If All the Gold's In Private Hands, Is a Gold-Backed Currency Possible?


Readers know from previously posted charts that gold has been a better investment than the stock market for the past seven years. Here is the "new record high" S&P 500 priced in gold, courtesy of frequent contributor U. Doran.

Please go to www.oftwominds.com/blog.html to view the charts.

Not so high as the mainstream and financial media makes out, eh?

Here is the issue in a nutshell. Forgive my brevity and all the complexity I have left out in trying to compress a deep and critical issue into a few lines.

Money supply (money created by "fiat" i.e. by government debt or printing presses) is exploding at 15%+ around the globe even as global growth is 4%. Massive expansion of money supply leads to inflation, which has been officially under-reported for years, though we intuitively know it is rising (and the bond market confirms this intuition). As a result, the cash in our wallets loses value every year.

In times of rapid growth of money supply, hard assets such as real estate and commodities skyrocket--exactly what we've witnessed over the past seven years.

Another result has been the declining value of the dollar in relation to other currencies--mostly the Euro, which is the only major currency which trades in a free market, i.e. "floats." (The yen is manipulated into a narrow trading range, and the yuan is pegged to the dollar.) If the dollar falls below the "line in the sand" of 80 on the Dollar Index, it could trigger a major decline of 30%-50%. Many observers consider this inevitable.

As the dollar weakens, investors and traders start backing away from their reliance on the dollar as a placeholder of value and as a currency used for trading. For instance, Kuwait split raises questions over longevity of the dollar (link courtesy of U. Doran).

Net result: owners of dollars (i.e. Americans and overseas owners of dollars or U.S.-denominated debt) find their purchasing power reduced/devastated. Many observers believe a pan-Asian currency will arise to replace the dollar: China, Japan, Korea on single currency unit. Many believe that any such currency will have to be backed by gold to have any "staying power."


For background on the issue of gold-backed currency, here are three links provided by U. Doran. I especially recommend the first one:

The Once and Future Money

The End Of National Currency

Gold and Economic Freedom (by Dr. Alan Greenspan, 1966)

So far so good. But as astute reader Don E. explains, there's a fly in the ointment for any gold-backed currency: most of the world's gold is in private hands:

"This idea presented itself as a problem last week when I read Anatal Fekete’s commentary on the preponderance of gold having moved from the hands of governments, central banks, to private holders. Gold Vanishing into Private Hoards.

This idea bothered me inasmuch as I began to wonder how on earth we will ever get back to a sane policy, a gold standard, where money really is money if the banks don’t have the gold to back it. Gradually I came to some understanding of the mechanics of this.

I read a lot of economic commentary, and if it is well-written and fairly simple I can follow along. You will find my own thoughts at least simple. Money is a store of value and a medium of exchange. Who determines the value of money? Those who hold whatever backs it. Presently we are in a state where money is not backed; it is all fiat currency - money by government decree only, having no intrinsic value. Who then sets its value?

Well, money, let’s just say ‘the dollar’ is not money, not any more. It is a commodity, a produced item, much like a farmer produces potatoes. As a commodity it is for sale on the open market and can be bought, at the very end of the line, with gold, with real money. Jim Sinclair likes to say that the value of gold does not change, only the value of the dollar does. I have read that many times without really grasping what it means - call me slow.

In my case it means that my pension from the State of California and the County of Alameda and the Social Security System comes to me not as real money, but as a commodity of ever decreasing value. Should those folk all send me potatoes I could eat them, and I could eat them as well in ten years as today. This is not the case with dollars. How many potatoes will my dollars buy in ten years? Not as many as today.

This brings me around to my small epiphany. It doesn’t matter if most of the gold is in private hands, because the market will always fix a value on the commodity-dollar. At least so long as this particular commodity is needed. It will be needed for quite some time as this commodity is what we pay rent, shop, buy services, and get taxed in. We will get squeezed as our personal stream of this commodity becomes worth less and less - what else is new?

But no matter who holds the gold the commodity-dollar will have some value, set by those who own the gold. Gold moving into private hands must simply be some part of the cycle of rebalancing. Do the governments finally get enough of it back to back a true-money currency? Probably sooner of later. Maybe countries where it is mined extensively, Canada?, will fill their coffers from domestic production and bring back real money.

