-->Gold v. The Dollar
The Daily Reckoning
Paris, France
Wednesday, March 19, 2003
---------------------
*** Give war a chance...who knows what it will produce?
*** Stocks up again...gold too...But big drop in
housing...Gloom for world economy...
*** Dollar's sharp edges...Chirac to get Nobel Peace
Prize?...and more!
---------------------
Give war a chance.
Stocks rose again yesterday, anticipating the sound of
cannons by perhaps only a few hours. Investors expect a
neat little guerre, one with few American body bags, few
complications and few surprises.
What was supposed to have been a post-war rally has become
a pre-war rally. What will happen when the war is over?
Will the pre-war rally turn into a post-war bust?
All we can say with any assurance is that there will soon
be a big boom in Baghdad. Lots of them. Whether they will
do investors any good is an open question.
The world is full of question marks.
Suppose the war is short and sweet. And suppose it is
followed by a bull market on Wall Street, a boom in the
economy, and George W. Bush's reelection. Will that be a
good thing? Or would it be only a prelude to an even bigger
disaster - as the bear market of 2000 -? (another question
mark!) inevitably grinds down towards its eventual bottom.
Whoever heard of a bear market bottom at 40 times core
earnings? Somehow, sometime, stocks have to go
lower...wouldn't putting it off just make it worse?
But what if the war appears to have done great things for
the economy? If a little war produces such agreeable
results, who would say 'no' to a big one? Wouldn't it turn
the next wheel on the Axel of Evil into an irresistible
target?
That is the problem with history, dear reader; it is always
more complicated, more perverse, and full of more surprises
than people want to think about.
In a bull market, the question marks disappear. Investors
stop asking about funding pensions, stock options,
executive compensation, P/E ratios, and 'pro-forma'
earnings. They stop worrying about earnings all together.
All that matters is that they are 'in the market'. Because,
as everyone thinks he knows at the top of a bull market,
nothing beats buying and holding stocks.
Later, stocks come down, and the question marks come out.
"What was I thinking?" becomes a common point of
interrogation."I wasn't thinking at all," is the answer
most often given.
In today's financial markets, the question marks are only
beginning to appear. Most people still believe in 'stocks
for the long haul'. But after three years of negative
returns, they're beginning to wonder how long the long haul
will be.
Meanwhile, it is still a bull market in U.S. power. And in
the group-think of politics, question marks are as scarce
as tourists in downtown Basra. People would prefer to avoid
niggling doubts and annoying arrière pensées. In fact,
judging from the hundreds of email messages arriving here
at the Daily Reckoning every day, there are a fair number
of readers who are downright sick of our quibbles. In their
minds, the situation is simple: there is Evil on one side
and Good on the other.
Tomorrow night, or thereabouts, the forces of Good are
expected to confront the forces of Evil...and bomb the hell
out of them. Then, the world will be a better place.
We hope they are right. But quibbling and question marks
are what you don't pay us for, dear reader. More
below...after Eric's report:
------------
Eric Fry in New York...
- The lumpeninvestoriat continued snapping up richly priced
stocks yesterday. The Dow jumped 52 points to 8,194, while
the Nasdaq advanced half a percent to 1,400. Gold for April
delivery added 50 cents to $337.70. Yesterday's eager stock
buyers understand that bombs are bullish, especially when
the bombs fall on distant countries with feeble armies.
Only numbskulls worry about rich stock market valuations or
deteriorating economic trends.
- U.S. housing starts fell 11% in February from January's
pace, the biggest percentage decline in nine years. But why
worry about such minutia when bombs will soon be falling on
Iraq in the largest quantities in 12 years?...Just imagine
how the bombing will boost housing starts in Baghdad later
this year!
- The flip side of this week's paradoxical stock market
rally is the paradoxical crude oil sell-off. Oil traders
seem to have determined that the imminent invasion of a
major oil-producing country is, somehow, bearish for oil
prices. Crude oil for April delivery tumbled $3.26 to
$31.67 a barrel yesterday.
- Speaking of paradoxical, who keeps buying all of our
bonds?...Compared to buying a stock at 30 times earnings,
buying a long-term bond yielding less than 4% might seem
like a lower risk proposition. Then again, compared to
jumping out of an airplane without a parachute, jumping out
of a 5-story window might seem like a lower-risk
proposition...but the outcomes would not be dissimilar.
