The Barbaric Relic
"Your gold history lesson reminds me of what I consider to be one of the great open questions in economics," writes Porter Stansberry. "How does Nixon’s action – removing the dollar from the gold standard – effect the fundamental monetary conditions you mention in your story?"
Porter’s position, shared by many investors, is that gold has been stripped of its monetary role…and left to respond to market forces like any other commodity. Under normal conditions, like other commodities, time and technology should reduce the cost of acquiring gold, increase its abundance and lower its relative price. In times of deflation, the price of gold, along with copper and pampers, should fall sharply. In times of inflation, gold should rise in price.
In the 1930s, the only period of significant deflation since the establishment of the Federal Reserve System early in the century, the price of gold rose. Gold was still money then, according to Porter’s view.
But in 1968, the `gold pool’ was closed down. A person could no longer trade his paper dollars for gold on the London market. Then, 3 years later, Nixon `closed the gold window’ at the Treasury – so foreign governments could no longer trade their dollar surpluses for gold either. Since these two actions, gold has not played an official monetary role.
But to Porter’s assertion of fact, that `gold is no longer money’ I reply, flippantly:
To his anticipated response: "The most powerful government on the face of the Earth, the world’s only remaining super- power and the custodian of the most successful monetary brand in history…" I retort:
For all his many talents and virtues, it is unlikely that Richard Milhouse Nixon could have achieved what no emperor, dictator, or elected official has been able to do since the beginning of time: eliminate gold as a monetary competitor. Many have tried. But gold, though malleable, is unyielding in its monetary rectitude. An ounce of gold is an ounce of gold. It is neither more nor less than it appears to be.
Paper money is a great aid to politicians. It makes it possible for them, said President Hoover, to confiscate "the savings of the people by manipulation of inflation and deflation."
"We have gold," he added, "because we cannot trust governments."
Have governments become more trustworthy since Herbert Hoover left office and Bill Clinton entered therein? I will leave that to you to decide, dear reader.
Paper currencies are, like so much else that issues from politics, subject to persuasion, ambiguity and financial gerrymandering. As a result, paper currencies are very useful for creating booms and bubbles – they can be readily multiplied and distributed.
"If your view of gold being a safe haven in times of deflation is correct," Porter continues, "then it would stand to reason that gold prices should fall during inflationary periods, right? That’s how gold prices have always worked throughout history. See Davidson’s work from the August 1997 issue of Strategic Investment. He traced 400 years of gold prices…up to 1970…and found conclusively that gold went up in purchasing power duringdeflation and down during inflation."
Agreeing that gold has acted as a hedge against deflation from the time of the Flood to the Nixon Administration, Porter brings us up to date: "But the facts since 1971 seem to indicate exactly the opposite. Gold went from $45 to $850 in the 1970s in the midst of an inflationary crisis."
"My view," says Porter, "is that Nixon’s action, and the structure of the US economy – an economy based on credit, not gold – turn the historic relationships upside down. Essentially the monetary conditions that we used to call inflation are now deflation."
Let us stop here or we are doomed to wallow in confusion for the rest of this letter. The terms `inflation’ or `deflation’ refer to the rise and fall in the supply of money. The increase or decrease leads to an corresponding movement in the prices of goods and services. As the money supply inflates, prices rise. When the supply of money decreases, prices fall.
If the supply of gold is inflated – whether you call it money or not – it will have the same consequence…each ounce of gold will buy less of other things. This is what happened when, for example, Spanish explorers began colonizing the new world and sending ships back to Spain laden with gold.
Inflation lowers the value of whatever is inflated: whether it is paper currency or gold. Deflation, on the other hand, diminishes supply and increases value. But is it possible that a decrease in the supply of dollars could produce a counter effect – an increase in the supply of gold? When the supply of dollars declines – a deflation of the money supply – will gold act like money and rise against other goods and services? Or will it act like any other commodity…and fall?
Is gold still money, in other words? Or is it just another commodity? And to those questions, I reply, confidently: Yes. Gold is both.
More to come…
January 3, 2001
*** Is Mr. Bear back on the job so soon? Most investors were expecting a nice lift in January – the "January Effect" as it is known. But if the first day of trading is any indication, the coming month will not be a pleasant one.
*** The Dow fell 140 points. The Nasdaq fell more than 7% – or 178 points. And the Nasdaq 100 – home of the biggest techs – dropped 212.
*** The Internets were down big too – with the Internet index off nearly 9%.
*** Cisco lost 13%…and now trades at $34. AOL is below $34. Oracle is below $30. Amazon is below $14. And CMGI is below $5. Wow.com!
*** There were 1339 stocks making progress on the NYSE yesterday; 1718 declined. 185 hit new highs. 28 hit new lows.
*** GE – a stock with a lot of ruin in it – lost 4%.
*** But gold stocks went up. The XAU index rose about 1%. Why? See below.
*** As gold stocks rose, the dollar fell. The dollar index dropped 1%. And the euro – the mighty euro – rose to 95 cents. Commentators are beginning to talk about the euro returning to par with the dollar. What a surprise it would be if the euro rose much higher! Surprises are just what he market tends to give us.