This is most certainly not the way the various governments want it, but print and spend must have its consequence. The private holders of gold will do a much better job of keeping our money correctly valued than our governments have. Market price must trump lies. While this doesn’t bode will for those of us paid in commodity-dollars, or worse, on fixed incomes, it does have a tinge of justice to it that makes me smile. Actually, I can’t imagine why I am smiling as the burden of the printers’ deceit will fall on all our heads with traumatic force regardless of our complicity in the fraud. Down the garden path and into the weedy fields we go.

It is my family’s good fortune that we have accrued some gold in the meantime. Most have not. If I had fifty pounds of it hidden in the rafters I don’t think it would be enough at this point.

As an aside, what assets aren’t in gold are in Canada. We live in Maine and drove up to a border town a couple of years back and opened a Canadian account with some cash from the sale of a home. In the meantime we have rolled over our remaining IRA into a Canadian Broker and trade only in Canadian stocks and keep all the cash in Loonies. Our present vulnerability lies in our pensions. Our home is paid off and doesn’t really count as it is where we live and secure as such.

So, all this is pretty obvious and simplistic, but coming to grips with the idea of money as a manufactured commodity, and gold in private hands as the arbiter of this commodity’s value has somehow cleared my thinking a bit. Don E., who never promised a deep and probing analysis."

Governments can of course confiscate all privately held gold, as the U.S. government did in the 1930s. Yes, it was a crime to own coined gold or bullion in the U.S.A. It doesn't take much imagination to speculate that a nation, or perhaps many nations, could decide to create a gold-backed currency by confiscating their citizens' gold and paying them in paper for the privilege of giving their gold to the State.

Not a reassuring thought, to be sure.

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Can the U.S. Go Down and China Stay Up?

Is China "decoupling" from the U.S. economy such that it can prosper even as the U.S. sinks into debt-bubble-popping recession? Many think so, but I am skeptical.

Let's start with knowledgeable reader Peter John Golda's observations about real estate speculation in China:

"I also confirm your theories regarding Chinese real estate. I investigated this in depth, with the help of my wife and relatives up there on the East-side as I was wanting to purchase some property there. The thing that scared me the most is something you did not really mention directly in your post. Apartments are being flipped at huge profit every 6 to 12 months, sure, but what is scary is that nobody is living in them. It's all 100% pure speculation on a scale that my mind is not even able to comprehend.

The moment the gains hit 0% or less and the buyers dry up, there will be entire suburbs the size of medium European cities, packed with empty high-rise apartment blocks and nothing else. The owners, who live with their mothers and uncles and third cousins in squalor and who thus cannot really afford the apartments will be left with a big problem on their hands."

Peter also recommended Dreams Built on Sand: Investing in China Real Estate which lists eight significant (and under-reported) difficulties with real estate investing in China.
Xinglongnite added this telling comment to the article:

"Land and property development has so far been one of very few successful businesses of the local governments and their powerful officials since the beginning of 10th 5-year planning period (2000 - 2005) --- imagine a gigantic entitlement program by a US state to grant unlimited land development and building rights to every local city council member, city manager, municipal judge, sheriff and deputy, and support them with abundant bank credit. The obvious end result would be a run-away property bubble. That is what the major cities in China are heading for.
A bubble is a bubble regardless of its location or the nationality of its players. Lending is fast and loose in China, with tens of billions of risky loans being made to local governments and developers. The ability to service those loans, never mind pay them off, once the property bubble pops is virtually nil."

As I have reported previously, the "middle-class" friends of our Chinese friends in Nanjing (we have a number of sets of Chinese friends, many of whom we have known for 15 years) already owned three "investment" apartments each even back in 2004.

The bullish argument is: China needs 200 million new housing units, so all this building is "natural demand." The problem with this story is only a few tens of millions of wage earners can afford what's being built. A good two-wage family income is $600- $700 a month ( nurse and teacher) while the units being sold are $100,000+.

Sure, once the price plummets to $30,000, there will be buyers, but guess what happens to the banking sector when all those bad loans are written off as uncollectible, and to new developments on the planning boards?

