May 23, 2003

The price of gold jumped up another $5.70 on Wednesday, bringing June contracts to $372. In 1999, for reference, the price of an ounce of gold was as low as $254. Investors have made nearly 50% on their money over the last 4 years.

Still, we can't remember the last time someone called at home, during dinner, and asked if he could make a few recommendations for gold investments. We've heard a lot of absurd pitches from Wall Street's cold callers, but none suggested he could make us rich in gold.

So far, only gold bugs have gotten excited. Most people think buying gold is as strange and subversive as reading the Constitution. They think investments are supposed to make them rich and they can't imagine how an inert metal could do that. It has no 'can do' corporate managers with their mugs on the cover of BusinessWeek...and no CFO to rig the numbers. It has no new fact, it has no product at all. There is nothing to talk about, nothing new to admire...and no one to persuade you what a wonderful investment it is.

Half of American households are said to own stocks. How many own gold? How many would even know how to buy the stuff? You can't call your broker and tell him to get you some gold. He wouldn't know what to do. And the experience of going into a coin shop, for most people, is like going into a massage parlor. You don't want to do it in your home town; someone might see you.

George Soros says he's buying gold, as well as non-dollar currencies. Asked why, he remarked that he is only doing what U.S. Treasury Secretary Snow seemed to suggest. Soros is known as the "man who broke the bank of England." That was 10 years ago, when he bet heavily against the pound, despite assurances from the British government that the pound was secure. Now it is the dollar that Soros is selling...and U.S. officials who try to soothe the markets.

And now it is the dollar that falls.

At the same time - as if to confound economists - the developed world inches towards deflation. Inflation rates, broadly speaking, have been coming down for the last 20 years. Japan, 10 years ahead of the rest of the world, has seen its consumer prices fall 7% since 1995.

How can it be that the dollar falls in value on international currency exchanges, while it seems to be gathering strength at home?

You see, dear reader, poor John Snow is not to blame for the dollar's fall any more than Alan Greenspan deserved the credit for its rise. Today, we let the cat out of the bag ourselves -- the dollar is going down, no matter what U.S. monetary officials say.

Decent men and women are not normally interested in the working of the international monetary mechanism anymore than they are interested in the workings of the digestive tract. We wouldn't blame them for setting aside today's column in disgust or boredom. But there is a time and place for everything. Suddenly, the world's money system is in the news...and at risk. Readers are urged to send the young and weak out of the room...fortify themselves with a shot of whiskey ...and continue reading. It isn't pretty, but it is necessary, sometimes, to understand how these things work.

There was a time when America had honest money. Both the Gold Standard and the Bretton Woods agreement required nations to settle their debts in real money --- number 79 (pls check) on the periodic table -- which none of them could create at will. Even in its late, corrupted version, under the Bretton Woods agreement, international accounts could still be settled in gold. If a country bought more from abroad than it sold, it could be forced to make good the difference in metal. America might have the dollar. Germany might have the mark. But the world's money was gold.

Then began a remarkable chapter in the history of monetary chicanery. The Nixon Administration 'closed the gold window,' at the Fed, meaning that foreign nations could no longer turn in their excess paper dollars in exchange for gold. The Dollar Standard was begun. With no access to gold, nations settled their international trade and currency imbalances in dollars...and built up dollar reserves, in place of gold reserves, for that purpose.

During the 20 years of the Bretton Woods agreement -- 1949 to 1969 -- total international reserves -- money held in central banks to settle accounts and protect the currency -- went up only 55%. Since then, the increase has exceeded 2000%, most of it coming since Alan Greenspan took over the Fed in 1987.

The Fed did not merely increase the supply of dollars in the U.S. -- it increased the entire world's money supply, which set the wheels of international commerce turning. So fast did they turn that a pile-up on the highway of the globalized economy was almost inevitable.

Richard Duncan explains:

"This explosion of reserve assets has been one of the most significant economic events of the last 50 years. Today, Asian central banks hold approximately $1.5 trillion in US dollar- denominated reserve assets. Most of the world's international reserves come into existence as a result of the United States current account deficit. That deficit is now $1 million a minute. Last year, it amounted to $503 billion or roughly 2% of global GDP. The combined international reserves of the countries with a current account surplus increase by more or less the same amount as the US current account deficit each year. So central bankers must worry not only about their existing stockpile of dollar reserves, but also about the flow of new US dollar reserves they will continue to accumulate each year so long as their countries continue to achieve a surplus on their overall balance of payments."

Since the breakdown of Bretton Woods, the U.S. has been able to do something that other nations could only dream of; it could settle its debts in 'money' that it could create, as Fed governor Ben Bernanke recently explained, at near zero cost. The rest of the world could sell as much as they wanted to the U.S. -- on credit, which Americans could by creating more dollars.

What a marvelous system this was! And not just for Americans. In fact, while they appeared to be its greatest beneficiaries -- for weren't they getting something for nothing? -- they were actually its biggest victims.

Daily Reckoning

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