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The ABCs of Gold Investing

How to Protect and Build Your Wealth with Gold

Addicus Books, Inc.

A is for ... Asset Preservation: Why Americans Need Gold

The possession of gold has ruined fewer men than the lack of it. — Thomas Bailey Aldrich

The incident is one of the most memorable of my career. Never before or since has the value of gold in preserving assets been made so abundantly clear to me. It was the mid-1970s. The United States was finally extricating itself from the conflict in South Vietnam. Thousands of South Vietnamese had fled their embattled homeland rather than face the vengeance of the rapidly advancing Communist forces.

A couple from South Vietnam who had been part of that exodus sat across from me in my Denver office. They had come to sell their gold. In broken English, the man told me the story of how he and his wife had escaped the fall of Saigon and certain reprisal by North Vietnamese troops. They got out with nothing more than a few personal belongings and the small cache of gold he now spread before me on my desk. His eyes widened as he explained why they were lucky to have survived those last fearful days of the South Vietnamese Republic. They had scrambled onto a fishing boat and had sailed into the South China Sea, where the U.S. Navy rescued them. These were Vietnamese "boat people," survivors of the final chapter in the tragedy of Indochina. Now they were about to redeem their life savings in gold so that they could start a new business in the United States.

Their gold wrapped in rice paper was a type called Kim Thanh. These are the commonly traded units in Hong Kong and throughout the Far East. Kim Thanh weigh about 1.2 troy ounces, or a tael, as it is called in the Orient. They look like thick gold leaf rectangles 3 to 4 inches long, 1½ to 2 inches wide, and a few millimeters deep. Kim Thanh are embossed with Oriental characters describing weight and purity. As a gesture to the Occident, they are stamped in the center with the words OR PUR, "pure gold."

It wasn't much gold — about 30 ounces — but it might as well have been a ton. The couple considered themselves very fortunate to have escaped with this small hoard of gold. They thanked me profusely for buying it. As we talked about Vietnam and their future in the United States, I couldn't help but become caught up in their enthusiasm for the future. These resilient, hardworking, thrifty people now had a new lease on life. When they left my office that day, there was little doubt in my mind that they would be successful in their new life. It was rewarding to know that gold could do this for them. It was satisfying to know that I had helped them in this small way.

I kept those golden Kim Thanh for many years. They became something of a symbol for me — a reminder of the power and importance of gold. Today, when economic and financial problems have begun to signal deeper, more fundamental concerns for the United States, I still remember that Vietnamese couple and how important gold can be to a family's future. Had the couple escaped with South Vietnamese paper money instead of gold, I could have done nothing for them. There was no exchange rate for the South Vietnamese currency because there was no longer a South Vietnam! Wisely, they had converted their savings to gold long before the helicopters lifted U.S. diplomats off the roof of the American Embassy in 1975.

Over the years, I have come to understand and appreciate the many important uses of gold — artistic, cultural, economic, and industrial. Gold is unsurpassed for jewelry and as a high-tech conductor of electricity. Gold has medical applications in dentistry and in treating diseases from arthritis to cancer. Gold plating is used in computers and in many other information-age technologies. In nanotechnology, it is used in a variety of cutting -edge medical diagnostic devices. As for its engineering uses, gold can be found in automobile antipollution devices, in jet engines, in architectural glass, and in a number of space applications. All of these pale, though, when compared to gold's ancient function as money, as an asset of last resort and an unequaled store of value.

The Stressed U.S. Economy

Some would have us believe that the financial crisis that began in 2007 with the residential real estate crash has been resolved, but nothing could be further from the truth. This crisis did not appear out of nowhere, descend upon the economy like a swarm of locusts, only to be addressed and sent on its way by a team of enlightened Washington policy-makers, never to be heard from again. It is, in fact, the latest manifestation of an ongoing crisis that has been with us for a very long time — one in fact that began in 1971 when the United States severed the link between the dollar and gold.

The multitrillion dollar bailout of the financial system that followed the collapse of Wall Street giant Lehman Brothers has already become the stuff of financial markets' lore, but it is not in any way a culmination, or an end, to the deeply rooted problems at its heart. At the time, Warren Buffet, the sage of Omaha, offered a warning: "[E]normous dosages of monetary medicine continue to be administered," he said, "and, before long, we will need to deal with their side effects. For now, most of those effects are invisible and could indeed remain latent for a long time. Still, their threat may be as ominous as that posed by the financial crisis itself." Those side effects amount to what is likely to be the next stage of the very same crisis "the monetary medicine" was intended to cure. What's past, as Shakespeare says, is prologue — a conclusion addressed in detail further on in this book in a chapter that deals with the Great American Bailout of 2008–2009.

