “buy and hold” mantra all the way from 1903. The Dow started at 30 points and stands at 11,700 points. This equates to a total return of 39,000%, or an average yearly return of 6.3%. Not bad. This is the type of statistic that retirement plans love to quote to you.

However, had we managed our accounts like the example above, our original investment of 1.5 of ounces of gold has grown to 9870 ounces of gold for a total return of 658,000%, or an average yearly return of 9.5%. That extra 3.2% in average yearly return compounded over 97 years results in 17 times more return than the “buy and hold” method!

What does this example mean to the individual investor? We will find out in the next post.

Judgment Day

This is the eighth post in a series entitled Currency, Money and the Economy.

In the last post, we discussed that central banks were trying to avoid having a superbubble form over the precious metals market. But what happens if that superbubble forms? Well, our government will then have only two choices left:

Deflation
This means popping all the bubbles and squeezing all the air out between the film and glass. Unfortunately, deflation is associated with an economic depression. Stock market crashes, falling house prices, loss of jobs, and all the bad things that come with a depression will become reality. The loss of economic stability may result in political upheaval in lesser developed countries.

Inflation (historical playbook, step 6)
The central banks will attempt to pump as much air as possible between the film and glass such that superbubbles form much faster over the stock, commodity and other investment markets than they do at the center of the glass. However, this becomes a chase your tail dilemma. Your salary might climb from $100,000 to $200,000 in only two years and the Dow Jones average might climb from 10,000 to 30,000. However, the cost of a cup of coffee will rise from $4 to $16 during the same period and gas will cost $20 a gallon.

So which path would you choose? Federal Reserve chair Ben Bernanke has studied the Great Depression and has been quoted as saying he would drop money from helicopters to avoid another deflationary period. So as long as he is Fed chair, he will choose inflation.

It seems logical doesn’t it? Although inflation sounds terrible, it is a better option than political upheaval and mass loss of wealth an economic depression brings with it. However, before you pick your poison, here are two facts to consider:

1) Deflation is the only way the financial system can re-establish equilibrium between the price and value of goods and services. As painful as the Great Depression was, the United States survived and led the world for the next six decades.

2) Every other empire throughout history has chosen to follow step 6 in the historical playbook rather than face deflation. None has survived as a global power. The United States have followed the historical playbook to the letter and now have gone on record to state that they would also follow step 6. One definition of insanity is trying the same thing in the same manner and hoping for a different result.

So what is the timetable of this supposed financial doomsday decision? Unfortunately, if the scenario were to occur, it will most likely be within our own lifetimes. What evidence is there to support this argument? Here's one more fact to ponder. The term M3 currency supply is the largest count of US currency in circulation and used to be reported on a monthly basis. In 2006, the Federal Reserve suddenly stopped reporting this figure for a good reason. Watchdog groups furious with the lack of transparency have carefully pieced back together the formula and by rough estimates, there is approximately $15 trillion in circulation today and growing. In a previous post, I gave you a link to the US debt clock. It now reads $12 trillion. What does that mean? It means we should only have $3 trillion in circulation, but have pumped five times as much into the system to pay for our debts. The buying power of the US dollar has been effectively reduced by 80% thanks to our overspending ways. The only reason this fact is not more readily apparent is because the United States is manipulating its currency in a shell game with other countries. To make matters worse, there is another $107 trillion waiting in the wings for unfunded liabilities expected to take hold by 2040, including Social Security, and Medicare A, B and D. $3 trillion versus $119 trillion in potential debt. It does not take a financial genius to realize we are on the edge of a bottomless abyss.

The Consequences of Currency Manipulation

This is the seventh post in a series entitled Currency, Money and the Economy.

In the last couple of posts, we have discussed currency manipulation. But what exactly are the consequences of it? Well, with all the bonds being issued and all the currency being printed, the bottom line is that there is too much printed currency in the world by all nations. These central banks print this stuff and then manipulate it with other countries. Every country's central bank is guilty of it. Unfortunately, there are only so many places all this currency can flow.

