Nixon and the gold window

I won't belabor this topic, as I know monetary policy discussions can quickly become tedious. But I thought I'd point those who are interested in reading more to a few additional resources.

* It was one of those seminal moments whose significance has only gradually become apparent, obscured as it was at the time by Vietnam and then Watergate. But the more one examines economic history, the more obvious it is that this was one of the most important policy decisions in modern history. (Edmund Conway writing in The Telegraph)

* In their impossibly good book Money, Markets, and Sovereignty (2009), Benn Steil and Manuel Hinds make the point that over the last four thousand years, the only period in which humanity has not consistently based its currency in metal, specifically gold, is the last forty. That’s right. Ever since President Richard M. Nixon announced forty years ago today, on August 15, 1971, that the U.S. would no longer officially trade dollars for gold, we have been enjoying a new era of human history. (Brian Domitrovic for Forbes)

* The most notable change occurred with the value of dollar-denominated assets. Gold has served as money for thousands of years precisely because it has a constancy of value to it but, unhinged from the "golden constant," the dollar went into free fall.

As is well known now, though the dollar bought roughly 1/35th of an ounce of gold in 1971, today it buys less than 1/1750th. It gets interesting, however, when we notice just how little some things have changed in the last forty years.

Indeed, as Brookes calculated in his essential book The Economy In Mind, "In 1970 an ounce of gold ($35) would buy 15 barrels of OPEC oil ($2.30/bbl). In May 1981 an ounce of gold ($480) still bought 15 barrels of Saudi oil ($32/bbl)." Fast forward to the present, and an ounce of gold ($1750) buys roughly 20 barrels of oil ($85)... (John Tamny for Real Clear Markets)

Reading all these 40th anniversary pieces, several points become clear. One, the Bretton-Woods system was unraveling and was unsustainable in its current form. From 1960 to 1971, America's gold reserves had been cut in half, to roughly $10 billion. Britain was asking for a guarantee on $3 billion in dollars. Something had to change.

Unfortunately, rather than reform the system, Nixon scrapped it. It's pretty clear he and his team had little idea what they were unleashing. As self-serving a politician as he was, I have a hard time believing that even Tricky Dick ever imagined his 1971 dollar would be worth just 18 cents a short four decades later.

These articles offer a healthy sense of perspective. It's only been 40 years since we left the stability of a gold standard (in some form) behind. Yet many parties act as though a return to some sort of gold tie is impossible — an antiquated fantasy. Not so.

If all this discussion has whetted your appetite but you're looking for more of a basic primer on the topic, SMI's special 22-page report, Inflation History: The Rise and Fall of the U.S. Dollar, is a great place to start. And if you're thirsty for more, our recently released Gold as an Investment: Will Precious Metals Continue to Shine? report makes a great companion piece to the inflation report. Best of all, these reports are FREE. To request these or any of our other special reports, visit our free downloads hub.

And speaking of gold, I was recently the guest on the nationally syndicated radio program MoneyWise with Howard Dayton. Give it a listen. And I would love your feedback.

Inflation History: The Rise and Fall of the U.S. Dollar

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SMI's Mark Biller talks gold with Howard Dayton

SMI's executive editor Mark Biller is the guest today on MoneyWise, the nationally syndicated radio program hosted by Howard Dayton and Steve Moore. The subject: gold.

As a reminder, MoneyWise, which debuted in March, is produced by Compass — finances God's way, a ministry Howard launched in 2009 after leaving Crown Financial Ministries. The program is heard on more than 400 stations and outlets.

The timing of this radio program coincides nicely with our recently released 21-page FREE report: Gold as an Investment: Will Precious Metals Continue To Shine? Get your free copy today!

Use the audio players below to listen (click the arrow for the program you want to hear).

Inflation History: The Rise and Fall of the U.S. Dollar

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SMI releases new FREE Gold Investing report

The recent market chaos and continued economic turmoil has been hard on investors' nerves, not to mention their portfolios. On top of that, the debt crisis has taken on a global flavor with additional credit “downgrades” of other nations a real possibility.

But amid all the chaos, gold continues its steady upward climb. Many investors are concerned about the declining value of the dollar and are considering gold as an investment for their portfolios.

SMI's founder and publisher Austin Pryor has written an easy-to-read guide that will help you understand our current fiscal crisis and describe how gold can help stabilize your portfolio in a world growing increasingly wary of paper currencies. The report will give you the facts to help you decide if buying gold is an appropriate move for you.

This 21-page special report is yours free! Simply go here to request your copy of Gold as an Investment: Will Precious Metals Continue to Shine? (in PDF).

You may also want to get one of our other free special reports, including Christian Investing, IRA's and 401(k)'s, or Understanding Inflation. To request them, visit our free special report hub.

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Inflation update — and a reminder about our FREE Inflation History special report

Does it seem as though lots of prices are going up? They are. Year-over-year price increases hit 3.6% as of the end of May, according to last week's report (PDF) from the U.S. Bureau of Labor Statistics. As recently as November, that rate of increase was only 1.1%, as shown in the graph below.

Most people think of price increases as "inflation" — and that's true in a sense. But, strictly speaking, inflation is related to the supply of money available. When too much money begins to circulate (i.e., an imbalance is created between available money and available assets), the value of money is lessened.

Prices go up not because things are inherently more valuable than they were before, but because the money used to buy those things is worth less than before.

A sharp increase in the money supply over the past three years has led some economists and analysts to predict significant levels of inflation ahead — and that could have a big impact on your finances.

SMI founder and publisher Austin Pryor, author of The Sound Mind Investing Handbook, has written an easy-to-read guide that explains the connection between excessive money creation and the rising cost of living — and we'd like you have a complimentary copy.

