“Paper money eventually returns to its intrinsic value – zero.”--Voltaire
Introduction
Suggesting that hyperinflation is in our future, and that we should prepare for it, may surprise some investors. It’s certainly not what you will hear from most economists or financial advisors (although some are beginning to express concern about it). This article explains why I believe hyperinflation is a certainty and how to protect yourself or even profit from this historic event.
I’ve seen ordinary inflation developing for quite some time because so many factors were contributing to a decline in the purchasing power of the US dollar (USD). The dollar price of gold is the best way to track the value of the USD, for several reasons:
- It takes fluctuations in other currencies out of the equation.
- Gold is far less subject to supply interruptions than commodities such as oil, which is highly sensitive to global political developments, and agricultural products, which are significantly affected by weather and use in bio-fuels.
In the month of April 2004, when the price of gold averaged $408, I wrote and published an article entitled “The Perfect Golden Storm.” It began, “An array of forces is converging to drive gold toward and probably beyond its 1980 peak of $852 per ounce, creating exceptional opportunities for investors.” It went on to describe those forces in detail.
Four years later, in April 2008, I followed up with another article, entitled “Gold: $2011 by 2011.” Gold had surpassed its 1980 peak. On March 17, 2008, the London PM Gold Fix set a (then) record of $1,011.25. This article showed why the forces propelling gold to new heights would continue.
Three more years have gone by, with gold setting one all-time high after another. The question I continue to be asked is, “Will your prediction that gold would reach $2,011 by the end of 2011 come true?” My projections have been changed by the financial bailouts of 2008, 2009, and 2010 and continuing high unemployment and declining home prices in the US. Back in 2008 I felt that we would be in Phase II of the gold surge by late 2010-early 2011, and that we would reach $2,011 in Phase III by the third quarter of 2011, followed by a dramatic correction.
What do I mean by referring to gold bull markets as having three phases?
The charts above show the previous bull market in gold. As you can see, there is a period of gradual increase from early 1977 to July 1979 (Phase I), followed by a period of accelerating increase from July 1979 to the end of 1979 (Phase II), followed by a near-vertical ascent in January 1980 (Phase II). The table below summarizes these phases.
Gold price increases from 1977 to 1980 (the previous all-time high)
| Phase I | ||
| Date | Price | Change/Time |
|---|---|---|
| Jan 1, 1977 | $134.50 | |
| Jan 1, 1978 | $169.20 | +25.79% in a year |
| Jan 1, 1979 | $226.00 | +33.56% in a year |
| July 1, 1979 | $277.50 | +22.78% in six months (45.56% annualized) |
| Phase II | ||
| Jan 1, 1980 | 512.00 | +84.50% in six months (169% annualized) |
| Phase III | ||
| Jan 21, 1980 | $850.00 | +66.01% in 20 days (1,204% annualized) |
The chart and table (below) of the current bull market in gold show that this run up is more prolonged and more gradual.
Gold price increases from 2001 to 2010
| Phase I | ||
| Date | Price | Change |
|---|---|---|
| Dec 2001 | $276.50 | |
| Dec 2002 | $348.10 | +25.90% |
| Dec 2003 | $415.70 | +19.42% |
| Dec 2004 | $437.50 | +5.24% |
| Dec 2005 | $517.10 | +18.19% |
| Dec 2006 | $638.00 | +23.38% |
| Dec 2007 | $833.20 | +30.60% |
| Dec 2008 | $878.30 | +5.41% |
| Dec 2009 | $1096.50 | +24.84% |
| Dec 2010 | $1422.00 | +29.68% |
| Average annual increase | +20.29% | |
| Phase one has yet to end. |
Recent events in Japan, the Middle East, North Africa, and debt crises in the US and Europe have created extraordinary instability in the world. Even before recent events, over a period of the last three yearsdemand for gold changed. It now comes mainly from China, India, and the Middle East, rather than from the US. I believe this trend will continue and intensify, with demand from these three areas increasing dramatically because of fear of inflation and lack of faith in paper money.
During the past 10 years gold prices have averaged over 20% annual increases, building an exceptional base for the coming Phase II and III surge. I believe that during Phase II we will see 50% annual increases over a period of about two years (with a number of +$50 and +$100 days), taking gold to around $3,000. Phase III would see gold reaching $5,000 with three or four months—an annualized rate of over 200%. As a result, I believe gold will reach $5,000 an ounce during Phase III. I believe my price estimates are conservative, and that Phase III will occur by 2014. A US government decision to adopt a gold standard or start a gold confiscation program would accelerate this timetable.
I think my clients who invested in gold based on our analyses in 2004 or 2008 are happy about their decisions. No other asset class has increased every year, or is up over 250% from 2004 to 2011. As I wrote near the end of “Gold: $2011 by 2011,” “Fortunately, I don’t need to be sure that gold will reach $2011 by 2011 to see the logic of holding gold and continuing to invest in gold. As long as the interrelated forces I have labeled limited supply, declining US dollar, interest-rate bind, investment climate, and global instability remain in place, they will continue to drive the price of gold higher. I believe I have shown that these forces do remain in place and are, in fact, intensifying. The Perfect Golden Storm continues. Your opportunity to profit from it remains.”
The 1977-1980 gold bull market ended without hyperinflation. In fact, a combination of very high interest rates and wage and price freezes sent the country into a recession and gold into a bear market. As you will see from this article, the United States is in a very different place today, facing much stiffer global competition, much higher federal deficits and national debt, and much more committed to stimulating the economy through low interest rates.
Most of us think of hyperinflation as something that happens in other countries. Actually, we’ve had two episodes of hyperinflation in the US, but they were a long time ago, during the Revolutionary War and the Civil War. Consider the evidence for upcoming hyperinflation below. Acting on it could save you from severe losses and even put you in a position to amass significant profits. Someone always does profit from severe economic dislocations. You may also be surprised to discover that while I believe gold is going to go a lot higher, I will suggest investing in another asset class as a critical component of preparing for hyperinflation and the gold confiscation—such as happened in 1933—that might accompany it.
Hyperinflation happens
During the 20th Century, 30 countries experienced hyperinflation(1). In every case, horrifying price increases that quickly wiped out the value of savings and of most forms of investment took people by surprise. A few politicians, economists and investment strategists issued warnings that were ignored by governments and by almost everyone else, until they were suddenly caught up in the daily struggle for survival. Prices increased every week, or every day, or even every hour; incomes lagged far behind. Business stagnated as it became difficult or impossible to plan production and make a profit. Unemployment rose, and for those without jobs and for retired or disabled people living on fixed incomes, hyperinflation was a hyper-nightmare that often lead to homelessness and starvation. (1 See “Hyperinflation” in Wikipedia.)
Many of the factors that have led to hyperinflation in the past are present in the United States today. We’ll analyze them in detail later in this article. Two of the most important are rapid increases in national debt and in the creation of money. In March 2006 Congress raised the national debt limit for the fourth time in five years, to what then seemed an astounding $9 trillion. By May 2011, after several more limit increases, the national debt had risen to $14.3 trillion—a rate of increase of just over $1 trillion per year. What’s worse, the rate of increase is up sharply. In April 2008 the national debt was $9.6 trillion. Reaching $14.3 trillion in May 2011 represents an average increase for three years of $1.6 trillion per year. The national debt per taxpayer is $128,000 and rising(2). The chart below shows the national debt through September 2009. Since then the debt has increased another $2.5 trillion. (2 See “U.S. National Debt Clock,” at www.brillig.com/debt-clock.)
Since 2008, the Federal Reserve Bank (the Fed) has injected trillions of dollars to “stimulate” the US economy. One of its methods, known as “quantitative easing,” involves creating money to buy up US debt. Increasing the money supply to buy Treasury Bonds is known as “monetizing the debt.” Monetizing national debt has also been a key forerunner of hyperinflation.
The Fed creates money in the form of fiat currency: money backed not by silver or gold, but only by confidence in the government and economy of the United States. This form of creating money is often referred to as “printing money.” However, in the electronic age, the Fed can create money with just a few keystrokes. For example, to buy Treasury Bonds under “QE2” (the second quantitative easing program), the Fed electronically sends to the US Treasury billions of dollars that did not exist moments before the transfer. That money then streams into the general economy as the federal government uses it to pay salaries & bills.
What Is Hyperinflation?