- The fact is, investors needn't buy either expensive
stocks or expensive bonds. As Warren Buffet recently
remarked,"Occasionally, successful investing requires
inactivity." Cash is not trash when the alternatives are
fraught with risk. Nevertheless, many investors tend toward
hyperactivity, feeling the need to do SOMETHING at all
times. How else does one explain the strong demand for low-
yielding bonds?
-"I cannot see a reason to buy anything other than
government bonds," a Mr. Kornelius Purps, fixed-income
analyst at HVB Group in Munich, declared to Bloomberg News
recently. We do not know Mr. Purps personally. But the man
seems to lack imagination. We can think of many reasons why
an investor might want to avoid Uncle Sam's IOUs, miserly
yields being only the most obvious reason. 10-year Treasury
note yields have tumbled to 3.90%, the lowest since the
Eisenhower Administration.
- A paltry yield on a long-term bond creates what
professional investors refer to as"asymmetrical risk". In
other words, many things must go right for the investment
to work out well. But very little has to go wrong for the
investment to work out badly.
- Another reason why an investor might not want to put
every egg he's got into the low-yielding-bond basket is
that bond issuance is soaring. The Federal government -
along with many state and local governments across our fair
land - is ramping up its borrowing. And that means there
will be plenty of bonds to go around.
- Several years ago, a cartoon on the cover of Grant's
Interest Rate Observer depicted a man bolting upright in
his bed with beads of sweat flying off his brow, as if
awakening from a nightmare. The caption read,"I dreamed
they ran out of bonds!"
- Many of today's bond buyers seem to possess a similarly
irrational fear of a bond shortage. But investors needn't
lose sleep over that possibility. The Federal Government's
growing budget deficit will insure a steady supply of
bonds. And the state governments will also do their share
to make sure that each and every citizen who wishes to buy
a bond will be able to do so.
-"State and local governments tapped the municipal bond
market for cash at a faster clip in the first two months of
2003 than they did a year ago," Dow Jones News reports.
"Long-term borrowings in January and February tallied an
unprecedented $52.3 billion, up 22.8% from $42.6 billion in
the year-earlier period."
- So why do yields keep falling, even though supply is
rising? Two words: fear and foreigners.
- Fearing additional losses in the stock market, individual
investors have been dumping stock mutual funds for the last
several months and rolling the proceeds into bond funds.
Merrill Lynch estimates that households were net sellers of
$466 million of U.S. equity funds in January and net buyers
of $12.7 billion of bond funds. The trend continued in
February. But individual investors are not the only ones
lining up to buy bonds. Foreigners have been big buyers of
government bonds as well.
-"Rest of World [i.e. foreign] acquisition of U.S. credit
market instruments surged last year to $416.9 billion," the
Prudent Bear's Doug Noland explains."This compares to
2001's $320.6 billion...The day our foreign-sourced
financiers move to liquidate U.S. securities, we are faced
with a calamitous dislocation."
- The good news is that calamitous dislocations don't come
along that often.
------------
Back in the land of croissants and quibbles...
*** The bull/bear cycle in a stock market over-rides logic
and reason. A dollar's worth of earnings is thought to be
worth only $8 at the bottom of the cycle...and as much as
$200 at the top. From fear to greed...from confidence to
desperation...markets run their course.
And who are we to argue with it? If that is the way the
gods want it, well...so be it. We'll just try to enjoy it.
*** But what happens in politics? If our view is correct -
that bubblish sentiments have leaked from the financial
markets in America into geo-politics - mustn't the same
cycle run its course, no matter what we or anyone else
says?
We don't know, of course. But history is full of examples
of politics run amok. People rarely seem to come to their
senses. Instead, bubbles continue to expand until some
sharp object comes along to prick them. Then, they continue
to deflate until they are flattened.
*** Few investors have noticed, but the dollar's edges have
become razor sharp.
Thanks to the cost of its wars on terror and Iraq, the
federal budget deficit, says Bill Gross, is expected to
come to between $400 and $500 billion"as far as the eye
can see". Most of this is in addition to the current
account deficit - now running about $500 billion. Together,
this leaves the U.S. with about $1 trillion per year in
financing needs.
Already, 80% of the world's savings are spent by Americans.
Maybe, in the post-war era, the world will want Americans
to spend even more of its savings. Then again, maybe it
won't.
