Gold rose 2,300 percent over the nine years that ended in 1980, one of the most spectacular runs that any major financial asset class has ever recorded. If the 1990s Nasdaq rocket had surged as gold did, it would not have stopped at its peak of 5,049 on March 24, 2000.
It would have doubled again to over 11,000. While gold initially rose because the U.S. government was unable to maintain its price fixed at $35 an ounce in 1971, it continued climbing so sharply and so fast because the gold market is tiny in the immense global financial ocean: a relatively small amount of investor interest was able to make it surge as stocks and bonds languished.
Today, following the long years since 1980 during which gold has generally lagged other investments, the effect would be far more dramatic because the $140-trillion global asset market is so much larger. All the gold in the world is worth $3.4 trillion, yet only a small fraction of that amount is traded on financial markets. If one percent of the global value of stocks and bonds—roughly $960 billion—went into gold the precious metal would skyrocket.
This amount is 18 times what the min- ing industry produces and substantially more than what is traded on gold markets during an entire year.There simply wouldn’t be enough gold available at the current price.With gold still trading below the peak of $850 it reached almost three decades ago, thinking of prices well above $10,000 per ounce would suddenly become rational.
Although it has been regarded mostly as a commodity over the last three decades, for thousands of years gold was the world’s purest form of money and, being nobody’s liability, the indisputable store and measure of value. Like U.S.Treasury bonds or cash today, gold was also seen as the ultimate escape from all financial risks, including the risk inherent in holding paper currency itself.
But since 1971—that is, during less than one percent of the span of human civilization—all monetary value has ultimately been measured in U.S. dollars, the quantity of which are no longer limited by physical gold as had been required underThe BrettonWoods monetary system that effectively collapsed in that year. Being the premier currency in virtually all of the world’s central bank vaults, the U.S. dollar is the de facto foundation of the global monetary system, the metric used to weigh all other currencies, and hence the final measure of the value of everything that has a price.The dollar is the world’s money.
But the world’s money is not well. Another country’s leader said many years ago that the dollar being the world’s currency was an “exorbitant privilege” since it forced other nations to absorb American liabilities and fund our deficits. But in the 1960s, Charles de Gaulle was speaking far too soon, as Vietnam War-induced deficits were negligible by present standards.
The United States held a massive net international asset position and almost half the entire world’s monetary reserves. Today, forty-three years later, the country’s financial condition is entirely different. Our nation absorbs more than half of the world’s savings to fund our current account deficit—since we now consume six percent more as a nation than we produce—and to do so,American debt to the world is growing like never before.
Our once colossal net international assets have become a net liability of $2.5 trillion. International foreign currency reserves, which the U.S.Treasury Department reports weekly, are now lower than Mexico’s. Figure I.1 shows that U.S. debt has grown to more than 300 percent of gross domestic product, a level last approached when thousands of banks were collapsing in the 1930s, which makes this picture all the more striking.
Our GDP is not falling today as it was in the thirties—it is our liabilities that are rising faster. Five dollars in debt are being added for each dollar in American GDP. And while government liabilities are surging, what is happening to American consumers, who cannot raise taxes or lay off their spouses, is far more troubling:
Household debt has more than doubled so far in this decade while inflation-adjusted wages have been stagnant for years. Debt payments each year are taking a larger share of American paychecks, which are already being battered by sky- rocketing healthcare costs.
For each of the last five years in which consumer debt has risen by an average of one trillion dollars, concerns have been brushed aside by a cheerful Federal Reserve revelation: The value of assets, primarily our real estate, has been rising faster than that of our debts. But to think that credit—not income growth—has made us wealthier than ever is becoming harder to believe now that the recent surge in foreclosures and homes for sale is causing the median American home price to fall for the first time since the Great Depression when we are not in a recession.
And homes are where the bulk of American household wealth resides. Now that we are no longer winning the race with debt, perhaps it is time to take a long, hard look at the American balance sheet instead of expecting the next Fed rate cut to reignite the economy—with even more credit.
Is the U.S. economy so stretched by debt that we are on the verge of a balance sheet recession, one in which no amount of monetary or fiscal stimuli are sufficient to make consumers continue borrowing, such as occurred in Japan during the 1990s, or perhaps here in the 1930s? Will foreign central banks, bloated as they are with dollar currency and American liabilities, continue funding our deficits?
Central banks have been forced to absorb trillions of deficit-driven dollars in new reserves this decade, each year injecting more liquidity into their own economies in an effort to maintain competitive currencies. Doing so has been vital: exporters to the U.S. need their governments to maintain what has become a vendor financing system— amassing dollars and lending Americans more money so that we can continue buying attractively-priced foreign products. But with Chinese liquidity becoming less manageable as a direct result and inflationary pressures rising, will our biggest lender finally be forced to stop buying our dollars?
This book examines these vital questions, which are intimately linked with present troubles in financial markets.The small problem in the U.S. subprime mortgage arena that has grown into an outright multi-trillion- dollar credit crisis had its roots in the increasingly unhealthy American balance sheet: Many consumers simply can’t afford to make the higher payments on their reset subprime mortgages.
And now it has become clear that a great many other Americans, some with jumbo mortgages, are also beginning to face difficulties. But serious problems began emerging further up the mortgage chain in 2007. The stocks of Fannie Mae and Freddie Mac, the heart and soul of the $22-trillion American real estate industry, lost more than half their value in just two months.
Dozens of mortgage lenders have collapsed, and shares of Countrywide Financial, the country’s largest mortgage lender, plummeted on fears that it could go into bankruptcy for lack of liquidity. But liquidity might be the least of our problems if the U.S. economy cannot withstand increasing levels of debt at any rate.