This 22-page report, Inflation History: The Rise and Fall of the U.S. Dollar is available FREE to our SMI blog readers. Simply download a PDF copy from our Free Reports page — and check out our other free reports while you're there!

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Category(s): Inflation Watch, SMI General Announcements
Tag(s): Falling Dollar, Inflation, Inflation History, Risk of Inflation

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"The Path to Prosperity"

Following up on Austin Pryor's Monday post that mentioned the new budget plan put forward by Rep. Paul Ryan, chairman of the House Budget Committee, let me steer you to three resources that provide more information about the plan. Titled "The Path to Prosperity," the plan sets forth a strategy for cutting $6.2 trillion from currently projected federal spending over the next decade.

1. The full text of the plan (a 73-page PDF file) is here.
2. Chairman Ryan offered a summary of his plan in yesterday's Wall Street Journal.
3. The House Budget Committee has released a brief video that lays out the essence of "The Path to Prosperity."

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A return to the gold standard? Not likely

In this month's cover article (subscribers' link) in the SMI newsletter, I listed several of the arguments made by the gold bulls. One was the suggestion that the U.S. might some day return to a gold standard. It's assumed to be the only way guaranteed to rein in out-of-control federal spending and defeat inflation once and for all.

I indicated that of all the bullish arguments, this seemed the weakest. It relied on the Congress and president to conspire to limit their own spending ambitions. This seems to me an obvious non-starter.

Here's the relevant excerpt:

In recent decades, rare has been the monetary heavyweight who would openly suggest a return to a form of gold standard. Following the various financial and currency crises of the past three years, that's no longer the case. Last year, the president of the World Bank called for a return to a fixed rate exchange system (the former one broke down in 1971), adding, "The system should also consider employing gold as an international reference point of market expectations about inflation, deflation and future currency values."...

Gold bugs have seized on the possibility of a new gold standard and made the calculations to determine what gold's price would need to be in order for the dollar to once again be backed by gold. One approach to doing this is to compare the amount of dollars in the Fed's monetary base ($1,700 billion) with the amount of gold the U.S. currently owns (263 million ounces). The answer pegs the required price of gold at about $6,400 ounce, 350% above current levels.

The problem with this particular bullish argument is that a gold standard restricts a government's freedom to print money to pay for every whim. A return to one, even in partial form, seems only remotely plausible, if not unthinkable.

Here's a similar skeptical response, except in this writer's view the "blame" for the unlikelihood of a successful return to a form of gold standard lies not with the political class but the American people:

The voting booth would quickly crush any attempt to bring back what the masses do not understand, and the American people have little understanding of what money is.

In addition, and despite another old proverb that tells us "we have gold, because we cannot trust governments," your average American, especially her elite, harbors an extreme trust of government. It can solve all problems in their view, it can even tame "climate change" if only given a chance, and something as fundamental as the provision of money cannot, and should not, be left to anything as independent of political manipulation like adhering to a gold standard requires. Democratic America is simply not prepared for a gold standard...

We'll soon be testing Americans' appetite for spending discipline as Rep. Paul Ryan introduces his plan for avoiding the debt crisis that everyone knows is coming unless we dramatically change our present course. Everyone wants a solution. Few are willing to sacrifice.

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Tag(s): gold, gold standard

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Reviewing the financials of USA Inc.

Kleiner Perkins Caufield & Byers (KPCB), one of the world's largest venture capital firms, has issued a sobering report on the financial challenges now facing a well-known entity that has been around for a more than 200 years. That entity is the United States government.

KPCB researcher and strategist Mary Meeker has put together an "income statement and balance sheet" for Uncle Sam, and it's not a pretty picture. Her report includes a two-page foreword (by George P. Shultz, Paul Volcker, Michael Bloomberg, Richard Ravitch and John Doerr), a 12-page text summary and 460 PowerPoint slides.

Here is one of those slides, followed by part of the text summary:

Imagine for a moment that the United States government is a public corporation. Imagine that its management structure, fiscal performance, and budget are all up for review. Now imagine that you're a shareholder in USA Inc. How do you feel about your investment?....

If we were long-term investors, how would we evaluate the federal government's business model, strategic plans, and operating efficiency? How would we react to its earnings reports?.... [F]ew of us take the time to dig into the numbers of the entity that, on average, collects 13% of our annual gross income (not counting another 15-30% for payroll and various state and local taxes)....

By the standards of any public corporation, USA Inc.'s financials are discouraging. True, USA Inc. has many fundamental strengths.... But cash flow is deep in the red (by almost $1.3 trillion last year, or -$11,000 per household), and USA Inc.'s net worth is negative and deteriorating....

Since the Great Depression, USA Inc. has steadily added "business lines" and, with the best of intentions, created various entitlement programs.... Apart from Social Security and unemployment insurance, however, funding for these programs has been woefully inadequate — and [is] getting worse.

Entitlement expenses amount to $16,000 per household per year, and entitlement spending far outstrips funding, by more than $1 trillion (or $9,000 per household) in 2010....

Regardless of the emotional debate about entitlements, fiscal reality can't be ignored — if these programs aren't reformed, one way or another, USA Inc.'s balance sheet will go from bad to worse.

None of the information in the report is truly new. Larry Burkett, who was honored posthumously last week at the annual National Religious Broadcasters convention, was writing about these same issues nearly 20 years ago. But the KPCB report offers a clear and sobering reminder that time is running out.

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Tag(s): federal budget, federal debt, federal spending

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SMI releases new FREE inflation report

Most people think of "inflation" simply as an economic condition when lots of prices go up. Well, that's part of the picture. But why do prices go up?

It's not because things are suddenly worth more. Instead, inflation is rooted in the supply of money available.

When too much money begins to circulate (i.e., an imbalance is created between available money and available assets), the value of money is lessened. So prices go up because the money used to make purchases is worth less than before.