Consumers know they are experiencing hyperinflation when the focus of their existence becomes dealing with rising prices and the attendant shortages of critical commodities. Life is a race to find food, fuel, medicine and other necessities and buy them before the price jumps higher.
Economists have tried to develop more objective definitions. The International Accounting Standards Board defines hyperinflation as “a cumulative inflation rate over three years approaching 100% (26% per annum compounded for three years in a row).” At that rate, an item that costs $10 today would cost $20 three years from now. Your income would have to double in three years to maintain your standard of living. Your investments would have to double in three years to maintain their value. In 1956 economist Phillip Cagan famously defined hyperinflation as an average monthly price increase of 50% or more. At that rate, our $10 item would cost $1,946 just one year. Unfortunately, most of the 31 nations that suffered from hyperinflation in the 20th Century were more like the Cagan model.
“It Can’t Happen Here”
The specter of hyperinflation is frightening. We can make ourselves feel better by pooh-poohing the possibility of hyperinflation happening in the United States in the 21st Century. Reality, however, does not respect wishful thinking. Think back to 2006-2007, when housing prices began to drop. An endless stream of bankers, economists, politicians, and journalists assured us that the crisis would be restricted to subprime mortgages and would be over within a year. In 2008, they assured us that within a year we would see a marked decrease in unemployment and an upswing in the housing market. Today, many of these pundits assure us that inflation, let alone hyperinflation, is not a problem.
If you believe that hyperinflation is coming—and I believe that after examining the evidence in this article you will—why put your head in the sand? Instead, obtain true peace of mind by preparing to survive and even prosper. Such preparation is especially sound because it protects you from the ravages of plain ordinary inflation, which is already upon us. Yes, the federal government assures us that inflation is not a problem. We’ll show later how similar that assurance is to pre-crash announcements that “the economy is fundamentally sound.” For now, we’ll simply ask, “Have you been to a supermarket or gas station lately?”
Let’s look at three examples of hyperinflation and see what we can learn from them.
Do You Own or Manage a Business?
After analyzing hyperinflation and related matters, such as the possible confiscation of gold and/or return to the gold standard, this article will focus on how to prepare as an investor. If you are a business owner or manager as well as an investor, we urge you to read a short (82 pages) book by University of Arizona economist Gerald Swanson, The Hyperinflation Survival Guide. Dr. Swanson and his team studied the strategies that enabled some businesses in Bolivia, Brazil, and Argentina to succeed during hyperinflation while others went under.
The History of Hyperinflation
Germany, 1922-1923
The German experience demonstrates that hyperinflation can occur in a large country with a democratic government and a highly developed capitalist economy. We will therefore examine it in some detail.
In 1914 the German mark, like most other currencies, was redeemable in gold. When Germany went to war that year, its central bank, the Reichsbank, suspended redemption. Rather than alienate its population through increasing taxes, Germany financed its war by borrowing. Unable to sell enough bonds on the market, Germany monetized its debt by having the Reichsbank buy bonds. The Reichsbank could print unlimited amounts of fiat money to do so.
When World War I ended in November 1918, Germany’s national debt had increased 1,700% and money in circulation had increased by a factor of four. By 1918 the consumer price index (CPI) was up 140%—a lot but less than one might expect given the run ups in the debt and the money supply. Price inflation had been kept down by rationing and low demand. Millions of soldiers in the trenches were not in the marketplace. Civilians, hard at work to support the war effort, had little time for leisure. Money was piling up but was not being spent.
The German government had expected to win the war and force the defeated countries to pay its debt. After losing the war, there was great incentive to continue printing money to monetize the debt and finance promised social programs. From November 1918 to February 1920 prices shot up another 400%.
After 15 months of relative stability, prices surged again, rising 700% in 14 months. France, claiming Germany was not living up to its agreements to pay reparations for war damages, occupied the Ruhr. Germany sponsored “passive resistance” and paid citizens in the Ruhr not to work under French occupation.
Germany injected so much money into the economy that business everywhere but the Ruhr were operating at full capacity, with full employment. However, prices rose so quickly that, despite frequent wage increases won by unionized industrial workers, real wages plummeted. Farm workers, white-collar workers, and professionals lost ground even faster. Germans, losing all confidence in the mark, immediately spent every mark they could get their hands on. If someone could buy 10 jackets, he’d do it, knowing that they would keep their value and could be used for barter.
By 1923, Germany was printing notes with denominations as high as 100-trillion marks. At the height of hyperinflation, in December of that year, a 100-trillion mark note would get you US$23.81 at the official exchange rate.
Housewives burned 100-million-mark notes for heat; it was cheaper than buying fuel. Business owners turned into speculators in commodities. Farmers kept their produce rather than sell for marks that lost half their value in two days. Food riots broke out; groups of workers went to farms and seized food. Businesses closed; unemployment surged; chaos reigned.
The German government passed monetary reform decrees that forbade the old central bank from buying government bonds, thus stopping the printing of marks. It also created a new bank, the Rentenbank, which issued a new currency, the Rentenmark. To build confidence in the Rentenmark, the quantity in circulation was regulated. The goal was to have sufficient currency for government and commercial transactions, but not to issue credit to the government or speculators.
The Rentenmark was supposedly backed by mortgages on land and bonds on factories. However, the land and factories could not be turned into cash or used for foreign exchange. What gave the new currency real strength was gold. Although the Rentenmark was not redeemable in gold, it was backed by bonds indexed to the price of gold. The value of these “gold bonds” was defined at the same fixed rate as pre-war gold marks, 2,790 per kilogram of gold.
Paper marks and Rentenmarks circulated together, with up to 1,200 quintillion (3) paper marks in circulation. In 1924 the German treasury issued a new currency, the Reichsmark, equal in value to one Rentenmark. A monetary law permitted the exchange of a trillion marks for one new Reichsmark. This rate of exchange gave back to people a fraction of what they had lost, because 3-trillion marks were the equivalent in purchasing power of one new Reichsmark. (3 A quintillion is 10-million trillion.)
Krupp, Thyssen, Farben and other major German industrial conglomerates emerged strong from hyperinflation. They had supported the government’s inflationary policies because a weaker mark made their products cheap to foreign buyers, enabling them to increase exports. Their exports were paid for in sound foreign currencies with which they could buy raw materials to import into their plants in Germany. Millions of middle-class people, workers, and farmers, however, saw their savings wiped out and their lives destroyed. Embittered, many of them supported the Nazi party in its rise to power.
Argentina
Under a military dictatorship from 1976 to 1983, Argentina went into debt to finance the Falklands war, government takeover of the debts of failed banks, and projects that were not finished (and therefore produced no revenue). Unemployment reached 18%. The military junta became extremely unpopular and ceded power.
As part of its plan to stabilize the economy, the newly elected civilian government introduced a new currency, the austral, and took out new loans. Tax revenue did not increase quickly enough to pay theinterest on the debt. The central bank reacted by printing money and monetizing national debt, using a variety of tricky financial maneuvers to conceal its actions(4). Despite the deception, public confidence in the austral plummeted. Prices increased by 10 to 20 percent per month. July 1989 saw a sharp increase in the monthly inflation rate—to 200%. For the year 1989, prices went up 5,000%. Real wages fell 50% from 1983 to 1990. Rising prices and declining real wages led to riots and the resignation of the president in favor of the president-elect. (4 See Argentina: From Insolvency to Growth, A World Bank Country Study, pp. 180-185, available on Google Books.)
Hyperinflation continued into 1990. In 1991 the Argentine government stopped inflation by fixing the value of the austral at 10,000 to the US dollar (USD), with full convertibility. Later, a new Argentine peso replaced the austral, and convertibility was fixed at one peso to one USD.
Convertibility created a new set of problems. The fixed exchange rate made many imports more affordable than domestically produced products, causing a constant outflow of dollars. The central bank had to buy dollars to support convertibility. Meanwhile, the flood of imports caused factories to close and unemployment to rise. Public spending on unemployment benefits and on corrupt payments to private corporations and wealthy individuals rose, causing the national debt to continue to grow. Widespread tax evasion exacerbated the problem.
Argentina sold off many state companies at prices favorable to the buyers, who were cronies of government officials. The revenue generated by this 1-time fix was quickly spent. Argentina then financed its debt largely by external borrowing, particularly from the International Monetary Fund. By 1999 the economy was in a recession that lasted three years.
