08/08/2011

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 its 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 1930s Silver coins circulated as money until the 1970s

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.

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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 worlds largest manufacturing base The worlds largest gold reserves The worlds 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 worlds 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

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Problems with the US Dollar

The United States economy grew briskly through the late 1940s, 50s, and 60s. 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 1960s 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 1970s, 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

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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 dollars 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 coursethey did

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Inflation, Inflation, and More Inflation

Key Point
US Monetary base 1917 - 2009
2008 Financial Crisis Bank bailouts, TARP, QE, QE lite, QEII, etc doubled the money supply in just 18 months

The United States was $8 trillion in debt in 2008, which took over 225 years to amass. In Aug 2011, the debt ceiling was raised to $16.7 trillion, which should last until 2012. The US government will borrow and spend, in just 4 years, the 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.

Nixon cancels the gold standard

Money supply On the gold standard

The Financial Systems 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, etcif 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.

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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 70s

There was double-digit annual inflation in North America throughout the 1970s.
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 didnt 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.

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Dealing With Inflation

The US was able to avert hyperinflation in the early 1980s, 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 dollars 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-1980s methodology.
Can you think of just one thing that has increased in price by only 1-2% per year over the past 10 years?

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Hiding Inflation
Based on my own experience:
Item College Tuition Groceries Furnace oil Gasoline Alcohol Vacation to Cuba Levis jeans Magazine Candy bar Movie admission McDonalds combo DVD rental Price in 2000 $3,623/year 400$/month 0.49$/L 0.69$/L 8$/six pack $600/week $50 $3.99 $0.69 $5.99 $4.59 $3.99 Price in 2011 $8,673/year 900$/month 0.95$/L 1.31$/L 13$/six pack $1100/week $80 $6.99 $1.19 $11.99 $6.59 $5.99 % Increase 140% 125% 94% 90% 62% 83% 60% 75% 72% 83% 44% 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 its 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.

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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 1970s. Massive sovereign (government) debt, much of which will never be repaid A collapse of the US dollars 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 1970s, 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 1970s, 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 1970s. 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 1970s, 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.

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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 its 1980 high of $850/oz. Silver is still below its 1980 high of 50$/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 its 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.

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