All this economic theory can be a bit confusing, but it's important to understand, given that current conditions seem ripe for creating inflationary pressure that could affect your future finances.

To help you gain a clear understanding of the forces that cause inflation, SMI's founder and publisher Austin Pryor has written an easy-to-read guide that explains the connection between excessive money creation and the rising cost of living.

We're making this new 22-page special report available free! To request Inflation History: The Rise and Fall of the U.S. Dollar (in PDF), simply go here and let us know you want a copy.

You may also want to get our other free special reports, Seven Key Principles for Christian Investing and IRAs, 401(k)s and Social Security: A Retirement Planning Primer. Request them here.

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Category(s): Inflation Watch, SMI General Announcements
Tag(s): inflation, special report, what causes inflation

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Running the government on 8%

Following up on Joseph's post from yesterday, this CNNMoney.com graphic is telling:

From the article:

Today, the United States spends roughly 76 cents of every federal tax dollar on just four things: Medicare, Medicaid, Social Security and interest on the $14 trillion debt. That leaves 24 cents of revenue to pay for everything else the federal government does. ...

Barring serious efforts to curb the growth in the country's debt, by 2020 Washington could be spending 92 cents of every tax dollar on Medicare, Medicaid, Social Security and interest alone. That would leave just 8 cents to pay for everything else.

It's easy to gripe about government spending and to rail against it generally. It's very hard to figure out how specifically to reduce Medicare, Medicaid, and Social Security. And yet these are the three areas within our direct control that are going to soak up most of the dollars (interest really isn't within our direct control anymore — that money is spent and interest rates will be dictated by the markets).

Any spending cuts are welcome at this point. But we have to realize — and soon — that spending cut proposals that don't reach to these three specific programs simply aren't going to be enough.

May God give us wisdom and the strength to make the hard decisions that lay ahead.

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Category(s): Economy, Inflation Watch
Tag(s): federal budget, federal spending

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Report: 2011 deficit to hit all-time high — national debt will go to 69% of GDP

Once a year, the Congressional Budget Office releases a report that looks ahead at the federal budget situation over the decade ahead. The latest Budget and Economic Outlook (PDF—190 pages) came out last week, and (not surprisingly) the news isn't exactly encouraging.

Excerpts:

The United States faces a daunting fiscal outlook, both for the next few years and for the long term. The Congressional Budget Office (CBO) projects that if current laws remain unchanged, the federal budget will show a deficit of close to $1.5 trillion for fiscal year 2011, about $200 billion more than the deficit recorded in 2010....

The accumulating deficits [over the next several years] will significantly boost federal debt held by the public. Over the course of fiscal year 2010, debt held by the public jumped from $7.5 trillion to $9.0 trillion. By the end of 2011, CBO projects, that figure will be $10.4 trillion and, at 69 percent of GDP, the highest level since 1950.

[D]ebt held by the public is projected to continue its upward climb, reaching $18.3 trillion...by the end of 2021. With such a large increase, along with an anticipated rise in interest rates as the economic recovery strengthens, interest payments on the debt are expected to skyrocket. CBO projects that the government's yearly net interest spending will more than triple between 2011 and 2021 (from $225 billion to $792 billion).

Interestingly, the report notes, if it weren't for those skyrocketing interest payments, yearly deficits would shrink significantly over the next several years, with outlays eventually almost matching revenues by 2017. But, of course, interest must be counted.

And there's more:

Beyond the 10-year projection period, further increases in federal debt relative to the nation’s output almost certainly lie ahead if current policies remain in place. The aging of the population and rising costs for health care will push federal spending as a percentage of GDP well above that in recent decades.

In particular, spending on the government's major mandatory health care programs — Medicare, Medicaid, CHIP, and health insurance subsidies to be provided through the new insurance exchanges — along with Social Security will increase from roughly 10 percent of GDP in 2011 to about 16 percent over the next 25 years. If revenues stay close to their average share of GDP for the past 40 years, that rise in spending will lead to rapidly growing budget deficits and surging federal debt....

[A] growing federal debt...would increase the probability of a sudden fiscal crisis, during which investors would lose confidence in the government's ability to manage its budget and the government would thereby lose its ability to borrow at affordable rates. It is possible that interest rates would rise gradually as investors' confidence faltered, giving legislators warning of the worsening situation and sufficient time to make policy choices that could avert a crisis. Indeed, because interest rates on Treasury securities are unusually low today, such a crisis does not appear imminent in the United States.

But as other countries' experiences show, investors can lose confidence abruptly and interest rates on government debt can rise sharply and unexpectedly....

[T]here is no way to predict with any confidence whether and when such a crisis might occur and no identifiable tipping point of debt relative to GDP. However, the risk of a crisis probably will increase when investors' growing confidence in the global recovery and the stability of the financial system increases their desire to hold private securities and foreign debt rather than Treasury securities.

A report such as this is, by nature, speculative. Accurate 10-year forecasting is impossible. That said, the overall budgetary trend is indisputably unsound — and the results could be dire.

Let us hope Washington heeds the warning.

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Category(s): Economy, Inflation Watch
Tag(s): federal spending, national debt

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Gold bubble?

I've been seeing a lot of articles debating whether gold is in a bubble. Given the rather "bubblicious" past decade we've witnessed, it's become easy to believe there's a bubble lurking behind every bush.

But as the Minyanville chart below shows, it's not quite as easy to make the bubble case when it comes to gold — at least based on the action of the four previous bubbles we've seen over the past dozen years.

(Click here for larger version.)

While many are comparing the trading in gold to what happened a few years ago in oil, the chart above shows that each of the prior four bubbles — including the crude oil bubble — saw prices go up by 4-5 times in a relatively short span of time. Gold hasn't had that type of parabolic move higher. Granted, gold is priced 4-5x higher than it was a decade ago, but this has been a much longer, protracted rise, as the chart indicates.