By 2001, foreign investors were withdrawing funds from the country and Argentineans, fearing the worst, started withdrawing money from their savings accounts and sending dollars abroad. To stop the run on the banks, the government froze all accounts for 12 months, except for withdrawals of small sums. This led to a new form of protest—masses of people in the streets banging pots and pans. The crowds also smashed windows at banks, privatized companies, and European- and American-owned businesses.
In 2002 Argentina defaulted on its debt and abandoned the fixed 1-to-1 exchange rate. Hyperinflation returned. The peso quickly devalued to about 4 to the USD, with no increase in wages. Businesses failed; unemployment reached 25%.
A recovery started in 2003. Exports surged due to the devalued peso, which also discouraged imports, strengthening those local businesses that had survived. Rising soybean prices and huge exports of soybeans to China brought a flood of foreign currency into Argentina. Simultaneously, the government took measures to increase revenue by strengthening tax collection.
Brazil
Brasília—the futuristic city that replaced Rio de Janeiro as the capital of Brazil—was built in four years, from 1956 to 1960. It was a remarkable achievement: the unpopulated, arid area in the interior of the country had resembled a desert. A problem became apparent years later. The government of Brazil did not have the funds to finance the project. It paid the bills by printing money.
Unfortunately for the Brazilian people, the unfunded construction of Brasília was not a 1-time extravagance. It started—or at least reinforced—a trend that continued for decades. Public projects included a “bridge to nowhere.” Unlike its never-built Alaska counterpart, this bridge reached halfway across a canyon before construction was stopped. Corruption was also rife: a high government official diverted public funds to build privately owned (by him) apartment buildings, and never went to jail.
Brazil’s federal debt also increased when the government:
- Had to make good on guarantees to the Mortgage Assistance Fund.
- Was unable to collect on debts that had been listed as assets on its balance sheet.
- Bailed out failing banks.
To pay debts with devalued currency, Brazil cranked up the printing presses higher and higher. The table below shows the effect on prices.
Price Levels in Brazil, 1980 to 1997
| Year | Consumer Price Index |
|---|---|
| 1980 | 4 |
| 1981 | 8 |
| 1982 | 16 |
| 1983 | 38 |
| 1984 | 111 |
| 1985 | 362 |
| 1986 | 895 |
| 1987 | 2,940 |
| 1988 | 21,435 |
| 1989 | 328,113 |
| 1990 | 100,000,000 |
| 1991 | 500,000,000 |
| 1992 | 5,600,000,000 |
| 1993 | 113,600,000,000 |
| 1994 | 2,472,400,000,000 |
| 1995 | 4,104,400,000,000 |
| 1996 | 4,751,200,000,000 |
| 1997 | 5,080,300,000,000 |
People became used to living with a high rate of inflation. Some forms of income, such as some wages and interest, were even indexed to the CPI. But the effects of compounding plus loss of confidence in the currency brought hyperinflation, destroying businesses, jobs, and savings. As the table shows, in 1981 prices were “only” double what they had been in 1980—a 100% increase. By 1985 the annual rate of increase was over 200%. 1989 saw a huge jump, to 1,400%, followed in 1990—the worst year—to 30,000%.
At the peak of hyperinflation, price increases were measured in hours. Storeowners and managers could not change price tags to keep pace. Instead, they put colored stickers on products, and changed prices all at once on color-coded charts displayed on walls and at cash registers.
Brazilian hyperinflation was brought under control in the late 1990s through a number of measures that included raising taxes and interest rates, reducing government spending, and introducing a new currency, the real, that was indexed to the USD.
Common elements
The three examples of hyperinflation above had features particular to each country. I’m sure, though, that you were struck, as I was, by the elements they had in common. Hyperinflation in Germany, Argentina, and Brazil was characterized by
- Fiat currency not backed by gold and not pegged to another, stable currency.
- National debt increasing at an accelerating pace, not sustainable without major increases in tax revenue and major cuts in spending.
- Financing of wars through debt (Germany and Argentina).
- Government bailouts of failed financial institutions (Argentina and Brazil).
- Printing ever-increasing amounts of currency, ultimately resulting in total loss of confidence.
- Central bank monetizing government debt (Germany and Argentina).
- Sudden, unexpected change from ordinary levels of priced inflation to hyperinflation. (A Brazilian businessman described it as “waking up on a roller coaster.”)
28 other episodes of hyperinflation (see table below) in the 20th Century show the same common elements.
Countries that experienced hyperinflation in the 20th century
| Country | Period | Ratio of hyper-inflated currency to currency issued to curb hyperinflation |
|---|---|---|
| Angola | 1991-1995 | 1 billion to 1 |
| Argentina | 1975-1991 | 1 billion to 1 |
| Austria | 1914-1923 | N/A |
| Belarus | 1994-2002 | 1,000 to 1 |
| Bolivia | 1984-1986 | 1 million to 1 |
| Bosnia & Herzegovina | 1992-1993 | N/A |
| Brazil | 1986-1994 | 2,750,000 trillion to 1 |
| Bulgaria | 1996-1997 | 3,000 to 1 |
| China | 1948-1949 | 10,000 to 1 |
| Free City of Danzig | 1922-1923 | 10,000,000,000 to 1 |
| Georgia | 1993-1994 | 1,000,000 to 1 |
| Germany | 1922-1923 | 1,000,000,000,000 to 1 |
| Greece | 1942-1944 | 50 trillion to 1 |
| Hungary | 1922-1923 | N/A |
| Hungary | 1945-46 | 4x10^29 to 1 |
| Israel | 1971-1985 | N/A |
| Krajina | 1992-1993 | 50 billion to 1 |
| Mexico | 1982-1993 | 1,000 to 1 |
| Nicaragua | 1987-1990 | 50 billion to 1 |
| Peru | 1988-1990 | 1 billion to1 |
| Philippines | 1942-1944 | N/A |
| Poland | 1921-1924 | 1.8 million to 1 |
| Poland | 1989-19991 | 10,000 to 1 |
| Republika Srpska | 1993 | N/A |
| Romania | 1990s | 10,000 to 1 |
| Russian Federation | 1921-1922 | 1,000 to 1 |
| Taiwan(5) | 1940s | 40,000 to 1 |
| Ukraine | 1993-1995 | 100,000 to 1 |
| Yugoslavia | 1989-1994 | 10^27 to 1 |
| Zaire | 1989-1996 | 3 × 10^11 to 1 |
| Zimbabwe | 2006-2008 | 10^25 to 1 |
China’s Concern about inflation
Have you wondered why the Chinese government is quick to raise interest rates and restrict credit to keep their economy from growing too fast? As the table above shows, hyperinflation struck China in 1948-49. Tens of millions of Chinese peasants, workers, and professionals blamed the Kuomintang government for the financial losses they suffered from hyperinflation and threw their support to the Chinese Communist Party (CCP). On October 1, 1949, in control of most of the countryside and almost every major city on the Chinese mainland, the CCP established the People’s Republic of China.
Even before that, in December 1948, the CCP issued the original renminbi as part of its effort to control inflation in the areas it governed. To this day, the leaders of China are acutely aware of the fury of the masses against their government when hyperinflation strikes. Therefore they try to walk a fine line between controlling inflation and keeping employment high.
The Chinese people are also acutely aware of the dangers of hyperinflation—they’ve heard about the suffering from their parents and grandparents. That’s one reason why they are so motivated to own gold and have been buying it at an accelerated rate since it became legal for them to do so in 2004.
The Path to Hyperinflation in the United States
First Step toward Fiat Currency
In June 1933 the United States House and Senate, acting jointly, passed House Joint Resolution #192. In response to the “existing emergency,” i.e., The Great Depression, the resolution terminated the right of people, corporations, and governments in the US to demand payment of financial obligations in gold. Instead, US dollars, no longer backed by gold, were to be accepted as “legal tender for all debts, public and private.”
Prior to that resolution, in April 1933, President Franklin Roosevelt had issued Presidential Executive Order 6102. This order confiscated gold. It required virtually all gold and silver coins, bullion, and gold certificates (US paper currency redeemable in gold) to be turned in to the Federal Reserve Bank or its branches or agents, in return for an equivalent amount of US currency not redeemable in gold. Failure to turn over gold and silver was punishable by a $10,000 fine and/or 10 years in prison. Rare coins, jewelry, and metals needed for industrial use were exempt from this order.