Let’s think about adhering a piece of film to a piece of glass. The glass has some black dots on it, each one with a different name. The names of the dots are commodities, stocks, bonds, and every other type of investment you can think of. In addition, at the center of the glass is one more dot. The name of the center dot is precious metals. Now let’s try to adhere the piece of film to the piece of glass. At first, you will naturally have air pockets that form bubbles between the film and glass. Those air pockets represent extra currency that should not be in the system. As you try squeeze the film tighter to the glass, the bubbles will move around, even joining together to form a superbubble. The central banks, either deliberately or inadvertently, push these bubbles around by squeezing certain areas (currency manipulation). If a superbubble forms over a dot, you get that “irrational exuberance” feeling. One formed over the US stock market between 1996 and 2000 and over the US real estate market between 2003 and 2006. Because the film can take only so much stress, the superbubble eventually goes pop! Now, here is the difference between our analogy and real life. In our analogy, the goal is the squeeze all the air out between the film and glass. In real life, the central banks are actually pumping more air between the film and glass. This is why, despite the calls for increased financial regulation, more superbubbles are inevitable, because there is simply too much currency in circulation to control.

Now the one thing all central banks are trying to do is to keep all the bubbles away from the center of the glass. Remember our historical playbook that all world powers have gone through? The United States have followed steps 1 through 5 and are desperately trying to avoid step 6. If a superbubble forms over the precious metals market at the center of the glass, this means that the population has lost faith in its own currency and are now seeking safe harbor in precious metals, which fulfills step 7. The problem central banks are facing is that they are pumping so much air between the film and glass, it is getting more and more difficult to steer the bubbles away from the center of the glass.

What happens if a superbubble forms over the precious metals market? We will find out in the next post.

Recent Examples in Currency Manipulation

This is the sixth post in a series entitled Currency, Money and the Economy.

One of the more interesting examples in currency manipulation involves the Japanese. When both the stock and real estate markets crashed in the early 1990’s, Japan faced a major deflation issue (similar to the Great Depression). Remember, in order to combat deflation, you need weaker currency (more currency in circulation). Therefore, the Japanese tried the following solution. They printed 35 trillion yen out of thin air. They traded all of it on the FOREX market for US dollars, thereby deliberately watering down their own currency. Then, in turn, Japan turned around and loaned those US dollars back to us for 30-year US treasury bonds paying way higher interest than they were getting in their own country. Then they printed more yen for their own circulation purposes. This is known as the Yen-Carry trade and up until now was working with some effectiveness. Unfortunately, Japan did not anticipate that the United States would eventually go through the same thing a decade later, so now they are trying to unwind their own trade.

China has been in the news recently for supposedly violating international currency trading rules. However, China is manipulating their currency in a different manner. China has a nation of savers; therefore, their biggest fear is inflation. Since the United States is nation of spenders, its biggest fear is deflation. Therefore, China has artificially pegged the value of the Chinese Yuan relative to the US dollar in order to keep inflation in check. As long as we keep in inflation in check on our side of the Pacific, China is perfectly content going along for the ride. China also buys every US Treasury bond they can to avoid selling US dollars on the FOREX market, which would make the US dollar weaker relative to the Chinese Yuan. This allows China to keep exporting inexpensive goods that the American consumer cannot live without.

The United States want China to comply with currency trading rules by removing the peg. However, some warn the government be careful what it wishes for. Think about a person who has slipped into a frozen river. When you pull the person from the river (still alive), the medical advice is to warm the extremities first, then the heart. The reason is that if you warm the heart first, it will fool the rest of the body that it has returned to normal temperature and send all of the cold blood back to the heart, causing cardiac arrest. So with all the debt that China has collected on the United States, what if they decided to send that avalanche of US dollars back through our door all at once? That's correct, we would be dealing with inflation not seen since the early 1980’s. China will eventually remove the peg at its own pace anyway. How do we know this a certainty? Because at some point the US dollar will become so worthless with the debt they are piling up that China will have no choice but to disassociate itself from the United States and take their chances out in the real world.

So what does all of this currency manipulation really mean anyway? We’ll discuss the consequences in the next post.

The Fine Art of Currency Manipulation

This is the fifth post in a series entitled Currency, Money and the Economy.

