 Deflation and
the Kennedy Half Dollar
Roland Watson
Jul 25, 2005
While silver and gold continue
to backtrack against the dollar's higher degree rally, my thoughts
turned to other things.
First I indulged in some silver
housekeeping as I closed all my storage accounts including my
participation in the Perth Mint Certificate program. The reasons
for that are outlined in the next issue of my newsletter where
I look at the potential and real systemic effects of a cash flow
problem in precious metal warehouses. It has happened before
and it will happen again. I also look at the Perth Mint's credit
rating as part of the Western Australian Government.
So, with cash in hand, it also
was a good time to convert silver and gold holdings since the
metals were in a corrective phase. What to do? Buying the physical
metal was the obvious choice and that is the tactic I have pursued
so far. However, a few recent articles on the inflation/deflation
debate got me thinking about ways to hold silver and gold bullion.
There are two questions that
need to be asked. The first is whether a major monetary crisis
would be deflationary or inflationary. The second is how silver
and gold would perform in a deflationary situation.
The answer to the second question,
in my opinion, is that silver and gold will drop in price during
a deflation unless two things happen. One, government intervenes
to prop up the price (as with gold during the Depression) or
a related systemic threat to the fractionally reserved banking
system puts the stability and accessibility of paper money in
public doubt.
Unfortunately, there are some
ifs, buts and maybes involved in the debate. During the commodity
deflation of the 1920s and 1930s, silver performed terribly (see
my article here)
but at the same time gold held firm at $20 an ounce due to the
American gold standard. Yet despite silver dropping to 25c an
ounce in 1932, a dollar coin still held the same amount of silver.
During that period, gold and
silver were used as money; so fleeing to 100oz silver bars and
gold Krugerrands would have been a pointless exercise even if
such items were available. The main fear was not how money was
defined but whether your money was safe and accessible in the
vault of your bank. Thousands of banks went bust as the fragility
of the fractional reserve system was exposed during countless
bank runs.
And so we find ourselves in
a different era but with similar worries. Our banks still do
not cover all liabilities, but we now have the added "luxury"
of money that is a liability itself being back by nothing more
than hope in the future.
Fiat money rules the roost
and gold and silver have taken a back seat. There has been no
major episode of deflation since the 1930s as monetary expansion
runs at rates ten times faster than anything seen under a stable
gold standard. Deflation seems unlikely as even Japan manages
to slow deflation down with a tsunami of yen hot off the digital
printing presses.
So how does the investor in
gold and silver approach this subject? If inflation is going
to be the dominant force on the economic horizon until fiat money
is finally dropped as a bad idea, we just hold onto gold and
silver. Okay, but how do we hedge against a possible episode
of deflation?
As I thought on how to reallocate
my liquidated storage accounts, I thought back to the early 1930s
when silver was an investment dog. In that time silver dropped,
but the Peace or Morgan dollar in people's pockets was still
officially valuing silver at $1.29 an ounce. The Roosevelt government
reaffirmed this by passing the 1934 Silver Purchase Act, which
instructed the Treasury to fix the price of silver at $1.29 per
ounce. To eliminate market competition, large stocks of silver
bullion were called in and a huge 40% tax was placed on any silver
profits.
So what happened in the public
perception? By holding onto silver dollars and any other silver
currency, they knew the government had pledged to maintain that
0.773 ounces of silver would have the purchasing power of one
dollar. That pledge was revoked in 1964 as the inflating of the
dollar caused the price of silver to exceed $1.29 an ounce.
Now if we look at one of the
last 90% silver coins, a 1964 Kennedy half dollar, we see that
the silver content of the coin at today's spot price is $2.57
based on its silver content of 0.362oz. So its silver value is
just over five times its 50 cents face value. Nobody is going
to spend such a half dollar in their local store at that rate
of exchange.
Now look at the Kennedy half
dollars minted between 1965 and 1970. They are only 40% silver
and contain 0.148 ounces of silver. At today's spot price, they
have a silver value of $1.05 or just over two times face value.
