Why Gold?

From about 1815 to 1915, all the major currencies like Pound, Franc, Dollar, Mark etc was gold backed. This meant their exchange rates were also linked to gold. One Dollar would be defined as say, 1/30th of an ounce of gold. Pound was say, 1/6th of an ounce of gold. Therefore the exchange rate between USD and Pound would be $1 = 0.2 Pounds.

This was simple mathematics and it made sense. If you had $30, you can take it to a Bank and demand 1 ounce of Gold. The banks were obliged to keep gold reserves. They were fully solvent.

First world war changed this. Urgency for financing the war gave way to partial gold back-up. Governments started printing currency notes without gold back up.

Thus, currencies became partially gold based. They became non-convertible (to gold) nationally. But internationally, gold back-up continued. All transactions between international banks, exports etc were backed by gold.

Even this partial gold base prevented countries from printing paper money. How?

Lets say one country prints paper money to boost their domestic money supply. What will happen?

As money supply increases, prices will rise. It would be much cheaper to buy imported goods than to produce. Import would mean outflow of gold. As gold reserves are limited, they will be forced to keep this in check and look for efficiency in production or reduction in money supply.

Simple, isn't it?

If the world had kept gold standard, the economic growth as we see today would not have happened. But the growth would have been more natural and organic.

Fractional reserve banking system was the steroid. It lead to credit creation. $1 million in printed currency based on $10000 gold reserve would become $10 million in credit. This credit would drive the economy. So, $10,000 became $10 Million.

Worldwide, especially in the western world, all the governments are used to this opium of fiat currency. They are addicted to it. The parasite took over the host and became the host itself. Gold gave way to paper.

What is finance? It is just a way to facilitate the meeting between capital and the generation of goods and services, which we call economy. But, now finance is the king. Real capital and real economy - for which we introduced finance - is forgotten. In the U.S, all the growth in the last 25 years has been in finance. Clever guys created instruments called derivatives which could be based on the price of anything from pepper to oil or the thickness of your backyard grass. The turnover of these derivatives were higher than the turnover of actual commodity or instrument they supposedly represent.

It is a bit like self-fulfilling betting results. I will explain.

Imagine you are a part of a vast digital network of gamblers, numbering in the millions. You are betting your substantial portfolio on the results of a general election happening in your country. There are two candidates - X & Y. You see that in the betting market, X has more odds, meaning the betting market expects Y to win. Even though ideologically you are with X, you want to win and hence you bet on Y. Now that you are committed, you will make sure that not only you, but all your friends and relatives vote for Y on the voting day. The betting market now influenced your real life.

We forget why the betting market was skewed to Y in the first place. It is because big money got there before you did and made it look like a win situation for their man Y. You were part of the crowd lead by these pied pipers.

This is what happened in the case of oil last year. Large business houses were betting on it, driving the real price up. It happens to commodities, your food, real estate, anything and everything. Warren Buffet calls these derivatives "financial weapons of mass destruction".

Niall Ferguson, the famous economic historian, wrote an article in Vanity Fair in 2008:

"We have witnessed the death of a planet. Call it Planet Finance. Two years ago, in 2006, the measured economic output of the entire world was worth around $48.6 trillion. The total market capitalization of the world’s stock markets was $50.6 trillion, 4 percent larger. The total value of domestic and international bonds was $67.9 trillion, 40 percent larger. Planet Finance was beginning to dwarf Planet Earth"

The facilitator became larger than the deal. Parasite became bigger than the host.

Let us come back to gold. Do you know that there is a big gap between the supply and demand of gold? The total world wide demand for gold is about 4000 tonnes per annum. The supply is only about 2500 tonnes. But then, why aren't we seeing the price rise in gold that it actually deserves? Who is filling this gap? Who is keeping it down artificially? What is their purpose? How do they do it?

I know the who part. It is western central banks and the U.S Federal Reserve.

Why? Beacuse this is very vital to their strong dollar policy. The low price of gold has a sort of a calming effect in the economy. To maintain the illusion that that the paper you are holding is valuable. Not to cause a flight towards the precious metal. Which would be disastrous and destructive now.

How? I actually do not know. May be they are selling it from their reserves. Deceit has its own ways. You will get more answers when Ron Paul's bill to audit the Fed passes in the Senate.

