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For some time, the dollar has been the most influential currency in the International Monetary Fund’s (IMF’s) calculation of Special Drawing Rights (SDRs). The current breakdown of SDRs includes the dollar (with a weighting of 44%), the euro (34%), the yen (11%) and pound sterling (11%). The ratio of each currency’s proportionate influence is reviewed every five years, with the next review scheduled for 2010. Recent events, however – especially those surrounding the economic downturn of the last eighteen months – have led investors to reconsider whether the US dollar is and will remain the “gold standard” by which the value of other currencies are measured. Indeed, some investors are beginning to rightfully question whether the dollar even represents a prudent investment medium at all. Just as investors began moving their assets from weaker banks to stronger ones earlier this year, they are beginning to look to other currencies that have shown increasing strength compared to the weakening dollar. As a result, the outlook for the US dollar is not nearly as rosy as it has been for many years. Some would say that its future prospects are downright ominous.
How the mighty has fallen…and why it fell Jason Whitney, CEO and President of First Fidelity Reserve, a leading coin and precious-metals dealer in Beaumont, Texas, has been observing the decline of the dollar and the corresponding rise of gold for many years. “A number of factors, both domestic and foreign, have led to the weakening of the dollar,” says Mr. Whitney. “The U.S. national debt, which has increased dramatically over the last decade, is skyrocketing as the federal government prints a seemingly unlimited number of greenbacks in an effort to stem the hemorrhaging of the economy.” Mr. Whitney points out that the deficit for the fiscal year that ended in September 2009 was about $1.4 trillion, and in 2009 alone, the White House estimates that the budget deficit will be increased by a record $1.6 trillion, due primarily to the Troubled Asset Relief Program (TARP) to shore up major financial institutions and the bailout of beleaguered mortgage lenders Fannie Mae and Freddie Mac.
“The net projected result,” says Mr. Whitney, “is that the total deficit will be more than three times greater than last year’s, and an astounding ten times the deficit realized in 2007.”
According to the Congressional Budget Office, “The 2009 deficit ($1.4 trillion) is equal to 9.9 per cent of gross domestic product (GDP), up from 3.2 per cent in 2008, and was the highest shortfall – relative to the size of the economy – since 1945.” And the White House recently predicted that over the next ten years, another $9 trillion will be added to the deficit, effectively doubling the current US national debt by 2019.
“Naturally, as a country’s debts continue to balloon, the value of its currency is eroded,” Mr. Whitney continues. “As the US pours more currency into the economy, the value of each dollar is reduced even further.”
There are global factors at work as well, Mr. Whitney explains. “Prudent investors – including other governments – have no choice but to seek out the strongest medium of exchange in which to place their funds,” he says. “There’s been widespread speculation recently, most prominently by leaders in China, Russia, and Brazil, that the dollar’s weakness should force the IMF to reconsider its role as a reserve currency. Now, while such speculation is unlikely to result in the dollar’s role being significantly diminished in the near term, just the fact that the conversation is taking place makes the already difficult trading conditions for the dollar even more daunting.”
Mr. Whitney cites the example of China, which holds a staggering $1.43 trillion of US debt, and has already taken measures that allow it to conduct transactions in its own currency (renmibi), based upon the yuan, rather than in dollars, as has historically been done. Furthermore, India’s emergence as a significant economic force, as well as other (particularly oil-rich) countries’ decision to switch their reserves from the dollar to the euro, serve to further dilute the dollar’s influence. Obviously, such circumstances do not bode well for the dollar.
As China in particular begins showing signs of shifting away from its dependence on the dollar, while its own currency becomes a more important element in international trade, it is at the same time faced with the need to back the value of its currency with a reserve standard that offers the kind of solid foundation it once perceived the dollar as offering. “The foundation that China, as well as other nations, seems to be leaning toward is gold,” says Mr. Whitney.
Beyond buying increasing amounts of gold to support its central-bank reserves, China is also promoting gold ownership by the private sector. China’s official news agency, Xinhua, has strongly encouraged private investment in gold, resulting in the creation of over a billion new Chinese “gold bugs,” or private investors in gold. The term “gold bug” comes from the title of the 1843 Edgar Allan Poe story, “The Gold Bug.” In the latter part of the nineteenth century, the term was used (usually with a derogatory connotation) in reference to people who felt that the U.S. monetary system should be backed only by gold, to the exclusion of silver. Nowadays – especially in China – the term has lost its pejorative connotation, and refers to anyone in the private sector who chooses to invest in gold.
The Chinese government’s act of instituting the practice of gold exchange at local banks served to further fuel domestic demand for the metal. In the last five years alone, China has nearly doubled the bullion holdings at its central bank. Mr. Whitney observes that the increase in holdings is comparable to the upswing in private investments in gold that occurred in the US when the government abandoned its ban on such private ownership of gold, albeit on an exponentially higher scale of magnitude.
Conspiracy theory…or cautionary note?
Is there a concerted effort to devalue the dollar? Some insist there is, even going so far as to posit a global conspiracy against greenbacks. There has been some speculation that there has actually been an organized effort to undermine the dollar, allegedly perpetrated by a consortium of influential Russian and Chinese leaders in concert with Arab oil sheiks. At one time, the very notion of such a cooperative effort would have been laughable, written off as the delusion of a conspiracy theorist. However, with the decline in value of the dollar, and the well-documented resentment of the US’ long-term exertion of influence on world markets and other countries’ cultural evolution, what once was deemed impossible has suddenly become a lot more plausible.