(See also: How You Can Seek Protection From A Dollar Breakdown
http://www.agora-inc.com/reports/RCKN/Everbank)
*** If foreigners do not willingly lend the money, how will
America finance its new industry - exporting 'security?' We
ask the question without prejudice or malice. We just want
to know. Successful or not, someone will have to pay for
it. And we have a sneaking suspicion that the answer will
be the key to the world's investment markets for the next
several years: either Bernanke & Co. will really manage to
inflate the dollar - putting the costs on the creditor
class (35% of U.S. Treasury bonds are owned by foreigners)
- or the weight of debt will collapse the economy and the
markets. Argentina or Japan, in other words.
***"Gloom for world economy" following the war, predicts a
BBC report. The head of the IMF thinks American deficits,
combined with recession and stagflation in Europe, will be
fatal. But, of course, he doesn't know any more than anyone
else. And in this new Information Age, with around-the-
clock news available to everyone...we are all ignorami,
now. You may quote us on that.
*** It is a bright, beautiful day in Paris this morning.
The outdoor cafes are already starting to fill up. Lovers
stroll in one another's arms. The smell of pain au chocolat
drifts up from the bakery. What a pretty day for a war.
The frogs do not seem to be worried about tomorrow's war...
but they are proud not be a part of it. Today's LIBERATION
even suggests that President Chirac may be a candidate for
a Nobel Peace Prize, thanks to his determined stance
against the war.
Contrary to what our critics may think, we have no
illusions about Chirac. While we've never met the man, we
have no reason to think he is any wiser...or any more
honorable...than, say, George W. Bush! A pox on both of
them...
There, we've managed to insult our American readers and our
French readers at the same time. Bravo for us...
..so go ahead. Cancel your subscription!
The Daily Reckoning PRESENTS: Throughout the ages,
governments have had a love-hate relationship with gold.
Never has the relationship been more tenuous. Since 1971,
when all the world's governments suspended gold payments,
the U.S. dollar has been the world's de facto reserve
currency. Alas, suggests Hans Sennholz, it may be time for
gold to shine again.
GOLD v. THE DOLLAR
by Hans Sennholz
It is difficult to argue with gold.
To men everywhere, gold is a desirable economic object. It
can be used for the manufacture of jewelry and ornaments.
It is a corrosion-resistant element, the most malleable and
ductile metal, ideal for plated coating on a wide variety
of electrical and mechanical products. It is a good thermal
and electrical conductor. It is durable and storable, can
be easily hidden from partakers and predators, and readily
shipped to other places. Gold is very marketable. In fact,
gold may be the most marketable commodity around the globe.
The value of gold is determined by the same considerations
as that of all other economic goods. Individuals give it
value according to the enjoyment and satisfaction they
expect to get from its possession. Economists explain this
fact in terms of utility and scarcity. Value rises or falls
in accordance with the utility which people ascribe to an
object and the scarcity they perceive. Like that of any
other economic good, the value of gold changes according to
changing perceptions and situations.
This must be emphasized because there are many goldphiles
who wax eloquent about the eternal, immovable value of
gold. They obviously have never experienced, and cannot
think of, a situation in which basic essentials that
sustain or safeguard human life do soar in value while that
of gold in any form plummets. In fact, in desperate
situations, people may prefer a pound of bread to an ounce
of gold, essential clothing and shelter to a pound of gold
and, when their lives are at risk, their lives to a ton of
gold.
The supply of gold is plentiful. For thousands of years it
has been mined and accumulated; very little is consumed or
lost. Existing supplies in the form of coins, jewelry,
decoration, and plated coating are greater by far than
current production. No matter how much gold is produced in
South Africa or Russia, current output is rather negligible
when compared to the quantities in individual possession
throughout the world. This characteristic, in which it
differs from all other metals, reduces the risk of sudden
changes in quantity and, therefore, sudden changes in its
value. Even silver, which has many characteristics similar
to those of gold, is subject to great changes in production
and consumption that may affect its value.
The special characteristics man ascribes to gold have made
it the most marketable economic good of all, the popular
medium of exchange and unit of economic calculation and
account; they have made it man's money. For more than 2500
years, from ancient Greece to modern USA, gold coins have
served as money and the standard of calculation and
account.
Throughout the ages governments have had a love-hate
relationship with gold. Most of the time, they sought to
amass it in their treasuries and monopolize its use. They
claimed and brutally enforced a monopoly of the mint. At
other times governments waged war on gold, seeking to ban
it under penalty of fine, imprisonment, or even death.