The other bullish mantra is that the Chinese consumer will soon buy much of the output of its stupendous manufacturing base, so China no longer needs the U.S. consumer. On sheer numbers, this seems plausible, but if you look at reality, there is little evidence to support it.

Consider this recent story in Businessweek:

Cautious Consumers: The Chinese are on a spending spree, right? Not really. In fact, they're so tightfisted, Beijing is worried.

"But look beyond the headlines and you'll find that China's 1.3 billion people are actually buying relatively little. Although the mainland's population is four times that of the U.S., Chinese consumers last year spent just 12% of what Americans did, figures investment bank UBS (UBS ). And private consumption as a share of gross domestic product in China is falling, to less than 40% today from about 48% in 2000.

Prying open the wallets of tightfisted folks like the Xus is emerging as the hottest political topic in Beijing. Although the economy is still expanding at 10%-plus annually, China's economic mandarins are concerned that the country's growth depends too much on its soaring exports and investment in ever more factories and luxury high-rises. Exports leave the Middle Kingdom vulnerable to potential downturns in the U.S. and Europe while causing trade tensions with Washington. And too much investment threatens overcapacity in industries from steel to autos."

That pretty much refutes every bullish argument being made about the sustainability of China's current bubblicious boom.

It's important to recall that the majority of Chinese workers do not have a pension nor do they have medical insurance/coverage. The "iron rice bowl" of the pre-1978 era has largely been dismantled. So Chinese saving most of their earnings makes perfect sense.

So what happens when the property/debt bubbles burst? Will Chinese investors and consumers be hurt? Will U.S. consumers be hurt when our slow-moving property bubble finally sags under its own weight? Of course they will; it's called the reverse wealth effect, and it works in every nation and era.

Some thoughtful commentators believe Asia and Europe will grow so vigorously that they will replace the overburdened U.S. consumer as a buyer of all China's staggering output. But Europe is living off its own real estate bubble, just as we have in the U.S. As for Japan--like its EU export-dependent cousin, Germany, it's enjoying a boom based on selling machine tools and such to China's export machine. Should that export machine falter, then so too will Japan and Germany.

Bottom line: when the only consuming/importing nation goes down (the U.S.), all the net exporters will have no one to sell to. You can't all be net exporters forever.

In sum: the entire globe is living off of a debt /derivatives /lending bubble of epic proportions. When the global debt/ derivatives/ real estate bubble pops, there will be no safe ground.

Thanks to Schahrzad Berkland for suggesting this entry subject.

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A "Free Market" for Labor?

Astute reader Matthew N. had some very interesting comments on the labor market in reaction to the May 24 entry Health, Healthcare and Bankruptcy:


"Hey Charles, I was thinking about something related to your article. Lots of the downward pressure on wage growth and stagnant wages, as I see it, is from global competition. Heck I know there is someone in India that can do my job cheaper. I already compete with guys in China for what I do (architectural visualizations) ans can't really argue when a guy in China is doing my job for a couple bucks a day.

Anyways, I was reading a book by the founder of Nolo Press. He thinks some of the best jobs with good pay, are service jobs. The guys that do your lawn, clean carpets, plumbing, things that can't be produced overseas. For any service job, if you want the job done, the person hiring will have to pay local wages, wages which allow a person to live in the area of the service. He argues these jobs are on the rise.

It seems to me that many good jobs go to illegals. (I live in Southern California). The jobs that are left over are the 'jobs Americans want to do' --at least this is how it is sold. These jobs include informational jobs, where you use your mind more than your back. But those jobs are the jobs under pressure from global competition. In summary it seems the best jobs, at this time, are filled by people who get the best of both worlds. They get good cash for their work and they dont pay taxes, how does that sound? Sounds a lot better than my 'American job'. Maybe this is the 'grass is greener on the other side' syndrome, who knows."

Excellent points, Matt. I will start my comments with a chart, showing the rise of "imported labor" in states far from Texas and California.



What we see here is employers hiring immigrant labor at a furious clip. Note that this chart does not break out legal immigrants from illegal immigrants, so we have to be careful to differentiate between the two: the first are hired legally, and pay taxes. We should also note that statistics on "black market/cash" jobs and employment of illegal immigrants are unreliable.