When President Nixon took the dollar off the gold standard in 1971, he effectively made every single currency in the world a fiat currency. The price of the US dollar and every other currency in the world is backed only by the faith and credit of each nation. The price of each one of these currencies can be measured relative to one another through foreign exchange rates and can be traded on the foreign exchange markets, also known as FOREX. In theory, based on the amount of currency each nation has printed, the exchange rate between two countries is set by the supply and demand for each currency on the FOREX market.

When you travel overseas and need to exchange US dollars for Euros, you are actively participating in setting the foreign exchange rate. When one country has accumulated currency of another country, under the rules of international trade, they are required to trade back the other country’s currency for their own currency so they can reinsert it back into their own economy. However, in recent years, central banks in every country have developed methods to manipulate the price of their own currency to suit their economic needs.

Why would a nation want to manipulate its own currency? The reason is simple. The price stability of the goods and services of its country must be maintained in order to maintain political stability. Economic instability has been the downfall of many a nation throughout history. To reiterate a couple of definitions, when a country is a nation of savers, inflation is the enemy because for each unit of currency a country prints, it devalues every other one being held in a bank deposit account. When a country is a nation of spenders, deflation is the enemy because falling prices increases leverage on debt. Therefore, a country will usually manipulate its own currency when it is trying to avoid these outcomes.

The easiest way for a country to manipulate its currency is through the issuance of national bonds, or a simpler definition, IOU’s. For the United States, it issues US Treasury bonds in all shapes and sizes. For example, let’s say Brazil has accumulated $100 million US through international trade. In theory, Brazil is supposed to go to the FOREX market and trade the US dollars that it has for Brazilian reals. However, this action would weaken the US dollar and strengthen the Brazilian real from a supply and demand perspective. Since Brazil likes the current relationship with the US dollar because it allows for cheaper exports to the United States, it does not want to weaken the US dollar. Therefore, Brazil loans back the $100 million US for US Treasury bonds and will wait a number of years for the currency back with interest. Therefore, Brazil and the United States short-circuit the currency trading aspect in order to maintain the strength of the Brazilian real relative to the US dollar. How does Brazil make up for the Brazilian reals they were theoretically supposed to receive for trading US dollars? That’s easy. Their central bank simply prints more of them!

By bypassing the supply/demand rules of the free market system by issuing national bonds, all countries are guilty of currency manipulation. The best analogy is to get twenty people in a room and have them start writing IOU's as fast as they can and pass them off to one another. By writing an IOU, they avoid having their currency weakened. And by buying someone else’s IOU, they are allowed to print more currency into circulation (historical playbook, step 5)! If you and I were to do that, we would be arrested for check fraud. Yet central banks around the world do it every day. Is it illegal? Not to them. Is it immoral? You can decide that for yourself.

In the next post, we will look at some of the more creative currency manipulation examples.

World War II and the End of the Gold Standard

This is the fourth post in a series entitled Currency, Money and the Economy.

In the last post, we discussed the consequences that World War I had on the economic situations in both the United States and Europe. Knowing the havoc it wreaked, when the Allied Nations got the upper hand in World War II, the leaders got together at Bretton Woods, New Hampshire to come up with a plan to avoid the same problem. Once again, the United States was in the best position since it had stayed out of the war at the beginning and no fighting had taken place on American soil except Pearl Harbor. Therefore, the solution they came up with was that the US dollar would be pegged to the value of gold, while the other European nations would be pegged to the US dollar. This effectively established the US dollar as the world reserve currency. Anything traded in the world, from sugar to oil, was primarily traded in US dollars (and still is today). However, when the deal was conceived, there was no reserve ratio set for the Federal Reserve for dollars in circulation versus the gold it had on hand. Essentially, this gave the United States license to print as much currency as it wanted.