None of this proves anything, of course, since there's no rule that says all bubbles necessarily reach the same degree (though it's interesting to note how similar the four bubbles since 1999 have been). Also, this chart probably understates the gold line a bit by not giving it a separate scale.

The main point, though, is simply that gold hasn't seen the same type of acceleration these earlier bubbles did as they were heading to a peak.

With the financial news recently dominated by worldwide currency devaluations, "Quantitative Easing 2.0", and so forth, it's no wonder gold has been doing so well. Each day's financial news confirms the widespread national desires to see their currencies weaken. That creates a strong environment for gold.

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Will gold keep rising against major currencies?

The answer, of course, is "no one knows." But the prospects for gold seem good — or, put another way, the prospects for currencies appear to be not-so good.

Reporter Tom Sullivan offers details in Barron's.

The dollar is not as good as gold. Neither are 22 other currencies.

A recent study by GoldMoney.com, which enables online cross-border transactions using gold as a currency, found that from 2000 through 2009, gold rose an average 10.1% a year versus the Swiss franc...14.9% against the U.S. dollar... [and] 20.0% for the Sri Lankan rupee.

"Gold isn't going up, currencies are going down," says James Turk, GoldMoney.com's founder. "The purchasing power of gold remains basically unchanged against commodities. In contrast, the purchasing power of national currencies is being constantly eroded."...

That's because governments are debasing currencies, he says, destroying their citizens' purchasing power by spending beyond their means and using debt to stay afloat. The U.S., as one example, is trying to goose its economic recovery through massive deficit spending, but it may worsen the situation should the dollar tank, Turk asserts.

As always, there are those who see things a different way. The Barron's article quotes Ashraf Laidi, chief strategist at CMC Markets, who predicts gold will fall against the dollar.

Laidi could be right. But for any weaker gold/stronger dollar scenario to extend to the longer term would require the reversal of a pronounced nearly decade-long trend (see table).

A more extensive version of the table is here (PDF).

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Category(s): Inflation Watch, SMI Model Portfolios

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Kansas City Fed chief: Hyperinflation could happen here

I started working for Larry Burkett in 1990, about the time he was beginning work on a book called The Coming Economic Earthquake. Larry wasn't an economist. He was just an extraordinarily insightful, common-sense guy who had the uncanny ability to see around corners.

Although some criticized The Coming Economic Earthquake (I think unfairly) as alarmist and economically unsophisticated, Larry's point was simply this: a government that takes on obligations it can't pay for will eventually face a time of reckoning.

Today, who can deny that this is true? Just read the newspapers. Greece. Dubai. California.

I suppose what made The Coming Economic Earthquake controversial is that Larry argued that even the strongest nation with the largest economy — i.e., the United States of America — was not immune from the principle that too much debt and too many unfunded obligations will ultimately lead to financial upheaval.

If you remember the book, or recall hearing Larry talk about these issues on the radio, a speech delivered last week by Thomas Hoenig, president of the Federal Reserve Bank of Kansas City, will seem eerily familiar.

Congressional Budget Office (CBO) projections have the federal debt reaching an unsustainable level of two to five times our total national income within the next 50 years, which leads us to an inescapable conclusion — U.S. fiscal policy must focus on reducing this debt buildup and its consequences....

[I]t strikes me that we have only three options. First...: We can knock on the central bank’s door and request or demand that it "print" money to buy the swelling amounts of government debt. Second..: We can do nothing so long as domestic and foreign markets are willing to fund our borrowing needs at inevitably higher interest rates. Or third, the most difficult and probably the least palatable politically: We can act now to implement programs that reduce spending and increase revenues to a more sustainable level....

Throughout history, there are many examples of severe fiscal strains leading to major inflation. It seems inevitable that a government turns to [the first option; it calls on] its central bank to bridge budget shortfalls, with the result being too-rapid money creation and eventually, not immediately, high inflation....

German hyperinflation [in the 1920s] is one classic and often-cited example, and with good reason. When I was named president of the Federal Reserve Bank of Kansas City in 1991, my 85-year old neighbor gave me a 500,000 Mark German note. He had been in Germany during its hyperinflation and told me that in 1921, the note would have bought a house. In 1923, it would not even buy a loaf of bread. He said, "I want you to have this note as a reminder. Your duty is to protect the value of the currency." That note is framed and hanging in my office....

Many say it could never happen here in the U.S.... [But] the unthinkable becomes possible when the economy is under severe stress....

[T]he fiscal projections for the United States are so stunning that, one way or another, reform will occur. Fiscal policy is on an unsustainable course. The U.S. government must make adjustments in its spending and tax programs. It is that simple. If pre-emptive corrective action is not taken regarding the fiscal outlook, then the United States risks precipitating its own next crisis.

Back in early 1990s, some of our elected leaders read Larry's book and took heed. I know because I accompanied Larry on a trip to Washington (made at the invitation of a Congressman) where he spoke to many members of the U.S. House about the direction of the nation's finances. For a time, in the mid- to late-1990s, the situation improved. Spending increases were slowed and some of the national debt was retired.

Today, the government's economic picture is far worse than when Larry wrote the Earthquake book. Let's hope and pray that today's leaders will listen to Mr. Hoenig, and to the hundreds of thousands of citizens who are rising up to say, "Enough is enough."

The full text of Thomas Hoenig's address to the Peterson-Pew Commission on Budget Reform Policy Forum is here (PDF).

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Category(s): Inflation Watch
Tag(s): current market events, hyperinflation, inflation

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What next for gold?

