Keep Your Head above Dollar

By Peter Schiff

There has been so much discussion recently about “QE 2” that you would think the entire financial sector were about to embark on a transatlantic cruise. Unfortunately, they, and we, are not so lucky. In the year 2010, “QE 2” doesn’t refer to a sumptuous ocean liner, but a second, more extravagant round of “quantitative easing” – stimulus. In the past, this technique was simply called “printing money.” As if the nation has not already suffered enough from the first round, Captain Ben Bernanke and the Fed are determined to compound the damage by hitting us with another monetary juggernaut. Their stated goal is to boost the economy and create jobs. However, since economic growth cannot be achieved by printing money, their QE 2 will sink just as surely as the Titanic.

Fed Mandates Inflation

By Peter Schiff

Much of the content of the latest Fed statement, released on September 21, echoes the central bank’s previous post-credit crunch pronouncements: there is still too much slack in the economy, interest rates are still going to be near-zero for an “extended period,” and the Fed will continue to use payments from its Treasury purchases to buy yet more Treasuries. But this recent statement uses a new turn of phrase that should have Americans very upset. The Fed says that “measures of underlying inflation are currently at levels somewhat below those the Committee judges most consistent, over the longer run, with its mandate.” Though the wording treads lightly, it should not be taken lightly. It may signal the final push toward dollar collapse.

The Fed’s dual mandate, since an amendment in 1977, has been to promote “price stability” and “maximum employment.” While often discussed as if both goals are complementary facets of one mandate, they tend to have been at odds during every recession since the Great Depression. The problem is that central banks tend to keep interest rates too low for too long (usually to create a feeling of prosperity credited to the government), which then causes major asset bubbles. When the bubbles pop, there is a period of high unemployment during which prices are supposed to fall. Then, the central bank must choose between boosting short-term employment through inflation or defending price stability by allowing assets to return to a reasonable market value. Aside from the early 1980s chairmanship of Paul Volcker, the Fed has always chosen more inflation.

But they’ve never admitted it.

The Fed statement said, “inflation is likely to remain subdued for some time before rising to levels the Committee considers consistent with its mandate.” Notice that there is no mention of a deflation threat here — as quantitative easing has effectively quashed that possibility — but rather “subdued inflation for some time.” The Fed defines inflation differently than I do, as an increase in consumer prices rather than the amount of dollars in circulation. By my definition, massive inflation has already been created, which is reflected in the fact that prices for houses, consumer goods, stocks, and bonds haven’t fallen steeply and stayed down since the dot-com and mortgage bubbles popped. But even by the Fed governors’ definition, they acknowledged that we are experiencing inflation — just not enough for their taste.

Apparently, according to the renegade policy of the Fed, we’re not paying enough for food, energy, clothing, healthcare, or education. No matter that nearly 20% of the population is unemployed or underemployed, that each US taxpayer’s share of the federal debt is now some $121,000, or that average tuition at a private university is set to rise 4.5% this year to $27,325. Apparently, these factors do not affect “price stability.”

Some might say that a certain amount of inflation must be permitted when unemployment is so high — that the dual mandate involves trade-offs. If that were the case, then when we were in a boom period like the ’90s or mid-2000s, the money supply should have been shrunk. Also, there is ample evidence that falling prices during the Great Depression actually provided life-saving relief to the unemployed. The truth has always been that whatever the question you ask the Fed, the answer is inflation. With prices drifting steadily upward since its establishment in 1913, I dare to ask: has the Fed ever achieved its dual mandate?

The market has certainly lost any hope of price stability in dollar terms. Since the Fed statement was released, gold prices have hit new all-time nominal highs, silver is the highest since the Hunt brothers tried to corner the market in 1980, and the Aussie dollar (a commodity currency) is nearing its own record highs. Even housing is headed back up. Meanwhile, the dollar index has hit a new 7-month low. In short, holders of US dollars are trading for any real assets they can acquire.

