 Casey Files:
Why Strawberries Are Not
Money
Balancing Risk in a Time of Crisis
By David Galland,
BIG
GOLD, Managing Director
Casey Research
Dec 20, 2007
 As
you have probably heard, Federal Reserve Chairman Ben Bernanke
has gone on record stating that, if the need arose, the Fed would
print dollars by the helicopter load to smooth over a collapse
in the 25-year borrow-and-spend bubble, a collapse that is now
underway.
Putting Bernanke's words into
action, since early August of 2007, the Fed has stepped up to
the plate with tens of billions of dollars. On November 15 alone,
the Fed injected almost $50 billion into the banking system,
the largest single-day cash infusion since 9/11.
Then, on December 12, the Fed
announced that it would open the spigots by providing lending
$28 billion created out of nowhere to the nation's banks in exchange
for a "wide variety of collateral."
In other words, the Fed will
accept as collateral even the very same toxic waste paper now
bedeviling the financial system.
And that's just one of many
ways that the government is scrambling to keep the house of cards
from falling. For instance, there are 12 Federal Home Loan Banks
(FHLBs) whose job it is to serve as "lenders of last resort"
by making cash available to banks and other financial institutions.
In the third quarter of 2007
alone, FHLB loans skyrocketed to a record $746.2 billion, nearly
18 times the yearly average between 2003-2006.
That alone should tip you off
to how serious the government considers the current credit crisis
to be. And no wonder. The following chart shows the steeply worsening
increase in non-performing bank loans and outright charge-offs.
Faced with the very real threat
of a deep recession caused by a freeze-up in credit, falling
home values and soaring loan defaults, the Fed is left with a
rock-and-a-hard-place decision. Hold tight and let the economy
fall... hard. Or, open the money spigots wide in an attempt to
maintain liquidity in the markets, sacrificing the dollar in
the process.
Given two untenable choices,
it is our view that the government will continue on the path
of a loose monetary policy, the implications of which are not
hard to figure out.
Sticking with the helicopter
metaphor for a moment longer, creating billions of new dollars
out of thin air to smooth over a litany of problems caused by
decades of irresponsible debt creation is analogous to a helicopter
trying to put out a raging forest fire by dropping tank loads
of gasoline.
In other words, the "solution"
is more of the same. It is only making the situation worse.
The result is simply this:
as more and more dollars are created and injected into the economy,
the purchasing power of all the dollars in circulation comes
under pressure. It's called inflation. The last time we saw anything
like what we are seeing today was in the 1970s. Here's a snapshot
of the dollar against foreign currencies, then and now. The parallels
are eye-opening.
You don't need me to tell you
that, regardless of what the Fed would like you to think, inflation
is already a problem. Yesterday I paid $3.10 for a gallon
of gas, $7.50 each for movie tickets, and just shy of $30 for
two cheese Stromboli's following the show.
Since March 2002, the U.S.
Dollar Index, which measures the value of the dollar against
a basket of six major currencies, has fallen 35.3%. The downtrend
in the U.S. dollar is far from over.
Balancing Risk
Once you've identified the
problem, identifying how to balance the risk to your portfolio
is easy. In times of inflation, people turn to tangible "stuff."
Viewed in that context, it is perfectly understandable why oil,
gold and other commodities have been moving higher.
And, just as the U.S. dollar
has farther to fall, so do the commodities have farther to rise.
On that point, JPMorgan went on record a few days ago with their
forecast that of all the commodities, they expect precious metals
to be the strongest in 2008... followed by agricultural products,
base metals and energy.
We think JPMorgan has it right,
and that of all the possible portfolio diversifications you can
make today in an attempt to protect your overall portfolio and
to profit over the coming year, few will serve you better than
gold.
 But Isn't Gold
a Relic?
The younger generation of money
managers know little about gold. They know about structured investments
such as those that are now failing left and right, but they don't
know about gold.
Rather, they sneer that gold
is a barbaric metal, an artifact from yesteryear.
And they're right.
While gold doesn't go up in
a straight line - no investment does - it has been considered
real money since about 4,000 B.C. Compare that track record against
that of government-issued paper currencies. Actually, there is
no comparison.
Given the historical record,
it's hard to argue with the adage that all paper money continually
falls in value, just at varying rates of speed.
And, since 2002, that is exactly
what has been happening. In fact, while the next chart shows
just four currencies, over the last six years gold has risen
in all the world's currencies. As you can see, the price rose
more in yen, because the yen has been weaker than the dollar;
and it rose less in euros because that currency has been stronger
than the dollar.
