The Revenge of Gold, Part II
"It will be desirable to select as the standard of value that which appears likely to continue to exchange for many other commodities in nearly unchanged value."
– William Stanley Jevons
Recall the 1970s.
Back then, the future of the financial world seemed to depend on the money supply…as it seems to hinge on the consumer today. People watched money supply figures the way they watch consumer confidence tallies today.
As the money supply rose, it seemed inevitable that commodity prices…particularly gold…would follow. A man with a little imagination didn’t even have to open the newspaper. Because he knew that government controlled the money supply and that no government could resist increasing it. Ergo, the dollar would fall like a stone in a well…and the price of gold would soon hit $5,000.
What made the ’70s were the years preceding – the 1960s. A war on terrorism, ’60s-style…in Vietnam…had escalated into a full scale war – in fact, if not in law. Congress had never bothered to declare war…and never bothered to raise the funds to pay for it. With the additional burden of the Great Society programs at home, it began to look as if the federal government was living beyond its means. Foreign dollar holders began to wonder.
The gold standard of the 19th century had "died like a soldier" in WWI. It spent some time convalescing, disastrously in England’s case, in the interwar years, only to get drafted and shot again in WWII. But the habit of monetary rectitude was so firmly established that it was hard to break. The U.S. government had organized a Gold Pool, by which major central bankers conspired to keep the price of gold below $35.20 an ounce. Managed by the Bank of England, member nations supplied gold – which was sold at critical moments to keep the price down.
But General de Gaulle noticed the weakness in America’s financial position in the mid-60s. In 1968, France pulled out of the Gold Pool arrangement and demanded gold in exchange for its dollars. Soon after, other nations began to wonder too. How could America continue to print so many dollars and still maintain the dollar’s value at $35 per ounce of gold?
It couldn’t, of course. Three years after de Gaulle broke ranks with the London price fixers, Richard Nixon was obliged to "close the gold window" at the Fed. Henceforth, a dollar was just a dollar – a piece of paper with no value beyond what the world is willing to give to it.
Thus began a remarkable experiment. No nation had ever made a sustained success out of paper money. Instead, each episode reads like a cautionary tale. The dates, names, places and circumstances change – from Imperial Rome to Revolutionary France – but the moral of the story remains the same: paper money is not merely a mistake, but a kind of sin; like bestiality, it is unnatural…like larceny, it is repugnant…like sloth, it is ruinous.
Nothing in the experience of the ’70s suggested that this time would be any different. The price of gold rose from $35 an ounce in 1971 to over $800 in 1979. Silver ran up from under $5 to nearly $40. Oil went from under $15 a barrel to over $30. Who could doubt that the process would continue? With no golden anchor to moor it, the dollar would soon float out to sea and disappear over the horizon.
But tides go both ways. Just about the time people became convinced that gold would continue to float higher, the water level dropped. The decade which had been the best time ever to buy gold was replaced by two decades in which gold was nearly the worst investment a man could make. From more than $800 an ounce in 1979 dollars, the price fell to less than $275 an ounce in 1999 dollars.
But, there is a lot of ruin in a nation, dear reader – more than can be drawn out in a single decade. Besides, markets do not destroy people right away, they toy with them first…flattering them cravenly before knocking them down.
Twenty-three years after gold reached its peak, people no longer watch the money supply figures. Who cares about them? No matter how many dollars or yen or euro central bankers create, people seem to want more of them. Nor do they seem to care that nothing but bad intentions stand behind the paper.
In attempt to gin up economic growth, Japan is increasing its money supply at the fastest pace in 30 years. In January, the Bank of Japan’s monetary base was clocked at a 35.7% annual rate of increase. Just a year earlier, it was falling. "I genuinely fear hyperinflation in Japan once banks slow down the write- off of bad debt," said an analyst to Grant’s Interest Rate Observer.
Meanwhile, in Europe, de Gaulle’s successors seem to want to get back in the Gold Pool. The European Central Bank recently announced that it would sell gold at auction.
It has been the fashion of the last few years for central banks to sell gold and buy yield-producing dollar-based assets. Central banks still have many tons of gold – the legacy of the gold reserve years. Central bank sales have kept the price low, and the threat of greater sales discouraged buyers.
Charles de Gaulle has been dead for many years. Barring some incredible breakthrough, he will stay that way. But while the general may have been sui generis, Gaullism (the annoying trait that makes a man break ranks in order to secure an advantage) is probably widespread. In a gold bear market, central bankers may readily stick together, taking turns offering their gold for sale in order to keep the price down. But when the tide turns…and the price of gold rises…Gaullism is sure to rise too.
More tomorrow…including why the banks will not sell their gold.
April 22, 2002 — France
Gold goes up. Gold goes down. But gold is still $20 more than it was at the beginning of the year. Gold is outperforming every currency and every stock market. What’s up with gold, anyway? More below.
But first, special insight on the world market from our UK correspondent, Capital Insight’s Sean Corrigan. Sean, what’s happening?