A confounding factor is the strong performance of US dollar-denominated bonds. When the Fed creates inflation, that erodes the value of fixed-asset investments like bonds, which can’t adjust their returns to the new price level. So many commentators are pointing to the record low bond yields as evidence that inflation is not a threat. But this is a misreading of the situation. What is overlooked is that when the Fed prints more dollars, it typically uses them to buy bonds. Traders know this, so they are stocking up on bonds at ridiculous prices just to flip them to the Fed. They don’t care that, in the long run, the Fed’s policies will destroy the bonds’ value because in the short run, the weak dollar policy serves as a tremendous subsidy to bond sellers.

All the salient indicators tell me that the global dollar crisis has entered a new phase. The Fed is getting more aggressive about money printing because it really doesn’t have any other politically viable options. I’ve always said the Fed uses inflation to give appearance of prosperity, but I never expected them to come out and say it. You don’t give warning when you’re about to rob somebody, because then the victim might take precautions — in this case, buying gold and foreign equities. We should be angry at what the Fed has pledged to do to us, and frankly I’m surprised there hasn’t been more of an uproar. But more important is to figure out how you are going to protect yourself.

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What’s Holding Gold Back?

By Peter Schiff

Gold first broke $1,200 on December 2, 2009; nine months later, instead of witnessing the birth of the full-on gold boom I have long anticipated, the yellow metal has gained a modest 4%. Fortunately, it has spent the summer solidly above $1,150, which should put to rest the claim that we are seeing an exponential gold bubble like we saw in 1980. And those waiting for the “big pullback” to $8-900 might be seeing the futility in their cause. But I never doubted the strength of this secular bull market. In fact, I still maintain that gold is grossly undervalued. So, what’s holding gold back?

First, it’s important to account for the season. While everyone is at the beach, on their boats, or switching apartments, very few are out buying gold. June and July have always been low-volume months in the gold market. August tends to pick up a bit, and then by September, we’re off to the races. The fact that gold hasn’t had a major pullback this summer is very bullish for the fall.

The Golden Decade

By Peter Schiff

As gold hovers near $1,200 an ounce and pundits speculate about a ‘gold bubble’, it’s important for investors to remember that a mere decade ago the picture was very different. In the year 2000, gold sat at an unimpressive annual average of $279 an ounce – a two-decade low. At that time, most analysts thought gold was finished as a monetary metal. They said its price would never recover and only kooks with tin hats would invest in it. I was one of the very few financial commentators publicly saying that gold was not only viable, but entering a long-term uptrend.

With the benefit of hindsight, we can all see that the consensus was wrong. Gold has performed remarkably against the Dow, NASDAQ, and US real estate. The reason I was able to confidently forecast this result is because I ignore the ‘certainties’ determined by Wall Street consensus, and instead study the fundamental trends.

2000’s – The Great American Century?

Ten years ago, the United States was the world’s largest consumer of energy, house prices were steadily appreciating nationwide, the government was running a budget surplus, and there was widespread consensus that the world had entered a period of Pax Americana – stability brought about by permanent US dominance.

Overseas, the euro was just getting to its feet, no Western country could even imagine facing default, and the only BRICs anyone had heard of were the ones used to build houses. These circumstances were extremely bearish for gold, especially as the dollar was at a multi-year high against other major currencies.

But I correctly perceived that this grand tapestry would quickly unravel.

The Tortoise & The Hare

China started moving toward a market economy in the late 1970s. In the ensuing decades, their economy grew exponentially as more than a billion people won the economic freedom to compete in the world economy. While others were stuck in the Cold War mentality of the US versus the Soviet Union, where the Soviets’ collapse guaranteed America’s perpetual dominance, I was paying attention to this Chinese freight train that was gaining on us at a million miles an hour.

I saw that while the entire Third World was embracing capitalism, the West was embracing ever more lavish entitlements, ever more debt, and was using inflation to pay for it all. Developing economies were buying many of these new dollars, thus keeping the dollar index deceptively high; but all chickens come home to roost and I knew this inflation would come back to haunt us.

