The Grandest Larceny

An intriguing mystery… What was the crime? Theft? Fraud? Counterfeiting? First, Bill Bonner with a review of the clues…

Behind every big financial headline is a crime, we wrote earlier in the week.

Today, we open the police ledger and follow up.

August, 1971 is the date on the top of the file. It is the date the administration of Richard Milhous Nixon did something extraordinary; it crossed the Rubicon in monetary history. Henceforth, foreign governments would not be able to redeem their surplus dollars for gold.

Mention the late president’s name and the average person recalls the crime with which he is so often associated: B&E at the Watergate.

But while the public’s attention was distracted by the breaking and entering of Nixon’s fumbling sidekicks, another team of Nixon goons was pulling off the biggest bank heist of all time.

A lumpen investor, a university economist, or a Federal Reserve governor might have read the headlines of the last 30 years without noticing how they tucked together. He might have seen the boom in gold of the ’70s…or the bubble in Japan in the ’80s…or the subsequent bubbles throughout the rest of Asia…as events as independent of each other as a stolen hubcap in New Orleans and a stolen kiss in Boston.

Dollar Standard Era: The Productivity Miracle

He might also have looked upon the boom and bubble in the U.S. as unrelated…and mistaken the run-up in stock prices as a consequence of the New Era wonder-age…or of the new productivity of information age technology…or of the newfound wisdom of the guiding hands at the Federal Reserve. He may even have referred to the ‘productivity miracle’ as the source of such a wonderful thing. Never, on the other hand, would he have imagined that all the great economic and market events of the past 3 decades found their inspiration in the same sordid place and time: at the hands of Nixon’s henchmen in the early ’70s.

What was their crime? Breach of contract? Theft? Fraud? Counterfeiting? Weren’t they the ones who began the practice of printing up Federal Reserve Notes by the trillions – and passing them off as real money? And had they not breached the promise of the U.S. government to settle its debts in gold? And did they not set in motion a pattern of robbery – stealing away the value of every dollar-based asset in the entire world?

Imagine an investor who bought a 30-year U.S. Treasury bond in 1970. Did he not have a right to expect to receive a dollar back for every dollar lent? And shouldn’t he have been able to expect that each of those dollars he received – in the year 2000 – would be worth about as much as those he had given up?

We can measure the damages by looking at the price of gold. In 1970, each dollar would buy an investor 1/34th of an ounce of gold. Thirty-three years later, Mr. Market, sitting as judge and jury, tells us that a dollar is worth less than 1/10 as much, or 1/360th of an ounce of gold.

Even so, our guess is that Mr. Market has more punishment in store.

Dollar Standard Era: Applauding the Crime

Investors, taking the U.S. government at its word, have lost trillions. Still, so subtle was the theft that the victims have practically applauded the crime for the last 20 years; they seemed to think it was making them rich!

Printing up trillions of dollars worth of new money was bound to have an effect. After the initial shock and adjustment in the ’70s, most investors smiled; the effect was quite pleasant. Cash and credit flooded out upon the world; everywhere it gushed, asset prices sprouted and economies turned green. The year after Nixon ‘closed the gold window,’ commencing the Dollar Standard era, the Dow rose over 1,000 for the first time in its history. This began what Richard Duncan describes as the "Great End-of-the-century Stock market bubble." By the time it was over, the Dow has risen 11-fold. It was absurd, even grotesque. But who traces crime leads when no one complains?

Of course, this was not the first time America had felt the effects of a flood of extra money. Nor was it the only country to benefit. Richard Duncan describes the process in his book, The Dollar Crisis, which we strongly recommend:

"The breakdown of the classical gold standard at the outbreak of World War I set off a chain of events remarkably similar to that which occurred following the collapse of the Bretton Woods system. Once the discipline inherent in the gold standard was removed, trade imbalances swelled and international credit skyrocketed. The result was prosperity…followed by depression."

When war came in 1914, France, Germany and England were in positions not so different from that of Richard Nixon in 1971 – their backs were to the wall. Cornered…trapped…they erred and strayed from the classical gold standard and reneged, as Nixon later did, on their promises to pay for what they bought in currency backed at a fixed rate by gold. At the time, the American economy was much like the Japanese economy of 1980; it was growing quickly and ready to sell to the war-mongers anything they wanted to buy. Orders rushed into American companies. Soon, the country was awash in with commercial activity…and then with foreign currency and gold. This tide of new money, says Duncan, did for the American economy of the ’20s about what the flood of dollars did to the Japanese economy of the ’80s – it caused a boom, which turned into a bubble, which then blew up and was resolved in a long recession/depression.

