The Sushi Slump

Sell stocks; buy gold.

The Dow dropped 238 points yesterday.

Gold popped up an additional 2% yesterday – taking the price to $883.

The Financial Times explains why gold rises:

“The arguments for further gains in the gold price are compelling. It looks cheap, despite climbing from a low of about $250 a troy ounce in 1999, when central banks were selling reserves. The UK’s decision back then to sell 60 per cent of its official holdings looks particularly poor judgment.

“But it is the relationship between the dollar and the reaction of the world’s central banks to the credit squeeze that some bulls would say really makes gold an attractive bet.

“The US Federal Reserve’s aggressive, rate-cutting response to the credit squeeze has created a risk of a sharp rise in American inflation. That in turn creates the risk of a precipitous fall in the dollar and so makes gold more attractive as a hedge.

“The world’s major economies have experienced rapid money supply growth of 10 per cent plus per annum in recent years. The Fed remains the world’s biggest holder of gold, yet supplies of the metal are growing at only 1.5 per cent a year. If gold is a finite currency, its value against not just the dollar, but sterling and the euro too, should rise.

“Moreover, a sharp decline in US real interest rates – financial markets expect another half percentage point cut this month – means that the low yield on gold matters less. It may have been a poor hedge against inflation in the past but the combination of rising consumer prices and economic stagnation may make it a better store of value.”

The FT goes on to say, “Gold is new global currency.”

Elsewhere in the news, the price of oil rose $2 – ending a few days of downward movement. You may be tempted to see this as the triumph of the forces of inflation. But that would be far too simple. This is a battle of the Titans – inflation vs. deflation…free markets vs. government manipulators…boom vs. correction.

And guess what? We can tell you how it will end – at least in broad outline: The Titans are going to get together and destroy the U.S. economy. Inflation will reduce Americans’ purchasing power. Deflation will collapse the value of their assets. Between the anvil of falling prices…and the hammer of rising ones – the American middle class is going to get smashed.

While inflation was boosting up the price of gold, deflation was playing hell with the rest of the economy.

KB – one of the largest builders – reported a loss of $773 million. And the National Association of REALTORS said it had been too optimistic previously. Remember, a few months ago…the NAR said that the “worst was over” when property prices were down just 2%. And then, U.S. Treasury Secretary Paulson came out and said the subprime credit problem was “contained.” This week, both of them changed their tunes.

The NAR said housing prices were already down 5.2%. The last three months were the worst so far – with prices falling 1.7% in the quarter – the worst quarter for residential property in 21 years. And now the experts are saying that weak sales will drive down prices in the first part of 2008…with no rebound until, maybe, 2009.

Paulson now says a correction is “inevitable.” As to the problems in the credit market, he adds that there is “no easy answer.”

He must have been reading the Financial Times, which reports that a recession “has arrived” in the United States, citing a study from Merrill Lynch.

Naturally, the Fed did as expected. Rather than fight inflation, it turned its guns on deflation, cutting the signal rate by another quarter of a point, to 4.25%. The feds regard a Sushi Slump – a Japan-like recession – as the Greatest Of All Dangers. They want to avoid it in the worst possible way – by destroying the dollar. Gold, so far is just reacting…trying to keep up with declines in the U.S. currency.

But dear readers should get prepared for the next stage – when speculators turn to gold. So far, the price of the yellow metal has only returned to the nominal level it hit back in 1980. 28 years ago, it rose briefly to $850. But a lot of cash, credit, and debt and dubious financial instruments have gone under the bridge in the last quarter century. If gold had merely kept up with consumer inflation…that $850 an ounce would have had to run up to $2,200 an ounce.

So far, gold has only mirrored the decline of the dollar. The buck falls…gold rises. Since the feds are so intent on seeing the dollar go down further – in their efforts to fight the Sushi Slump – it is likely to go down much further.

But that’s not all. Pretty soon, speculators are going to start buying gold because they think it has some magic of its own. They’re going to start believing that they can get rich by owning gold…and they’re probably going to drive the price up beyond $2,000.

So, buckle your seat belts…it’s going to be a wild ride.