By taking gold and silver out of circulation, Roosevelt’s order eliminated the competition to fiat currency. People had no choice but to accept paper dollars backed only by government decree. A US dollar could now be created without the necessity of acquiring a dollar’s worth of gold to back it. Devaluing greenbacks was seen as a way to get out of the Depression by stimulating commerce and, especially, by making US exports cheaper and therefore more competitive. However, in a “beggar thy neighbor” policy, every other major capitalist country also abandoned the gold standard.
Ending the gold standard opened the door to price inflation by allowing more money to chase the same amount of goods. Here’s one easily comparable example. In 1933 the price of a first class postage stamp was three cents. In 2011, it takes 44 cents to mail the same 1-oz. letter. That’s an increase of 1,367%. (And the US Postal Service still can’t make a profit.)
Completing the transition to fiat currency
After 1933, people within the US could not convert dollars to gold. US trading partners, however, could and sometimes did.
After World War II, international financial exchange was governed by the Bretton Woods Agreement. The Agreement required each country to adopt a monetary policy that tied the value of its currency to the value of the US dollar (USD), at a fixed rate of exchange. The US in turn tied the dollar to gold, agreeing to stabilize the system by buying gold from its trading partners, or selling USD to them, at $35/oz. of gold.
This agreement worked reasonably well until about 1970. By then, several factors, including the cost of the Vietnam War and rebuilt, modernized industrial capacity in Japan and West Germany, had led to the United States running trade and balance-of-payments deficits. In response, the US printed more money. European nations, seeing that each dollar was backed by less gold, began to lose confidence in the USD. Not wanting to risk inflation by devaluing their own currencies, their demands to convert dollars to gold increased sharply.
On August 15, 1971, President Richard Nixon closed the US Treasury’s “gold window.” The USD was no longer redeemable in gold by anyone, inside or outside the United States. The era of fixed exchange rates and a fixed price for gold was over.
At the same time, in an effort to reduce inflation in the US, Nixon imposed temporary wage and price controls. The 90-day controls were extended three times. By 1973 they had been in effect for almost 1,000 days. These controls helped create temporary shortages of some commodities (remember the gas lines of 1972-3?) but essentially failed to stop inflation in the long run.
The word “stagflation,” first used in Britain in 1965 to describe a period of rising prices but negative-to-low growth, became widely used in the US at this time. It summed up the economic conditions here in the early 1970s and at several times since. Previously, most analysts of the US economy believed inflation occurred only during periods of strong economic growth.
Current monetary inflation
According to Bloomberg News (February 24, 2009)6, “the U.S. government has pledged more than $11.6 trillion on behalf of American taxpayers over the past 19 months.” The article includes a table detailing the bailouts and stimulus spending. (6 http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aZchK__XUF84)
Even before the current Great Recession, the US Federal Reserve was engaged in monetizing national debt: it held $700 to $800 billion of Treasury notes. In late 2008, the Fed started buying $600 billion in mortgage-backed securities (MBS). Within four months, it held $1.75 trillion of bank debt, MBS, and Treasury notes, which grew to $2.1 trillion by June 2010. This “quantitative easing,” a euphemism for monetizing national debt, became known as QE1—because it was followed by QE2.
In November 2010 the Fed announced QE2, a stimulus program in which it would buy $600 billion of Treasury notes, at approximately $75 billion per month, ending in June 2011. Like QE1, QE2 is aimed at keeping interest rates down. Low interest rates enable businesses to more easily borrow money to finance expansion. They also keep mortgage rates low. The fear is that the housing market, which shows no signs of recovery, will be plunged even lower if mortgage rates rise.
Confidence in the USD is so low that interest rates on 10-year Treasuries are climbing despite the Fed’s purchases. The yield has risen from 2.5 percent on Nov. 4, 2010, when QE2 was announced, to 3.46 percent on April 10, 2011. That’s a 38% increase in five months: a huge change in the normally slow-moving bond market. According to US News (March 15, 2011),7 “Bond guru Bill Gross, who manages the world’s largest mutual fund, PIMCO Total Return, is forecasting a spike in treasury yields. Gross has sold off all of the T-bills in his flagship fund because of his concerns about the end of QE2. In his investment outlook for March, Gross writes, ‘Bond yields and stock prices are resting on an artificial foundation of QE II credit.’ He adds: ‘Who will buy Treasuries when the Fed doesn’t?’”,
(7 http://money.usnews.com/money/personal-finance/mutual-funds/articles/2011/03/15/what-happens-after-qe2-ends)
(7 http://money.usnews.com/money/personal-finance/mutual-funds/articles/2011/03/15/what-happens-after-qe2-ends)
An article in the Wall Street Journal (April 15, 2011) supports Gross’s view: “…the Fed has purchased the equivalent of more than two-thirds of Treasury issuance since last fall. The worry is that when the central bank stops buying, no one else will step up, forcing rates higher.”
Finally, on April 18, 2011, the unthinkable happened. Standard & Poor’s, while maintaining its triple-A sovereign credit rating on US government debt, changed its “outlook” on the rating from “stable” to “negative.” “Negative” means S&P believes there is at least a 1-in-3 chance it could lower the AAA rating in the next two years, which would send interest rates on Treasuries up. In Ben Bernanke’s April 28th 2011 press conference it become clear that in spite of Standard & Poor’s warning the Federal Reserve’s interest rate policies will not be changed until late 2012. This should lead to a continued weaker dollar and higher precious metal prices.
All central banks, including the Fed, operate on the assumption that their chief weapon for fighting inflation is increasing interest rates. They also believe that even tiny increases in interest rates will curb inflation by slowing economic growth and giving investors an alternative to buying gold and silver. However, the yield on the 10-year Treasury note had to increase to 15.32% in September 1981—4.5 times the current yield—to hold down the price of gold and send the economy into a recession. (The federal funds rate—the rate at which banks lend each other money overnight—went to 19.1% in June 1981 compared to zero to 0.25% currently.) Under today’s conditions, it is hard to see the federal government allowing interest to go that high short of a USD already made virtually worthless by hyperinflation.
Federal budget deficit
As mentioned earlier, the US national debt as of May 2011 is $14.3-trillion dollars(8) US gross domestic product for 2010 was $14.7-trillion dollars. The federal government owes almost an entire year’s worth—97%—of all the goods and services produced in the US. The national debt has only once exceeded that ratio to GDP. In the midst of World War II, when the nation had one-third of today’s population and 14.5-million soldiers at war, the national debt reached 120% of GDP. (8 See “U.S. National Debt Clock,” at www.brillig.com/debt_clock.)
Emerging victorious from WW2 as the only major country with its industrial capacity intact, the US was in a position to rapidly reduce its national debt. By 1960 national debt to GDP was about 52%; by 1981 it had reached its modern low of about 33% of GDP.
The picture today is different. US corporations must fight for market share at home and abroad against many strong competitors, including Japan, China, South Korea, Brazil, India, and Germany, France and other EU countries. Among its competitors, the US is the only nation supporting a global network of military bases and significant, prolonged armed interventions.
As a result, the national debt is going up, not down. The estimated budget deficit for fiscal year 2011 (October 2010-September 2011) is $1.65 trillion. For 2012, it’s $1.1 trillion. These estimates are almost always on the optimistic side. Interest payments have been an ever-increasing component of the national debt. If interest rates on Treasury notes continue to rise, as Bill Gross and many others expect, the national debt will be driven dramatically higher. Interest payments already constitute 5-6% of the federal budget—at today’s rock-bottom rates. Interest rates are being raised to curb inflation in Europe, China, Australia, Brazil and many other countries. Those rate increases will attract capital away from Treasury notes. At some point, to finance its debt, the US will have to raise rates.
At House Budget Committee hearings in February 2011, Rep. Mick Mulvaney [R-SC] confronted White House Budget Director Jacob Lew on the assumptions in the President’s 2011 and 2012 budgets. Mulvaney said that the budgets were based on the federal government’s revenue coming in at 19-to-20% of GDP, which has happened only once or twice in the past 40 years, and that they assumed a rate of growth of the economy that “dramatically exceeds what the CBO [Congressional Budget Office] is assuming.” Mulvaney also pointed out that the budget assumed an interest rate of the 10-year Treasury note at 3%, when it was currently at 3.65%. According to Mulvaney, the CBO concluded that for every percentage point interest rates exceeded the budget’s assumptions, the national debt would increase by an additional $1.3 trillion over 10 years.