For 6000 years, mankind held gold as valuable. All these years what we have managed to dig out is about the size of a 20m cube - about 140,000 tonnes.

Here is how I see it. This may be crazy - may be there is no scientific basis. But this is how my mind works. I am just a common man. Prove me wrong if you can.

If this were the original and only money, this should represent that $48.6 trillion that Niall Ferguson was talking about. I mean what the world is truly worth. Any growth would be offset by additional mining of gold.

Now I do my math. You will not find this anywhere. It is my original thought.

I will round things up. $48.6 trillion to $50 Trillion.

$50 Trillion divided by 140,000 tonnes should give me intricate value of gold per tonne. $50*1000*1000*10,00000 divided by 140,000*1000*1000. Then you multiply the result by 31.1034768 to convert it to $ value per ounce.

This works out to be about $11,108 per ounce of gold. This is the real intrinsic value. The current value is about $900.

Add the frenzy on top and on a speculative day, it could go to $20,000 per ounce!! People are mad, they are crazy. You can't predict what will happen once hell breaks loose. There simply aren't any financial or economic models available.

As the D-day approaches, you will see a sudden plunge in the value of gold. I bet my dear life that this will happen. That is only a red herring. Big money is trying to make you sell so that they can buy it at low value. Don't be disheartened. Keep buying. It should pay off.

Therefore, I am with 6000 year history. Not with a piece of paper invented about a couple of hundred years back. I want to make sure I am holding the real asset at the time of reckoning. My minimum point of argument would be not to look like an idiot at the crucial time. I don't want to get caught swimming naked when the tide turns low.

What about you?

All about Dollar

U.S Dollar is going through its most critical phase now. It is facing an unprecedented test of confidence. All these years, U.S was exporting paper ($) and importing real goods. This may come to an end soon.

Lets study the history of the mighty dollar first. Dollar was fully pegged against gold from 1800's onwards. An ounce of gold was worth around $20. This price never fluctuated much till 1970's - mostly it was in $20-$22 price band. Thus, for nearly two centuries, the value of the dollar remained stable against the gold.

Then, the most infamous president in U.S history, the most crooked of them all, Richard Nixon, removed the gold standard and made it a fiat currency - well not quite - he pegged it against the oil. In a masterstroke, he laid the foundation of dollar imperialism by forcing the biggest oil exporter in the world (Saudi Arabia) to trade its oil in dollar.

That single act changed everything. Dollar became the world's most preferred currency. If China wants to import oil, they have to pay in USD. Not in any other currency. They have to earn USD first by exporting goods to U.S.

This is the reason why no central bank in the world wants their currency to rise against the dollar. China is artificially controlling the value of yuan so that it will not rise against the dollar. If it does, well - it actually is - it will be expensive for the U.S to buy goods from China and China won't get dollar through export. And if it doesn't, China won't be able to buy oil.

Through that single act, U.S managed to get an unlimited credit card. A card for which there is no repayment - not even a minimum amount due.

U.S had gone a step further with oil exporting countries. Not only they have to accept USD as the trading currency, but they will have to invest the proceeds - USD - into U.S treasury bonds. U.S will use the interest on those bonds as a return for lending them their military and other technologies - for example construction.

This is called petro-dollar recycling. U.S will print this worthless papers called treasury bonds, sell them to these suckers and the suckers will feed U.S with their resources. By suckers I mean every other country on earth.

Then U.S went one step further. If anyone steps out of the line (like Saddam did - he tried to trade oil for Euro), they will use military force. And how does U.S feed this most destructive force on Earth? With your money!!

It is estimated that the recent bailout of U.S economy cost anything between 12-15 trillion dollars. How did they get the money? They just printed it. Conjured it out of thin air! None of those trillions went into real economy like commodities or other goods and services. All of it had gone to financial services - mostly false economies. It went to those who had made a casino out of U.S economy - who literally blackmailed U.S Government with the threat of bankruptcy.

This is not the end of the story. Worse is not over yet. U.S will need another infusion of trillions of dollars. We have only seen the beginning.

Citibank recently reported a profit after the bailout. I am not sure about the numbers. But it was pathetically clear that it was done to boost the share price. Months before that profit announcement, the regulators amended an accounting treatment to suit Citibank.

