Monetary Digest, October 2000
Edited from The Privateer
In terms of its eventual effects, there is nothing worse than inadvertently or mistakenly using the wrong measuring standards. Right now, what the world is seeing for the second time, and on a global scale, is a huge repeat of the events that took place between 1922 and 1929.
Both the performance and the potential of the U.S. stock market were “measured” back in the 1920s, just as they are today. Back then, the most renowned economists, men like Irving Fisher and John Maynard Keynes, declared that the U.S. economy was running perfectly. To support their positions, both pointed to stable consumer prices. One dissenter was the Austrian economist Ludwig von Mises. As early as 1922-23, Mises stated that if the Fed’s policy was maintained, the eventual result would be a huge crash. The Fed’s policy was maintained. The crash came in October 1929.
Irving Fisher and Keynes could see nothing wrong with the economic situation because consumer prices had not moved much. What really had moved were the values of shares on the U.S. stock market and real estate values. Additionally, productivity had exploded, as had the inflow of foreign funds into U.S. shares and into direct investment.
Does any of the above sound familiar? It should because the same thing has been happening since the mid-1990s. During both “booms,” the economists were happy because most prices were “stable.”
“Productivity” in the U.S. climbed by 5.3% in the second quarter of 2000. Economically, this amounts to saying that, with the same quantity of capital equipment, output has increased by 5.3% without any increase in inputs. Over time, and translated into prices, this productivity growth should lead to falling prices because more output with the same input leads to lower unit cost, given a stable monetary system.
This is precisely what has not happened because the monetary system is not stable; the total quantity of money is steadily increasing. That increase ensures stable prices, not lower prices. But what has also been ignored is that the U.S. current account deficit (4.5% of GDP) is caused by the inflation of the U.S. total stock of money.
The Greatest Boom Ever
Between 1873 and 1898, the U.S. economy had the greatest real economic boom of all of recorded economic history. Both producer and consumer prices fell throughout the period, with consumer prices falling 40%-50%!
In modern economic “reasoning,” such an outcome is impossible. In modern economic parlance, falling prices, especially falling consumer prices, are defined as deflation. Deflation, we are told, always leads to a recession at best, and consumer prices which fall by 40%-50% lead to a depression.
Between 1873 and 1898, the U.S. economy added more to its stock of productive capital than had ever been done in a similar period anywhere in the world at any time. That rate of addition to real productive capital has never been equaled or even approached since. Please also note carefully that there was not a price “stabilizer” to be found anywhere. There was no central bank. There was no Federal Open Market Committee (FOMC). There was no Cost of Living Allowance (COLA) clause built into anyone’s employment contract, for the simple reason that the cost of living was steadily falling. And there was next to no government debt.
Between 1873 and 1898, the U.S. Dollar was 1/20 of an ounce of gold. In fact, the U.S. currency remained fixed at $20 = one troy ounce of gold from 1837 to 1933. This cannot be overly stressed. The dollar was not a Federal Reserve Note-there was no Federal Reserve. The dollar was not “worth” 1/20 oz of gold-it was 1/20 oz. of gold. Every piece of circulating paper currency was a “Gold Certificate,” redeemable in gold coins on demand. A stable currency was the foundation of that mighty U.S. economic boom.
The U.S. banking system was more fragile in one sense because each bank stood effectively alone. If a bank had overextended its credit through loans issued and then got into trouble when the depositors showed up wanting their money, and if the bank failed to meet all valid claims, it simply ran out of money, crashed, and disappeared. But the banking system as a whole was much stronger because, with no Federal Reserve to bail out incompetent or improvident private bankers, the effects of the failure of a single bank were confined to the customers of that single bank.
Prices Were Not “Stable”
In 1873-1898, prices were not stable. In fact, there wasn’t even an attempt to keep them stable. They could either rise or fall. But they fell because of increased productivity.
Wage rates rose slowly but the standard of living rose rapidly because of falling prices. Interest rates were low, but the purchasing power of the dollar steadily increased. People saved with confidence.
The best feature of the U.S. economic boom in 1973-98 is that everyone benefited from it. Innovation brought new products; productivity increases brought better products; and lower resource costs brought more products at cheaper prices. Even stationary wages bought more and more, and the purchasing power of savings could be confidently relied upon to increase.
