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.