It took some SMI readers by surprise when we started writing positively about gold in our May cover article, then came right out and suggested buying it in August's A Dollar in Danger Leads Many to Gold. Some believed it was too late to buy at that point, having seen gold rally from roughly $250 at the beginning of the decade all the way to nearly $900 at that time.

Now, with gold up another 20% in the six months since those articles were written, any such concerns of being too late to the party have only grown. Many are still wondering if it is too late to be buying gold.

A lot of this "is it too late" questioning reflects the split between the two approaches to gold that Austin discussed in the August cover article. The "short-term trader" mentality sees gold's recent run and thinks it may be due for a correction soon. The long-term accumulator sees the reasons for long-term appreciation in the years to come and recognizes those are still intact regardless of whether the price of gold corrects here.

What is the long-term case for gold? In a nutshell, it's a safe haven against poor stewardship of the world's fiat currencies. Most of us are focused on the dollar, given that we live here and conduct most of our business in dollars. But gold is also gaining popularity as an alternative to the British pound, the Euro, the Yen, and other currencies. The dollar isn't the only currency in trouble, it's just the biggest and most prominent.

One of the big dilemmas facing investors right now is the question of inflation vs. deflation. It's a tough call. On one hand, we see the dollar devaluation, the huge expansion of the money supply and easy money policies of the Fed, and signs of life from the economy. It's not a difficult task to connect the dots and construct a high inflation scenario.

On the other, there are all sorts of catalysts that could tip the world economy back into recession again, which would be distinctly deflationary (at least for the short-term). It's even easy to concoct a scenario where inflationary forces (like the rising price of oil) cause another deflationary recession. If you feel a little overwhelmed trying to sort through the possibilities, you're not alone.

The troubling part of all this as investors is that what works in an inflationary environment is typically the opposite of what works in a deflationary one. Bonds should do well with deflation and poorly with inflation. Stocks are the opposite.

Which brings me back around to gold. This Minyanville article quotes David Einhorn of Greenlight Capital with one of the better insights into gold that I've seen this year:

I have seen many people debate whether gold is a bet on inflation or deflation. As I see it, it is neither. Gold does well when monetary and fiscal policies are poor and does poorly when they appear sensible. Gold did very well during the Great Depression when FDR debased the currency. It did well again in the money printing 1970s, but collapsed in response to Paul Volcker’s austerity. It ultimately made a bottom around 2001 when the excitement about our future budget surpluses peaked.

Prospectively, gold should do fine unless our leaders implement much greater fiscal and monetary restraint than appears likely. Of course, gold should do very well if there is a sovereign debt default or currency crisis.

In other words, while another deflationary round of recession may temporarily bring gold prices down, providing better buying levels for traders and accumulators alike, in reality it's the decisions being made regarding the fiat currencies that are going to drive gold's future prospects.

In one major respect, this makes the gold question much easier. Rather than having to figure out whether we're headed for inflation or deflation next, you really only have to decide whether those calling the shots are going to make decisions that are in the long-term best interests of the dollar and other currencies, or whether they will likely continue to make short-sighted decisions that put the future value of these currencies at risk.

Given the "fix it now, and worry about the consequences later" mentality so prevalent in this generation, that seems to be a relatively easy call.

To recap then, it's entirely possible that gold pulls back from these levels, perhaps even significantly if we slip into a double-dip recession (or if it looks like we may). However, longer-term, we still think the prospects are quite strong for gold.

To read SMI's coverage of how best to invest in gold, as well as to get all of our latest investment recommendations, become an SMI Web Member. It only costs $8.95 per month, and you can cancel anytime — no long-term commitments. Try it today.

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Category(s): Inflation Watch

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Gold vs. Bonds

Mark Hulbert points out that in recent months both gold and bonds have performed well. But, he asserts, that can't last — eventually they're going to have to part ways.

While he focuses on different reasons than we did, Hulbert's conclusion echoes our own from the October issue of SMI: "Don't be surprised if the bond market over the next several months is markedly weaker than gold."

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Category(s): Inflation Watch

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Paper vs. physical gold

In our September cover story, A Road Map For Investing in Gold (web membership required, sign up here), Austin tackled the issue of buying paper gold (like an ETF based on the gold price) vs. owning real, physical gold. Basically, his view was that paper gold is fine to trade if all you're trying to do is make a profit on the increase in gold's price over the short-term. But for those who envision a long-term move in gold based on an accelerating devaluation of the dollar, being an accumulator of the physical metal itself seems like a better idea.

With that in mind, I found this warning from the World Gold Council (via the Uncommon Wisdom blog) to be very interesting:

There is approximately 78 times more "paper-gold" being held by investors than physical gold in existence on this planet that has ever been mined, according to the World Gold Council.

As this clearly implies that un-backed "paper-gold" accounts may be subject to the risk of default, investors should stay clear of buying paper-metal accounts from banks and make sure that any precious metal investment vehicle used does actually store the metals in a fully unencumbered, "un-leased" and physical form.

Not surprisingly then, the author comes to a similar conclusion as Austin at the end of this similar blog post on the dangers of paper silver:

My point is that while I prefer to hold physical gold and silver, I think there’s nothing wrong with using the SLV (or the GLD or DGP, for that matter) for a trade. It's much easier than shlepping down to a precious metals dealer and buying physical gold and silver with the intention of selling it later.

Physical gold and silver you buy and HOLD. Paper gold is fine for trading.

If you're thinking at all about investing in precious metals, it would be time well spent to read our recent two-part cover article: A Dollar in Danger Leads Many to Gold, and A Road Map for Investing in Gold. Web members will also find links to our specific primers on gold coins, gold bars, and gold funds at the bottom of that second article.

Posted by Mark at 3:49 PM | Comments (0) | TrackBack
Category(s): Inflation Watch

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Meet James Turk

In my August cover article, "A Dollar in Danger Leads Many to Gold," I explained why higher inflation seems likely, why having some exposure to gold in one's portfolio is reasonable, and briefly looked at how much of one's assets might be allocated to gold.