As Figure I.1 implies, since the 1980s the immense asset edifice of the United States was erected with significant reliance on credit, and credit has helped support the many productive efforts that have made us wealthier. But the currency with which our building was constructed is only as strong as our balance sheet, and growing doubts about our financial foundation could in time provoke an unparalleled catastrophe.
Approximately 60 percent of paper dollars circulate outside the United States and the majority of U.S.Treasury bonds are owned by foreigners. Today we rely on the world’s confidence more than ever. If faith in the dollar were lost, there would be no one to finance the $650-billion current account deficit in our saving-deficient economy. As a consequence, interest rates and inflation would likely soar, financial markets would fall very sharply as investors fled U.S. assets, unemployment would rise, and the economy would almost certainly go into a severe recession.
The Fed could be powerless since cutting rates deeply would apply further downward pressure on the dollar, already at a record low; and raising rates might strengthen our currency but also ensure a recession in our debt-laden economy, which in time could also weaken the dollar.
The U.S.consumer accounts for a fifth of global GDP.Despite the rise of China and emerging markets as core players in the global economy, the world’s reliance on U.S. consumer spending is stronger than ever. It accounted for 19 percent of world economic activity in 2006 compared with 17 percent in 1990 and 15 percent a decade before then.
If the dollar were to collapse other major economies, which derive a substantial part of their growth from exports to the U.S., would suffer deeply as well.With the bond markets in disarray, there would be few places for the ocean of liquidity present in global markets today to hide, and prices of the few assets in which to take cover, like gold and other precious metals, would rise substantially. Although demand for gold should rise gradually in nor- mal times, it would spike dramatically in a major currency crisis.
This book makes a case for buying gold as protection against the ris- ing risks of an unprecedented global currency crisis provoked by the dollar. It examines our debt predicament, the U.S. real estate market, and the future of our economy, discussing some of the alarming issues that many economists are pointing to with concern. Gold rises when the risks inherent in holding paper currency increase, as they are doing today, and when stock, bond, and other investment returns are insufficient to compensate for climbing risks in financial markets.
Bond yields remain near historical lows with the 10-year treasury bond offering barely 4 percent. Corporate profit margins are at 50-year highs (implying the stock market will struggle to continue climbing), the economy is slowing and with a great many other financial concerns rising, it is no wonder that gold broke through $500, and then $600 and $700 an ounce in the past two years.
But there are other reasons why the price of gold should remain strong. For one, supply has weakened. Gold mining production peaked in 2001, and the average global cost of producing a refined ounce of the ever-harder-to-find precious metal has doubled in just seven years. Central banks, which have dumped gold on global markets for decades—clearly to preserve the mirage of global monetary stability and faith in the dollar— have sharply reduced their precious metal sales in the last two years.
Government gold sales fell 38 percent in 2006, and despite a rebound in 2007 Germany, the world’s second-largest holder, surprised the market during the summer by announcing that it would not sell any more gold in that year, and it was followed by Spain a few months later.
Perhaps this decades-old policy of dumping gold on the market could be grind- ing to a halt out of concern for the sinking value of the dollar, or because they have been selling the precious metal for decades: There simply might not be much left that central banks want to cash in.
Would the monetary authorities of any country want to hold 100 percent of their reserves in paper currency? Probably not. Every single currency in human history, bar none, has fallen against gold. Perhaps the gold likely to be sold by the International Monetary Fund, in need of funding, may end up being bought by other central banks. Russia is a buyer, and not a small one anymore, and China and Japan, which possess by far the largest foreign reserve cache in the world—more than two trillion dollars—hold less than two percent of them in gold. The world will notice if these economic powers turn their attention to gold and diversify their assets away from the dollar, as the investment world is doing today.
While supply has weakened, new avenues of demand have arisen, thanks mostly to gold exchange-traded funds, which allow more and more investors around the globe to buy and hold representative amounts of gold with the click of a mouse. Gold ETFs only began trading in 2004, and they are now present on several markets throughout Europe and Asia and will soon be bought and sold on most major exchanges.The growing affluence of India, the world’s largest market for gold, has increased demand. And in 2007, Chinese citizens, proportionally the world’s biggest savers, were allowed to trade gold legally for the first time.
Gold is a political and economic asset and a spike in its price would immediately raise concerns for every central banker.As a signal of intense risk aversion, a sudden, sharp rise in gold investment, which would likely accompany a decline in stock and other asset values, could lead to direct intervention to stop its climb.
The U.S. government unexpectedly confiscated gold in 1933 as worried citizens—and foreigners—were attempting to flee the dollar, as well as most other paper currencies, during the Great Depression. Keeping this and other issues in mind, the final chapters of this book discuss the advantages and disadvantages of the various ways of owning gold, and securing wealth for the future.
Despite the pessimism implied in buying gold, the book in your hands proposes a unique investment opportunity arising in precarious economic times.There is a notable difference between being a pessimist and feeling pessimistic about present financial conditions. In retrospect, few would call Warren Buffett a pessimist for selling his stock portfolio—virtually all of it—in 1969.
He was merely being pessimistic about the market’s temporary overvaluation.The sage of Omaha liquidated Buffett Partnership and returned money to investors after a 1,100 percent return over the previous 10 years—five times better than the Dow Jones Industrial Average had returned. In 1970, the market promptly lost roughly half its value.
But in the 1960s, Buffett escaped the financial markets to the shelter of dollars.Today, the dollar has become something altogether different and now there is increasing safety in gold.