Now, the United States was pretty good at restraining itself for the next twenty years. The baby boomer generation was born and life was good. That is, until a little Southeast Asian conflict known as the Vietnam War. Instead of asking its citizens to buy war bonds or pay for the war through higher taxes, the Johnson and Nixon administrations simply paid for the war through deficit spending, or printing the money they needed to pay for the war (historical playbook, step 3). President Charles de Gaulle of France worried about the price of his country’s currency relative to the US dollar, decided to take a preemptive strike and began cashing the US dollars his country had on hand for gold. The run on gold forced President Nixon in 1971 to remove the US dollar from the gold standard (historical playbook, step 4). In other words, you could no longer trade your dollar into the United States government and receive gold in return. This left the United States with a raging inflation problem throughout the 1970’s. Eventually raising interest rates exceeded the rate of inflation and the problem was brought back under control. However, once again, the value of people savings had been eaten up unless, once again, you owned gold or silver. Gold set a record at $850 an ounce while silver set a record at $52.50 an ounce.

In the next post, we will set the stage for what could be the final act of the US dollar.

Early United States History and the Great Depression

This is the third post in a series entitled Currency, Money and the Economy.

From its early days of independence until 1913, the United States was only a loose knit republic of states (historical playbook, step 1). We were not a global power, as England, France, Spain, and Portugal continued their colonial conquests. We had our share of wars, booms and busts, but were still surviving. However, a banking scandal now known as the Panic of 1907 led to the eventual passing of the Federal Reserve Act in 1913. Up until then, Congress had had the right to coin money, and usually outsourced the job to many banks. However, Congress gave up that right when it created the Federal Reserve Bank. Most people think the Federal Reserve is a government agency. However, it is really a private bank that has the power to create currency from nothing and is shielded from audits and congressional oversights. Coincidentally, that same year the income tax was introduced. For the first time in the United States, the loose knit republic was becoming centralized and power was being consolidated at the national level.

World War I would change the role of the United States forever (historical playbook, step 2). While the United States stayed out of the fighting early on, most of Europe’s economy became engaged in producing goods for the war effort. Thus, in order to still supply its citizens with daily necessities, they imported what they needed from the United States. Since every power still had currency backed by gold, that meant the United States saw an influx of gold during World War I. At the end of World War I, the United States had a huge supply of gold reserves. Based on the amount of gold it had on hand, banks could loan an amount to the general public at a certain ratio (known as the reserve ratio). Thus, with a ton of gold that the United States had, the amount of money loaned out was also tremendous. And the people spent it, much like they did today, in what is now known as the Roaring Twenties. Eventually, most of the money found its way into the stock market and the real estate market. Well, with every bubble comes the crash, and in 1929, the house of cards fell apart to begin the Great Depression.

The main component of the Great Depression was deflation. How was this achieved? Let’s take a look at the banks again. When someone deposits currency into the bank, the bank can take a ratio of the deposit (say 10 times the deposit amount) and loan it out. However, when someone withdraws its currency from the bank, the bank must remove that same ratio amount from the currency in circulation. When people panicked after the stock market crash, they made a beeline for the bank to withdraw their currency. As a result, banks were forced to call in tons of loans they had on their books. The holders of those loans could not pay them off in their current economic state, so they simply defaulted on them. By loans going bad or banks taking them off the books, the currency supply shrank at a tremendous pace. Many banks went of business simply because they could not balance the reserve ratio anymore. The only thing that did not fall in value was gold and silver.

It was during this period that President Roosevelt consolidated the power of the federal government. Since states were in shambles and broke, they gladly deferred power for federal assistance. And thus any remainders of the loose knit republic our founding fathers designed were swept away as the American Empire took its place.

Across the Atlantic Ocean, Europe was having very different problem. Because most of their gold went overseas to the United States, many nations had to rebuild their economies by printing currency, lots and lots of it. Thus, while the United States was suffering from depression, Europe was battling inflation. Inflation in the Weimar Republic of Germany was so bad that it eventually led to the rise of Adolf Hitler to political power, leading the world into World War II.

In the next post, we will continue our history lesson.

Currency and Money in Ancient Times

This is the second post in a series entitled Currency, Money and the Economy.

During ancient times, gold and silver were used as both money and currency. Even in Biblical times, the three wise men gave Jesus gold. Egyptians, Greeks, and Romans also used gold and silver as the backbone of their economy at first. However, an interesting pattern emerges when looking at all major ancient civilizations from a financial standpoint.

