Saturday, October 25, 2008

Homework assignment

Is to click on the link below, read the article it leads to, and think about the potential ramifications.

To quote the Chinese STATE newspaper: "Asian and European countries should banish the U.S. dollar from their direct trade relations for a start, relying only on their own currencies."

Nice start. Wonder what comes after a start?

Being the reserve currency of the world has given the U.S. a huge advantage since WWII. Nixon broke our promise to the rest of the world when he stopped redeeming our dollar for gold in the early 1970s. Since we did this, we have been essentially relying on our charm, economic market stability and military strength to keep the charade going.

In the past several months, the global perception of our economic market stability has changed. Angry voices such as those put out by a STATE Chinese newspaper tell me our charm is wearing thin. And that last thing, the military strength, it requires the Chinese and Europeans (among others) to buy a lot of our bonds and use our dollar for transactions. If these two buyers aren't happy with us, they don't have to buy as many of our bonds and we run into a funding crunch that suspends the War on Iraq, the War on Afghanistan, the War on Terror, the possible War on Iran, and even the War on Drugs.

We'll be broke and overextended if currency "regime" changes like the one proposed above are implemented. These things, once started, can quickly become contagious. If all the "big money" around the world started to diversify out of this country, even a moderate amount, we could experience a serious currency crisis. This is what concerns me looking out at the big picture over the next decade.

I must hold gold due to my fear of this type of event. Cash is doing well right now - U.S. Dollars have been kicking ass. They've been the best bullish investment out there (though being a bull on being bearish and shorting the hell out of the market was the best strategy of all...). HOWEVER, the current currency game relies on cooperation. If cooperation fails, the U.S. stands to lose a lot.

If an "event" like this were to happen, there would be little or no time to prepare. If you woke up tomorrow and your currency had been devalued by 30-50% while you slept, what then? Gold protects against these types of events. That's why it's good portfolio insurance. Gold will be around longer than all the currencies now floating around the world. Think about all the global currency changes just during the last century. The Euro, a household name and a leading world currency, has been around only since 2002! Gold has been used as money for thousands of years, not less than a decade. Every fiat currency in history has failed. PERIOD. Gold may change in price, but hasn't failed in its long term role of maintaining purchasing power like fiat money has.

I don't deny that gold's shorter term twists and turns, like say the very brief (ha, ha) period from 1980 to 2001, can make it a poor investment at times. That's why I like the Dow to gold ratio, as I plan to switch back to regular stocks once they become undervalued relative to gold. Until then, gold and gold stocks are the apple of my eye.

Those who defied the government and kept gold after it was outlawed during the "First Great Depression" made out well relative to holding cash. That's the problem with cash in a fiat system. It fails to hold its value over time, which is one of the functions money is supposed to perform. If your family amassed 10,000 US dollars in 1929 and you kept them under your mattress and still had them, you'd have money for an exotic vacation or enough to buy part of a car. If someone gave you 10,000 US worth of gold in 1929, given that it sold for a little over $20/ounce, you would have received about 484 ounces of gold. At a current price of $700/ounce, you'd have over $338 thousand worth of gold (and gold's bull market ain't over yet).

Even if the U.S. dollar remains strong relative to other fiat currencies, they are ultimately all caught in a strong long-term bear market of depreciation. Gold isn't subject to depreciation in the same manner as fiat currency. Whether gold is hated, loved, laughed at, worshipped, ignored, buried in the ground or worn around an extremity, it retains value over long periods of time. The same cannot and should not be said about the US dollar or any other fiat currency.

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