In September, I followed with "A Road Map for Investing in Gold," where I discussed five ways to invest in gold should one wish — the first three involve owning gold bullion directly, the last two represent indirect avenues of ownership. I explain why I recommend direct ownership for those who want to start adding gold to their other investments.

One of the organizations I recommended was GoldMoney.com. It is a low-cost vehicle for those who wish to accumulate gold bullion via dollar-cost-averaging. James Turk is the founder of that organization.

In these four brief videos, James addresses the UK Silver Investment Summit on the topic "Factors That Will Drive Precious Metals' Bull Market."

The videos are from last year and so are slightly dated, but they do a good job of introducing you to James and his views on the gold and silver markets. In Part 4, he answers a question concerning ETFs and why he feels they are more suitable for traders than for long-term accumulators.

Posted by Austin at 5:14 PM | Comments (0) | TrackBack
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Bernanke - Take II

Earlier this week, President Obama made it official and reappointed Ben Bernanke for a second term as Federal Reserve Chairman. This wasn't a big surprise and was viewed by many as the safe choice. It would have been tough to switch to a new leader while we're still very much in the midst of volatile economic times.

That's not to say, however, that everyone loves the decision. Bernanke is getting mostly positive reviews from economists for his performance during the financial crisis. But he's also drawing his fair share of criticism. Here's a sampling.

Robert Samuelson thinks that while Bernanke made some significant mistakes, he got it mostly right:

Here is where Bernanke distinguished himself. A student of the Great Depression, and especially of the disastrous effects of bank failures, he went well beyond the standard response of lowering interest rates (the overnight Fed funds rate dropped effectively to zero by December). The Fed created a dizzying array of "liquidity facilities" that substituted more than $1 trillion of Fed credit for retreating private credit. The Fed supported markets for mortgages, money market funds, commercial paper, auto loans and student loans. The strategy was, as [In Fed We Trust author David] Wessel says, to do "whatever it takes" to avoid a complete loss of credit and confidence — a loss causing continuous drops in spending and asset prices (for stocks, bonds, homes) and culminating in depression.

Although there were other actors, the Fed's interventions were decisive in halting the panic. It is an open question whether any other Fed chairman — someone without Bernanke's detailed knowledge of the Depression — would have been so bold in supporting credit markets. Moreover, Bernanke's approach inspired similar moves abroad. After the 1997-98 Asian financial crisis, Time magazine ran a cover story called "The Committee to Save the World" featuring Summers, then-Fed Chairman Alan Greenspan and then-Treasury Secretary Robert Rubin. An updated version might have Bernanke on the cover under the headline: "The Man Who Saved the World."

The Wall Street Journal isn't quite as generous. In their estimation, Bernanke deserves credit for what was done after the crisis blew up. But he also deserves criticism for being largely responsible for creating the problem in the first place:

This commodity spike weakened the economy further in 2008 and contributed to the failures that struck after Labor Day. As economists Anna Schwartz and John Taylor have noted, Mr. Bernanke misdiagnosed as a liquidity crisis what was principally a bank solvency problem. This is one reason his easing did little to stem the panic throughout 2007 and 2008. A steadier monetary hand might well have avoided the autumn panic. But the Bernanke Fed was taken as much by surprise as Lehman Brothers.

All of this history is relevant because the Fed is now back where it was in 2003, albeit with a weaker recovery and more political complications. The test of Mr. Bernanke's second four years will be whether he has the wisdom and political courage to roll back his epic monetary easing before it creates the next set of problems or a new inflation. Everyone loves a central banker when he's flooding the economy with money, at least while the mania lasts. But Mr. Bernanke will sooner or later have to say no to the political class. This is something he has never done, and already there are signs in China and the edges of the dollar bloc of new asset bubbles.

But those criticisms pale when compared to the harsh words John Hussman has for Bernanke in his latest commentary:

Ben Bernanke (like Tim Geithner and his predecessor Hank Paulson), shows no hesitation in diverting the real resources of the American public to defend and compensate the bondholders of mismanaged financial companies who made reckless loans and who should have (and equally important, could have) been expected to write down principal or swap debt for equity as an alternative to receivership. This is not decisiveness. It is timidity and poor stewardship. Worse, the underlying problems are not healed — only band-aided temporarily by a flood of public money.

Unfortunately, the resources used in the recent bailout were not just free money tossed out of a helicopter. Only a partial-equilibrium economist thinks that way. No, this was an allocation of trillions of dollars of real resources that could be spent improving access of poor families to health care, finding cures for life-changing diseases, providing better education, and reversing the crowding-out of productive private investment. A public servant willing to act this carelessly with the resources entrusted to him, and so strongly in defense of fellow bankers, frankly does not deserve the job. Most likely, we will face the same credit issues a few quarters from now, given that the lull in the adjustable-rate reset schedule is near its end. We continue to expect a fresh acceleration of credit losses as we enter 2010. It would be best if we faced these challenges with more thoughtful leadership.

It's good to realize that judging the performance of Fed Chairmen is difficult to do accurately in the moment. Volcker was hated when he was breaking the back of inflation in the early 80s, as it involved brutally painful interest rate hikes. But today he is widely lauded as one of the best Fed chiefs we've ever had. On the opposite end of the spectrum, Greenspan was widely hailed as "The Maestro" — a supposed genius who left the job with great popularity. Yet just a few short years later, many hold him responsible as one of the prime culprits of the financial crisis.

Time will tell how Bernanke is remembered. How he deals in his second term with the inflation threat created during his first term will likely go a long way toward writing the rest of the story.

