Why i invested_in_gold_and_silver (investing overview) (aug 8, 2011)
Why I Invested in Gold and Silver
Why Gold and Silver Must Soar• In 2004, I became interested in understanding how the global financial system works• What I learned is that – For the past 6,000 years, gold and silver have always been money because they are the only things that meet a number of criteria such being limited in supply (rare), a store of value, divisible, fungible, etc. – But, gold and silver are heavy and inconvenient to carry around – So, paper money (and it’s digital equivalent) was created as a convenient substitute for real money (gold and silver), and could be exchanged for real gold or silver at any time. • Gold coins circulated as money until the 1930’s • Silver coins circulated as money until the 1970’s Key Point Paper money is just a ‘receipt’ or ‘certificate’ representing real gold and silver being held in storage. To have any value, paper money must be backed by gold or silver.
Why Gold and Silver Must Soar• Throughout history, hundreds of nations have created hundreds of different paper currencies that were unbacked by gold or silver.• Every single one of them eventually failed and went to zero. – A few examples include North Korea 2009, Zimbabwe 2008, Argentina 2002, Bulgaria 1996, Brazil 1994, Soviet Union 1992, Poland 1991, Nicaragua 1990, Mexico 1982, China 1955, Greece 1944, Germany 1923, United States 1865, etc..• Why do unbacked currencies always fail? – Because without the requirement to have enough gold and silver to back the currency, the government can print unlimited amounts of money to pay for anything needed to satisfy voters and keep them in office! – This temptation is irresistible, so governments always end up doing it. – Eventually so much money is printed that inflation begins to run out of control, and the public abandons it altogether as the currency becomes worthless.
The Importance of the US Dollar• After World War II, the global economic system was in a shambles• Most of the major economies had been bombed and destroyed• However, the USA had – The world’s largest manufacturing base – The world’s largest gold reserves – The world’s only major economy that was undamaged by the War• So, all countries agreed in 1944 that the US dollar (which was backed by gold) would become the world’s ‘reserve’ currency – All international trade would be conducted in US dollars, which were convertible to gold. =• All countries then began building up US dollar reserves to support their own currencies and facilitate international trade
Problems with the US Dollar• The United States economy grew briskly through the late 1940’s, 50’s, and 60’s. These were the Golden Years in the USA when the cost of living was low and wages were the highest in the world.• But, following the typical script, in the 1960’s the government began to spend more US dollars than they had gold to back it up – The Vietnam War was incredibly expensive, funded entirely by deficit spending (money-printing) – Medicare and Social Security were signed into law, eventually costing hundreds of times more than projected – US oil production began a permanent decline and the US started importing more oil than they produced, costing additional billions of dollars The US essentially printed the money to pay for all of these burdens.
The Closing of the Gold Window• By the 1970’s, the United States had created so much money, that other countries became concerned about the effect that this dilution would have on the purchasing power of their own US dollar holdings• So, many countries began exchanging their dollars for American gold at the official exchange rate of $35/oz.• The massive US gold reserves were reduced by almost 2/3 in just a few years
The Closing of the Gold Window• In desperation, President Nixon went on television on Aug 15, 1971 to announce that the US would no longer honor the convertibility of US dollars into gold. This was the same as the US declaring that they were bankrupt and could not pay their obligations to other countries.
Inflation, Inflation, and more Inflation• By severing the link between gold and the dollar: – The US dollar instantly became an unbacked paper currency, and simultaneously removed the gold backing of all other currencies in the world through the US dollar’s gold backing. – So, suddenly all currencies in the world no longer had any claim on gold, and were now unbacked paper currencies!• So, starting in 1971, the US and governments worldwide were now free to print as much money as they wanted, unhindered by the requirement to have enough gold to back their money.• And of course…they did…
Inflation, Inflation, and More Inflation Key Point US Monetary base 1917 - 2009 2008 Financial Crisis – Bank bailouts, TARP, The United States was $8 QE, QE lite, QEII, etc doubled the money trillion in debt in 2008, which supply in just 18 months took over 225 years to amass. In Aug 2011, the debt ceiling was raised to $16.7 trillion, which should last until Nixon cancels 2012. the gold standard The US government will borrow Money supply and spend, in just 4 years, the On the gold standard same amount of money that was borrowed and spent over the previous two centuries. This is the financial behavior of a failed empire, just before currency collapse.