Bottom line: for the last 6
years, gold has been a better investment than paper currencies.
We can expect this trend to continue and to accelerate.
A minute ago, I mentioned that
since March 2002, the U.S. dollar has fallen by 35.3% against
a basket of six major foreign currencies. Well, over that same
period gold has risen by 181% against the dollar. (And the HUI
Index of large cap gold stocks, the sector you want to play in
to get more bang for your buck, has risen 367% over that same
period.)
But why is it that gold is
still considered a store of value after all these millennia?
Why is it that record numbers of investors - private and institutional
- are beginning to turn to more modern forms of gold, including
gold ETFs and, of course, the shares of established gold mining
companies?
For the answer to that question,
I defer to none other than Aristotle who, in the fourth century
BC, explained why gold is money...
To serve well as money, an
object must be:
- durable, which is why we don't
use strawberries as money;
- divisible, which is why artwork
isn't practical;
- convenient, which is why lead
isn't very good;
- consistent, which rules out
real estate;
- and useful in itself, which
is why paper is such a weak choice.
Of all the 92 naturally occurring
elements, none fits the requirements better than gold. No one
ordained that it should be money; it grew into that role through
the practical decisions of millions of people over thousands
of years.
Not to pick a fight with Aristotle,
there's another essential characteristic I'll add to the list.
For an object to serve well as money, it must be difficult to
produce - otherwise, a growing supply of the object will undermine
its value. Gold is again the standout. Adding to gold reserves
requires a massive expenditure of labor and capital to find it
and dig the stuff out of the ground.
So difficult is it to produce,
all the gold ever mined would fit into a cube roughly 25 meters
on a side -- and that's something no politician or banker can
ever change. How different from paper money, and even more different
from the deposits the Federal Reserve regularly creates just
by running electrons (there are plenty of them, and they don't
cost much) through a computer.
The "Inflation Factor"
Key for gold is how little
supply is added in a year -- only about 80 million ounces ($62
billion worth at today's prices). That amounts to a gross "inflation"
rate for gold of 1.6% per year, compared to the existing supply
of approximately 5 billion ounces. And gold's net inflation rate
is actually a little less than that, since some amount of metal
disappears every year in uses that are not fully recoverable.
Competing forms of money -
the U.S. dollar, for example - typically increase at an annual
rate of 10% or more (in some years and in some places, much,
much more)... and have been doing so for decades. Per the above,
as we head into 2008, we see the increase in the supply of U.S.
dollars ratcheting up well above the norm.
With the supply of paper money
growing so fast and the supply of gold growing hardly at all,
gold now represents just a tiny percentage of the hundreds of
trillions of dollars worth of paper money in the world's financial
system.
Given the easy-going creation
of money by politicians trying to paper over today's problems
and yesterday's expensive promises - don't forget that 76 million
baby boomers are now beginning to enter their retirement years,
triggering a demand for trillions of dollars in Social Security
and Medicare entitlements -- every minute a few more people become
uncomfortable with the thought that everything they own is just
paper. That's when they become potential gold buyers.
What might happen to gold prices
if this process were to accelerate or if there were a general
shift in attitudes about paper money?
The total market value of all
publicly traded stocks is about $50 trillion. If just 5% of that
total value shifted toward gold - which could happen with just
a modest uptick in worries about paper currencies -- $2.5 trillion
would flow into gold. At today's prices, that would buy all the
gold in the central banks three times over. In fact, it would
buy three-quarters of all the gold in the world, including wedding
rings, gold teeth and the contents of the Saudi Princes' vaults.
Of course, such a thing wouldn't
happen at "today's prices." Instead, the price of gold
would leap, perhaps by a factor of two or much more, to accommodate
the increased demand.
In the final analysis, if you
have not already done so, it's time to begin getting acquainted
with gold and gold stocks as a portfolio asset.
###
David Galland
is the managing director of Casey Research, LLC. For over 27
years, the Casey organization has been providing unbiased research
to self-directed investors looking to profit from developing
trends. If you're interested in learning more about gold, gold
stocks, gold mutual funds and gold ETFs, check out BIG
GOLD,
Casey Research's unique publication designed for investors looking
to cautiously diversify into gold.
For a limited
time, a full 12-month subscription to BIG GOLD is just $79, plus
you'll receive the special report 3 Prudent Ways to Profit
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Doug Casey
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