*** What a vacation!

We all assembled in Buenos Aires…and then made the trek up into the Andes.

Our ranch is on the very edge of human habitation. If it were any drier or higher, the place would curl up and blow away…which is what seems to be happening.

“It was much wetter here 20 years ago,” Jorge, the ranch foreman, explained. “This whole valley would be green in late springtime. You could fatten up the cattle and sell them at the end of the summer. But there is less water now. It hasn’t really rained here in almost two years. Unless we get some rain soon, we’ll have to sell the herd.”

One of the predictions made by earth scientists is that the dry areas on the edge of the tropics will become even drier. We don’t know if we believe it. But that is what seems to be happening here. This time of year, there is only a trickle of water coming down from the Andes. The whole ranch…trees, people, cattle, grass…all survive on that water.

“Yes, and there used to be more people, too. Look at that house over there. There was a family living there. And another one just up the valley. There are abandoned houses all over here. The people just moved away because they couldn’t support themselves. Not enough water.”

We had gone on horseback over to a little valley about two-hour ride from the main house. The last time we were there, the little ‘rio’ that ran through the valley had a nice flow of water in it. This time, you could strike a match on the bottom of it.

Jorge looked up. The sky was clear and blue. Only a little wisp of cloud hung over one of the nearby mountains.

“Yes, it’s too bad. The price of beef is way up. But we don’t have much beef to sell. Our cows are thin. I don’t know what they eat. There’s no grass. Of course, we bought some hay…but it was only an emergency ration.

Your editor bought the ranch, figuring that a beef operation was a better place to keep money than a bank account. He would have dollars…or pounds…or euros in a bank account; he doesn’t particularly like any of them.

But at least dollars don’t need water. Or grass.

And you don’t get hurt checking on them.

We ate lunch in the valley and then headed back to the main house. The air was so thin, and the sun so strong, that your editor was feeling a little lightheaded. Maybe that was why he thought he could mount his horse like Gene Autry in a rodeo. As he put his left foot in the stirrup, Muerte…or whatever his name was…started to move away. Rather than rein him in and forcing him to stand still, your editor attempted to mount up on-the-fly. A more experienced rider might have pulled it off. But when The Daily Reckoning honcho hit the saddle, old Muerte started to buck, and off we went, head over heels, until we did a kind of Fosbury Flop onto the sun-baked dirt.

Jorge got down off his horse and looked concerned.

“Señor Bonner, are you going to be able to get up?”

Jorge had one of those looks on his face. When we speak to him, we always speak in Spanish, of course. And our Spanish is not very good. Jorge is too polite to laugh. Instead, he gets a quizzical look on his face, as if to say: what in the world are you trying to say?

The previous day, for example, we had wanted to ask him to pick up some desserts at the store. There is a delicious Argentine cake called an ‘alfahore,’ made with dulce de leche. But we got mixed up and asked him to get some ‘alfombras” for dessert. Immediately, he got that look on his face. Alfombras are carpets. We had just suggested that we would like to eat some carpets for dessert.

Lying there on the ground, we understood his question. And we knew it had an answer. But at that moment, we didn’t know what it was. Instead of getting up, we rolled over…

“Oh…we better get the cactus needles out first,” Jorge suggested.

Until tomorrow,

Bill Bonner
The Daily Reckoning
London, England
Wednesday, January 9, 2008

The Daily Reckoning PRESENTS: In the essay below, Nathan Lewis suggests that OPEC go back to its original plan: Sell oil, and take gold in return – or a gold-linked currency. But, you argue, there aren’t anymore gold-linked currencies. Mr. Lewis has an answer for you, below…

by Nathan Lewis

OPEC had a problem. They were selling their oil and getting dollars in return. However, the dollar was losing value quickly. They worried that, in the future, the dollar might not be worth very much at all. They would have sold their irreplaceable natural resources for a paper promise from a country that didn’t keep its promises.

The year was 1971. On August 15 of that year, president Richard Nixon officially ended the dollar’s link to gold, which had been the policy of the U.S. government since 1789. At the time, the dollar was worth 1/35th of an ounce of gold, as it had been for the previous 38 years. When OPEC sold its oil, it was, in a sense, receiving gold in return. That was the idea, anyway.