State and municipal budget deficits
The problems caused by the surge of the national debt are compounded by the sharp increase in the budget deficits of states. The Center on Budget and Policy Priorities reports that 44 of the 50 states face budget shortfalls—despite years of accounting gimmicks, such as moving federal Medicaid funds from the next to the current fiscal year. The Center says that the total state shortfall projected for FY 2012 is $140 billion. Total state deficit would be approximately double what it is if not for the federal American Recovery and Reinvestment Act (ARRA). Early in 2009, ARRA authorized $140B for states, in increased Medicaid, education and public safety funding over 2.5 years. In August 2010 the jobs bill extended some funding through June 2011.
In addition to state deficits, throughout the United States, endless numbers of counties, cities, school districts, and other public agencies face budgetary shortfalls. These problems compound each other. The states try to hold onto tax money coming in from counties; the counties struggle to get more of it back. States and municipalities try to extract more money from the federal government. States compete with each other for federal grants. States, counties, cities and school districts lay off workers, reducing federal and state tax revenues while raising the cost of unemployment benefits and other public services. States and municipalities raise fees, which has an inflationary impact, while cutting wages and hours and jobs—a recipe for stagflation. Stagflation is persistent high inflation combined with high unemployment and stagnant demand in a country’s economy. All of this causes political turmoil, which we’ll address later.
Trade deficits
Every year since 1976 the United States has paid more for imported goods than it has received for exported goods. These negative balances of trade are known as trade deficits. Prior to 1976 the US almost always had the opposite, an annual trade surplus.
The US annual trade deficit tends to decrease during recessions, when people and businesses have less money to spend, and increase during periods of economic growth. However, as the chart below shows, the overall trend is for the annual trade deficit to increase, particularly since the 1990s.The US annual trade deficit tends to decrease during recessions, when people and businesses have less money to spend, and increase during periods of economic growth. However, as the chart below shows, the overall trend is for the annual trade deficit to increase, particularly since the 1990s.
The effect of large trade deficits on prices is complicated. Importing oil contributes significantly to the trade deficit, particularly when the price of oil is high. High oil prices contribute to higher prices for gasoline and diesel fuel and almost everything else. Oil is used to make plastic and petrochemicals, to power tractors for agriculture and heavy equipment for construction, and to transport everything to market. However, another significant part of the trade deficit comes from flooding US markets with goods from China and other low-wage countries. That keeps prices for US consumers down, producing an anti-inflationary effect.
But there’s another, inflationary side to that coin. What do China, Japan, South Korea, Saudi Arabia and other net exporters to the US do with the dollars they accumulate? Until recently, they have been investing most of it in US Treasury notes, in mortgage-backed securities, and in other forms of US debt. They have been “enablers” of the federal government running a budget deficit, much as family members who loan money to a drug addict are enablers of their relative’s habit.
Now that the Federal Reserve has taken to printing (or rather electronically creating) previously unheard of amounts of money, China and the other creditors have cut way back on their purchases of US debt. They, along with the EU, Australia, Brazil and even Canada are raising interest rates to hold down inflation and are urging the US to do the same. But with unemployment remaining high in the US, economic growth sluggish, and the housing market slumping further, higher interest rates here would contribute to stagflation. Decades of trade deficits have put the US in a bind.
Increase in the money supply
As we noted in discussing Germany, Argentina, and Brazil, a sharp increase in the supply of money is characteristic of hyperinflation. It’s happening here. There are a number of measurements of money supply, all known as “M”s. M1 includes notes and coins in circulation (but not in bank vaults), traveler’s checks of non-bank issuers, demand deposits (such as checking accounts) and other accounts on which checks can be written (NOW accounts). M2 includes M1 plus savings deposits, time deposits under $100,000 and money-market accounts of individuals. This chart shows the trend in each.
Commodity inflation
To justify keeping short-term interest rates at close to zero, the Fed has been reassuring us that inflation is not a problem. They support this claim by citing the Consumer Price Index (CPI). According to the Bureau of Labor Statistics (BLS), the CPI (average annual expenditure for all items in the index) rose only 1.6% from 2009 to 2010(9). The BLS uses a lot of complicated social assumptions and mathematical calculations to arrive at the CPI. These assumptions and calculations have changed over time. According to Shadow Government Statistics, if the CPI were calculated today as it was in 1990, inflation would be running at about 5.5% rather than 2%. If the CPI were calculated as it was in 1980, inflation would be running at just under 10%.(10) (9 http://www.bls.gov/cpi/cpid10av.pdf; 10 http://www.shadowstats.com)
When our friends and family members talk about what they actually spend money on—food, gasoline, medical care/medical insurance, utilities, housing, college tuition—their experience seems more in accord with the Shadow CPI than with the official CPI. Some prices, such as for certain clothing and electronics, have come down or held steady as a result of retailers desperate to bring people into their stores. And new and existing homes sell for well below the prices they went for during the housing bubble. Of course, if you have cut back on clothes and electronics purchases, and you are not in the market for a house (as few people are these days), those numbers have little influence on your personal “CPI.”
What is undeniable is the run up in almost all commodity prices. In fact, the Wall Street Journal (April 12, 2011) reports, “China on Sunday registered its first quarterly trade deficit in seven years, reflecting the rising prices of imported commodities.” Manufacturers, builders, and investors are paying far more for almost everything that comes out of mines, wells, and farms than they did a short time ago. Just look at this table (units explained in footnote). (11) (11 All prices wholesale, in USD, rounded off to nearest dollar except when cents are statistically significant. Units: gold and silver per oz; base metals and coal (Australian thermal) per metric ton; oil per barrel, simple average of Dated Brent, West Texas Intermediate, and the Dubai Fateh; wheat per metric ton; sugar, US import price, per pound; soy beans per metric ton; coffee, robusta, per pound; pork, beef, salmon, cotton per pound. Commodity price index includes all commodities, 2005 = 100.)
| Commodity | March 2001 | March 2011 | Change |
|---|---|---|---|
| Gold | 263 | 1,424 | +441% |
| Silver | 4.40 | 35.94 | +716% |
| Copper | 1,742 | 9,503 | +445% |
| Iron ore | 0.12 | 1.69 | +1,308% |
| Aluminum | 1,512 | 2,555 | +69% |
| Tin | 5,049 | 30,590 | +505% |
| Oil | 25 | 109 | +506% |
| Coal | 33 | 137 | +413% |
| Wheat | 130 | 316 | +143% |
| Sugar | 0.22 | 0.36 | +64% |
| Soy Beans | 164 | 499 | +204% |
| Coffee | 0.31 | 1.22 | +294% |
| Pork | 0.63 | 0.81 | +28% |
| Beef | 0.91 | 1.88 | +106% |
| Salmon | 3.10 | 7.27 | +134% |
| Cotton | 0.55 | 2.30 | +318% |
| Commodities Index | 60 | 199 | +230% |
We are often told that these changes in wholesale prices have not been or will not be passed on to consumers. It is inconceivable that increases of this magnitude would not be reflected in retail prices, unless manufacturers are content to accept enormous losses over long periods. Therefore, we have all the more reason to look with skepticism at the official CPI.
What difference does it make? Hyperinflation does not spring from nowhere. It is always the child of unchecked ordinary inflation. Those in a position to influence the economy—the Administration, the Congress, the Fed—either oppose inflation or abet it. When they pretend that price inflation is not happening, it’s clear which path they have chosen.
Economic analyst Peter Ferrara wrote in the American Spectator online (March 23, quoted in the March 24 Wall Street Journal), “The Producer Price Index rose 1.6% in February, an annual pace of nearly 20%. Over the last 5 months, the index has increased by nearly 5%, an annual pace of over 10%. The index for food increased by nearly 4% in February alone, the largest one month rise since November, 1974…. This trend is now beginning to show up in the Consumer Price Index as well…[and] the CPI is arguably understating inflation today because 40% of it is now represented by housing, which is still in a recession.” Most G-20 governments, however, express great concern about inflation and are taking measures to stop it before it runs away. The Wall Street Journal (April 15, 2011) reported, “China's premier, Wen Jiabao, warned last month that inflation is like a tiger—once unleashed, it is ‘very hard to cage again.’”