Fundamentally, this is the phenomenon which made the real economic boom of 1873-98 so different from the credit-induced boom of the 1920s and the even bigger credit-induced boom of the past decade. In the 1920s and the 1990s, prices did not fall because the stock of money rose.
In an economic regime where sound money is the central aim, the real economic consequences, over time, will be for all producers to improve their productivity by increasing their own capital and the quality of that capital. Not to do so means being forced out of business by competitors who have increased productivity and can lower their prices.
In an economic regime where “stable prices” is the aim, any producers that have in fact increased their productivity and stand able to lower their prices is “balanced out” by a monetary agency which storms forward and adds a new quantity of money into circulation, an amount sufficient to cancel what otherwise would have been a fall in prices. That’s the only way to get “stable prices.”
It should be obvious that in any sane economic system, the aim should not be “stable” prices, it should be lower prices. It should be equally obvious that to achieve “stable” prices, a money issuing agency is necessary. And when a money issuing agency (like a central bank) is present, the outcome is not usually “stable” prices but higher prices.
Let us say that your own company has invested time and effort into improving your productivity. You can now not only increase the quantity of your production but, due to an increase in quality too, you can do so while actually lowering your selling prices. The end result ought to have been a greater market share for your company as well as increased profits. But then the price-stabilizers show up. They counter your ability to lower your prices (and, therefore your ability to gain an increased market share) because they stand right outside your business, lending more money to your own customers.
It is true that even if you are now a more efficient producer and you could have sold at lower prices, you don’t have to because of the actions of the price-stabilizers. So you sell at the same prices and your nominal earnings go up. But please note that you have not increased your market share by much.
All your now slightly less-efficient competitors are all still there, selling the same amount as before. And they are selling their products at the same prices as before, just as you still are. But you have increased your capitalization, and they have not. Now, you stand overcapitalized because you cannot really increase your production.
Finally, the additional amount of money is now circulating from hand to hand. And, at some point, simply because your prices and the prices of your competitors are not lower, some of that new additional money flows overseas and additional imports surge into the U.S. to compete with you. These importers have lowered their prices, because their price-stabilizers haven’t been as “successful” as yours have. So, because of the chimera of “stable prices,” all of your economic improvements have been nullified.
A Short Return to Economic Principles
Definition: Inflation is an increase in the total means of monetary payment.
Inflation can take the form of an increase in total cash (the government prints more), or it can be an increase in bank credit issuance (the banks lend more). In practice, most often it is a combination of both.
Definition: Deflation is a decrease in the total means of monetary payment.
Deflation can be, but rarely is, a contraction in the total stock of cash. Almost always, it is a contraction in total commercial bank deposits as people pay off outstanding loans or default on the loans and leave the banks with a mountain of bad debts. This stops banks from lending except at higher interest rates and that slows down the demand for credit at those higher interest rates.
Inflation is not a rise in prices, and deflation is not a fall in prices.
In any economy that has advanced to indirect exchange, i.e., an economy that uses money, all prices are expressed in terms of that money. In an economy with a sound currency and a sound wider monetary system with credit issuing and deposit taking agencies (sometimes called banks), as the total real stock of capital increases in quantity and quality (faster than any increase in population), prices will fall.
This will not be a uniform process. New products will be introduced and old products will disappear. Some prices will fall quickly and some will fall slowly. Where temporary shortages appear and/or new products are introduced, some individual prices may even temporarily rise. But as capital increases, the general price level will definitely fall. The converse is equally true. Where capital is decreasing, prices will rise.
Real progress is not an increase in GDP or GNP. Any political idiot can (and most will) increase these by the simple means of increasing the total amount of the monetary means of payment. Increase that by, for example 100%, and you will find that shortly after, the GDP/GNP is also about 100% greater than before.
That internal final prices nearly double and that the currency loses half its value are, of course, never mentioned by the proponents of this method. Real economic progress is an increase in capital.
The worst part of the longer-term effect of the price stabilizers is that, as they add to the quantity of money in circulation and as they add to the issuance of additional credit, they cause malinvestment. Simply put, if you began to print money in your basement and spend it, you could undoubtedly cause some local businessmen to believe that they had better expand their businesses. When you are caught, the businesses will all stand with the additional investments in capital but without you as their favorite customer.
