The Bankrupting of America

Frontline Thoughts ^ | June 6, 2003 | Porter Stansberry

[sourcery]

FYI

[headsonpikes]

A worthwhile read.

[Billy_bob_bob]

BTTT

[liberallarry]

The money isn't going into new capital investment

Do you really think tax cuts are going to change that?

[sourcery]

Do you really think tax cuts are going to change that?

Well, I know that tax increases would just make things even worse. But without cutting both spending and taxes--and far more substantially than is politically possible--I expect things to get much worse before they get better.

[RippleFire]

bump

[ClearCase_guy]

It could be true that Gold had an annual return of 19.4% between 1968 and 1981, but maybe there's more to that story. I seem to recall Gold being restricted until 1973, and the price being regulated at $35 an ounce. After deregulation the price (predictably) jumped up.

The article might be right in some respects, but Gold is not going to be de-regulated this time, so it's performance in the next 10-20 years is unlikely to match its performance from 1968 to 1981.

[RobFromGa]

bump for later reading.

[sourcery]

The article might be right in some respects, but Gold is not going to be de-regulated this time, so it's performance in the next 10-20 years is unlikely to match its performance from 1968 to 1981.

Yes, this is my major disagreement with the article.

Firstly, in spite of central bank attempts to inflate the money supply, the excessively high levels of debt portend deflation. This is what happened in the 1930's, it's what has been happening in Japan, and it's what will happen next in Europe and then finally here.

Secondly, gold is no longer money, it is simply a commodity. The bank runs of the 1930's were all about exchanging gold depository receipts (paper currency) for gold, because back then gold was conceptually and legally the basis of money. There was a well known, legally binding exchange rate between dollars and gold. That's not the case today at all. The dollar is now backed by the same thing that backs gold: the willingness of society to accept it as payment.

I do think gold would make a better monetary unit than any fiat currency. But that's a completely different issue.

[lelio]

Doug Casey says fair value for gold right now is $700 an ounce. And he expects it to go to $3,000.
Oh come on. That reminds me of a caller to a real estate radio program saying that based on the past 3 years of housing price increases in the Puget Sound area, a $310k house today will be worth $3M in a 30 years (back of the envelope says that's a 9% increase every year).
What he failed to take into account was that prices going up at 9% only occur in certain markets. Its a lot higher in sub $100k houses but not near that in $1M+ ones.
And secondly, he doesn't take into account that paying 3M for a three bedroom house in Tacoma is just insane. Its just an okay house after all. Likewise with gold. Its just something you dig out of the ground. If it ever hits $500 an ounce someone's going to think about new ways of obtaining in, or look for a big deposit in a remote area.
The price of anything is governed by this: its insane to think that anything will go for $3000 when its 1/10th of that today. The market will find ways of finding a reasonable level.

[Jack Black]

There is a lot of volititily in the gold market. Depending on where you pick your endpoints you can prove almost anything. Gold has lost 1/2 its value since the mid eighties (when it was $800 an oz). Etc.

[arete]

Like John, I'm sure we'll find a way to muddle through. In the end - even if there's more deflation in the short term - our government will end up monetizing its debts. Greenspan and others at the Fed have already mentioned they're prepared to buy large amounts of long-dated Treasury bonds. Retiring Treasury obligations with dollars the Fed prints will cause a weaker dollar. That means, sooner or later, inflation will be back -- and in a big way.

Yep, that's pretty much the way I see it. Deflation now and then hyper-inflation later. Be prepared. It's coming.

Richard W.

[liberallarry]

But without cutting both spending and taxes--and far more substantially than is politically possible--I expect things to get much worse before they get better

I agree.

So the real question is how can the damage be minimized. Historically, nations escaped from these situations with wars. The Soviet Union found that road closed - so it collapsed. Can we escape that fate?

[OhhTee5]

A buddy of mine, who is a smart investor, but has never been much of a gold bug, has been doing a lot of research lately about the relationship of the price of gold to the Dow Jones Industrial average.

He's quite smart, so I'm not sure of all the details, but I believe he said there has been a historical ratio of gold to the Dow somewhere around 5 or 10 times. For example if gold is $300/an ounce then 10 times that would be a Dow of 3000 points.

He was suggesting that the current ratio of gold to the Dow is really out of wack and that either gold is going to rise, or the Dow will fall, to re-establish this historical ratio.

Personally, I'm not much of a gold bug either, but I think it is prudent to hold some kind of gold or precious metals in your portfolio. This would be to hedge against inflation and in case of economic or political turmoil.

I would think somewhere around 5% to 10% of your portfolio should be in precious metals or gold, and I would only use a mutual fund or a unit investment trust as the vehicle.

Individual gold stocks are too volitile and risky and owning the metal is way too expensive (big mark-ups, you have to store it, and how do you know if it's really gold and not gold plated lead for example?)

Just my two Maple Leafs (hahaha). Good luck all.

[bvw]

Yeah, I've also been thinking along those lines, only I've been expecting a moderate defalation that triggers at some random point a lightening-quick collapse of derivative/re-insurance structure, followed by hyperinflation, then finanicial system beakdown/martial-financial law/chaos!, followed by a general amnesty and return to a gold and silver standard.

[Jason_b]

Every time I hear this bad usage of "the price of gold" being regulated at $35 per ounce, I cringe. It is such nonsense!

The gold is the money. It has a value stamped on it such as $20 for a double eagle. That $20 indicates it has 20 times the amount of gold as a $1 gold coin. A $1 gold coin has a precise amount of gold that equates to the $1 face value. That equation must not be broken. U.S. paper currency used to be a warehouse receipt for gold coin. The concept of $/oz was of no use.

