Rick's Picks
Wednesday, August 25, 2004
For investors who'd rather be smart than lucky
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First Deflation,
Then Gold-Mania
Let's return once more to the widely misunderstood threat of deflation, since yesterday's give-and-take on the topic in Rick's Picks elicited a provocative rejoinder from Steven L., who still thinks massive inflation will sink the dollar. My comments are in italics:
"Thanks for the exchange of ideas in these unprecedented times. I understand your points and it will be interesting to see how events unravel. There are a few things I would reiterate regarding the decline of the dollar (whose chart looks like Enron's before its demise, as its current highs are lower than preceding ones since 2001.)"
First, just to provide a frame of reference, I've reproduced the long-term charts of both Enron and the dollar at bottom. In fact, they are quite similar up to a point. But that point is crucial, for it leaves unanswered the question of whether the dollar has already suffered a 5th wave decline.
Dollar Already Worthless
I'll concede the point that it has not, and that, were we to refer to a chart that goes back 50 years, we would see that much, much lower lows are likely for the dollar. Basically, then, I agree with those who believe the dollar will eventually be destroyed by inflation. How could it end in any other way? I've asserted here many times before that the dollar is already fundamentally worthless. This implies that the $1 bill, the twenty and the hundred in one's wallet are fundamentally equal in value. Sounds bizarre, I know, but someday, when "new" dollars are implemented, each to take the place of a zillion "old" dollars, Joe Sixpack will come to understand exactly what I was talking about.
My disagreement with the inflationists is not over whether we will have inflation, but when. I see the prospect of a years-long period of deflation first, one that would cause a manifestly worthless dollar to appreciate in value, notwithstanding the fact that everyone on earth who owes dollars -- as well as the world's patron saint of asset inflation, Easy Al -- would desperately prefer otherwise.
Too Broke to Buy Gold?
"Americans don't need to buy gold to have it increase against the dollar, should they even become interested in buying it with dollars they do not have. The trade imbalances are too large for their participation to be necessary in this equation for the inevitable unwinding."
An interesting point: Could gold rise even if Americans are too tapped out to buy much of it themselves? In theory, yes. But that supposes foreigners would step in and trade assets of their own for bullion coins and ingots. But just which assets would they possess if all of their dollar investments were to go down the drain in a U.S. economic collapse? Keep in mind, moreover, that it is not just the dollar that has become intrinsically worthless, but all currencies. Might OPEC's members stoke demand for gold by requiring bullion as payment for oil? Not if they want to keep selling the stuff, since none of the oil-importing countries would be able to afford it on those terms.
Bottom line, we should not try to reckon gold's prospects in dollars, or in other currencies, but in terms of how much an ounce of gold will buy of the things we need to survive, never mind live luxuriously. On that score, gold is likely to do just fine, come - literally - hell or high water.
Chinese Buyers
"If Americans won't trade their homes for gold," as you assert, "there undoubtedly are Chinese who would trade plenty of anything else that isn't bolted down for it. Since I believe that the worldwide value of the dollar will plunge in the next default crisis, I could trade highly valued gold for whatever asset Americans might desire in a trade. To think that massive derivative defaults would cause a rise in a currency whose confidence the default would cause a loss of confidence in, is a bit bizarre for me to fathom. Although, I don't dismiss your scenario outright, confidence in any derivative, contract, or currency is based upon 'promises to pay.' "
Once again, we mostly agree. A massive wave of defaults would almost certainly send investors scrambling out of dollars and into gold, as well as other currencies mistakenly perceived as being "less worthless" than the dollar. But as I've implied above, such a collapse could be a few years off. In the meantime, arcane dollar-instruments and mortgaged-backed securities could continue to be the best game in town.
"Weimar Germany was able to destroy its currency with merely ledgers and printing presses. Today we have computers."
U.S. Is Not Germany
At the time, in the early 1920s, the D-mark had no role as a global reserve currency, so the rest of the world was not affected to the extent it would be today if quintillions of dollars were dumped from helicopters. For Germany, hyperinflation was not exactly the easy way out, either, since it wrecked what was left of their postwar economy. But it had the advantage of stiffing the Allies, whose reparation demands were thought by Germans to be excessively punitive.
Concerning the capabilities of our computers (i.e., electronic-money factories), they don't create money, but credit. If you think that cosmically vast quantities of new borrowing will arrest a financial collapse, then I've got a bridge to sell you.
Some Rescue!
"The abandonment of gold as money ensured hyperinflation for Germany at the time of a worldwide deflationary depression. The Treasury/FED/ESF could conceivably rescue Fannie Mae/Freddie Mac or any other entity 100 or 1,000 times over with just a few computer entries. Trillions of dollars (fourteen zeroes etc), is no barrier to reliquefy any paper asset(s).
What kind of rescue would that be? The resulting hyperinflation would destroy savers as a class, instantly vaporizing the capital of Fannie's and Freddie's bondholders in the process. To say that the U.S. would simply bail out debtors by printing money is tantamount to saying the government would choose to ruin all creditors. I doubt this is what banks, pension funds and bond funds have in mind when they talk about bailouts behind closed doors.
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Rick Ackerman
August 25, 2004
Information and commentary contained herein comes from sources believed to be reliable, but this cannot be guaranteed. Past performance should not be construed as an indicator of future results, so let the buyer beware. Rick's Picks does not provide investment advice to individuals, nor act as an investment advisor, nor individually advocate the purchase or sale of any security or investment. From time to time, its editor may hold positions in issues referred to in this service, and he may alter or augment them at any time. Investments recommended herein should be made only after consulting with your investment advisor, and only after reviewing the prospectus or financial statements of the company. Rick's Picks reserves the right to use e-mail endorsements and/or profit claims from its subscribers for marketing purposes. All names will be kept anonymous and only subscribers' initials will be used unless express written permission has been granted to the contrary. All Contents © 2004, Rick Ackerman. All Rights Reserved. www.rickackerman.com
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