As a Devil's Advocate observation: isn't buying illegal drugs and hiring illegal workers more or less the same thing? Both are illegal, yet the demand is high for both. In both cases, the government always tries to limit the supply rather than decrease the demand. If the poor wretched fools buying cocaine got a healthy life and stopped buying coke, then the supply (and the price) would both decrease. Yet our government has wasted approximately $100 billion of our taxes fruitlessly trying to limit the supply with essentially zero success--except to keep the street price artificially high. High fives, guys. You've accomplished nothing.

Trying to limit the supply of illegal (read cheap/profitable) workers is similarly spectacularly unsuccessful/a huge waste of money. You want to stop illegal workers? Then turn 100,000 special agents loose on the American landscape investigating employers, not their workers. Throw the employers in jail and fine them $1 million per worker per incident. You will quickly find the demand for illegal workers dries up.

Why won't this fly? Because employers are reaping immense profits paying workers $10/hour cash rather than $30/hour "total compensation" to legal workers (wages, taxes, FICA, workers comp, disability insurance, etc.) And who donates big bucks to the politicians ranting about illegal labor? The same people who are hiring the illegal workers and profiting from their black market "purchase" of "illegal labor."

Here's an example from real life--my own. Back in 1976, as a young carpenter, I was earning $7.50 an hour. According to the Bureau of Labor Statistics inflation calculator, this works out to $27.24 in today's dollars. Add in the overhead (workers comp, state disability, 7.5% FICA, etc.) and that's about $40/hour. A more experienced "lead" carpenter would be about $50/hour in total labor costs (this is without medical or retirement benefits).

The contractor's overhead and profit is on top of this, of course; thus in Northern California, contractors charge $55/hour for semi-experienced labor. This is not laborers or contractors getting rich--this is just keeping up with $7.50/hour 30 years ago and paying the overhead expenses.

Now I know semi-skilled illegal workers are paid as little as $10 - $12/hour locally--a mere 1/3 of a legitimately employed worker (immigrant or born-in-America). Do you reckon the contractor plugged his "actual cash costs" in his bid? Ha. That's the gravy, buddy--the pure profit raked in by the employer. Sure, maybe he underbid the legit employer by 5% to get the contract, but he certainly didn't price in illegal workers' actual pay scales on the bid. He put in $35/hour and pays $12/hour cash--a very sweet deal for the employer.

Consider, too, the regional differences in pay. Wages in high-cost areas of the country are, as Matt noted, higher because the worker actually has to live there. In areas of the U.S. with lower living costs, maybe the legal worker costs $15/hour and the illegal $10/hour--still a nice "discount" to the employer. But in high cost areas, then the illegal wage is maybe $12/hour, but it replaces a $30/hour wage: a much larger "discount."

How do illegal workers live in high-cost areas? they live in shabby enclosed garages, or six to a one-bedroom apartment (that rents for $1,000 or more in California). They do what they have to do to send money home to support their families. They are merely "free labor" moving through a "free market."

I expect some will argue that businesses can't survive if they paid legal wages. If this is true, then they should get their political act together and start making their realities known to the political classes. Yes, we all know running a small business in a high-tax state (on top of high federal taxes) is generally a thankless struggle. We (small business operators) pay lots of tax and get little recognition as the broad supporters of the tax base. (The corporations can flee to Delaware to Burmuda, but we're stuck here paying local taxes and fees.)

I understand this; I have been self-employed for 23 of the past 30 years. But as Matt suggests, paying cash/no taxes is a sweet deal for the employers, and a pretty good deal for the illegal workers, too, at least until it comes time to retire and they have no Social Security or Medicare benefits because they worked in the black market their entire lives. That is hardly fair or a "good deal" except for the employer who skipped out on paying the taxes.

There is one more pernicious result of employers being able to hire illegal workers freely: they lower the price of services below the operating cost of legitimate businesses. I am sorry, but I have no sympathy for employers claiming they can't afford to hire legal workers. If they stopped underbidding, then prices would rise to levels which support legit businesses.

For example: a few years ago I paid a legit tree-trimming contractor $1,200 to trim a couple of trees. It was a fair price for a legitimate contractor running a real business and paying the usual overhead and taxes. I could have found a black-market tree-trimmer for less, of course, but it was my decision to support guys like myself. That's every consumer's choice.