The current economic epoch can really be said to have begun when the Dow Industrials stood at 776 back in August 1982. Now, the Industrials hangs slightly below 11,000. This epoch has expanded the total-funded debt of the U.S. Federal government from the $914 Billion when Reagan arrived to $5.6 TRILLION. It has lasted through sequential massive waves of U.S. credit expansion which have turned the U.S. from being the No.1 creditor nation into the world’s most indebted nation. Official external debts owed by the U.S. Treasury amount to more than $1 TRILLION. Money debts in the form of the amount of U.S. currency floating outside its borders and owed by the Federal Reserve amount to about $850 billion. U.S. corporations stand with external debts now amounting to about $1.8 TRILLION (some estimates go as high as $2.3 TRILLION). The sum of this is what the U.S. owes.
Globally, this has taken place during an 18-year period, during which the U.S. just borrowed and Borrowed and BORROWED and then spent and Spent and SPENT.
Across the world, in Europe, and especially in Japan, Korea and South East Asia, there are now enormous amounts of capital which have been used to produce consumer and other economic goods for the internal U.S. market. Were the U.S. capacity to import in the current huge amounts to fall even slightly, many parts of this now existing external plant and equipment would instantly turn into malinvestments.
Inside the U.S., the same insidious effect has taken place upon the U.S. stock of capital. Most of the capital now existing has been pulled forward by the credit expansions since 1982. The productive capacity of the U.S. economy has not increased; what has increased is the ability of the monetary authorities to issue new debt and the willingness of the American people to borrow. Real capital is the productive tools standing on the factory floors. Shares in General Motors do not constitute real capital; the plants where the cars are made do.
This 18-year period of cumulative global malinvestment and the accumulated internal U.S. malinvestments are the fundamental dangers. All or most of these investments in real plant and equipment are economically viable only as long the U.S. can continue its credit expanding.
But this ongoing U.S. internal credit expansion is now flowing over into record monthly trade deficits ($30 Billion plus) and out into the even larger current account deficit, which is predicted to be $500 billion this year. Each of these deficits adds to the sum of U.S. external debt. And it is the rest of the world that must lend these huge sums to the U.S. to keep the global system going.
As long as the rest of the world keeps right on lending to the U.S. and the U.S. also keeps credit expanding and borrowing and then buying from the rest of the world, the global economy, as it is presently constituted, can continue to function. But if the rest of the world slows down or even stops lending to the U.S., the global music will stop-dead.
The price stabilizers know this, that is why the Fed refrained (for a second time in a row) from raising U.S. interest rates. Any slowdown in borrowing inside the U.S. would stop the global music just as dead. But if the slowdown were to come from inside the U.S., then the greatest danger would be to the U.S. stock market. Foreign investments would exit U.S. stocks, and then exit the U.S. dollar. The ultimate victim of this global game of musical chairs will be the dollar.
CMI commentary: The fuse has been lit on a bomb. The best we can expect are a collapsing dollar, massive price increases, and financial crises “resolved” via printing press money. Yet, we may see the worst: a repeat of 1929 where government intervention only worsens matters. In either case, gold and silver will reemerge as the only real forms of money.
Silver Eagles Premiums Fall
As CMI predicted, the premiums on Year 2000 Silver Eagles have fallen. Because of last year’s Y2K buying and promotions of “colorized” coins, the premiums on Silver Eagles of all years shot up dramatically. The 1999 coins rose to $15 but have dropped below $10. Year 2000 Silver Eagles climbed to $12, a $7 premium, but now can be bought in U.S. Mint boxes of 500 at about $1.60 over spot. Smaller quantities cost more.
Investors who like Silver Eagles should buy them. This is especially true with silver trading below $5.00. If you like Silver Eagles, do not wait. If they get any cheaper, it will be only pennies.
Additionally, readers who want them for Christmas presents should order while prices are low and where there if ample time to get them. CMI has official U.S. Mint velvet jewelry-style presentation boxes for buyers wanting to embellish their gifts. The boxes are $3 each.
Pilla Tax Conference
November 10-11, 2000, Dan Pilla will hold his annual Taxpayers’ Defense Conference at the Flamingo Hilton Hotel in Las Vegas, Nevada. Dan has been doing battle with the IRS for 23 years, has testified before Congress about the IRS abuses, and has written at least eight books on dealing with the IRS. Additionally, he is a Cato Institute scholar, and he publishes Pilla Talks Taxes, a monthly newsletter about-what else?-dealing with the IRS.