Dollar Standard Era: Boomerang Currency

Now the process is being repeated. Japan boomed and busted, then Thailand, now China. But the real crime was committed in America, and it cannot escape punishment, says Duncan. The ‘boomerang currency’ leaves the U.S. to buy goods – causing booms and busts wherever it goes – but it comes back home. What can the foreigners do with their dollars except buy U.S. stocks and bonds…and hope the dollar doesn’t fall?

And now the biggest boom in the world…in the U.S….is about to turn into the world’s biggest bust. We have been predicting it here for the last 4 years. We have harped on it. We have bored readers and ourselves with it. But it is inevitable and inescapable — a kind of divine justice that no rate cut or fiscal stimulus can avoid.

Since 1971, the U.S. has added trillions to the world’s supply of dollars and credit. During this same time, only about 58,000 metric tonnes of gold have been brought from the ground. Many are the calculations showing how much the dollar should fall. All we know is that it should fall a lot…which would effectively end the Dollar Standard period, lower standards of living in the U.S., bankrupt 20 million Americans, put an end to the U.S. consumer-driven growth, collapse stock and bond prices, and send America and most of the world into a long slump from which it might not emerge for another 10 to 20 years.

Some adjustment is irresistible. Every crime gets punished, somehow, and because there is no way the U.S. can continue adding to its trade deficit at the rate of $1 million per minute, its misconduct will be no exception.

Dollar Standard Era: Economic Overheating

"Balance of payments deficits of an unprecedented magnitude have resulted in credit-induced economic overheating on a global scale," explains Duncan. "The foundations for sustainable economic growth will not be restored until this flaw is corrected and the U.S. trade deficit ceases to flood the world with U.S. dollar liquidity.

"Now," he continues, "the engine of global growth is flooded and beginning to stall. Too much credit has been extended that can’t be repaid. Businesses have baldly misallocated capital, and consumers have grown accustomed to living beyond their means. Bankruptcies are soaring as share prices plunge. The U.S. economy is coming in for a hard landing…perhaps even a crash landing…"

Of course, it hasn’t happened yet. Investors are tempted to look out their windows, see the sun shining, and think the good times will last forever. They have no interest in the financial crimes of the Disco Age…nor in the balance of trade during the reign of Bush the Younger.

They might be tempted, says Duncan, to reply to our worry like Caesar to the soothsayer. "Beware the Ides of March," the seer warned. Later in the day, spotting the soothsayer, Caesar pointed out that the day had come and all was well.

"Yes, the Ides has arrived," the soothsayer replied, "but it has not yet passed."

Bill Bonner

August 22, 2003

P.S. More than just foreign central banks are getting in on the act. Consumers, too, have been borrowing more than ever before. From 1997 to 2002, Americans added $10,464.9 billion to their debt, while GDP grew a modest $2,127.8 billion.

In other words, it took 4.9 dollars of debt to create one additional dollar of GDP growth.

Overall, credit expands at a rate of some $1,500 billion annually. And every single dollar has to be paid back. When Americans realize how much they owe, their spending is going to come to a screaming halt. But they won’t have enough money to pay off their debts. If the Fed wants to avoid a tidal wave of bankruptcies, it will have no choice but to devalue the dollar.

Bill Bonner is the founder and editor of The Daily Reckoning. He is also the author, with Addison Wiggin, of "Financial Reckoning Day: Surviving The Soft Depression of The 21st Century" (John Wiley & Sons) due out in September.

"Factors Align in Gold’s Favor," says TheStreet.

Yesterday, gold fell heavily – by $5.20 an ounce, to $361. This is good news to us because we want to buy more of it. But it must make most investors wonder what ‘factors’ TheStreet is talking about.

Isn’t the stock market booming? Aren’t we recovering from the slump? Doesn’t the U.S. have the world’s most robust economy?

People are still buying things they don’t need with money they don’t have…they’re still buying houses (the median house in Orange County now sells for $428,000…which is especially amazing considering that the median house in Southern California is a charmless carton stuck in the middle of a desert)…and they’re still fattening up on those delicious Krispy Crundefinedme doughnuts.

But what’s this? Krispy Kreme disappointed investors yesterday. The stock fell 3% after being up 35% so far this year. Even after yesterday’s decline, however, a share still costs 78 times earnings and 6 times sales.

How likely is it that people will eat so many Krispy Kreme doughnuts…at a reasonable profit margin…that investors will be able to get a decent return on their money? How much more likely is it that the price will fall to the point where earnings justify the price – say, by about 70%?

How likely is it, on the other hand, that gold will fall by 70%? Well, there you have it – one of the factors that TheStreet may not have thought about. Gold is just coming out of a 20-year bear market. Stocks, most likely, are just going into one.