One believer in the global-conspiracy idea is The (UK) Independent’s Robert Fisk, a British journalist who has lived in Lebanon since 1976, and has long studied the attitudes and political workings of the Middle East. In an article published in the October 6, 2009 edition of The Independent, he wrote that Arab states have launched secret moves with China, Russia and France to stop using the U.S. dollar for oil trading. In the wake of this seeming announcement of its imminent demise, the dollar tumbled even more, although some have questioned the veracity of the information in Fisk’s article.
“At First Fidelity Reserve, we’re not prone to buying into conspiracy theories, even those that are as seemingly viable as the current one,” says Mr. Whitney. “But it’s becoming increasingly difficult to ignore the fact that the well-being of the American economy – and with it, the value of the dollar – is not nearly as sacrosanct as it once was.
“And even if there is no such conspiracy taking place,” he continues, “the mere discussion about it, along with the well-known motives of the players and their ability to pull it off, is further driving the rush for gold as a hedge against a dollar that might not have the clout it once had.”
How is the price of gold being affected?
“Historically, whenever the dollar has lost value, the value of gold has increased proportionally,” says Mr. Whitney. “Current activity seems to be consistent with that historical trend; in 2009, the dollar is down 15%, while gold is up by a virtually identical amount.”
Indeed, in a recent article in the New York Times, investor Warren Buffett issued a warning that history will repeat itself to the detriment of our economy, writing, “Unchecked greenback emissions will certainly cause the purchasing power of our country to melt.”
Coupled with the dramatically increased demand for gold in both governments and the private investment sector is the fact that the supply of gold has not seen an equivalent increase. “Like any other commodity, when demand surpasses supply, the price inevitably goes up,” Mr. Whitney explains. “Two of the world’s largest gold producers, Newmont Mining and Barrick Gold, reported sharp earnings gains in February of this year, but projected that production – at least in the near-term – would continue to decrease due to the diminishing quality of the available ore supply. Furthermore, producers are encountering increased labor, energy, and general operating cost increases, which will cause either an increase in the price they must charge for the gold they produce, or a decrease in the quantity produced. Either way, the price of the gold itself will very likely go up, and an awful lot of really smart investors are in the buy mode now.”
Why buy gold when it’s so high?
This is typically the first question an investor asks when considering purchasing gold, and Jason Whitney has heard the questions more times than he can count. “There are numerous factors to consider,” he says. “The first factor is the actual price of gold in today’s dollars, as compared to its price in years past. While the projected price of $1,500 an ounce in the not-too-distant future seems quite high, let’s compare it to 1980, when the price of gold peaked at $850. That $850 would actually be closer to $2,500 in today’s dollars! And the common wisdom is that the seemingly astronomical price of $1,500 per ounce is probably just an interim value point on the way to even higher prices. When you consider that U.S. coinage was tied to gold prior to 1933, and the price of gold was stable at $20.67 per ounce, the historical growth has been phenomenal, and there’s every reason to believe in its potential for a continued increase in value.”
Another factor is that no matter how high the price seems now, it is almost certain to go even higher, due to the previously-noted substantial increase in demand for gold. Whether instigated by the falling value of the dollar, by the surge in private gold ownership domestically and abroad, or in response to a concerted multi-national effort to “de-dollarize” the world economy, it’s a safe bet that increased demand will force the price of gold up even more than it already has.
“It is an inarguable fact,” says Mr. Whitney, “that while additional dollars can be printed indefinitely, in spite of the devaluing effect of such actions, the world’s supply of gold is finite, and it’s conceivable that it may one day simply run out. Even if the end of supply is a couple hundred years in the future, it is human nature to gather and hoard anything of even minimal value. This emotional factor plays no small part in the fluctuation of the dollar’s value, as well as in the selling price of an ounce of gold. The more uneasy the world gets about the dollar’s stability, or the closer some perceive that we are getting to the end of the gold supply, the higher the price of this precious metal will go.”
One of the inevitable domino effects will be an upsurge in advertisements by dealers in bullion and gold coins. And while it is relatively easy to establish the value of an ounce of gold itself, the task of determining the value of a gold coin, over and above its worth as precious metal, is much more of a challenge, requiring extensive knowledge above that required for trading in commonly valued commodities such as precious metals. “The $1,000-an-ounce gold price that people gasp at today could well constitute an unimaginable bargain next year, or even next month,” says Mr. Whitney. “At the same time, the ‘incredible bargain’ they think we got on a supposedly rare numismatic could end up being worth no more than – or even less than – its purchase price. While we cannot determine for certain the future value of anything, it only makes sense to know as much as possible about your investments, even if that means knowing whom to trust to help you make your decisions.”
It is on the latter subject that Jason Whitney becomes most animated in his responses. He says, “I am continually amazed at how readily some people will throw their money at things that have little or no real collector value, simply because they saw it discussed in a glossy magazine ad or on an infomercial. First Fidelity Reserve strives to educate our clients, because we know that the more an investor knows going in, the happier they will be with their investments down the road. And since it’s infinitely more pleasant dealing with a happy client than a disappointed one… well, it just pays for us to do whatever it takes to make sure our clients stay happy!”
Whether the dollar is under attack, or just being re-evaluated in comparison to outside factors; whether gold will be the new oil, or merely a stable measure of wealth, what it all really comes down to is this: where will the wise investor place his or her bets? In a rapidly changing global economy, it would seem that few things are more precious than gold.
For more information, see First Fidelity Reserve’s web site at http://www.firstfidelityreserve.com, or call them at 1-800-336-1630.
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