During the French Revolution, hundreds of businessmen died
on the guillotine because they had dared to calculate
prices in gold or ask for gold. In the United States, from
1933 to 1975, it was a crime punishable by fine and
imprisonment to own standard gold coins. At present, the
U.S. government, while clinging to a sizeable hoard buried
in Fort Knox, seeks to disparage it and make little of it
as an unimportant metal.
We are living in an age in which all governments,
regardless of the system of political and economic
organization, whether interventionistic, socialistic,
democratic or dictatorial, are occupying an economic
command post. Most of them work through central banks
issuing legal-tender notes and through government mints
manufacturing coins. In 1971, they suspended gold payments
and made the most important and most stable currency - the
U.S. dollar - take the place of gold. The world has been on
a dollar standard ever since.
For the US federal government the dollar standard has been
a magical guide to cheerful spending and soaring debt. It
released the Federal Reserve System from the shackles of
gold and set it free to finance federal deficits no matter
how large. In 1971, the federal government deficit amounted
to $23.033 billion, and the federal debt stood at $409.5
billion.
By now, the 2003-2004 federal budget calls for expenditures
in excess of $2.1 trillion and a debt of some $7 trillion.
Since 1971, the American dollar has lost almost 70 percent
of its purchasing power and is losing more every day. It
makes it difficult to project future debts and deficits,
but it is likely that the dollar standard will disintegrate
if foreign investors should ever lose their confidence in
it.
For the American people, the world dollar standard has
been, and continues to be, both a welcome boon and a
dreaded affliction. It is pleasant and beneficial as it
permits the Federal Reserve System to engage in massive
credit creation that generates unprecedented trade
deficits, now running at a rate of over half a trillion
dollars a year. At some five percent of gross national
product (GNP), the trade deficits actually have lifted the
levels of consumption of the American people, while they
depressed the levels in creditor countries. Moreover, the
dollar standard has enabled the U.S. Treasury to place much
of its new debt with foreign investors and thereby shift
much of the burden of debt to foreigners.
The dollar standard has also been a dreaded affliction, as
it allowed the Fed to depreciate the American dollar every
year and finance a frightful expansion of government
functions and powers. Dollar savings have lost some 70
percent of purchasing power, while the number of government
rules and regulations probably has risen by a similar
proportion.
Many economists are convinced that the current pattern of
Treasury deficits and Federal Reserve money and credit
expansion is not sustainable. They call for large tax
increases or drastic spending cuts that would allow the
Federal Reserve to decelerate its money fabrication. But
they also are aware that large tax increases at this time
of economic stagnation and rising unemployment would
depress economic activity even further. Spending cuts, on
the other hand, probably would bring relief to the ailing
economy, but undoubtedly would be unacceptable to the
political forces that benefit from the spending. They
usually cite old notions and theories that advocate deficit
spending as a panacea for economic evils and difficulties.
The huge budget deficits may yet be solved in another way:
the Federal Reserve may continue to cover them with new
money and credit, which may depreciate all dollar debt as
fast or faster than it can be added. A five-percent
inflation depreciates the purchasing power of a $7 trillion
federal debt by $350 billion a year. At the 1980 rate of
inflation of 12.5 percent, the federal debt would shrink by
$875 billion in purchasing power, and at the 1990 rate of
inflation of just 6.1 percent, by $427 billion. But such a
solution may cause a crisis of confidence in the integrity
of the American dollar and precipitate the end of the
dollar standard.
For most of a generation, the almighty dollar has been a
great object of confidence and trust throughout the world.
It brought honor, friends, influence, and possessions to
the United States. As a symbol of power and prestige, it
answered all things. Although we do not know what the
future has in store for us, we are fearful that the age of
the world dollar standard may some day draw to a close.
Huge federal government deficits and chronic Federal
Reserve inflation may destroy it. The deficits force the
Fed to generate ever more money and credit, which in turn
weaken and erode the dollar's trustworthiness in the eyes
of the world. Its present weakness toward many other
currencies, such as the euro, the Swiss franc, and the
British pound, is an early symptom of the erosion.
No other currency, national or international, can
conceivably take the place of the American dollar. They all
suffer seriously from the same ideological malady: they are
the creation of political concern and authority. Whatever
we may think of gold, it always looms in the background,
beckoning to be used as money, as it has been since the
dawn of civilization.
Regards,
Hans Sennholz,
for The Daily Reckoning
|