Posted by Mark at 4:06 PM | Comments (0) | TrackBack
Category(s): Economy, Inflation Watch

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Presumably non-partisan federal budget commentary

You know blogging has gone mainstream when the director of the Congressional Budget Office (an independent nonpartisan agency) has his own blog. It's been around for more than a year... not sure why I never came across it before. Looks like he (or, possibly his staff, since he's presumably a pretty busy fellow) posts fairly regularly.

Here's the front page if you want to bookmark it for future reference. Tuesday he reported what went on at the White House when he met with President Obama, "his key budget and health advisers, and some outside experts."

There's an archive section devoted to budget projections. And from that archive, here's a July 16 post on The Long-Term Budget Outlook. Some excerpts:

Under current law, the federal budget is on an unsustainable path, because federal debt will continue to grow much faster than the economy over the long run. Although great uncertainty surrounds long-term fiscal projections, rising costs for health care and the aging of the population will cause federal spending to increase rapidly under any plausible scenario for current law. Unless revenues increase just as rapidly, the rise in spending will produce growing budget deficits. Large budget deficits would reduce national saving, leading to more borrowing from abroad and less domestic investment, which in turn would depress economic growth in the United States. Over time, accumulating debt would cause substantial harm to the economy....

CBO estimates that in fiscal years 2009 and 2010, the federal government will record its largest budget deficits as a share of GDP since shortly after World War II. As a result of those deficits, federal debt held by the public will soar from 41 percent of GDP at the end of fiscal year 2008 to 60 percent at the end of fiscal year 2010. This higher debt results in permanently higher spending to pay interest on that debt....

Not easy reading, but appears to be a good source of data directly from the horse's mouth rather than as filtered through the liberal or conservative media.

Posted by Austin at 4:00 PM | Comments (0)
Category(s): Economy, Inflation Watch

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National Debt road trip

Austin forwarded this to me last week during our writing frenzy. I think some of you will find it eye-opening, as I did.

One of the problems with discussions of government spending and debt is that the numbers are so huge. Most of us have no reference point for numbers in the billions and trillions, so we react much the same way to a report of a $300 billion deficit as we do a $500 billion deficit — they're both incomprehensibly huge.

This short video (less than 3 mins) does a good job of translating the pace of federal spending to something we're more familiar with: miles-per-hour on a cross-country road trip. Take a few minutes to watch it. You may be surprised.

Posted by Mark at 1:11 PM | Comments (0)
Category(s): Economy, Inflation Watch

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Inflation experiment

The Fed is “running a laboratory experiment” on what drives inflation: the money supply or the output gap, says Laurence Meyer, a former Fed governor and now vice chairman of St. Louis-based Macroeconomic Advisers.

That's the summary of an excellent Bloomberg article on inflation and the recent government actions. There are two competing heavyweight theories squaring off right now. Call it Keynes vs. Friedman II.

Nobel-prize winner Milton Friedman contended that “inflation is always and everywhere a monetary phenomenon.” In other words, when you create too many dollars, it will eventually show up as inflation as more dollars chase the same supply of goods.

SMI tends to agree with the Friedman economic view of the world, so you've been exposed to a regular diet of this sort of thinking. We believe the government's massive spending will ultimately be inflationary (which is why we'll be exploring the inflation topic in the cover article of next month's newsletter).

While Friedman is a big name and his followers are widespread, his view is by no means unchallenged. The primary competing viewpoint on inflation comes from Keynes, whose economic theories dominated for decades (some would say until they were disproven during the 1970s by rampant inflation coupled with stagnant growth; i.e., the infamous "stagflation").

The article explains how the current economic situation is viewed through Keynes' framework:

At the root of that concern is substantial and growing slack in the economy, which, according to White House chief economist Christina Romer, is operating 5 percent to 10 percent below potential. That means the economy will have to grow a percentage point above trend — reckoned by the administration to be about 2.5 percent annually — for five or more years before the slack is used up.

The Phillips curve — developed by economist A.W. Phillips using Keynesian concepts — posits that such excess will reduce inflation as firms stuck with idle capacity cut prices and workers facing layoffs accept smaller wage hikes.

In essence, it boils down to this: can the government get away with significant money creation (to help spur the economy out of its present trouble) without causing serious inflation at some point down the line? Friedman would likely say no, Keynes would likely say yes.

Even if inflation is the eventual result, there's the tricky issue of timing. As San Francisco Fed President Janet Yellen is quoted in the article as saying a few weeks ago, “For some time to come, disinflation, and even deflation, will represent greater risks than inflation."

Much more to come in the May issue of SMI.

Posted by Mark at 1:44 PM | Comments (0)
Category(s): Economy, Inflation Watch

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Revisiting The Coming Economic Earthquake

In recent weeks, several SMI message board posts and blog comments have mentioned Larry Burkett's 1991 (and revised in 1994) book, The Coming Economic Earthquake.

When published, the book was widely criticized as being 1) unnecessary scare mongering and/or 2) too simplistic in its view of the U.S./world economy.

As one who helped research that book, I am convinced that much of the criticism came from people who didn't actually read it. Larry simply presented the idea, consistent with basic economics and documented by history, that debt - whether it be personal, business-related, or governmental - cannot continue to expand indefinitely. At some point, a time of reckoning must occur.

I heard echoes of Larry when reading a long interview in a recent Barron's with Ray Dalio, chief investment officer of Bridgewater Associates.

[I think we are experiencing] a "D-process," which is different than a recession - and the only reason that people really don't understand this process is because it happens rarely.... This was the dynamic that occurred in Japan in the '90s, that occurred in Latin America in the '80s, and that occurred in the Great Depression in the '30s.

Basically what happens is that after a period of time, economies go through a long-term debt cycle - a dynamic that is self-reinforcing, in which people finance their spending by borrowing and debts rise relative to incomes and, more accurately, debt-service payments rise relative to incomes.