1)  The civilization starts off as young sovereign state or republic with good money (gold or silver, or currency guaranteed by gold or silver).

2)  As the civilization grows, it becomes more socially responsible and takes on more and more economic burdens. It also needs to create a military to both defend its borders and expand its territories (for resources).

3)  The civilization engages in wars that are extremely costly, leaving the government in severe debt.

4)  In order for the government to continue functioning, it converts money to currency that has no backing. This allows the government to print as much as it needs to run its civilization. The citizens are anxious at first, but because life is still good in civilization, they accept it.

5)  As time moves forward, the civilization continues to spend currency on military and social endeavors (including dealing with natural disasters), forcing it to continue printing more and more currency.

6)  As some point, the amount of currency in circulation causes extreme inflation throughout its borders.

7)  The citizens, burdened by this inflation, lose faith in its own currency and revert back to accumulating gold and silver.

8)  The civilization, now without the support of its citizens or currency, declines into the history books, replaced by the next young sovereign state or republic waiting in the wings.

Time and time again, ancient history has followed the same pattern. For reference purposes, we will refer to this as the historical playbook. So how does the United States match up against the historical playbook? We shall see in the next few posts.

Currency, Money and the Economy

This is the first post in a series entitled Currency, Money and the Economy.

When we think about our investment portfolio, we associate it with dollars. We hear terms on the news, such as inflation and budget deficits, and those are also associated with dollars. However, have you ever stopped for a second and figured out exactly what a dollar is? Over the next series of posts, I will be covering the basics of currency and money, and discussing why we are living in a very dangerous age.

As we explore this topic in depth, you will find things that will seem unbelievable and other things that might make you feel depressed. However, throughout the series I hope you will keep an open mind, for it just might change the way you view the economy forever.

In this first post, we will establish some definitions that will be used throughout the series.

Currency is a medium of exchange used to purchase something of value, such as goods and services. Currency is always associated with the price of something.

Money is a form of currency that has value in itself. Money is always associated with the value of something, not the price.

In order to clearly differentiate between these two definitions, let’s take a look at two examples. First, let’s take a $100 bill. We can purchase something that is priced at $100, such as two pairs of shoes that are priced at $50 per pair. However, if you think about it, the bill has no actual value, except for the minuscule cost of the paper and ink. Since the $100 bill is associated with price, but not value, it is currency, not money.

Now let’s take a look at a one-ounce Gold Eagle coin issued by the United States Mint. The coin has $50 stamped on it, meaning if we took it to a store, we could buy a pair of those $50 shoes. However, if you have followed the news you may have heard that gold recently topped $1000 an ounce. Therefore, while the price of the coin is $50, the value of the coin is $1000. Therefore, since the coin has price and value, it can be considered both currency and money.

In order to know the value of something, you must measure it against something with value. For example, a house might be priced at $300,000, but what is its value? One simple way to determine value is to divide the price of the house by the price of an ounce of gold. $300,000 divided by $1000 is 3000. This means that the house has a value of 3000 ounces of gold. You can also divide the house price by anything that has value, such as ounces of silver, barrels of oil, and bushels of wheat.

Here are two more definitions you need to know:

Inflation is an expansion of the currency supply such that each unit of currency has less purchasing power. Since there are more units of currency in circulation, the value of goods revalues themselves upward (rising prices).

The fear of a nation of savers is inflation because each new printed unit of currency devalues every other one that is held in a bank deposit. That is because when they withdraw their currency, they will find it will purchase less due to rising prices.

Deflation is a contraction of the currency supply such that each unit of currency has more purchasing power. Since there are fewer units of currency in circulation, the value of goods revalues themselves downward (falling prices).

The fear of a nation of spenders is deflation because falling prices creates a higher leverage ratio on debt. For example, if your house falls in price to $200,000, but your mortgage is still $400,000, you cannot simply sell the house and payoff the loan because your debt leverage ratio has increased with deflation.

Now that we have established these basic definitions, we can take a look at these dynamics in action. In the next post, we will discuss currency and money used in ancient times.

