The Fed Can't Stop Inflation

May 18, 2004

Here are some hard-core facts that you need to consider.

Starting in 2000, the U.S. has created $1.5 trillion new dollars (M2), and has a cumulative trade deficit of $1.6 trillion. This totals $3.1 trillion on the negative side of the dollar equation. To say the least, this is bad monetary karma and will lead toward a very strong gold price.

From 1973 to 1981 the inflation rate in the U.S. averaged 9.2% per year ! The Fed raising interest rates during this time, on balance did nothing! Why? Because the money increases from prior years were already in the system…the horses were out of the barn. For most of this time gold went up, interest rates went up and inflation went up. Prior to this time the money supply (M2) from 1965 to 1974 increased 101%. This caused the inflation from 1973 to 1981. The Fed could not stop it. Gold went from $100 to $850.

Here is a reality check on the above mentioned $1.5 trillion created from the year 2000. First, I will refer to the U.S. money supply (M2) in 1980. It was $1.5 trillion. All the tangible wealth in the United States, every bridge, office building, home, car, television, plane, everything was created over 200 years with a money supply that ended up at $1.5 trillion. 200 years of blood, sweat and tears to create all the tangible wealth in the U.S. Our country in a bit more than four years has created the same amount of money! $1.5 trillion! This new money has not created anything near the tangible wealth of the first 200 year's $1.5 trillion. This is currency depreciation on a grand scale.

This is economic madness and this is the madness that has made people like Warren Buffet recently increase his foreign currency investments (out of dollars) to over $12 billion.

Bill Gross, who manages the largest bond portfolio in the world and is considered on the same world class investment level as Buffet, was on CNBC just last week and in response to Ron Insana's question of "what to do now" stated, "Move money elsewhere to a central bank in Euroland that is more rational."

Warren Buffet, Bill Gross, and hopefully you understand this situation. The smart thing to do is to protect oneself with assets of real monetary value….gold. One of the best ways to own plenty of this time tested asset is with gold and silver mining companies that are sitting on mountains of resources and reserves in the ground.

The Dollar and The Price of Gold

Here is something else important to understand. The dollar is not always that good a barometer of the gold price. From 1976 to 1980 the dollar index went from 106 to 92, down only 13%, yet gold during this time went from $103 to $850, up over 700%.

From 1985 to 1995 the dollar index collapsed from 140 to 80, down 43%. Gold during this time went from $325 to $390, up only 20%. Gold should go opposite to the dollar but the magnitude of the move has a life all it's own and regardless of all complexities and theories…the bottom line is that it is the world's heavyweight champ of money and liquid wealth, regardless of whatever everything else is doing. Besides, the price of gold is based on supply and demand of gold not dollars. If the top 10 gold mines in the world closed down for any reason, that would take 20% of the mine supply off the market. Regardless of the dollar, you could bet gold would go up. The gold/dollar relationship has merit, but it is not the key determinate to the ultimate value of gold.

Gold is headed higher regardless of the dollar, the Fed, or interest rates. The gold stocks are also. The current sell-off in the mining shares is a buying opportunity.

The U.S. stock market is worth about $13 trillion and the bond market about $22 trillion. That would be about $35 trillion. Since the U.S. has about 30% of all the liquid wealth in the world, we could assume that the global stock and bond markets would be about $100 trillion.

The market value of every gold mining company in the world on every stock market in the world is $200 billion. For comparison General Electric's market value is $300 billion. The point is that there is an awful lot of money that could potentially flow into these gold mining shares and most likely will. The wake up call will certainly be there when the economic repercussions of all the past and current monetary and economic mismanagement manifest themselves. Not only are the chickens coming home to roost but in the next few years the debt levels and the printing of money will most likely have to increase even more to keep the show on the road.

Despite all this bad news, the world will still turn, people will get up in the morning and eat breakfast, the cereal makers will still be in business, their employees will still shop at stores, the store owners will still buy cars, the PGA Tour will go on, etc., etc. A depression of productivity will not be the end result. Life will go on . But the big change will be the value of everyone's assets. Here is where a massive shift of value and wealth will take place.

M2 just since 2000 is up 32%. Since 1995, up 73%. This means plenty of inflation in the next 5-10 years, and although hard to imagine, the bond market could lose 30-40% of it's value. Raising interest rates couldn't stop inflation from 1973 to 1981 and it won't stop it now. All the money printed in the late 60's and early 70's was already in the system. Today it is no different. This time it could be much worse because of all the debt, which dwarfs the debt levels of the 70's. Also the new economic power, China, has increased it's money supply (M1) by 84% just since 2000. All this is bullish for gold and the mining stocks.

The monetary insurance of gold mining stocks, coupled with the growth and value attributes of this investment group make a compelling and logical rationale in this day and age for investment capital. It is your life jacket on a sinking ship.

In 2004, we just could be seeing the last real great buying opportunity in the mining shares for a generation. I would encourage clients to contact our office and add funds to your gold mining stock account this quarter and take advantage of this opportunity.

Kenneth J. Gerbino

The melting point of gold is 1337.33 K (1064.18 °C, 1947.52 °F).