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As the Dollar Crashes, Gold is heading to $4,800 & Possibly Much Higher

April 17, 2007

The ignorance about gold in America's mainstream press and on Wall Street is amazing. The conventional "wisdom" on the Street is that gold is already way, way too overpriced. Americans have been brainwashed to the extent that most people have not a clue that there is a connection between the supply of money and prices of everything, even though Milton Friedman said over and over again during the inflationary 1970s that the only cause of inflation was a rising money supply! In those days, Wall Street watched the money supply numbers like no other statistic. Now, even the likes of Wall Street favorites Larry Kudlow and Brian Wesbury don't even get it. (Perhaps they are Wall Street favorites because they don't get it.) They think there is no relationship between the money supply and stock prices and housing prices. I guess ignorance is bliss, at least if you work on Wall Street and are taking down billions of dollars in bonuses every year.

But there is a relationship between inflation, whether you are speaking of the phony government number or actual prices for everything we buy. Gold, in fact, is money, though politicians and their crime buddies on Wall Street do the best they can through legislation and propaganda to keep it from being used as money. That is so they can continue to rob honest, hardworking Americans, who actually produce things of value, unlike government and Wall Street, who do not create wealth but just redistribute it, with a considerable amount of it kept for themselves. But ultimately, politicians and bankers destroy paper money in their process of "legalized" theft because they simply can't stop robbing, any more than a drug or sex addict can stop their pathologies. The process continues until the currency in question becomes worthless. That is when gold always reemerges as money and when it reasserts its lost value, vis -à-vis paper.

In 1913, the supply of money in the U.S. as defined by M-3 was $20.4 billion. You can't see it on the chart above, because relative to the current M-3 money supply of $11,545 billion ($11.545 trillion), $20.4 billion is too small to show up on the chart. If you look carefully, you detect a very slight rise above the X axis along about 1945 during World War II or so and then a gradual rise through the 1960s as President Johnson printed money to pay for the Vietnam War and America's net move toward socialism in what was dubbed "The Great Society" program of Lyndon Johnson. The real rise in the money supply, however, got underway in 1971 when Richard Nixon took us off the international gold standard.

In a very demented way, we have been brainwashed to think of the dollar as a stable unit of measure, but in fact, thinking that way would be like chopping an inch off a yardstick every year and still calling a yardstick a yardstick. Every year it would take more yardsticks to measure the same distance as it took the year before. The dollar is very rapidly becoming more and more worthless as Americans are duped into holding paper dollars.

The good news for you and me is that the longer most Americans remain stupid about money, the more chance those who get it have for acquiring more gold, which will one day-perhaps very soon-rise to levels that even the most ardent gold bugs cannot perceive. To get a sense of just how cheap gold is, I have created the chart below which measures the price of golf relative to the quantity of money in circulation as measured by M-3. What you see is the ratio of the supply of money (M-3) to the price of gold since 1913, the year the Federal Reserve was created.

Note there were two spikes in gold's value relative to paper money since the Fed was created in 1913. One was in the 1930s, when it rose to 0.88 from a low of about 0.45 in 1929 before the crash. The other spike was in 1980, when the ratio rose to 0.40 from under 20 in the mid 1970s.

For all of the talk about gold being "overpriced," we see from this chart that gold remains extremely cheap relative to the money supply. In both the Great Depression and again in 1980 when the paper money system was severely threatened, the Fed was able to hold the dollar monetary system together. My sense is that either a hyperinflationary environment, as economist Walter Williams is suggesting, could happen by 2010 or a deflationary bust this time around could end the dollar's role as the world's reserve currency and with that in my view would come a return back to or even beyond the 1:1 level in 1913 when the Fed was created. With gold currently at $672 per ounce, and with M-3 at 11,545.8 billion, the ratio is currently 1:0.14. To get back to parity, with this amount of M-3 we would need to see a gold price of $4,800. But keep in mind that even as we speak, the supply of money is growing like wildfire. In other words, the ultimate price of gold could be much, much higher even than $4,800.

Remember back in the 1990s' stock market bubble, when one guy wrote a book predicting a 36,000 Dow? Remember when another so-called stock market expert predicted Dow 100,000? I'm going to shock you by saying, "I think they might be right." But then I'm going to say something else that may appear to be equally nuts and that is, "It doesn't matter!" What does matter is what an ounce of gold will buy rather than what a dollar will buy, because in the end analysis, despite all of Wall Street and Washington's lies, gold is money. When the dollar goes the route of all other fiat currencies through history-to zero-gold, and no doubt silver to an extent also, will be left standing as money.