Bread And Circuses

During the Roman Empire, when the political structure and societal infrastructure was beginning to decay, politicians managed to distract the citizens with handouts and petty amusements. The latin term panem et circenses, or “bread and circuses”, was used to describe this tactic. Today, it is a term used not only to describe politicians who use distracting gimmicks to gain support (such as negative ads), but also to criticize the general public for giving up their civic duty of holding their politicians accountable.

In the land of the American Empire today, we do not need politicians to provide us bread and circuses. That’s because Hollywood fulfills the role quite nicely. In homage to blue collar comedian Jeff Foxworthy, who coined the phrase, “You might be a redneck,” I have started a list called “You might like bread and circuses.”

If you can list more of Oprah’s favorite things than you can list choices in your retirement plan, you might like bread and circuses.

If you spend more time studying your fantasy sports team than studying stock charts, you might like bread and circuses.

If the cost of all of the items in your wardrobe, including shoes, handbags and sports jerseys, is more than the size of your savings account, you might like bread and circuses.

If you would rather watch an hour of reality television instead of thirty minutes of Nightly Business Report (or CNBC or Bloomberg), you might like bread and circuses.

If you own more infomercial products than you own stocks, you might like bread and circuses.

If you spend more time looking for iPhone apps than looking at the business section of the newspaper, you might like bread and circuses.

If you have an urge to appear in a commercial singing the silly $5 sandwich jingle, you might like bread and circuses.

If you follow the antics of Lindsay Lohan, Paris Hilton, Britney Spears, or the Octomom, you might like bread and circuses.

If you are more concerned with the contents of your DVR than with the contents of your IRA, you might like bread and circuses.

If I think of more, I will put them in later posts. Feel free to add more.

Where Does The Stock Market Go From Here?

In the last post, we covered how the market has performed the past six months. The next question was: How does the stock market move up from here? The answer to that question consists of two parts.

The first part has to do with the government. As stated in the last post, the government is currently propping up the economy with lots of financial aid. In other words, the stock market is on government life support. If the government were to remove its intervention at this very moment, the stock market would most likely suffer a setback. Therefore, the stock market will only truly regain momentum when it is able to stand on its own again without government support.

The second part has to do with the American consumer. As stated in the last post, consumer spending hit the skids when the economic crisis began, forcing companies to slash costs to maintain profit margins. The value of a stock will only increase if profits increase. Since companies have already cut costs to the bone, the only way to generate increased profits is to generate increased revenues. Therefore, companies need to get the American consumer spending again.

Both parts of the answer are quite straightforward. However, when those two parts are achieved is the bigger question. The Federal Reserve and Treasury Secretary have testified before Congress that they have yet to figure out when and how their exit strategy will work. And nobody knows yet whether the American consumer will return in full force or whether they have changed their spending habits for good. In other words, your guess is as good as anybody else’s.

I know a lot of you out there, myself included, hope that the stock market rebounds quickly. However, until both parts of the answer have been addressed, the stock market is not likely to move anywhere, up or down. Unfortunately, that might be quite a long time.

Stock Market Report, March-September 2009

We have all seen (and felt) the stock market drop to new lows in March 2009. Since then, the market has rebounded and recovered approximately one-third of the losses it had sustained. How was the stock market able to get back this much within the last six months? The answer to this question has three components to it.

The first part is relatively straightforward. In a steep selloff, the stock market always overcorrects itself, such that the market is realistically lower than it should be. Hence, by pure reflex action, the stock market bounces up. Therefore, the first leg up is termed as the dead cat bounce (the saying goes, “even a dead cat bounces”).

The next component is government support. The Federal Reserve and Treasury have poured hundreds of billions of dollars into financial institutions and businesses to shore up and stabilize the economy. This shoring creates a floor in which the stock market can build off of.

The last thing is that many companies have been able to maintain their profit margins throughout this crisis. This may come to you as a surprise; however, the answer is quite logical. The value of a stock is primarily governed by the company’s ability to generate a profit. The basic definition of a profit is revenues minus expenses. Since the economic crisis began, we know that revenues have dropped as Americans have curtailed their spending. Therefore, the only way companies could maintain their profit margins was to slash costs. All the job layoffs and budget cuts you heard about on the news have gone to cut costs to maintain profit margins. As earnings were reported on Wall Street, stocks made nice moves upwards as these reports were better than expected.