Another factor that seems to weigh on gold’s scales is that while dollars are being created by the trillions, gold production is actually going down! TheStreet notes that production is expected to fall by about 3% per year through 2007.

Beyond that, says TheStreet, gold rises "when investors lose confidence in paper money."

As far as we can tell, investors still have much more confidence in the dollar than it deserves. Which means this bull market in gold has a long, long way to go. As of yesterday, a shareholder could take 8 shares of Krispy Kreme and trade them for more than an ounce of gold. By the time this cycle is finally finished, years from now, he’ll wish he had. (More on this and other things…below…)

Eric, what else is happening in the Big Apple?


Eric Fry in New York City…

– The Dow Jones Industrial Average added 26 points to 9,424, a fresh 14-month high, while the Nasdaq Composite soared 1% to 1,777. Stocks seemed to gain strength from a potent cocktail of favorable economic reports and bullish blather from Wall Street strategists.

– The Daily Reckoning’s favorite bullishly blathering strategist, Abby Joseph Cohen, raised her 2003 and 2004 earnings estimates on the S&P 500. The perpetually positive Goldman strategist upped her estimates to $49 from $46 for 2003 and to $53 from $51 for 2004. Based upon Cohen’s new and improved estimates, the S&P 500 trades for a little more than 20 times earnings. That’s not obscenely expensive perhaps, but 20 times earnings is hardly ‘deep value’ territory.

– So it seems that investors now embrace the ‘2004 recovery trade’ as wholeheartedly and passionately as they embraced the ‘deflation trade’ last April and May. Recall that during the breezy days of spring numerous Fed officials and Wall Street economists worried aloud about the looming threat of deflation.

– The lumpeninvestoriat trembled with fear at the prospect and rushed to buy bonds. The lumps came to believe that long- term bonds offered a terrific investment opportunity, no matter how miserly the available yields might be. "In deflationary times, stocks are risky," bleated the lumps, as they poured billions of dollars into bond mutual funds.

– But the anticipated deflation failed to appear, and failed therefore to deliver the legions of hopeful bond investors into the Promised Land of milk, honey and capital gains. Instead, bond prices collapsed at the very moment most investors expected it to rise…

– But now, late spring has given way to late summer, and likewise the threat of deflation has given way to the near- universal hope of economic recovery and ‘benign inflation.’ As ‘markets make opinions,’ nearly everyone now holds the opinion that the deflation scare was overdone – a kind of unintentional hoax, just like the Millennium bug scare. So now the lumps are unwinding their ill-fated bond investments in order to initiate ill-fated stock investments.

– Folks now know that the economy is recovering. They also know that a ‘small’ rise in the inflation rate and therefore, in bond yields, is nothing to fear. ‘So sell your overvalued bonds and buy stocks,’ says the conventional wisdom, ‘especially richly valued growth stocks and cyclicals.’

– Perhaps this nationwide portfolio shift from bonds to stocks will succeed much better than the preceding catastrophic shift from stocks to bonds…but we wouldn’t bet on it.

– The stock market’s feverish anticipation of robust economic growth does not make robust growth a fait accompli. As pleasant as a months-long stock market rally might be, its curative powers are limited. A stock market rally cannot, for example, cure the common cold, nor can it cause the spontaneous disappearance of spouses…and a stock market rally certainly cannot eliminate the residual effects of a stock market bubble-gone-bust.


Bill Bonner, still out in the country…

***…our favorite River-of-No-Returns stock has found a new way to lose money. Business Week reports that CEO and Founder Jeff Bezos is investing the firm’s money in a start-up that will make space travel available to the common man.

*** The euro fell to $1.09. This may be the best chance to get out of the dollar for a long, long while.

*** The IMF is pulling out of Iraq…along with private companies and other international organizations. For all its high-tech military hardware, the U.S. cannot guarantee foreigners’ safety in its new fiefdom.

Oh reader, we stand back in awe and wonder. Could life really be so elegantly perverse? The Bush Administration faced no serious enemies when the 21st century began. No conventional army could stand against it. So, what did it do? Did it do the one and only thing that might ruin it…and re-establish a balance of power in the world?

Lacking a conventional enemy, the Bush team created an unconventional one. It pinned its army down in a hostile environment and invited guerrilla attacks, against which its computerized military machine had no defense. "Bring them on," boasted the president of the world’s biggest debtor nation. Now, they are coming on…and the greatest superpower the world has ever seen wastes its great advantage on a fight it cannot win…against an opponent it cannot find…in a part of the world no American really cares about. Little by little it leaks away…like blood into the desert sand.

More below…sort of…

The Daily Reckoning