Sean Corrigan in London…
– The Dow ended the first big earnings week barely improved from the week before, with the bulk of the net gains made in Friday’s 51 point rise to 10,257. Nasdaq was off 6 at 1796.
– The game goes as follows: Companies warn analysts that their "forecasts" are too high. Analysts duly say, "lower forecasts." Companies miraculously ease over the lowered bar and everyone talks about how the bottom is finally in and how the second half will be better.
– At this point, (hopefully) everyone forgets how shaky things look outside consumer goods and real estate, and the market rallies, justifying the whole charade with higher stock prices.
– Notice, however, that nowhere has any wealth been created…only that laughable, military intelligence type oxymoron, "Shareholder Value."
– So, according to Thomson Financial/First Call, companies in the S&P 500 are surpassing the estimates by an average of 2.3 percent. The average was 1 percent in the fourth quarter and 0.9 percent in the third quarter.
– "Although the season has just begun, we are seeing some improvement margin wise and getting closer to the norm of the past, which is about 3 percent," said Ken Perkins, research analyst for First Call.
– Barron’s annual exercise in ranking 500 stocks in terms of the real cash flow return on equity (the first step to an actual increase in genuine profitability) shows the dichotomy in the economy in the clearest possible terms.
– The top ten was comprised of four health groups, four retailers, one bank and one homebuilder. Nineteen out of the bottom twenty, by contrast, were airlines and technology.
– Personal debt: 1; New Era: 0.
– In Japan, the Nikkei rose 209 to a one-month high of 11,721, cheered by Canon’s record results as the company’s digital cameras flew out off the shelves, aided by the weaker Yen. NEC was also firm as institutions increased exposure on the hope that cost- cutting and other restructuring measures would soon prove beneficial.
– There remains, however, something about Japan’s protracted ills which attracts every crank in the world. The latest wild-eyed scheme, reported in the Nikkei Shimbun, comes from Prof. Ron Dore of the London School of Economics.
– The mad professor thinks the only way out is to create inflation (what else?), and has come up with the novel idea that in the spring wage talks, government needs to coerce the private sector into boosting wages across the board by at least 4 percent, thus creating inflation and giving confidence to consumers.
– Companies would then be willing to invest in new ventures, he argues, as they could envisage better returns. This ignores, of course, companies’ increased costs and the incentive to shed labor to reduce the wage bill again.
– "Such a coordinated wage rise has never happened in post-war history, but then neither has such a prolonged period of deflation," he says.
– Well, Herbert Hoover, for one, persuaded businesses to coordinate a real wage rise (by keeping dollar wages flat in the face of declining prices) in 1929, and there soon followed a "prolonged period of deflation"… otherwise known as the Great Depression…but that seems to have escaped Prof. Dore’s notice.
– But then we don’t really expect socialists to ever make sense of history, do we?
– On Friday here in London, the FTSE closed flat at 5203, with the biggest laggard being the roller coaster – as in ups and downs but inexorably lower – mobile phone sector.
– Sentiment will not be improved by Ericsson’s morning announcement of major losses, falling sales, plunging orders and a resulting 20% cut back in capital spending, and several thousand job losses to go with a $3 billion rights issue.
– "As expected, this past quarter was very challenging," Kurt Hellstroem, President and CEO, told Bloomberg News. "Many operators have recently lowered investment plans further. As sales will be lower than anticipated, with ongoing aggressive cost cutting, we plan to return to profit at some point in 2003."
– In London, as in the United States, the post-bubble market continues to confound, frustrate and annoy.
Back in rural France…
*** The Financial Times: "Citizens have invested (i.e., borrowed) beyond anything homes’ true values can sustain, distorting, perhaps perilously, the bedrock market on which consumer confidence rests." When will the housing bubble burst? Maybe soon…
*** George Gilder with a status report on the telecosm: "Of the 87 sectors ranked by Standard and Poor’s, telecom is dead last. Carriers aren’t spending, Wall Street isn’t funding and investors aren’t buying."
*** How do some people do so spectacularly well with their investments – when, as we Daily Reckoners know, it is impossible to predict the future of price movements?
*** John Mauldin explains: "Assume you have 10,000 people who flip a coin once a year. After five years, you will have 313 people who have come up with heads five times in a row. If you put suits on them, sit them in glass offices, and call them a mutual or a hedge fund, they will be managing a billion dollars. They will absolutely believe they have figured out the secret to investing that all the other losers haven’t discerned. Their 7-figure salaries prove it.
"The next year, 157 of them will blow up. With my power of analysis, I can predict which one will blow up. It will be the one in which you invest!"
*** "Don’t forget to vote," said the old priest on Sunday. "There are plenty of candidates, so there should be something for everyone."
*** Yes, there’s a communist…a national socialist…an environmentalist…a syndicalist… The only thing there isn’t is a candidate you’d want to have as president. But good men are barred from politics in France…just as they are in America.
*** Yesterday was election day. And here in France, as in North America, people suffer the same illusions. "Remember," added a woman, speaking to the congregation, "that by voting, we can have a world of abundance."
*** "A world of abundance, by voting?" commented a fellow parishioner after the service. "She must be dreaming."