These three components have worked together to provide a good start to rebuilding the stock market. Remember, however, that we have only regained one-third of stock market losses incurred. Therefore, the next question is: What will it take to get the rest back? We will cover that topic in the next post.

Beauty Is Only Skin Deep

If you have been following the basic financial news headlines, then you might have heard how the experts are saying that the recession is over and the recovery is beginning.  They point to various indicators such as the stock market as proof. Consumer confidence has moved up for the first time in a year and most people are beginning to believe the worst is over.

However, imagine the total economy is an apple.  On the outside, it looks red and shiny and tasty.  Every once in awhile, though, you will bite into it and find you actually have a rotten piece of fruit.

Well, do you want to know what the core of the US economy looks like?  Then go to this website.

www.usdebtclock.org

What does this actually mean?  It means that whatever recovery is going on now is just a patch job, and future disruptions are inevitable because the core of the economy is rotten.

So How You Doing?

It's funny how lying with statistics can really give you a false sense of confidence.  I have been watching various financial programs and the experts say that we are at the beginning of a new bull market and that since March, the stock market has been up over 50%.  Sounds like great news, doesn't it?  Everything is fine and dandy.  That is, until you look from a slighty different perspective.

Most people did not start investing in March 2009.  If we had started right there, sure, I would be perfectly happy with a 50% gain.  The problem is that we were investing way before then.  Therefore, we really need to start counting from the last peak of the market.

In October 2007, both the S&P500 and the Dow Jones peaked.  For simplicity purposes, I will only use the S&P500 since it covers a broader range of stocks.  Now, the S&P500 peaked at 1562.  It then plunged to a low of 676 in March 2009, and since then has rebounded to 1044.  Therefore, while the S&P500 has increased by 54% since March, the market is still down 33% from its October 2007 peak.  From up 54% to down 33%, that is a huge swing and one that the media is reluctant to tell you.

Now, a more important question to you, is how is your portfolio performing? If you did nothing, either by putting your head in the sand or clutching to the "buy and hold" methodology, it is most likely that your portfolio is still down 30% or so, shadowing the performance of the S&P500.

However, if you had implemented some of those tips I had in the essays I had written during the start of this economic crisis, chances are probably doing better than the market.  You may not be even yet, but you are probably down somewhere in the 15% range.

Now, not to brag, but to provide perspective, this week I reached break even.  My portfolio reached its October 2007 value for the first time in nearly two years.  Instead of continuing to struggle with trying to recover what I lost, I can now move forward.  It is important to note that I did not have some miracle plan or magic bullet for recovering my losses.  I used what I have learned about finances over the last five years to make some key adjustments such that the crisis was just a glancing blow, not a knockout punch.  Hopefully, you have also learned and have made some changes as well, instead of sticking with the status quo.

So, two years into this economic crisis, how are you doing?

Answer To The Quiz

In a previous post, I proposed a simple problem and a question. Here it is again:

Let's say you make $5000 a month. However, over the last decade you have been spending $7000 a month. So you've built yourself quite a little debt pile. Okay, now times are tough and you decide that you need to cut your spending. You decide to cut your spending to $5500 a month.

Here's the quiz: Will you get out of debt?

Now it should be obvious that the answer is no. Even though you have cut your spending, you are still spending more than you are earning.  Therefore, you are not decreasing your debt, you are actually increasing it.

So here is the same quiz in a different context.  When United States politicians proudly inform us that they will trim the budget deficit from the $1.75 trillion this year to about $500 billion by about 2012 (give or take a few years), will we finally start paying off the national debt of over $11 trillion?  Even if they keep their promise, the answer again is obviously no.  Trimming a budget deficit does the national debt no good because we are still racking up debt.

So the next time a politician starts rambling about cutting the deficit, ask him/her what their plan is to create a surplus to pay off the national debt.  That should stump them good.