In September of 1971, only a month after Nixon pulled the rug from under them, OPEC gathered to decide what to do about the dollar’s declining real value. In Resolution XXV.140, they decided that: “[OPEC] Member Countries shall take necessary action … to offset any adverse effects on the per barrel real income of Member Countries resulting from the international monetary developments of 15 August 1971.” Eventually, this took the form of higher prices, as it took more and more depreciating dollars to buy a barrel of oil.

Today, OPEC is faced with a similar problem. They take dollars for their oil, and these dollars often end up buying Treasury bonds. Also, their own domestic currencies are linked to the dollar, which is causing domestic inflation.

OPEC should go back to its original plan. Sell oil, and take gold in return – or a gold-linked currency. In practice, taking payment in metal is impractical, so a gold-linked currency — like the dollar was — is a more appropriate choice for today’s financial world.

Gold-linked currency? There aren’t any more of those. So why not make one? Today, there are discussions about depegging regional currencies like the United Arab Emirates’ dirham from the unreliable dollar, and perhaps repegging to a currency basket. But is a currency basket, of many fiat currencies, much better than a single fiat currency? “Some [OPEC members] said producing countries should designate a single hard currency aside from the U.S. dollar … to form the basis of our oil trade,” Iranian president Mahmoud Ahmadinejad said recently.

Ah, there’s the rub. There are no hard currencies. Only varying degrees of softness. No central bank today wants its currency to rise further against the dollar. During the 1970s, all the fiat currencies in the world got dragged down with the dollar, because of the trade implications of allowing the dollar to fall too far against their currencies. The pound, deutschemark and yen were no escape. Inflation roared throughout the world.

Instead of pegging to the euro or yen, both just as unreliable as the dollar in the long run, the UAE could peg the dirham to gold – even if the government owns no gold at all. The important thing is not to stockpile bullion, but to properly adjust the supply of dirhams to meet demand, the exact same process now used by the existing currency board. The UAE would have, in effect, a currency board linked to gold.

This would not be anything new for the dirham. The dirham coin used to be worth 3.207 grams of gold, and circulated alongside another popular Islamic currency, the dinar, which was worth 4.25 grams of gold. The gold dinar coin was reintroduced in 2006 by the Malaysian state of Kelantan.

Middle East oil – traded on the Dubai Mercantile Exchange for example — could then be priced in gold-linked dirhams. The world would finally have a hard currency again, as the dollar was before 1971. The dirham would immediately become an international currency, because everyone would need it to buy Middle East oil. The UAE would get into the currency business, which can be very lucrative. The Federal Reserve makes a profit of about $40 billion a year on its roughly $800 billion of U.S. Treasury bond holdings.

Eventually, if people wanted access to Middle East capital, they could issue bonds denominated in dirhams. No more dollar bonds. This would be very attractive, because the interest rate on dirham bonds would sink to very low levels. When the British pound was pegged to gold from 1823 to 1914, a ninety-one year stretch, the average interest rate on Consols – government bonds of infinite maturity – was 3.14%. It never rose above 4.0%. In the past century, no central bank has ever managed such a record of success. After four decades of experimentation with floating currencies, nothing has ever come close to the performance of a gold standard in action.

The world is transitioning to a new monetary order. Ideally, it will be better than what preceded. The dollar-centric monetary order arose in the 1930s and 1940s because the dollar remained a hard currency – pegged to gold – while all the currencies of Europe and Japan were devalued during the Depression and two world wars.

Perhaps it is time for the oil-exporting countries to stop playing by the rules of the oil importers, and start setting their own rules. The first rule is that they get paid for their oil in a “hard currency,” which, over six thousand years, has only meant one thing: a currency linked to gold.


Nathan Lewis
for The Daily Reckoning

Editor’s Note: Nathan Lewis is the author of Gold: the Once and Future Money, published by Agora Publishing and J. Wiley. He runs an investment fund in Westport, Connecticut.

If you haven’t already, pick up your copy of Gold: The Once and Future Money here:

Gold: The Once and Future Money