Moreover, all the money printing was creating tremendous distortions in the domestic economy – first the dot-com bubble, then the housing bubble, then the financials bubble, all the way to the current Treasuries bubble.

2010 – The Great American Collapse

Today, China is the world’s largest consumer of energy, American house prices are at generational lows, Washington is running deficits in the trillions (an order of magnitude used only sarcastically back in 2000), and the United States is suspending military exercises because they might upset the Chinese government.

Since 2000, the euro became the world’s backup reserve currency, Iceland’s economy collapsed, Greece averted this fate only by the grace of its neighbors, and savvy American investors have turned to the BRICs for growth and preservation of capital.

This transformation of the global economy, and the turbulence that accompanies it, has been bullish for gold. We have now seen the yellow metal reach new nominal highs, causing former critics to go silent for awhile, then re-emerge claiming there is a ‘gold bubble.’

Bubble or Bull?

In response, I will return to the only strategy that ever matters to long-term investors – analyzing the fundamentals. The truth is the fundamental trends haven’t changed.

The US government continues to add new spending programs (Obamacare, homebuyers tax credit, extended jobless benefits) and new regulations (1099s for small transactions, bank taxes, credit card fee limits), undermining our competitiveness and driving us deeper into debt. Though the euro has grown up somewhat, it is still too young and too troubled to take the place of the dollar as the world’s reserve. The Chinese government has maintained a counterproductive peg between the yuan and the dollar which is only beginning to be relaxed. This process would have to be completed before the Chinese currency could win reserve status.

In short, the dollar is closer than ever to collapse and there is no other national currency ready to take its place. I believe the world may soon discover that there is no better alternative than history’s proven money – gold.

Some of you might be familiar with these arguments, and say they are old hat. The same Wall Street analysts who missed the dot-com bubble and the real estate bubble are now warning that gold has already had its run up and is way overvalued. However, they were making this same argument back in 2006, with gold at $600/oz.

Meanwhile, in April of that year, I wrote a commentary with a few personal observations: none of my mining stocks had split, precious metals investors were not rubbing shoulders with real estate moguls or dot-com millionaires, and I was still running my gold investment division with only one employee. On TV, Flip That House wasn’t followed by Deal That Gold. My taxi driver wasn’t offering me hot bullion tips. In fact, nine out of ten people you stopped on the street couldn’t even tell you the current price of gold within $200! And that’s still the case today.

A Healthy Appetite For Gold

A decade after gold started its current bull run, we are still at half its inflation-adjusted peak. The run-up has been slow and orderly, with the price consolidated over the last three months at around $1,200. Dips like the recent drop below $1,160 have been correctly identified as bargain buying opportunities.

Despite a long rally without a major reversal, Wall Street aurophobes still refuse to see gold as a good investment; but they were wrong on the fundamentals in 2000, and the fundamentals haven’t changed. As the world edges closer to the collapse of the US dollar system, gold prices have nowhere to go but up.

I continue to recommend that investors hold five to ten percent of their wealth in physical precious metals. Aside from the likelihood that gold and silver will rise in price, precious metals offer timeless benefits, such as financial privacy, elimination of counter-party risk (if you store them yourself), as well as protection from government confiscation, onerous securities regulation, and punitive tax rates.

Unfortunately, there are a lot of scammers out there who take advantage of rational interest in gold coins to sell people irrational investments. That is why I am so proud to finally offer a straightforward, ethical, no-gimmicks way to buy gold and silver coins and bullion, Euro Pacific Precious Metals. My company does not sell numismatics, proof sets, commemoratives, leveraged contracts, or any product that distracts from our goal: preservation of your capital. I encourage you to add precious metals to your portfolio now, because those waiting for a big correction before coming aboard may just miss the train entirely.

Follow us on Twitter to stay up-to-date on Peter Schiff’s latest thoughts: @SchiffGold
Interested in learning about the best ways to buy gold and silver?
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