But should we allow black-market types to hire illegal labor for 1/3 the going price, and allow them to drive out all legitimate employers? That is what's happening. And guess what, "price-conscious" consumers-- there goes your local tax base. Now you're going to have to pay all the taxes for services yourselves, because you've destroyed the legit businesses and employers who used to pay all those taxes and fees without you even noticing it.

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The Uncertainties of Creation

Every year, tens of thousands of novels and screenplays are written, tens of thousands of songs are recorded, and hundreds of independent films are shot, often funded by credit cards. With high hopes for recognition and perhaps fame and wealth, the creators send their best work into the dispassionate maw of the Next Big Thing Machine: the talent and literary agents, the publishers, the film festivals, and the media, which now includes the Web.

Of this vast outpouring of creativity, a few thousand novels will be chosen for publication, a few hundred movies will be made, a few dozen indie films will be selected for distribution, and a few hundred musical offerings will be picked up by the major labels. The rest will be self-distributed in relative obscurity, or gather dust; most will rest in boxes until the creators relinquish their hopes, or move, or die, and then their best work, the stuff dreams are made of, to steal a great line, is carted off to the dump.

Understandably, this isn't what you're told in film school or Creative Writing programs. But nonetheless it is the truth. Occasionally some work rises from obscurity to recognition of genius at a later date (almost always after the creator dies in abject poverty, tortured by failure), but few of the hundreds of thousands of books, screenplays, songs, plays, paintings and other artwork created every year will enjoy this belated success.

So why do people persist in creating works which will never find an audience, much less appreciation? To pursue a dream, of course; hundreds of thousands of boys dream of rising to the elite ranks of the NFL or the NBA, their hopes obscuring the grindingly poor odds of joining a group of several hundred in a nation of 300 million. Others dream of other flavors of elite success: on the stage, in Hollywood, on concert tours, in literary circles.

This is an essential part of human nature: to dream, to hope and to create. Just as Schumpeter's "creative destruction" lies at the heart of innovation and wealth creation, so creative failure lies at the heart of the Next Big Thing's relentless winnowing.

There's another reason: because they have to. My friend of 37 years Gary Baker recommended the film American Splendor to me last year, insisting I see it. Now, I recommend it to you, not just as an engaging and innovatively told story, but for its depiction of a person who can't help but doodle/write/create, despite the long odds of success and his own personal eccentricities.

As Gary told me after I'd seen the film: the guy had to create. It wasn't for fame or glory or wealth (this individual worked as a file clerk for the Veterans Administration his entire career)--it's because he had no choice. This is the heart of the story, and the heart of the process. If you really have no choice, then you create not by struggling but by opening the floodgates of what fountains up within you, unbidden.

Will everyone who has no choice be blessed with success? No, just as not every pretty girl will be discovered by a talent agent while waiting in line at a supermarket. (Yes, that happens, too.) Luck is always in play, as is timing. The mood of the era and audience can suddenly change, and those who found every door slammed in their faces for years (think Andy Warhol) are suddenly famous beyond anyone's imagination, the toast of the town and indeed the world.

From this perspective, there is nothing sad about the creations which will never be read, or heard, or seen; just as a tree throws off millions of seeds and only a few seedlings sprout and grow to maturity, so it is with the arts, and indeed all human invention.

I should confess here that I completed two novels this year, after years of what passes for labor. (That is, the sort of fun which requires discipline and effort.) The odds of either being published are vanishingly small, and even if that great hurdle should be leaped, then the odds of either book finding an audience is even smaller. This is reality, and if this sober reality causes any hesitation in the creator--well, perhaps it isn't something you must do.

I must also confess to being worn out by the process of writing several hundred thousand words this past five months, plus cobbling together this site and doing the work I do to pay the bills. Like many of you, I arise early and work late; but unlike you, I am a complete idiot, and do so mostly without pay. Why? Because I have to, I guess. There's no other explanation for such supreme idiocy.

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Stock Market Needs Suckers, John Q. Public Wary

The essential feature of any stock manipulation is distribution: selling the pumped-up over-valued stock to willing (gullible and greedy) speculators. This mechanism is beautifully described in Reminiscences of a Stock Operator , (recommended by contributor Harun I.) a book I have mentioned repeatedly here as a great resource for anyone trying to understand stock market actions.