The Financial System’s Dirty Secret• Since 1971, all money in the world comes into existence through the creation of a loan, and does not represent anything real • Every dollar you have is a dollar that someone borrowed somewhere else, and has to eventually pay back (with interest) – Therefore, each year more money must be created than the year before to be able to pay back the interest on that debt. • If not, the financial system would sink into a spiraling Great Depression-style deflation where the price of everything falls (including wages) yet heavy, unserviceable debts remain, causing most people to go bankrupt. • Central banks will do ANYTHING to keep deflation from happening, so they create more money every year to keep this from happening – Where does that money come from? It must be BORROWED into existence. • That is why governments, businesses, and individuals are enticed to borrow to the hilt through 0% interest rate policies, easy auto loans, credit cards and lines of credit, etc…if people got out of debt, the financial system would implode. • Debt = Money, and Money = Debt. The more debt there is, the more money there is. The more money there is, the more debt there is. The financial system mathematically requires there to always be more money printed next year than this year, or the system implodes.
Hyperinflation• Inflation is caused by the creation of too much money (debt) without increasing the production of real goods and services by the same amount• Inflation is felt when prices go up, not just for some things, but almost everything. This makes the cost of living much more expensive, causing living standards to fall for working and middle class people.• As inflation progresses over many years, the public increasingly begins to feel the loss of their spending power• At some point, the public realizes that their money is losing value rapidly, so they no longer want to save it. Instead they begin to spend their money as fast as they get it, before prices have a chance to increase even more.• This bids up prices even faster, which causes the value of the money to fall even faster, which bids up the prices faster still, in a self-reinforcing cycle called hyperinflation. Eventually, the situation reaches the point where people will no longer accept the currency in exchange for goods and services, and the currency is considered worthless.
Massive Inflation in the 70’s• There was double-digit annual inflation in North America throughout the 1970’s. – The cost of gas, food, and everything else tripled in a decade – It was so bad, the US government tried to implement price controls on staples such as milk, bread, and fruit. – That didn’t keep prices down however, it simply resulted in empty store shelves as producers could not sell their products at a profit, causing them to go out of business. – People were selling US dollar-denominated assets, and gold and silver reached all-time highs as people traded their increasingly worth-less dollars to buy real money (gold and silver). The US dollar was at a real risk of a hyperinflation.
Dealing With Inflation• The US was able to avert hyperinflation in the early 1980’s, by raising prime interest rates to 21.5%, causing the money supply to decrease rapidly and prices to fall (ie. the value of the US dollar to go up).• This action caused a devastating recession that lasted for many years• But, it saved the economy from runaway hyperinflation and the total collapse of the US dollar’s purchasing power.
Hiding Inflation• After this experience, Western governments learned how devastating high inflation was to the stability of the financial system• But, rather than managing their currencies more responsibly and living within their means, they decided to keep borrowing and spending and instead modify the government inflation measure (the CPI or Consumer Price Index) calculation to intentionally understate real inflation by – Excluding food and energy – Showing smaller increases for things that were going up in price – Showing larger decreases for things that were going down in price – Substituting many items that had gotten expensive with poorer-quality things that were not as expensive (eg. Prime steak with chicken)• That is why inflation has been reported at only about 1-2% annually in all Western countries for the past 20 years, when inflation is actually running between 8-13% every year as calculated using the old pre-1980’s methodology. Can you think of just one thing that has increased in price by only 1-2% per year over the past 10 years?
Hiding Inflation • Based on my own experience: Item Price in 2000 Price in 2011 % Increase College Tuition $3,623/year $8,673/year 140% Groceries 400$/month 900$/month 125% Furnace oil 0.49$/L 0.95$/L 94% Gasoline 0.69$/L 1.31$/L 90% Alcohol 8$/six pack 13$/six pack 62% Vacation to Cuba $600/week $1100/week 83% Levis jeans $50 $80 60% Magazine $3.99 $6.99 75% Candy bar $0.69 $1.19 72% Movie admission $5.99 $11.99 83% McDonald’s combo $4.59 $6.59 44% DVD rental $3.99 $5.99 50%Based on this ‘basket’ of consumer goods, inflation has been at least 7-8% annually since 2000, yet is reported by the government at 1-2%.
