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Richard S. Appel: Gold bugs, be careful about what you wish for

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  • GATAComm@aol.com
    By Richard S. Appel Financial Insights November 4, 2004 www.financialinsights.org Many investors and traders who have a keen desire for higher gold complex
    Message 1 of 1 , Nov 4, 2004
      By Richard S. Appel
      Financial Insights
      November 4, 2004


      Many investors and traders who have a keen desire
      for higher gold complex prices believe that it will be
      wonderful when gold finally breaks free from the
      shackles that have long restrained it and soars
      wildly higher in price. Some of these individuals
      believe that gold is headed toward $600, while others
      can barely contain their emotions believing that the
      sky's the limit.

      Many of these excited souls ponder the extent of their
      future wealth when the noble metal ultimately surpasses
      its earlier $875 high set in 1980 and soars to the $2,000,
      $3,000, or even $4,000 level that certain conditions may
      ultimately justify.

      Unfortunately, few direct their thoughts to even remotely
      consider the events that must first unfold in order to propel
      gold to these mind-boggling prices. Further, far fewer have
      any understanding of the consequences to our great
      nation and its citizenry, themselves included, that will result
      if these underlying driving forces truly play out and propel
      the eternal metal to the untold heights that they believe are
      its fate.

      I feel that the majority of gold community members who
      believe that the yellow metal is destined to greatly rise
      subscribe to the belief that the dollar will sharply fall in
      parity against the currencies of our international trading
      partners. They rightly recognize that our current account,
      balance of payments, and fiscal deficits cannot be
      sustained, and will one day prove damaging to our nation.
      They give lip service to the recognition that at some point
      other countries will demand a real form of payment for the
      valuable goods and services purchased by our country,
      rather than continue to solely accept declining dollar
      credits. Yet these gold community members avoid
      believing what they see when they gaze into the future.

      It has been incredibly beneficial for America to possess
      the world's reserve currency. Our officials learned long
      ago how to use this condition to their advantage. It
      provided our Federal Reserve with the ability to literally
      create dollars at will, without the need for our inhabitants
      to be similarly productive as did all of those who supplied
      us with their wares. Heretofore, controlling the reserve
      currency came with the responsibility to maintain its
      integrity and value. This was the case for decades
      because it benefited international trade and fostered both
      a strong American economy and financial system.

      Unfortunately, for various reasons this goal has been
      abandoned. At the forefront of these, is that possessing
      the world's primary currency allowed our country to
      become supported by the sweat and efforts of those
      toiling in faraway lands without our giving them anything
      of value in return. All that was necessary was to create
      dollar credits literally from thin air, and use them to pay
      for our foreign purchases. Sadly, this state has caused
      America to become accustomed to living far beyond its
      means. This, without the knowledge, recognition or
      understanding of this true underlying reason by most
      of our fellow citizens.

      The enormous and increasing U.S. budget deficits, on
      the other hand, are similarly unsustainable. To date,
      countries such as Japan and China along with the
      European Union members have helped fund these
      deficits. They acquired Treasuries with the expectation
      that the dollar would maintain its value, and gladly
      purchased our bills, notes, and bonds with the belief
      that they made a wise investment. History taught them
      that when they desired to sell these assets they would
      not only receive a similar or greater amount of their own
      currency in return, but would also gain interest on their
      holdings in the interim to boot.

      They were in for a shock.

      I believe that gold is quite undervalued. To my mind the
      purchasing power of an ounce of gold is far greater than
      the current $425 for which it sells. However, in order for
      gold to trade far in excess of the $600 or so that I feel
      conditions currently warrant, a number of events must
      first transpire.

      The United States has been riding the crest of a growing
      tidal wave since 1971. This began when President Richard
      M. Nixon "closed the gold window." That infamous day
      occurred in August when I was honeymooning in Europe.
      During the ensuing week or so after the announcement I
      could not exchange more than a $20 bill or traveler's
      check for any local currency. It was that fateful
      announcement that removed the final vestige of gold
      backing from the dollar. This opened the door to an
      unconstrained issuance of paper money, and later
      electronic dollar credits, by our Federal Reserve

      Throughout the subsequent period our country became
      increasingly dependent on the rest of the world's
      generosity, or, some say, naivete. Initially, they
      bought our Treasury paper with the expatriated dollars
      that flowed from our land in exchange for their products.
      This helped fill the gap and largely paid for our
      government's chronic fiscal deficits. Later, our ever-kind
      trading allies gladly accepted our readily produced dollars
      in exchange for their valuable services and goods. They
      were thrilled when the dollar soared in value on
      international markets between 1995 and 2001, and
      barely batted an eye when the greenback reversed
      course and began its present descending path.