Loss of confidence in the USD
The US Dollar Index measures the value of the dollar relative to a basket of six other currencies: the euro, Japanese yen, British Pound, Canadian dollar, Swedish krona, and Swiss franc. The formula was set at the start of the Index, in March 1973, to give the US dollar a value of 100.
On this Index, the US Dollar has reached as high as the 160s. It dropped below 100 in 2003 but always managed to stay above 80. Currency traders, economists, and others considered 80 to be a “floor” supporting the dollar. In late August 2007 the dollar fell below 80 for the first time, hitting a record low of 72.89 in March 2008. (At 80 the dollar had dropped to less than half of its highest value.)
DOLLAR INDEX SPOT CHART
May 2010-April 2011
Since 2008, the US Dollar Index has bounced back as high as 88 but has been falling rapidly since June 2010 and dipped below 74 in April 2011. The Index underestimates the fall in the dollar’s value, because the comparison is to other fiat currencies that have also been falling in terms of purchasing power. The basket of six currencies in the Index is weighted, with the euro alone accounting for 57.6% of the total. Confidence in the euro has also fallen with the debt crises requiring bailouts in Greece, Ireland, and Portugal, high levels of debt in some of the other EU members, and pressures that some believe might result in the breakup of the EU.Relative to gold, the dollar has fallen 93% since 1973, the year the US Dollar Index was initiated. $15 will buy the same quantity of gold as $1 bought in 1973. In euros, just in the five years from April 2006 to April 2011, gold has gone from €440 to €1,047.
Wage freezes
Governments commonly use wage freezes and price controls in efforts to reign in inflation. As we discussed earlier, President Nixon used both. We have yet to see price controls in this period, except in the maximum payments allowed for particular services by Medicaid and Medicare. In November 2010 President Obama announced a 2-year wage freeze on 2.1 million federal civilian employees, as part of cutting the federal budget deficit. In April 2011 New York’s Governor Cuomo and a union representing 1,160 law enforcement officers agreed to a 3-year wage freeze, including eliminating “step increases” for longevity on the job. Cuomo called the agreement a “model” for other public worker unions negotiating contracts with the state.
Also in New York, in March 2011, a state board that has taken over management of Nassau County’s finances imposed a wage freeze on 8,100 county employees. In Connecticut, Governor Daniel Malloy has proposed 2-year wage freezes for 45,000 state workers. The Minnesota Senate passed a bill that would freeze state workers’ salaries for two years. The Nebraska State Senate is discussing a bill that would freeze public worker wages if they could be shown to be “above average.” Countless municipalities, school districts, community college districts & public universities also imposed or negotiated pay freezes.
Social turmoil
I’ve mentioned that inflation always precedes hyperinflation. I should add that hyperinflation never arrives quietly. Inflation, stagflation, fiscal crisis, housing crisis—these economic concepts profoundly affect people’s lives. And people react. In February and March 2011 tens of thousands of workers and students demonstrated in Madison, WI and even briefly occupied the State House to protest the termination of collective bargaining rights. (The demonstrations have been followed by campaigns to recall eight Republican and eight Democratic state senators.) Similar protests have taken place in Montana, Illinois, and Indiana. In California, New York, and other states, thousands of college students, faculty, and employees have demonstrated against cuts to education budgets.
The demonstrations in the US are part of a worldwide phenomenon. In many European countries, millions have marched and gone on strike against government austerity measures. In Greece, the most militant and radical elements have stoned police, smashed cars, and thrown petrol bombs at police and government buildings, including the finance ministry. In North Africa and the Middle East, demonstrations against food inflation and unemployment played a key role in driving the mass movements against dictatorial regimes. And with the May 1st 2011 killing of Osama Bin Laden these problems could worsen with renewed terrorism in the Middle East.
Events in Libya have already, at least temporarily, taken much of Libya’s oil production off the market. Next door to Saudi Arabia, home of the world’s largest oil reserves, is Bahrain, home of the US Navy’s Fifth Fleet. Bahrain is in turmoil. A Sunni king is trying to maintain control over an up-in-arms majority Shiite population. Saudi armed forces have crossed the causeway into Bahrain to help keep the king in power. Oil prices have already risen sharply in response to these and other events in North Africa and the Middle East. The situation is unpredictable; one or two more shocks could put oil back to its record $140 a barrel or beyond, with devastating effect on the weak economic recoveries taking place in the US and Europe.
Social unrest, demonstrations, and rioting tend to make governments leery of taking economic measures, such as raising interest rates and tightening up on credit, that might create more unemployment and generate more protests. Often, it drives them toward papering over the problems with money, bringing on hyperinflation and even more social unrest.
Stocking up for upcoming hyperinflation
Perhaps your family has already made a plan for a natural disaster such as a hurricane, flood, or earthquake. If so, the plan no doubt involves stocking up on essentials such as drinking water, nonperishable foods, medicines and first aid supplies, toiletries, batteries, pet supplies and perhaps fuel and a generator.
Now think about an economic disaster lasting years rather than days, with constantly escalating prices compounded by shortages. You would want to have stocked up on as much as you can at today’s lower prices. And, depending on your finances and storage capacity, you might want to expand the list to include cleaning supplies, bedding, motor oil, tires, and perhaps even appliances. Money will lose its value but products won’t. Anything you don’t use you could barter. To figure out your family’s particular needs, review what you have spent money on over the past several years.
Many survivalists envision a period of hyperinflation, civil unrest, and panic in which US paper dollars become as worthless as 1923 German Marks and life’s necessities will be exchanged only for real money. Stocking up on one ounce .999 Silver Eagles or Trade Units and pre-1965 US Silver dimes, quarters and half dollars, which are .900 fine, will serve the purpose. I have heard of a neighborhood grocery store in rural Oregon that prices their goods in incremental amounts of silver. For example, a potato may cost .02 parts of an ounce—the equivalent of a dollar with silver at $50 an ounce. Such pricing may become more common as hyperinflation draws nearer.
Investing for hyperinflation
Based just on ordinary inflation and the beginnings of concern about hyperinflation (and of course the huge growth in demand in China, India, and other fast-growing economies) we’ve seen significant, sustained increases in the prices of gold and silver. As I pointed out in the beginning of this article, gold is still in Phase I of its bull run. Despite a remarkable 10 years of increases averaging 20% per year—outperforming just about any other asset category by far—you would be hard pressed to find a story about gold on the cover of a magazine (even a business or finance magazine) or on the front page of a newspaper (even of the business section). This is in marked contrast to Phases II and III of the run-up to January 1980, when the gold mania resembled the Internet mania of the 1990s.
Investing in gold and silver therefore remains an excellent way to protect your assets and even profit from inflation today and hyperinflation tomorrow. Of course, when Phase III of the bull run arrives and everybody is buying, you would want to be selling or trading for gold and silver products that have less volatility and can protect you from what comes next.
There are many ways to invest in gold, from physical gold, gold ETFs, and gold mining shares to derivatives such as futures and options. Since 2004, I have advised my friends and clients to own physical gold. Owning ETSs and mining shares involves unacceptable risks.
Hyperinflation is generally accompanied by social, political, and economic turmoil. Often stock markets and banks are shut down by the government for periods of time, or withdrawals from bank accounts are limited by government decree. I advise my clients to store their gold in a home safe or safe deposit box providing direct, immediate access. I advise them not to allow third parties to hold, store, or delay delivery of their precious metals.
For people residing in the US, a popular way to own gold or silver is through purchasing US Gold or Silver bullion and certified investment coins. The American Gold and Silver Eagles are produced every year by the US Mint, which certifies their gold content. Unlike federal budget or CPI assumptions, the gold and silver contents are not fudged and are accepted as sound everywhere in the world.
Prepare for gold confiscation
At the outset of this article I suggested that discussing the likelihood of hyperinflation coming soon to the United States might surprise you. Now that you’ve read this far, I hope you are seriously considering the evidence for hyperinflation and that you will be motivated to prepare for it. For most people, it’s hard to accept an idea that is out of the mainstream, and harder still to act on it—to “pull the trigger.” That’s why most people get swept along and harmed by “black swan” events and relatively few profit from them.