The Emperor Has No Clothes• The Financial Crisis of 2008 exposed the USA and most other Western nations for the financial basketcases that they are.• Western nations are fundamentally unable to live within their means (ie. collect enough taxes to pay for government spending)• So, they borrow and print whatever money is necessary to keep the party going – Since 2008, the USA has doubled it’s federal debt and increased their money supply by an unprecedented 300%! – All Eurozone countries, Ireland, Britain, even Canada all have massive federal debts, and are adding more every year through deficit spending. Much of this debt is unrepayable. – During this decade, it is projected that just the interest payments on the US national debt will become impossible to make without simply printing the money. This is massively inflationary. Smart investors know that all unbacked paper currencies are losing value at an alarming rate, and an international currency crisis is brewing. Since the early to mid-2000s they have quietly been selling their stocks, mutual funds, and bonds, and begun buying real money : silver and gold.
The Inevitable Outcome• So, gold and silver are destined to explode in price this decade due to – All of the global financial imbalances caused by leaving the gold standard completely in the 1970’s. – Massive sovereign (government) debt, much of which will never be repaid – A collapse of the US dollar’s purchasing power, which will cause significant financial uncertainty in global markets• This provides the greatest opportunity in 40 years to profit from the coming wealth transfer out of paper assets (stocks, mutual funds, bonds, etc) into real assets (primarily gold and silver, but also all commodities).• In the 1970’s, gold went up 24x in price and silver went up 36x in price over a 9-year period of high inflation.• The global financial system is in much worse shape now, and the returns for gold and silver investors will be staggering.
The Big Differences Today• Today is much like the 1970’s, but the factors propelling gold and silver are an order of magnitude more powerful – Governments, businesses, and individuals are far, far more indebted than in the 1970’s. – Interest rates cannot be raised to 20% (probably not even to 7%) to save the US dollar without causing a tsunami of US bankruptcies, foreclosures, and a massive worldwide deflationary Global Greater Depression. – In the 1970’s, only Americans and the citizens of some European countries were allowed to own gold. China, India, Russia, and many other countries had no stock exchanges and their citizens were not allowed to own gold. That is no longer the case, and hundreds of millions of people in these countries are going to be rushing into gold and silver as the global currency, the US dollar ( as well as all other unbacked paper currencies) loses significant value. – At some point, there may be panic selling of US-dollar denominated assets such as stocks, bonds, mutual funds, and cash deposits and a global stampede into gold and silver. The global market for gold is so small compared to total global financial assets, that a panic into gold would be like filling a cup with a firehose (and for the silver market, like filling a test-tube). The prices would EXPLODE.
Conclusion• Gold and silver are the only safe haven investment from the global financial problems that are ‘baked into the cake’ over the coming years• In spite of their unrivaled gains over the past 10 years, gold and silver remain more undervalued today in 2011 than they have been for many decades: – Gold is currently only 2x it’s 1980 high of $850/oz. – Silver is still below it’s 1980 high of 50$/oz. – Yet, there is 10 times more money in circulation today ($14 trillion) than in 1980 ($1.4 trillion), and quadrillions in derivatives.• Both silver and gold will have a lot of catching up to do over the coming decade. Huge gains lie ahead for both gold and silver – Silver will likely outperform gold (which will itself have absolutely stellar returns) by approximately 3:1, as the gold-silver ratio moves from the current 42:1 ratio back to the historical 16:1 ratio. Investing in gold and silver is a once-in-a-lifetime opportunity to build generational wealth by taking a position now and waiting out the bull market until it reaches it’s conclusion later this decade.
Personal Thoughts• Very difficult economic times lie in the years ahead that will impact most people – Slowing GDP growth in western countries – Persistently high unemployment, downsizing, job losses – A drop in the real value of typical retirement assets like stocks, bond, and homes – Revenue and debt crises at all levels of government, along with higher taxes – Very high inflation that will quickly erode the quality of life of the middle class and poor.• This economic environment will scare the pants off of investors globally, particularly the hundreds of millions of baby boomers who undersaved, overconsumed, and took on too much debt during their working years, and will have run out of time to rebuild their retirement portfolios when they are ravaged this decade.• Globally, investors will be desperate to move their assets into the only asset class that can preserve their wealth in this economic climate– gold and silver.• The coming ‘financial adjustment’ period of the next 10 years will likely result in the creation of a new global gold-backed international currency. Buying physical gold and silver coins and bars is the safest way to profit from the ongoing flight from unbacked paper currencies.