From the October 2011 issue of Investment Advisor • Subscribe!

Gold Standard

Without exception, all paper currencies have eventually ceased to exist

Aug. 15, 2011, marked the 40th anniversary of the U.S. default on the dollar’s convertibility into gold. It was the last of the world’s currencies to be backed by gold, and thus began an experiment with a reserve fiat currency that was doomed to failure before it began. Without exception, all paper currencies have ended in hyperinflation followed by complete devaluation and eventually ceased to exist. Aug. 15, 1971, was just like any other day for most people, and President Nixon’s unprecedented decision to cut the U.S. dollar’s gold convertibility was largely ignored by the public. The majority of citizens didn’t understand the implications for their financial future. Contrast that to today, where a historic downgrade of U.S. debt and a very public $2-trillion increase of the debt ceiling dominated headlines and the television news.

The U.S. dollar is the world’s reserve currency despite the fact that it is being issued by the world’s largest debtor nation. Investors around the world flee to it during times of crisis, despite it continually losing value through debasement. Gold meanwhile is dismissed as a viable asset, ignored by most pensions, institutions and asset managers despite increasing from $35 in 1971 to over $1,800 at the end of August.

It is important to note that on that historic day 40 years ago, the dollar quietly ceased to be money and instantly became a currency. While fiat currencies function well as a medium of exchange and a unit of account, they fail miserably as a store of value. The current monetary system, which began in 1971, has two critical features that have profound implications for our financial future:

1. Fiat currency is created out of debt via the banking system and the Federal Reserve.

2. The amount of currency created must continually expand.

Until governments around the world stop spending beyond their means, running huge deficits, incurring massive debts and creating endless amounts of fiat currency, precious metals will continue to rise and fiat currency values will continue to erode. The best way to protect portfolios and preserve wealth from this impending crisis is to own precious metals.

When we consider that total global financial assets are estimated at over $200 trillion, but total global above-ground gold bullion is a modest $3 trillion, and only growing by approximately $100 billion a year, we can see that once a shift toward gold occurs, there will be too much paper currency chasing too little gold. Of the $3 trillion of above-ground gold bullion, about half is owned by central banks and half is privately held. The central banks have been net buyers since 2009 and most of the privately held gold is not for sale at any price. If only 5% of the $200 trillion in financial assets were to allocate to gold, there would be about $10 trillion trying to buy the $1.5 trillion of privately held gold bullion. Under that scenario, $10,000 per ounce becomes a conservative price projection.

There have been many “experts” in the media discouraging the holding of gold since, they say, it is a useless, overvalued relic that pays no interest and is in a bubble. We heard this same rhetoric when gold was $300, then $500, $800, $1,000 and $1,800. Clearly these experts have never read a book on monetary history or fiat currency and their outcome. This advice has been costly to those who listened. In truth, gold is not rising; fiat currencies are falling and will continue to do so until governments around the world begin to act responsibly. There is nothing on the horizon to indicate this will happen any time soon.

Perhaps the former chairman of the Federal Reserve, Alan Greenspan, explained the importance of the gold best when, in 1966, he said, “In the absence of the gold standard there is no way to protect savings from confiscation through inflation. There is no safe store of value.” Forty years after President Nixon ended the dollar’s convertibility to gold, it seems that Mr. Greenspan was correct.

 

Nick Barisheff
President/CEO
Bullion Management Group Inc.

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