Now I’m going to raise another idea that might seem off the wall at first—the possibility of a gold confiscation. Of course, given that it’s happened before, it would be foolish to exclude the possibility of it happening again without thinking about why it might happen again.
(By the way, gold has been confiscated twice in the United States, the first time under President Lincoln to help finance the Civil War.)
Let’s think about why the federal government might confiscate gold (motive) and then about how the government could do so (means).
Motives for gold confiscation
For motive we have only to look at the 1933 gold confiscation. The government wanted to print money not backed by gold and wanted it to be universally accepted as payment for all debts, “public and private.” But people were accustomed to currency that was convertible into gold. By and large they didn’t convert it, but they knew they could.
If gold coins and paper currency backed by gold were still in circulation, competing with the new fiat currency, which would people want? Sure, stores might accept the fiat currency because the law required them to, but a parallel market would likely have developed, with gold coins and gold-backed bills more desirable and therefore having more purchasing power than their face value. We’ve seen similar scenarios many times in countries suffering from high inflation. A parallel market denominated in a foreign “hard currency” (a fiat currency in which people still have confidence) develops. In the past, the hard currency was typically the USD.
In addition, in 1933 the government still needed gold to back dollars used in international trade. But the Federal Reserve was printing billions of fiat dollars. By confiscating gold coins and “paying” for them in fiat dollars, the federal government was able to increase its gold holdings at zero cost other than the expense of administering the program. The value of gold held by the Federal Reserve increased from $4 billion to $12 billion between 1933 and 1937.12 Some of that difference is presumably the result of the change in price from $20.67 to $35 per ounce. Adjusting for that, it appears that the confiscation brought in about 228,571,428 ounces of gold. The gold confiscation was essentially a bailout of the Federal Reserve. Like the recent bailouts of big financial institutions, it was publicly financed. The recent bailouts were financed through taxes; the confiscation through snatching gold from people’s pockets and purses and replacing it with paper. (12 http://en.wikipedia.org/wiki/United_States_Bullion_Depository)
Today, US residents are buying more gold than ever before. Together with gold buyers in China, India, the Middle East, and elsewhere, their demand is pushing the price of gold up relative to all currencies. US buyers are stocking up on the US Gold Eagles & Buffaloes, Canadian Gold Maple Leafs and popular European small denomination gold coins. Many financial advisors—even some brokers at Goldman Sachs, Morgan Stanley, and other major financial institutions—are advising their clients to put a small portion of their portfolios into gold. That’s an about- face from the advice most were giving only a few years ago. As US inflation intensifies and confidence in the USD declines further, the trend toward investing in gold will accelerate.
One of the federal government’s motives for confiscating gold could, therefore, be the same as it was in 1933: to avoid competition for its fiat currency.
Another motive might be to increase revenues without seeming to raise taxes. How so? US residents forced to turn in their gold in1933 were compensated at $20.67 per oz. The United States Gold Reserve Act of January 30, 1934 ordered the Federal Reserve to turn the gold over to the US Treasury and changed the price of gold to $35 oz. (the price set for international gold-USD transactions until 1971). In the eight months from May 1, 1933 to January 30, 1934 the federal government made a profit of $14.33 on every ounce of confiscated gold. That’s a 69.3% profit. Annualized, it’s 92.4%. At $14.33 profit per ounce on 228,571,428 ounces of gold that comes to $3.28 billion. The entire federal budget for Fiscal Year 1933 was $4.6 billion.
In a modern confiscation, the same profit motive would apply, although it would work a little differently. The government would presumably pay the market price for gold, or a fixed price close to the market price. But the confiscation would occur at a time of an acutely weakening dollar and a sharply rising gold price, when holders of gold could likely have gotten a significantly higher price in days, weeks, or months. Given that the government might have two motives for confiscating gold—eliminating competition to fiat dollars and increasing revenue—would it have the means?
Means of gold confiscation
The 1933 confiscation was done by an executive order issued by President Roosevelt. The executive order was based on powers granted to the executive branch by the 1917 Trading with the Enemy Act. In 1971 President Nixon “closed the gold window” to international holders of dollars, also via an executive order. His act was known as the “Nixon Shock” because it was issued on a Monday morning before the US stock market opened and without consultation with US trading partners, the US congress, or anyone outside a small group of advisors in the executive branch.
Does the President still have the legal power to confiscate gold? Could he or she do it by executive order, without consultation with congress, and by surprise? In 2005, Chris Powell of the Gold Anti-Trust Action Committee (GATA) wrote to the US Treasury Department essentially asking those questions. He received a reply from Sean M. Thornton, Chief Counsel (Foreign Assets Control) of the Treasury Department, dated August 12, 2005.13 Thornton referenced the Trading with the Enemy Act of 1917 (TWEA) as giving the President the power to confiscate gold or, basically, any other asset, to “prevent certain transactions that might be of advantage to an enemy during wartime.” (13 http://www.gata.org/node/5606)
Powell had also asked if the President has the power to confiscate shares in gold and silver mining companies if some of the shares were held by foreign nationals or foreign governments. Thornton replied, “Under TWEA during times of war—and also under the International Emergency Economic Powers Act…during peacetime national emergencies—the president has broad powers to regulate property in which there exists a foreign interest.”
Talking about means of confiscation, we should note that ownership of gold through ETFs makes it easy. Rather than deal with millions of individual investors, the government can seize the gold from the ETFs’ storehouses, wire transfer money to each ETF, and let the ETFs pay off investors through their brokerage accounts.
Rare US gold and silver coins were exempt from the 1933 confiscation. This made sense because neither of the motives for confiscating the precious metals applied. Rare coins are by definition scarce, so there would never be enough of them to compete with fiat dollars as currency. Furthermore, while each modern 1-oz. US Gold Eagle bullion coin is “worth its weight in gold,” each grade of each type pre-1934 US gold and silver coin has a value in excess of it precious metal content due to its scarcity established over 77 years or more.
For the same reasons of scarcity and lack of uniform value, it would make no sense for the government to try to profit from confiscating rare coins. There aren’t enough of them and running the program to find them, buy them, and sell them would cost more than it would generate in revenue.
Therefore, part of a program to prepare for hyperinflation should involve investing in non-bullion gold and silver coins.14 I recommend buying only coins authenticated, graded, and encapsulated by NGC or PCGS, the most reputable third-party grading services. The US gold and silver investment quality coins I recommend are listed in the most recent CoinStats report. CoinStats is an in-depth statistical analysis of popular pre-1934 gold and silver coin series that enables investors to identify the best values in certified rare coins. We are proud to offer this unique and outstanding investment tool exclusively to our clients. I also recommend many popular pre-1934 world gold and silver coins, which I consider low-premium, bullion-plus investment items. Many long-term gold and silver coin investors and collectors prefer owning US gold and silver type coins and rarities graded Mint State (MS) 63 or higher. These coins have shown excellent capital growth over the long term. There is a liquid market for investment grade coins, including electronic markets in which authenticated, graded, and encapsulated coins are traded sight unseen. (14 “Bullion coins” refers to gold, silver, platinum, and palladium coins minted in recent decades for collectors and investors. Issued in large quantities, these coins reflect the market price of the precious metals they contain. By “non-bullion coins,” I mean relatively scarce gold and silver coins, mainly pre-1934 issues, which, because of their numismatic value, are worth more than the precious metals they contain.)
A gold and silver confiscation would almost certainly be kept secret until it was announced, so it makes sense to begin investing in non-bullion gold and silver coins now. Another reason for doing so is that the prices of US investment-quality certified gold and silver coins have lagged the recent rise in value of gold and silver bullion, due to the soft U.S. economy. However, history has shown me that unusual situations of this type don’t last long.
As there is no right price for the wrong coin, financial advisors and investors should work with an experienced numismatic professional. Select a member of the Professional Numismatists Guild (PNG). PNG members have a minimum of five years’ experience in the field, submit to a background check, and are required to abide by a code of ethics and to submit disputes to mediation and arbitration.
Prepare for a return to the gold standard
From 1792 until 1933 (or 1971 for foreign holders of USD), with the exception of 1862-1868 (during and immediately after the Civil War), the US Dollar was backed by gold or silver. Based on that history alone, it would be a mistake to assume without considering the evidence that the dollar will never return to the gold standard.
States take the lead in bringing back the gold standard
As typically happens when there are sharp and accelerating increases in money supply, people begin to question the value of their currency. State governors and state assemblies and senates are responding.
