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Gold and the US Dollar
05/27/2005 12:00 am EST
"We’re living in fascinating times," began the Aden sisters, in a fascinating overview of the prospects for gold. Here, we feature commentary from Mary Anne on gold and the dollar. Next week, Pamela will share her view on the "China factor."
"Let’s just say we were old friends, and you have money and I am broke. I need to borrow from you to just pay my expenses. That’s fine with you so you are lending me money. In the meantime, I’m taking that money and I’m just spending lavishly. I’ve bought a mansion on the beach and I’m having parties every night, traveling first class, buying designer clothes, and just spending like mad. Well you may not agree with that, but you don’t say anything, because we’re friends, and I’m paying you back— so that’s okay. But as time goes on, let’s say a few years later, for every $10,000 your lending me, I’m paying back only $7,000. After a while, you’re going to say, ‘Look, this isn’t working out too well.’
"Unfortunately, this is the situation that the US is in today. We’re definitely not gloom-and-doomers by any means. But if we just look at the facts of what is happening, you have to ask how this is happening. It actually started in the late 1990s. As you know, the stock market bubble burst. The NASDAQ then plunged 78%, at which point deflation forces intensified. To avoid deflation, interest rates were dropped hard and fast to 45-year lows. Monetary stimulation exploded, and to make matters worse, 9-11 added fuel to the fire. As the war on terrorism kicked in, the US budget surplus quickly went from a surplus to the biggest debt and deficits that the world has ever known.
"The end result was the biggest credit explosion in US history. Meanwhile, deficit spending and monetary stimulation also resulted in inflation. And even though inflation is still relatively low, it is the highest it has been in 14 years. This is all very similar to what happened in the 1970s. Like now, money was loose, deficits were huge, inflation soared, and budget deficits were large. There were war costs, due to Vietnam, and interest rates and commodities rose, including oil, which soared nearly 300%, And so did gold, silver, and platinum. In the 1970s, these mega-market trends lasted for many years. We believe that the current situation could be similar.
"This is really the key to what is going on for the years ahead. We look at the relative performance between the Dow industrials and the price of gold going back to 1919. When this ratio rises, the Dow is stronger than gold, and when it declines, gold is stronger. Starting in 1999, a mega shift occurred from financial assets to tangible assets, and this is a very big deal. This doesn’t happen often. In fact, this is only the third time this has happened since 1919, and these mega-shifts last a long time. The last one, for example, lasted 14 years. So what this is telling us is that gold is now stronger than stocks. So gold is where your investment focus should be, we believe, for the years ahead.
"This is going to take time and there will be ups and downs along the way. But the rise in gold, we believe, will be quite dramatic. What could cause this? The drop in the US dollar alone is one very important factor. The US has been a debtor nation for the past 20 years, and if we go back in history, no country has been able to maintain reserve status with record debts. And indeed, the major countries of the world are beginning to diversify out of US dollars and into other currencies and the dollar is slowly losing this privileged status.
"Yes, dollar reserves are still huge. But what’s important to note is that the US is using up 80% of the world’s available savings, and it is borrowing $2 billion a day from overseas to cover its debt. Now this means we are very dependent on foreign money. These huge imbalances simply cannot continue. Economists continually debate this situation and no one knows what will happen. Paul Volcker, for example, recently said, ‘Circumstances seem to be as dangerous as any I can remember— and I can remember a lot. What really concerns me is that there seems to be so little willingness to do anything about it.’
"So, in the meantime, the dollar continues to go down. It’s lost 30% of its value since 2001 and many countries are simply losing money, and they don’t want to keep lending to their extravagant friend. I don’t think you would either, which is why I think in the example we began with, you would stop lending me money as well. That’s essentially what’s happening on a global scale."
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