At each new turn, we find that the core problem has not gone away, it has only deepened, become more widespread, and imposed itself on a wider swath of the American, and indeed, global public. Paul Volcker, the former Federal Reserve chairman and economic advisor to the Barack Obama administration, summed up the problem this way: "[U]nder the placid surface there are disturbing trends: huge imbalances, disequilibria, risks — call them what you will. Altogether the circumstances seem to me as dangerous and intractable as any I can remember, and I can remember quite a lot. What really concerns me is that there seems to be so little willingness or capacity to do much about it ... We are skating on thin ice."

Far from disappearing, the disturbing trends Volcker mentions are at the heart of what's wrong with the international monetary system, and the primary driving force behind recurring problems in the financial sector. Many hope this deteriorating situation will simply disappear; but as Volcker indicates, in the absence of fundamental reforms, the situation will only worsen. Another former Fed chairman, Alan Greenspan, put it succinctly: "These trends cannot extend to infinity." In other words, in the absence of a genuine remedy, sooner or later there will come a final, and some think potentially calamitous, settling of accounts.

The disturbing trends affecting your investment portfolio:

• In 1970, the budget deficit was a meager $2.8 billion. By September 2011, it had reached $1.3 trillion — 464 times the 1970 figure. Over the 40 years covered in the study, the annual addition to the national debt has risen by 8219%.

• In 1970, the accumulated federal debt was $436 billion. By December 2011, it surpassed the $15 trillion mark — up 3896% since 1971. This figure does not include so-called off-budget items like long-term Social Security and Medicare obligations, which balloon that figure by multiples.

• Exports and imports were roughly balanced in 1970. The last time the United States ran a trade surplus was 1975. By 2011 year's end, the trade deficit was estimated to be a dismal $470 billion for the year.

• In the process, the United States has gone from being the greatest creditor nation on earth to being the world's greatest debtor nation. In 1970, U.S. debt held by foreigners was a mere $12.4 million. By the end of 2011, it approached a dizzying $4.7 trillion, and was cited in a 2012 Gallup Poll of Americans as a greater concern than the political situation in Iran, trade relations with China, or the financial situation in Europe. The problem of foreign-held debt has become so acute that some experts wonder whether the United States will be capable of pursuing its own monetary policy in the future, or whether the dollar is now hostage to our foreign creditors.

• Belying political claims that inflation is under control, the actual consumer price index has shot up nearly 500% since 1970, according to government-sanctioned measurements. Private economists say the number could be substantially higher.

• In 1970, the federal government collected a total of $196 billion in corporate and individual income taxes while it spent $195 billion. In 2010 it collected $2.34 trillion in taxes and spent $3.7 trillion. In other words, the real addition to the national debt that year was $1.36 trillion — a record. Thirty-seven cents of every dollar spent was borrowed.

The numbers in Figure 1 speak for themselves and do not require a great deal of embellishment. Over the years, the cumulative effect of these disturbing trends has been to steadily undermine the purchasing power of the dollar and leave in their wake a continuous stream of financial and economic crises of which the 2008–2009 breakdown is only the latest. Since 1971 when the United States severed the tie between gold and the dollar, the greenback has lost 82% of its purchasing power. The 1971 dollar, in other words, is worth 18 cents. Put another way, what the consumer could purchase for a dollar in 1971 now costs $5.54; and still another way, if you earned $50,000 in 1971, you would have needed to earn $277,000 in 2011 just to keep pace with inflation.

The 1980 dollar, over a period when Americans were constantly reminded that inflation was "under control," is now worth about 38 cents. Against two of the dollar's most tenacious competitors, the Swiss franc and the Japanese yen, its performance has been dismal. In 1985, it cost Americans 40 cents to purchase a Swiss franc and 0.4 cents to purchase a Japanese yen. In 2011, it cost $1.40 to buy that same Swiss franc and 1.3 cents to purchase a Japanese yen. In other words, the dollar has lost about 70% of its value against two of the world's major currencies over the past twenty-seven years.