Once again, this is not likely to appear in a cash register.
How would each coin fare in
a real deflationary situation where commodities tank and somehow
the Federal Reserve's best attempts to counter-inflate the dollar
fails? Let us suppose silver drops by half to $3.50 an ounce.
The 1964 half-dollar is now about 2.5 times face value but a
1965 half-dollar has nearly reached face value with a 52c silver
value. The 1965 coin has reached an important point. The face
value of the coin equals its silver value, and has reverted back
to circulating money as there is no incentive to hoard or sell
the coin for its melt value.
Now let us suppose deflation
takes a greater grip and silver drops to $1.38 an ounce. Now
the silver value of the 1964 half-dollar equals face value. But
note that even though the silver value of the 1965 half-dollar
has plummeted to a paltry 20c, the purchasing power remains at
50c and will do so no matter how hyper-deflationary things get.
By purchasing 1965-1970 half-dollars, we have set a floor on
the value of our investment at $3.38 per ounce of silver whereas
the floor is set at $1.38 for pre-1965 half-dollars.
The win-win situation kicks
in at the other end when silver takes off as we expect. Whether
your coin is 40% or 90% silver, its value will increase in proportion.
The silver equivalent of 100 1964 half-dollars is 225 1965 half-dollars.
Whichever of these you hold, both will increase with silver at
roughly the same rate. In terms of the premium on holding 40%
coins over 90% coins, I note that one popular coin dealer was
selling 40% coins at $6.72 per equivalent ounce of silver compared
to $7.24 per ounce for 90% bags with free shipping and insurance
on both. So it seems you can get your 40% silver cheaper (I don't
know their buy-back costs).
So what does this mean in practical
terms? If you bought a bag of 1965-1970 Kennedy halves at $5.00
an ounce you are limiting your losses to 30%. If you bought at
$7.00, the maximum loss is 50%, so the loss increases as the
purchase price of the silver increases. If you are unsure whether
deflation or inflation lies ahead then perhaps the 1965-1970
half-dollar is the investment for you.
There is another interesting
point about this $3.38 floor price for 40% halves. Pull up a
25-year chart for silver and you will notice that the silver
bear market made a double bottom in 1991 and 1993 at about $3.50.
The exact intra-day low I believe was $3.51 in March 1993. Could
it be that 40% Kennedy halves contributed to this floor in the
silver price? Note that at $3.51 an ounce, you could sell a 1965-1970
50-cent coin for 52 cents minus costs. In other words, it is
not worth the effort. Did their owners see the price of silver
approaching this magical price of $3.38 and stop selling their
coins? With over 848 million such coins minted with a silver
weight of 125.6 million ounces prior to the great silver melt
of the 1970s, was that enough to halt the drop? I don't know,
but it looks mighty suspicious to me!
Finally, if you live in Britain
or Euro-land, your old silver coins are no longer legal tender
and you cannot execute an equivalent deflation play. The alternative
you have is to purchase the 40% half-dollars in the same way
as American investors but then exchange them for your currency.
You would need to check first whether any bank would be prepared
to take them plus there is the matter of how the pound sterling,
euro and dollar exchange rates would fare in this deflationary
scenario. My feeling is that the dollar would outperform the
Euro and Pound due to its relatively stronger economy, so you
get more local currency for your dollar.
In conclusion, with Peak Oil,
Baby Boomers and a general fracturing of the fiat money system
ever threatening, the outlook is inflationary. Possession of
1965-1970 Kennedy half-dollars ensures that some of your investment
is both inflation and deflation proofed. You have the best of
both these calamitous worlds.
Roland Watson
email: newerainvestor@yahoo.co.uk
Roland Watson
writes the investment newsletter The New Era Investor that
can be purchased for an annual subscription of $99. To view a
sample copy of the newsletter, please go to www.newerainvestor.com and click on the "View
Sample Issue Here."
He invites comments
and questions at: newerainvestor@yahoo.co.uk.
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