In March 2011 Utah passed a law moving toward accepting US gold and silver eagles as legal tender—at their market value. (They are already legal tender everywhere in the US at their much lower face value.)
According to the Wall Street Journal (April 1, 2011), “The Utah law, set to take effect May 7, 2011, requires the state’s revenue and tax committee to study the possibility of establishing an alternative form of legal tender, which Mr. Galvez [Utah State Representative Brad Galvez, who introduced the bill] hopes will be the market value of gold and silver coins. ‘This would provide an alternative in the event the dollar tanks,’ said Mr. Galvez, who wants to see coin depositories where customers would deposit their gold and silver and be given a debit card containing dollars equivalent to their value.’”
Larry Hilton, a Utah Legislative attorney who wrote the Utah Sound Money Act, has been a guest on my weekly KABC radio show. Larry and I have discussed putting together a blue ribbon panel of gold/silver, banking, and depository experts to advise Utah’s governor and legislators on how best to implement the legislation.
As the table below shows, nine other states have proposed legislation similar to Utah’s.
| State | Status |
|---|---|
| MN | proposed legislation - HB 639 |
| MI | proposed legislation - HB 561- Electronic Gold Currency |
| IN | proposed legislation-Honest Money Act SB453 |
| NH | legislative service request reintroducing HCR 13 |
| TN | proposed legislation-HB 4501 |
| GA | proposed legislation-Constitutional Tender Act HB3 |
| VA | subcommittee study in progress - plans to submit bill |
| ID | proposed legislation - HB 633 - Idaho silver gem act |
| SC | proposed legislation - HB 4501 |
Gold standard raised in Washington and beyond
Ron Paul (R-TX) has introduced a bill in the US House of Representatives entitled the Free Competition in Currency Act of 2011 (H.R. 1098). One provision of this bill ends the prohibition on private mints. The concept is the reverse of Gresham’s Law that “bad money drives out good.” Rep. Paul believes that if given the choice, many people would prefer gold and silver coins (or paper backed by precious metals) that hold their value in inflation. Paul envisions this Act as a step toward restoring a USD backed by gold.
A return to the gold standard could result from federal legislation or a mandate from a majority of the 50 states. It would freeze the value of gold at a set price (estimated anywhere from $2,500 to $10,000 an ounce) at which the United States Government would buy or sell gold. The US would no longer be able to print money without a direct relationship to gold.
Is a return to the gold standard a fringe idea? Robert Zoellick is president of the World Bank. Before that he was a managing director of Goldman Sachs and a United States Deputy Secretary of State. According to Market Watch (Nov. 7, 2010), “World Bank chief Robert Zoellick said in an article in the Financial Times that leading economies should consider ‘employing gold as an international reference point of market expectations about inflation, deflation and future currency values.’ Zoellick made the proposal as part of reforms to be considered at this week’s G-20 meeting in Seoul. ‘Although textbooks may view gold as the old money, markets are using gold as an alternative monetary asset today,’ said Zoellick. He said such a reform would reflect economic realities and should be considered as a successor to the existing global currency paradigm known as ‘Bretton Woods II.’…Zoellick said a return to some sort of currency link to gold would be ‘practical and feasible, not radical.’”
Robert Zoellick is not a fringe player, and Alan Greenspan is not a fringe economist. Interviewed on Fox News (January 21, 2011), Greenspan said, “We have at this particular stage a fiat money which is essentially money printed by a government and it’s usually a central bank which is authorized to do so. Some mechanism has got to be in place that restricts the amount of money which is produced, either a gold standard or a currency board, because unless you do that all of history suggest that inflation will take hold with very deleterious effects on economic activity…. There are numbers of us, myself included, who strongly believe that we did very well in the 1870 to 1914 period with an international gold standard.”
What’s behind this seemingly amazing reversal by Greenspan? The USD is under siege. It’s been able to function as the world’s reserve currency since the 1946 Bretton Woods Agreement, even after Nixon took the USD completely off the gold standard in 1971. The single most important manifestation of the USD’s reserve-currency status is petrodollars—the pricing of oil in dollars. Until recently, every buyer of oil in the world had to accumulate dollars which with to purchase oil. Oil is sold at the rate of about 88-million barrels per day. At $100 a barrel—less than recent prices—that’s $8.8 billion a day. More and more, oil producers are making deals to sell oil for currencies other than the USD, such as the euro or the Japanese yen, thus lessening the demand for dollars. Iran, for example, OPEC’s second largest oil producer, created a bourse that accepts payment for oil and petroleum products only in Euros or Iranian Rials.
Additionally, more and more countries are agreeing to direct exchanges of their currencies, eliminating the need to use the USD as an intermediary vehicle. For example, Russia and China recently initiated direct exchange between the renminbi (AKA yuan) and the ruble. According to Reuters (March 2, 2011), “China hopes to allow all exporters and importers to settle their cross-border trades in the yuan by this year, the central bank said on Wednesday, as part of plans to grow the currency's international role. In a statement on its website www.pbc.gov.cn, the central bank said it would respond to overseas demand for the yuan to be used as a reserve currency.”
To make the yuan acceptable as a reserve currency, the China’s Central Bank is believed to be accumulating gold through imports and domestic purchases. (China has recently replaced South Africa as the world’s largest producer of gold.)
If a return to the gold standard were to occur, it would have two effects on the price of gold in USD:
- A significant additional increase in the price of gold. There are a lot of dollars to be backed. Assuming that the gold believed to be stored in Fort Knox is there, and hasn’t been leased out, it’s estimated that gold would have to be priced at over $6,000 per oz. to fully back each greenback.
- An end to the appreciation in the price of gold, by returning to a fixed dollar-gold exchange rate.
Even the prospect of congressional action on a return to the gold standard would send investors searching for a liquid hard asset that could continue to appreciate. Once again, investment-grade pre-1934 rare US and World gold and silver coins provide an answer.
Conclusion: Action and timing
I have shared with you why I believe our country will suffer hyperinflation very soon. If your assets are stored primarily in US Dollars, you need to act now to protect your family, wealth, and future. I recommend that you invest a minimum of 50% of your financial capital in precious metals. (Most of the financial planners I work with are recommending 20-25%).
We are in the pre-hyperinflation period and gold is still in Phase I. So, at this point in time I recommend the following breakdown of precious metal ownership. Using a $50,000 investment portfolio as an example:
20% ($10,000) .999 1-oz. Silver Eagles, Trade Units or .900 US Silver Dimes, Quarters, Halves & Dollars
Many survivalists envision a period of hyperinflation leading to civil unrest and panic, making it difficult to buy the necessities of life with US paper dollars. Should a period like that occur it would be critical to have survival money. Stocking up on one ounce .999 Silver Eagles or Trade Units and pre-1965 US Silver Dimes, Quarters, Half Dollars, and Silver Dollars will serve the purpose by giving you denominations that would correspond to most everyday purchases.40% ($20,000) Pre-1934 European small-size Gold Bullion-plus coins (Uncir. French, Swiss & British)
Brilliant Uncirculated, small denomination European gold coins have many ownership advantages. They are dated prior to 1934, minted by sovereign governments, with excellent worldwide collector and investor demand. The coins have a low premium over the spot gold prices, similar to small denomination US gold bullion coins. With a gold content of less than ¼ ounce they are affordable and easily traded with great liquidity. Many collectors and investors like the easy storage, security and privacy these uncirculated European gold coins offer.40% ($20,000) MS63 or higher investment-quality pre-1934 US Gold Coins (CoinStats recommended)
Whether US hyperinflation leads to a gold standard or gold confiscation, investment-quality US pre-1934 gold coins in certified PCGS or NGC holder will be the big winners. Pre-1934 U.S. gold coins have an excellent long term track record of appreciate and offer outstanding liquidity.A gold standard would lead to a freeze on the value of gold bullion coins, as our government would set an official price at which it would buy or sell gold. Only Pre-1934 rare coins with numismatic value could continue to appreciate in price. Gold confiscation would make ownership of bullion coins illegal; investment-quality coins would continue to be legal and freely traded—the only game in town.
As we approach Phase II of the current gold bull market and we see more signs of hyperinflation, I will have a better understanding of whether we are heading for gold confiscation or a gold standard, and I’ll update you about the changes. Follow my blog or email me to receive updates.
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