At cycle peaks, assets are bought on leverage at high-enough prices that the cash flows they produce aren't adequate to service the debt. The incomes aren't adequate to service the debt.

Then begins the reversal process, and that becomes self-reinforcing, too. In the simplest sense, the country reaches the point when it needs a debt restructuring. General Motors is a metaphor for the United States.... The process of bankruptcy or restructuring is necessary to its viability. One way or another, General Motors has to be restructured so that it is a self-sustaining, economically viable entity that people want to lend to again....

We will go through a giant debt-restructuring, because we either have to bring debt-service payments down so they are low relative to incomes - the cash flows that are being produced to service them - or we are going to have to raise incomes by printing a lot of money.

It isn't complicated. It is the same as all bankruptcies, but when it happens pervasively to a country, and the country has a lot of foreign debt denominated in its own currency, it is preferable to print money and devalue....

A wave of currency devaluations and strong gold will serve to negate deflationary pressures, bringing inflation to a low, positive number rather than producing unacceptably high inflation - and that will last for as far as I can see out, roughly about two years.

On this last point, I'm not sure Larry would agree. In his book, he expressed concern that trying to inflate the money supply by printing a large amount of new money would stoke inflation, even hyperinflation.

Dalio is arguing that, at least in the near-term, combining printing money with a devaluation of the currency can achieve the necessary balance. Maybe. But I am reminded of one of Larry's favorite sayings: "The man who tries to ride on the back of the tiger is likely to end up inside." (To be fair, Dalio's comment is specifically focused only on what he expects this year and next. He may well agree with Larry regarding the longer-term; we don't know from this interview.)

Focus on the Family recently re-aired a 1992 interview with Larry in which he talked about the Earthquake book. You can hear it here. (NOTE: The timetable Larry envisioned played out in 1997 in Asia. It was delayed here in the U.S. for several reasons, including technological innovation, a slowing in the rate of growth of government spending in the mid-1990s, and a long period of low interest rates that helped keep debt "affordable.")

Posted by Joseph at 1:45 PM | Comments (0)
Category(s): Economy, Inflation Watch

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Peering over the ledge

We interrupt our normally optimistic reporting to bring you this view of what could go wrong...

Crown's MoneyLife radio program yesterday was a really good discussion of a recent Wall Street Journal article titled The Doomsayers Who Got It Right (subscription required). While you can't read the actual article unless you're a WSJ subscriber, the first link above is a loose transcription of the radio program which discusses many of the details in the article.

The article catches up with the current thinking of three prominent economists/money managers who predicted much of the economic crisis. An extremely brief summary of their views follows.

Jeremy Grantham points out that the unintended consequences of the government's response to the financial crisis are unknowable. He thinks there's a long-term risk of a surge in inflation and sees a better than 50-50 chance 2009 will see the stock market decline further. He's setting aside cash in case stocks fall significantly lower, though the article doesn't say he's actually predicting that. In fact, somewhat surprisingly to me, Grantham mentions that he expects real (after inflation) returns of 9.5% from foreign stocks and 7.5% from U.S. stocks over the next seven years. Those are both pretty decent numbers.

Bob Rodriguez sees the economic slide continuing much longer than most. He says his concern isn't the next two years, "but period three through 10." He expects high inflation during that time and GDP growth of less than 2% per year, which would mean a very slow recovery.

Much of this prognosis is based on a change he sees in the U.S. consumer from spender to saver. The Crown program pointed out that the paradox here is that it's a great thing at the individual level for people to quit spending so much and start saving - exactly the right prescription for personal financial health. But 70% of our national economy is made up of consumer purchases, so if the savings rate does go from 1%, where it's been in recent years, to 7%-10%, where Bob Rodriguez sees it moving to by next year, that means the economy as a whole is going nowhere fast.

As an investing blog, it's also worth noting that Rodriguez was buying stocks in October and November for the first time in over a year, though mostly in the energy sector where prices for real assets (like oil) will likely rise as inflation catches hold.

Peter Schiff is probably the most bearish of the group, expecting massive inflation and sharply higher interest rates as foreign investors eventually refuse to buy U.S. debt. He sees the dollar dropping significantly in that scenario and foreign markets outperforming U.S. markets by a significant margin as a result. (Detractors would point out that while many of Schiff's dire predictions have panned out, his actual investment performance has been poor, as his investments have been mainly overseas stocks and commodity-based, both of which were hammered in the downturn last year.)

There's value in examining the "what if's" these bearish views present. The most important take-away from an article like this is probably not so much on the investing side (though there are elements there worth exploring, and we likely will in the months to come), but the personal finance side. If these men are right, the economy is not going to get better anytime soon. In these scenarios, it is paramount that readers do the hard thing in preparing themselves financially by spending less than they earn, paying down debt, and establishing an emergency savings reserve. Don't assume things will bounce back quickly.

I really appreciated the conclusion of MoneyLife host Chuck Bentley's take on all this, which you can find at the end of the program or transcript (linked to above). He explained that as Christians, we don't have to put a positive or optimistic "spin" on this sort of news, but we can and should have hope about the future, in spite of what may come economically because God can and will redeem even the tough things that happen to us. Read or listen to the ending of his program for his full take. It's good stuff.

As you know, SMI doesn't put a lot of faith in any expert's predictions. So we're not going to get all panicky about these predictions. But it is worth soberly considering these gloomier outlooks so as to prepare ourselves in case they are accurate. That starts with getting our personal finances in order, and then ripples into our investing decisions. Again, the investing implications of all this are a little beyond the scope of this post, but we'll likely delve a little deeper into some of this in the future.

Posted by Mark at 4:29 PM | Comments (0)
Category(s): Economy, Inflation Watch

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