      We have all heard the euphemism that "the U.S.
      pretended to pay foreigners with dollars and they
      pretended to be paid." In truth, it became a symbiotic
      relationship. The U.S. government found a way to
      finance its growing deficit-spending propensity, and our
      trading partners required an eager outlet to sell their
      goods and services. This in turn helped improve their
      economies, their employment rates, and the standard
      of living for their citizens. It also helped keep their
      leaders in power.

      The result was an unprecedented explosion in both
      global economic growth and the creation of U.S. dollar
      credits. Unfortunately, just as it appears that we are
      in the twilight of the world's greatest economic boom,
      we are also at the dawn of what will likely become the
      demise of the heretofore almighty dollar.

      At some point, one by one, our trading partners will balk
      at being reimbursed with dollars for delivering their goods
      onto U.S. soil. The likely trigger for such an event will be
      the declining parity of the dollar. The question is the level
      of pain that each country can withstand -- that is, the
      extent to which the dollar must fall against their local
      monetary units, before they rebel.

      What few people recognize or care to consider are the
      events that will unfold when this time arrives. True, gold
      will be at a far higher dollar price. But what economic and
      social price will be its cost?

      When people around the world begin to reject the dollar,
      they will sell their accumulated U.S. Treasuries. They will
      no longer desire these vehicles to act as a store for their
      dollar holdings. This will cause a sharp increase in
      domestic interest rates as their Treasury paper is sold
      into the market. Our earlier loyal trading partners will then
      take their received dollars and sell them for their own
      currencies. This will act to further depress the dollar's
      value on the world market. Further, the Federal Reserve,
      which will be the ultimate redeemer of the Treasuries, will
      be forced to issue new dollar credits. This will create a
      flood of dollars entering our monetary system, balloon our
      money supply, and threaten a serious outbreak of domestic

      The combination of increasing interest rates, a falling dollar,
      and a sharply rising money supply will produce a second
      series of events. The higher rates will damage the balance
      sheets of our country's businesses and will threaten the
      housing market. Further, the monthly interest payments
      on our already highly debt-burdened populace will soar.
      Stocks will weaken and single family home sales will
      decline. This will drive consumers to limit their purchases.

      These damaging events will be amplified when the "wealth
      effect" begins to wear off and Americans experience a triple
      whammy. Stocks will plummet, homes values will fall, and
      the news of layoffs will fill the airwaves. This will act to
      further restrict consumer spending and will foster a sharp
      decline in business activity.

      Additionally, the falling dollar will increase the price of
      imported goods entering our markets. This, combined with
      the sharply rising money supply, will not only add to the
      cost of living but will promote the threat of inflation. Further,
      foreigners will reduce their U.S. stockholdings for fear of
      additional currency and stock market losses.

      Consumers, already reeling from their increased cost of
      living, the fear of additional stock and home equity losses,
      and the threat of reduced incomes or their own
      unemployment, will further retard their spending. This will
      add to the damage sustained by our fragile economy and
      place still more workers on the unemployment rolls. These
      will swell while personal and business bankruptcies soar,
      and the cycle will feed upon itself and spiral lower.

      Of course the Federal Reserve will attempt to counteract
      these forces. We have already been comforted by
      statements from Alan Greenspan and Ben Bernanke, a
      Fed governor, that they will create dollars at will if needed
      through various schemes to circumvent a catastrophe.
      However, if they execute their methods they will only
      worsen the outcome. Yes, the Fed's machinations will
      likely temporarily forestall a severe economic downdraft
      and may indeed avoid a derivative meltdown, but at what
      cost? If they aggressively act in this fashion their deeds
      will only further damage the integrity and value of the
      dollar, drive gold far higher in price, and likely precipitate
      a damaging inflationary event. In fact, we may be forced
      to endure the worst of all worlds where our domestic
      prices are soaring while business is stagnating or

      I have not painted a pretty picture of the potential
      outcome when the world ultimately refuses to accept
      the dollar. I have done this with the desire to warn readers
      to protect themselves. "Forewarned is forearmed." I would
      highly recommend that you greatly reduce all forms of
      debt. Further, I believe that you should not only increase
      the percentage of your gold and gold share holdings but
      that Americans should also add to their cash positions
      and hold them in the form of short-term U.S. Treasuries.

      I hope that our leaders have prepared for such an event
      and are successful in the execution of their contingency
      plans. However, for those who will continue to anticipate
      a joyous and happy ending to soaring gold and gold
      equity prices remember, be careful for what you wish.


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