If the coin tells you its value in dollars, and you can figure out how many ounces or grains are contained in the coin, not that anyone would care, but then it makes no sense to go outside this arrangement and declare the price of gold in dollars.

Unless---you know that people are not paying attention. And that they in general don't know that debasement is a crime punishable by death. You can vary by statute the number of dollars per ounce of gold to enable corrupt people or government to pay their debts with what amounts to clipped coins. They don't know because they never see the coin, they get the paper that represents less gold. They've been robbed. Their property rights have been nullified. The sanctity of contracts---no such thing anymore.

In the mean time, dollars are now interest bearing debt instruments, representing unsecured debt of whoever did the borrowing that brought it into circulation. And since this debt unit is the unit of account, the price of gold is quoted in those dollar terms. And it works, now, because there is not even a pretense to have gold as money. But it is so against the law laid out in the Constitution and in the First money act of April 2, 1792, I don't even know where to begin.

[Jason_b]

It sounds like you are expecting a massive debt collapse. Since debt is monetized, it is used as money. Bad debts means expected income and therefore money, disappears. As debt disappears, material things become more valuable because they now will contain the perceived value that the debt once did but does no more. It could be said that monetized debt really monetizes the expectation of future income---which when that expectation is lost because the other party is insolvent, the money itself disappears with the possibility that the creditor will be repaid.


You said gold is no longer money. It is simply a commodity. For most people that may be true. But US gold coin is indeed legal tender in this country even with its silly face values. The Canadian Maple Leaf is legal tender in Canada and the Krugerrand is legal tender in South Africa. It is possible that very few people buy things with it in very specialized exchanges. But it has never ceased to be money.

You're statement "There was a well known, legally binding exchange rate between dollars and gold." reminds me of what used to be on old money. "This note is payable on demand to bearer, Twenty Dollars in Gold Coin." Never were ounces mentioned. There was really no exchange rate. The paper dollar note went from being a warehouse receipt, to being just debt-free paper money in the case of the united states notes in the '60s under JFK, to being unsecured debt instruments bearing interest, after LBJ.

You said, "The dollar is now backed by the same thing that backs gold: the willingness of society to accept it as payment." Willingness has nothing to do with it. Over thousands of years, cultures with markets have chosen gold as the preferred medium of exchange to take the market beyond barter---to money. The dollar is actually backed by aversion to having one's property confiscated for non-payment of property taxes. If we didn't hustle to get dollars, the government would come by and say pay the taxes or forfeit the house. That backs our money. The founders codified in the Constitution that we always use gold as money and not debts, not paper money, because they wanted contracts not to be paid of in depreciated paper, for that destroyed property rights.

Need to go. Will check back later to find out how wrong everyone thinks I am.

[arete]

Yeah, I've also been thinking along those lines, only I've been expecting a moderate defalation that triggers at some random point a lightening-quick collapse of derivative/re-insurance structure, followed by hyperinflation, then finanicial system beakdown/martial-financial law/chaos!, followed by a general amnesty and return to a gold and silver standard.

Complete financial collapse? Since all fiat currency systems have failed 100% of the time, that is a definite possibility. I don't think that it will be straight into the pit though. There will be all kinds of international turmoil and a few more wars before that happens. There would be such social unrest that the politicians will do anything to avoid it.

Richard W.

[sourcery]

It sounds like you are expecting a massive debt collapse. Since debt is monetized, it is used as money. Bad debts means expected income and therefore money, disappears.

Fractional reserve banking is a two-edged sword. When debts are liquidated, it works to deflate the money supply. This can happen faster than the central bank can ever hope to counteract by means of monetary expansion. That's how the Great Depression happened.

You're statement "There was a well known, legally binding exchange rate between dollars and gold." reminds me of what used to be on old money. "This note is payable on demand to bearer, Twenty Dollars in Gold Coin." Never were ounces mentioned. There was really no exchange rate. The paper dollar note went from being a warehouse receipt, to being just debt-free paper money in the case of the united states notes in the '60s under JFK, to being unsecured debt instruments bearing interest, after LBJ.

Any commodity, service or product can serve as a medium of exchange. In prisons, it is not uncommon to see cigarettes used as "money." But that does not justify the statement that cigarettes are "money" in any general context, only in very special contexts. The same is true of gold. It is not legal tender. One cannot pay one's taxes, debts or adverse judgements by delivering their weight in gold, computed from the spot price. Gold has ceased to be money in the same sense that cigarettes are not money: there may be specialized cases where it is used as a medium of exchange, but it is better understood as barter than as a monetary transaction.

The definition of the USD used to be a specific weight of gold. In effect, the USD was a unit of mass, just like the troy ounce. The reciprocal of the USD as a specific measure of mass used to be the dollar price of a specific amount of gold, legally defined in grains. In other words, the price of gold used to be the reciprocal of the weight of gold legally defined as one dollar's worth of gold.

You said, "The dollar is now backed by the same thing that backs gold: the willingness of society to accept it as payment." Willingness has nothing to do with it.

Willingness has everything to do with it. Anything which no one will accept as payment for anything, regardless of amount, has no value in society. Period. This point is not arguable.

The fact that all debts (especially including taxes) must be paid in USD certainly has a significant impact on the willingness (or even eagerness) of society to accept payment in USD. However, it would still be quite possible for society to prefer to set prices in gold, and to prefer payment in gold. Such a situation would naturally occur if the dollar price of gold began a steady, significant and secular increase--and if transaction mechanisms were developed making payment in gold as easy as payment in dollars (e.g,, gold-denominated checking accounts, credit accounts and electronic payment systems.) The rising price of gold in terms of USD would guarantee the ability to convert one's gold (held on accout at a bank) into USD whenever needed (such as when one's property tax were due.)