Suppose you have an investment for $250 Million dollars in some bonds or fancy financial instruments. The current market value of it is $1 Million. The old accounting practice was mark to market - meaning you are supposed to record the market value and write $249 million loss to your P&L. This is conservative, sensible accounting. If I am not mistaken, in India, the norms are tighter. If the market value has gone up to say $500 million, still you will record it at $250 Million. You are not allowed to show the notional profit in your P&l, unless you actually gain the profit by physically selling the investment.

Do you know what U.S Government did? They invented a new accounting method. Even if the value of your investments fell down by 99%, you can still value it at its original cost or even higher, depending upon what a computer model predicted as its potential value. Translated into layman's words - never trust the balance sheet of any U.S Bank from now on.

Why did the U.S government allowed this? Because they are the biggest shareholders of Citibank. They wanted Citibank's share price to go up at any cost. They wanted the Federal Reserve balance sheet to look healthy now that people like Ron Paul are demanding a Federal Reserve audit.

Do you know how the balance sheet of the Federal Reserve will look like?

On the liability side, $15 Trillion. On the assets side, companies like Citibank, Fannie mae, Freddie Mac etc.

How do you think a Country which borrows $4 billion a day will be able to pay back these trillions? If I were the creditor to U.S, what would I do? I would try to find out an ingenious way to come out of this s*it.

That is what countries like China, Saudi and Japan are doing. They are all thinking hard to come out of this unscathed. If dollar loses its reserve currency status, all these creditors would lose trillions because the treasury bonds would become worthless. Not that it already isn't.

There could be 3 situations. situation one - the bullet become larger. Somehow, all these will subside and we all wait for the next bubble to burst and then the bailout becomes much, much larger and eventually uncontrollable. Instead of biting the bullet now, you bite an cannon ball later and die.

Situation two - all these U.S debts would be consolidated in a bank like IMF as SDR's - special drawing rights. That would mean that instead of dollar, international transactions would be in some other form like the SDRs. I have an inkling this is the way things would eventually go.

Situation three - Instead of spending, U.S begins to save. Instead of importing stuff, they consume less and begin to export stuff. This would mean a 180 degree turnaround - a complete U turn. Unless the rest of the world sees a clear, tangible shift towards this, most likely it would be situation 1 first and then situation 2.

In situation 2, USD would be worthless and U.S would be indebted in some other sensible global currency forever. Hyperinflation would hit U.S economy. In comparison Zimbabwe (inflation - 1000000%) would look like a rich country.

The problem with one country controlling the reserve currency is that unless that country shows fiscal responsibility, the rest of the world suffers - of no reason their own. Like Iceland did. Like the rest of the world suffers now.

To my friends in U.S and elsewhere : switch your investments to Gold or real estate in an asian country like India. India's economy is really unique. Exports form only 20% or less of our GDP. Our domestic economy is one of the strongest in the world. Holding onto your USD or related instruments, you are taking the risk of your life.

You can make money out of this. Short USD and go long on gold.

Peter Schiff tells us a story about asians and an american in an island:

"Some people that got stranded on an island, and I think it was 6 or 7 were Asians and there was one American and as soon as they were on the island they had to divide up the jobs. And one Asian was given the job of fishing, the other one was hunting, one of them got the job of gathering fire wood. So they all had jobs, and the American was assigned the job of eating. And so at the end of the day, they would all gather around and prepare this feast and the American would sit there and eat it. But he would´nt eat it all, he´d just leave enough crumbs so he could give to the 6 Asians so they could go on and repeat it again tomorrow, spend all day preparing a meal for the American to eat. Now, the way modern economists would look at it, they would say “Well, this American is vital to the whole island economy. Without him nobody would have to fish, nobody would have to hunt, nobody would have to gather fire wood. He is creating all this employment on the island”. But the reality is, every Asian on that island, his lot in life would be dramatically improved if they kicked the American off the island because now they would have a lot more to eat or maybe they wouldn´t have to spend all day hunting and fishing and they can lay on the beach a little bit”

Thats the silver lining of the whole thing. If the dollar collapses, the rest of the world may face a temporary crisis. But the living standards for the rest of us would be much, much higher. Asian countries would be the biggest beneficiaries.

Lets kick this cancer out before it is too late.

Note: Please also see my earlier post on the subject: http://sydneymurugan.blogspot.com/2009/01/why-we-carry-you.html