At the top of any market, insiders are distributing/selling to suckers. As I documented in The Moon's a Balloon--And About to Pop (May 18, 2007), we have abundant evidence that insiders are unloading their over-valued shares at a furious, even desperate pace.
There's just one problem for the Wall Street crowd: there's no final batch of suckers willing to take the shares off their hands! At the top of the 2000 Nasdaq tech-stock bubble, John and Suzie Q. Public were ready buyers, as the millions of IRA and 401K accounts still sporting huge losses in tech stocks attest.

But John and Suzie Q. have wised up, and are simply refusing to buy into the current rally. They seem to recall being suckers seven years ago, and aren't interested in playing patsy again. Frequent contributor U. Doran sent in two stories which document American's refusal to jump on Wall Street's bogus band wagon this time around.

Here is one Mr. Doran calls "a perfect call for a top": S&P's run: A record for a new era (USA Today)

Americans are putting 9 out of every 10 of their investment dollars into international funds rather than the U.S. stock market--a rational bet, it would seem, against the faltering dollar. So Wall Street is confounded--we need a batch of suckers, and the public is refusing to play. Yikes!

The Con Before the Storm

The insiders are now so desperate for suckers that their media toadies are rolling out story after story that are basically pleading with the public to "buy" a super-bullish scenario.

The classic example is the recent Wall Street Journal front page piece which trumpets the views of a Nobel Prize-winning economist that "this time it's different," and that the global growth and easy-wealth-generation machine isn't about to explode, it's about to enter an era of permanent happy-happy times--But only if you cave in and buy my over-valued shares today!

Why Market Optimists Say This Bull Has Legs:

"Vernon Smith, a Nobel laureate economist, is so bullish on stocks that he's put money in small drug companies -- investments he "wouldn't have touched in the late 1990s," he says. Louise Yamada, a longtime Wall Street market analyst, sees the Dow Jones Industrial Average climbing to 16000 as part of a bull market that she compares with the post-World War II boom. Fritz Meyer, who develops investment strategy for AIM Investments, a $149 billion money-management group in Houston, sees stock gains stretching as far as the eye can see."

It must be very frustrating for the insiders. Here they generate a massive rally, and nobody believes it's sustainable. Dang, how could they tell? The insiders and their media toadies are literally pulling out all the stops to keep the market rising upward and the "story" compelling:

short interest is at record highs, which means those shorts covering will boost the market higher.
China's in a decades-long boom--but their stock market really doesn't matter (said when it's crashing) because it's only 1% of global capitalization
China's market matters (said when it's skyrocketing) because it's fueling the middle-class wealth of China
Slower growth in the U.S. means the Fed will soon lower interest rates (repeated ad nauseum for the past 9 months and still not true)
Growth is picking up which will feed higher corporate profits (never mind the above story-- just believe one of the bullish stories, please!)
Consumer spending is up even as consumer income is down. (Hey, we can't really spin that into a positive, so let's just say the consumer is indefatigable!)

So who is buying the rally? The insiders. Here's why and how. Say you're an insider and want to sell a vast horde of your free stock-option shares. You are your pals push the stock high enough to generate interest, then you place bullish stories in the mainstream media. The public buys the con and you unload your shares. But the public is refusing the con. So you move to Plan B.

What's Plan B? Buy your personal shares with corporate "buy-back" money. Yes, buy it from yourself, but with other people's money. Corporate buy-backs have hit an unprecedented high over the past three years: corporations have bought back hundreds of billions of shares of their own stocks.

Was this really the best "investment" of shareholder cash? Were there no investment opportunities in the whole wide world that were better than your own shares? Not if you needed a buyer for your own shares. How about giving the shareholders a huge cash dividend? No way--we make the big money by unloading our free shares. And if we have to use corporate cash to do so--hey, why not?

The insiders are still hoping to con the public into playing sucker, and the recent rise of the S&P 500 beyond its March 2000 high seven long years ago is the perfect opportunity to trumpet the amazing profit potential of buying shares at the top. But consider this chart of the stock market in previous Bull Markets, and note what happens seven years after the collapse of the bubble:

please go to www.oftwominds.com/blog.html to view the charts.

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