Dollar debasement has become as American as baseball and the Big Mac — a fact of life which each of us lives with on a daily basis. Keep in mind, too, that the data used to build the chart in Figure 2 are based on the Bureau of Labor Statistics' (BLS) — a measuring stick the reliability of which has come under question in recent years. Shadow Government Statistics, for example, gauges the consumer inflation rate at a little under twice the BLS rate using the same criteria the government utilized in 1990, and nearly three times the BLS rate using 1980 methodology.

Needless to say, the long-term decline of the dollar represents probably the most troubling of our disturbing trends because currency depreciation can be technically infinite, or proceed until a final breakdown occurs. For a currency to fulfill its function as money, it must be accepted in daily transactions as a medium of exchange; it must be reliable as a store of value; and it must be generally accepted as a unit of account. In two of those functions, the dollar fulfills its role — as medium of exchange and as a unit of account. It is in the remaining function — as a store of value — that many, in both the private and public sectors, have begun to question its viability.

The Dollar Viewed from Overseas

Former Federal Reserve chairman Alan Greenspan once tellingly told Congress:

"The imbalance in the federal budgetary situation, unless addressed soon, will pose serious longer-term fiscal difficulties. Our demographics — especially the retirement of the baby-boom generation beginning in just a few years — mean that the ratio of workers to retirees will fall substantially. Without corrective action, this development will put substantial pressure on our ability in coming years to provide even minimal government services while maintaining entitlement benefits at their current level, without debilitating increases in tax rates. The longer we wait before addressing these imbalances, the more wrenching the fiscal adjustment ultimately will be ... [G]iven the already -substantial accumulation of dollar-denominated debt, foreign investors, both private and official, may become less willing to absorb ever-growing claims on U.S. residents. Taking steps to increase our national saving through fiscal action to lower federal budget deficits would help diminish the risks that a further reduction in the rate of purchase of dollar assets by foreign investors could severely crimp the business investment that is crucial for our long-term growth."

Faced with the prospect of a diminishing market for U.S. debt overseas, the Federal Reserve might exercise the other option. It could very well crank up the printing press and flood the economy with money. In the aftermath of the 2008–2009 financial crisis, a good many economists believe that we have already made a turn down that road under the Federal Reserve chairmanship of Ben Bernanke.

Many of the world's central banks, particularly among emerging countries, have begun hedging their dollar reserves in the event of a full-blown currency crisis. As a group, central banks have become net buyers of gold in recent years after decades of being net sellers — a strong signal that the disturbing trends at work in the United States have begun to affect the way nation -states handle their dollar reserves. In 2011, central banks led by Russia, South Korea, Thailand, Mexico, and Turkey purchased 430 tonnes of gold — five times 2010s purchases and the largest volume of purchases in decades. In China, now the world's largest gold producer, the federal government purchased most of its domestic production in an attempt to shore up its dollar-based reserves. Simultaneously, it should be mentioned, China held steady on its acquisitions of U.S. Treasury debt. Though not a net seller of U.S. debt at this juncture, China is not a buyer either.

We have to assume that it is in the best interest of all nations, including China, to let the U.S. dollar down gradually, because it remains the world's principal reserve currency. Most nation-states have employed a gradualist approach. However, that could change as the U.S. federal government debt and fiscal problems worsen. In fact, People's Bank of China governor Zhou Xiaochuan warned the United States in 2011 that his central bank would continue diversifying its reserves in the absence of "responsible measures" with respect to the U.S. national debt. When China does make a foray into the gold market, its operations are kept totally secret. In 2010, however, it made a rare revelation that it had quietly accumulated over 450 tonnes of gold over the previous six-year period. True to its reputation for patience and steady, long-term progress toward its goals, China had taken the golden path and now they wanted the world to know about it. Other nation-states, as mentioned above, were quick to follow suit.

The United States is on a razor's edge with respect to its fiscal and monetary policies. As the world's primary reserve currency, the dollar is required to act as a reliable store of value if it intends to maintain that status, yet successive American governments have failed to fully address the issues undermining its value. Beyond the international repercussions, a recent Washington Post poll found 73% of Americans now doubt Washington's ability to fix America's economic problems. "The spreading lack of confidence," said the Post, "is matched by an upsurge in dissatisfaction with the country's political system and a widespread sense that S&P's (Standard and Poor's) characterization of U.S. policy-making as increasingly 'less stable, less effective and less predictable' is a fair one." That assessment from Standard and Poor's accompanied its August 2011 downgrade of the U.S. credit rating.

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Excerpted from The ABCs of Gold Investing by Michael J. Kosares. Copyright © 2013 Michael Kosares. Excerpted by permission of Addicus Books, Inc..
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