Readers presently at odds with the IRS should definitely attend. Readers fearing IRS problems should seriously consider attending, and anyone still filing tax returns should also consider attending. In addition to Dan, there will be other experts with whom attendees can consult. Registration fee is only $249, a small price considering what IRS problems can cost. Yet, Dan offers a “no questions asked” full refund to anyone “not satisfied for any reason.” Call 1-800-346-6829 for more info.
Silver at “Fire Sale” Prices
On August 23, silver traded in the $4.70s and closed at $4.78 in the U.S., the lowest silver prices since Warren Buffett began buying in 1997. The next day, the London market followed suit, and the London p.m. fix was $4.76. When trading opened in New York, however, prices rose, and silver closed at $4.86. The next day it traded in the low $4.90s before closing at $4.89.
Silver below $5.00 truly is a bargain. The May Monetary Digest noted the ten-year production deficit, which has drawn down some 1.26 billion ounces from above-ground supplies. CPM Group estimates only 756.6 million ounces left to fill the deficit. At last year’s deficit of 155 million ounces (GFMS’ Silver Survey), less than five years above-ground supplies remain.
Demand for silver remains strong. In 1999, industrial usage topped 800 million ounces for the third consecutive year. It was only 1984 that industrial demand rose above the 400 million-ounce mark. This growth illustrates the importance silver plays in our modern economy. And, contrary to expectations, digital cameras are not having a negative impact on silver demand.
Over the last four years, as digital cameras have become more popular, traditional silver halide film has continued to consume more silver. In fact, photographic demand has grown every year since 1980, when it used 123.8 million ounces. Last year, it consumed 267.2 million ounces.
Analysts who used to predict that digital cameras would reduce the need for silver now admit the two technologies will “coexist.” Other analysts say that digital cameras have caused an increased demand for silver halide paper as digital photos are reproduced. Furthermore, despite using the most expensive digital cameras available, the quality of newspaper photos has deteriorated. They often are blurred. This can be seen easily in looking at the eyes of people in digital photographs. If thousand-dollar digital cameras cannot match the quality of a $9.99 single use camera, it will be a long time before digital cameras are a threat to silver-if they ever are.
As noted in previous issues of Monetary Digest, investor attention remains focused on stocks. The year 1982 was the last time the Dow Industrials closed below the previous year’s close. Rising stock prices for nearly two decades have created expectations of rising stock prices forever. Few investors even consider the possibility that stock prices could fall for any sustained length of time. Therefore, with silver’s dismal performance during the stocks’ stellar climb, many investors could not care less about silver, despite its exciting story.
Nevertheless, when stock prices renew their downward path as earlier this year, investors will look for other investment vehicles, and none look better than silver.
With spot silver below $5.00, all silver products are tremendous buys. Circulated 90% silver coins can be bought (and delivered!) near spot. One hundred-ounce 999 fine bars sell at $.25/oz above spot. One-ounce silver rounds can be bought at only a few pennies more. During active precious metals markets, 100-oz bars sell at $.40-$.50/oz over spot and 1-oz rounds at $.65-$.75 over.
Low premiums on silver products (and gold) are because of investor indifference. In the past, such low premiums often preceded big moves up. If you are considering buying silver, do it now. It is highly unlikely that it will get cheaper. Silver has little-if any-downside risk but has great upside potential. Investors thinking of putting silver (or gold) in their IRAs should move quickly. These really are bargain basement prices.
Fidelity Funds Manager
Moving into Gold
CMI has long held that for the precious metals to get really moving, investor sentiment will have to change. The 1972-2000 bull market was the greatest in history. (CMI believes that it has ended.) Never have so many people made so much money; consequently, investors are reluctant to leave an investment medium that has been so good to them.
But, as time wears on and investors realize the bull market in stocks is over, they will look for other investments. Many will turn to gold and silver. Unfortunately, most investors will have to suffer losses before abandoning stocks. Professional investors, however, exit stocks while the public is still buying (They need somebody to sell to!)
According to a recent Bloomberg report, Fidelity Investments’ John Muresianu, who manages Fidelity’s $536 million Fifty Fund, has dumped all his technology stocks and is buying gold stocks. As of March 31, precious metals stocks made up only 1.5% of the fund’s portfolio. By April 30, they had jumped to 9.9% and by June 30 to 15.5%. This is a major commitment to the metals.
Muresianu’s move has already received ridicule from peers; yet, other fund managers are certainly evaluating the switch. Before this bear market in stocks is over, many fund managers will switch to gold.