*** Bonds rose in what was described as `almost panic buying’ early yesterday. Yields on 10-year bonds fell below 5% to 4.92%. Bond buyers seem to be expecting not merely a rate cut from Greenspan, but recession too.
*** The latest figures from the National Association of Purchasing Managers point in the same direction – they came in lower than expected. But the ‘prices paid’ figure rose 8%. Hmmm…a business slowdown with increasing prices. We used to have a word for that – `stagflation’. If so, it is
the best of all possible worlds for gold. More below.*** "US Syndicated Loan Value Tops $1 Trillion in 2000" proclaims a headline from Hoover’s Online. The biggest borrower? AT&T, with $35 billion in loans.
*** But lenders beware. Standard & Poors released a report yesterday showing that credit quality continues to decline…and predicting even wider spreads between high- grade loan rates and junk. The S&P report noted that there were 7 defaults in the telecom sector last year…and that investors should expect more in the year ahead.
*** There will be no soft landing, according to George Soros. Instead it will be "bouncy and hard." Another global financial crisis is inevitable, he added.
*** Floyd Norris, in the NY Times, says that a record $100 billion of IPOs were sold in 2000. But the last quarter was a disaster – with only $10.8 billion in sales – the slowest period since 1992. Two-thirds of the IPOs are now trading below their offer prices.
*** The most interesting item in the financial press is an article by Gretchen Morgenson also in the NY Times. Morgenson is providing the grist for tort lawyers’ mills, pointing out how Wall Street analysts misled investors. "How Did So Many Get It So Wrong?" her headline asks.
*** Well, it was not exactly an accident. Analyst Jack Grubman made $20 million in ’99 touting telecoms for Salomon Smith Barney. Grubman urged caution on the telecoms – but only after they had fallen 77%. All of the stocks he recommended – surprise, surprise – were underwritten by his own firm.
*** Meanwhile, the Queen of the Internet, Mary Meeker, took home $15 million in ’99 thanks to her recommendation of Amazon.com at prices over $100…and a host of other Internet stocks… Amazon, as noted above, is now a $14 stock. Her 10 other Internet picks – which she now rates as "outperform" – have similarly collapsed. A Dean Witter spokesman defended Ms. Meeker, saying that her picks were for the "long term." If they don’t come back in this life, maybe they will in the hereafter.
*** Anthony Noto, analyst as Goldman Sachs finally downgraded his picks from `buy’ to `market perform’ after they fell 98.2%. Seven of the 9 stocks he follows were underwritten by Solly.
*** And let us not forget Walter P. Piecyk, Jr., analyst with Paine Webber. Mr. Piecyk made history with his target price of $1,000 for Qualcomm. Following his recommendation, the stock rose to a record of $717.24, hit on this day one year ago. Since then, the stock has split 4 for 1 and now trades at $82.
*** "There is virtually no such thing as a sell recommendation from Wall Street analysts," concludes Ms. Morgenson. The analysts work for their companies – it might be added – not for retail investors.
*** Is it any wonder people are growing more reluctant to send money to Wall Street. Companies raised $3 trillion in equity and debt last year – down 9.6%. Bloomberg reports that sales of new securities fell in 2000 for the first time in 6 years.
*** I am still in holiday mode. I write this letter in the morning and try to leave the afternoon free to work on the stone walls or take little excursions. Then, after the sun goes down, I sit in front of the fire and reply to my e- mail and read.
*** Benoit, the gardener’s son, has been helping me on the stone wall. He’s a university student – in economics – who asks my opinions on the stock market as we work. A couple of weeks ago, I suggested that he might want to keep an eye on W.R. Grace – simply because the stock had become ridiculously cheap. Since then, it has zoomed up nicely. So, Benoit thinks I might know something. He will find out later that I don’t know any more than anyone else – but I am enjoying his na?ve respect in the meantime.
*** Yesterday, we ran out of cement, so rather than work on the wall, we drove down into Limousine to look at a derelict chateau. Benoit explained that it was owned by a countess who had had only one child. When the infant died in the chateau she decided she wanted nothing more to do with the property – except to see it in ruins.
*** She should be pleased. It is in ruins. The rooves have caved in…stones have fallen. It looks at though it might have been struck by a bomb in WWII and never restored. But amid the ruins is the most stunning and impressive fireplace I have ever seen. It is so big that an entire football team could stand inside. And it is carved in white stone – with a statue of a mounted horseman set into the stone face above the mantel and elaborate figures decorating the entire ensemble.
"Why not give her a call," I suggested to Benoit. "Ask her if she would sell the ruins. We will do quickly what nature is doing so slowly – remove the fireplace and destroy what is left!"
"Okay," was Benoit’s reply. "What is there to lose?"