With an economist of John Williams's stature seriously suggesting that hyperinflation is a distinct possibility by 2010, I thought it might be helpful to take a look at Germany's hyper inflationary picture. As with the U.S., Germany was heavily indebted to the rest of the world, and so in order to try to pay its debts it inflated its money supply like there was no tomorrow. And for that German government, there was no tomorrow. With foreigners now owning more than 42% of U.S. Treasury debt, I believe the day may not be far off when other creditor nations, like China and even Japan, might say they no longer want to share their savings with Americans, who are living beyond their means. The day may well be at hand when the Federal Reserve will have to print money like there is no tomorrow in an attempt to pay our debts. And as with Germany, it might be that there is no "tomorrow" for the American empire. Our God Almighty sits on the throne outside of time and space with his hand on the universe. He will decide when America's day of dominating and killing for oil and riches is over. So any notion that we can forecast such events with any certainty would be arrogant and stupid on our part. Yet, it would be equally foolish if we didn't learn some important lessons from past history. And one lesson that is rather clear is that when nations do not subject themselves to the discipline of gold or some other commodity-backed currency, their fiat paper money will ultimately go up in smoke. So let's take a look at some charges from hyperinflationary Germany, in illustrations I, II, & IV in The Economics of Inflation by Costantino Bresciani-Turroni, published in 1937.

Notice in Diagram I how the volume of the German currency rose by more than fourfold from 1913 through about 1918. Clearly, the money supply was rising much more rapidly during this time frame than were domestic or imported prices. The Dennis Gartmans of 1913 to 1918 Germany were saying to the John Embrys of that day, "What are you worrying about? Everything is humming along quite alright, so it always will!" We would also point out that during those early days of the German hyperinflation pathology, domestic prices were rising more rapidly than imported prices, as foreigners had not yet begun to dump the German mark in any serious manner.

Above, on the right, Diagram III covers 1918 through 1920 and shows that the value of the dollar, the currency of the creditor nation, USA, began to explode, which caused imported prices to rise dramatically. Note that domestic price increases, though rising by approximately 500%, were tame compared to imported price increases caused by a plunging German currency. Could a similar event lie in our future if China and other creditor nations lose their appetite for U.S. dollars, given that the U.S., like Germany then, is the world's largest debtor nation? I would also point out that the volume of currency is barely growing at all, relative to price increases. No doubt that was because of rapidly rising turnover of money as it became increasingly urgent to buy things as rapidly as possible in order to avoid paying drastically higher prices within a few days. But at that point, Germany hyperinflation was just getting warmed up.

The dramatic blow off in German hyperinflation took place in only a few short months, is pictured in the chart on your left. From January 1922 to the middle of 1923, the price of food rose nearly 14,000%, domestic prices overall rose nearly 18,000%, while imported goods and the value of the dollar rose nearly 22,000% during that time frame.

Could this kind of thing happen in America? I think it can, and actually far more than people realize, America has undergone some enormous decreases in the purchasing power of the dollar, as shown in the chart below, prepared by Walter Williams. The chart was shown at the Astrologers Fund-Spring Equinox Conference that I attended a few weeks back. The graph plots the level of consumer prices during the last 340 years in America.

The data for the period 1665 to 1913 were estimated by Robert Sahr of Oregon State University, using the research of John J. McCusker of Trinity University, San Antonio, Texas. The continuing thin line from 1913 to 2006 is the official reporting of the annualaverage CPI-U by the Bureau of Labor Statistics (BLS).

The heavy line from 1982 to date represents official CPI reporting net of methodology changes made that year to suppress inflation reporting. As of February 2007, the CPI-U stood at 203.5 and the Shadow Government Statistics Alternative Consumer Price Measure at 522.0. The SGS Alternative CDPI reflects the BLS's Consumer Price Index Research Series using current methods (CPI-U-RS) plus an SGS-estimated differential in adjusting for the shift to geometric weighting. In other words, changes made in the way the government calculates inflation in recent years.

Of course you can create any kind of image you want with charts. But the point is easy to see above, that since we have gone off a gold standard, our currency is losing an enormous amount of its purchasing power. In his speech, Williams pointed out that in a few years when the baby boomers reach their peak in retirement demands on U.S. transfer payments, there will not be enough income in America, even if everyone was taxed at a rate of 100%, to meet all the government's obligations, most significant of which will be Medicare obligations and Social Security obligations. And that says nothing about our obligations to the Chinese and Japanese who have enormous claims against our future wealth.

I'm not ruling out Ian Gordon's Kondratieff winter and the deflationary implosion that comes with it. Inflation and deflation are two different symptoms of the printing press money disease. But at this juncture, I have become much more concerned about hyperinflation than I was even one year ago. Which way are we heading? For that we turn to our IDW, and so far, there are no hints of anything but more and more inflation, though from a common perspective it certainly isn't hyperinflation yet.

How do we define hyperinflation? I think when you look at the charts of Germany's inflation, the definition offered by Walter Williams makes a certain amount of sense. He says hyperinflation is when a country's largest bill is worth more as toilet paper than as currency. Clearly, when the dollar crashes, gold will have a long way to rise.

We suggested above that given the current growth of M-3, a price for gold of $4,800 was in line. But that is based on current M-3 numbers. As Global U.S. Dollar Liquidity (one of the data points in our IDW) suggests, printing presses around the globe are humming at a very rapid pace, with this measure of money accelerating once again at over 11% annually. If, God forbid, we enter into a hyperinflation, then the nominal price of gold could be virtually infinite. So, while it may require a wheelbarrow full of $100 bills to buy a loaf of bread, chances are a fraction of a gram of gold or a silver dime should do the trick for those who have been smart enough to buy the metal and store it for this kind of economic calamity.


April 17, 2007

Jay Taylor, Editor of J Taylor's Gold & Technology Stocks

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