Gold Dragons Production Ending
Minting of the Gold Dragon, the fifth coin in the Perth Mint’s Lunar Calendar Series, will cease sometime between now and December 31, 2000. The Lunar Series is based the Chinese lunar calendar and will end in 2007 with the Year of the Pig. Another Year of the Dragon will not roll around again until 2012. Production of the 2001 “Snake” has already begun.
Although Australian law allows The Perth Mint to mint up to 30,000 of the one-ounce coins for any year, it is doubtful that mintage of the 1-oz Gold Dragon will top 15,000. Coins are turned out to meet orders. Mintage may be a low as 10,000. These are only guesstimates because the Perth Mint, unlike the U.S. Mint, does not release mintage figures, even after production has ended. After the first of the year, better estimates will be attempted.
CMI recommends Gold Dragons for several reasons. First is the mystique that anything “dragon” holds with Asians, who make up more than half the world’s population. The coin should have tremendous appeal for years to come. Adding to its allure is its 2000 date, the first year of the new millennium. (Actually, 2001 will be the first year of the new millennium, but most people couldn’t care less.)
Additionally, the Gold Dragon are among the most beautifully-stuck bullion coins presently available. Their “eye-appeal” is tremendous. Gold Dragons carry small premiums other bullion coins; yet, they hold tremendous numismatic potential, meaning collectors may put big premiums on the coins in the future. This makes Gold Dragons ideal for IRAs.
Year 2000: Low Mintage
Year for Gold Eagles
Judging by statistics posted on the U.S. Mint Web site, Year 2000 will be the smallest mintage year ever for the 1-oz and the 1/4-oz Gold Eagles. Through late September, the posted numbers were:
Previously, the low mintage years resulted in the following numbers (years):
For the 1-oz Gold Eagles, 12,000 comprise less than 10% of the previous year’s low mintage, and for the 1/4-oz Gold Eagles, 18,000 is right at half 1998’s production. Some dealers are touting them as the coins to buy. Before plunging, there’s more to know.
The U.S. Mint posts “sales,” not mintages. The actual mintages are not released until years after production has ceased; then, they are published in The Guide Book of United States Coins, commonly referred to as the Red Book. The Red Book for 2000 has mintages through only 1997.
Furthermore, investors need to know that in December 1999, the U.S. Mint took orders for Year 2000 Gold Eagles and included those orders in 1999 sales. Some of the December 1999 sales (106,000 for the 1-oz Gold Eagles) were Year 2000 dated.
How many? We will not know for three years or so. It is highly unlikely that all 106,000 were dated 2000. Yet, 50,000 could have been. For 1993, the U.S. Mint lists “sales” of 439,000 1-oz Gold Eagles, but The Blue Book shows 480,192 being minted. That’s an increase of more than 40,000 coins. So, it is not out of the question for mintage of Year 2000 1-oz Gold Eagles to already be at 60,000.
Even so, Year 2000 is shaping up to be a low mintage year for 1-oz Gold Eagles, and CMI believes the 1-oz coins are a good investment. If it turns out that only 20,000 to 30,000 are minted, then it will be a tremendous investment.
Finally, here’s some interesting aspects to consider. Shortly before this newsletter went to the printer, a wholesaler faxed bids for specific coins it was looking to buy, a common practice in the coin industry. The dealer wanted the following 1/2-oz Gold Eagles:
In mint tubes of 40, Year 2000 1/2-oz Gold Eagles sell for less than $150 each.
When coins enter the collectors’ realm or are promoted, their prices rise. If a promoter, or telemarketer, is putting together sets that he plans on selling at $1500, then he will pay more for coins to complete those sets. Then, he pops up on TV and says, “We have only 79 of these sets left and when they’re gone, we don’t know if we’ll ever again find them.” To the unknowing, this may sound good, resulting in him or her writing a check for $1500 for less than $600 worth of gold.
Premiums on most gold coins come and go with promoter interest. However, there are millions of genuine coin collectors (numismatists) who constantly buy and sell coins. When certain coins are in vogue, they carry premiums; when they fall out of favor, their premiums decline. Short mintage coins always get more attention than those with large mintages. With Year 2000 being a short mintage year for the 1-oz Gold Eagles, investors who like Gold Eagles should pay the small premiums that Year 2000 coins carry.