Be Careful For What You Wish
by Dr. Richard S. Appel
November 04/04
Many investors and traders that 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 towards
$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, ascribe 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,
in return for the valuable goods and services purchased by our country,
rather than continue to solely accept declining dollar credits. Yet, they
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 far away 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 presently 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 first 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 System.
Throughout the subsequent period our country became increasingly dependent
upon 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 their 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, widespread
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, i.e. 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 the world begins 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, who 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,
will balloon our money supply, and threaten a serious outbreak of domestic
inflation.
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 collapsing.
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 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.
I publish Financial Insights. It is a monthly newsletter in which I discuss gold, the financial markets, as well as various junior resource stocks that I believe offer great price appreciation potential.
Please visit my website www.financialinsights.org where you will be able to view previous issues of Financial Insights, as well as the companies that I am presently following. You will also be able to learn about me and about a special subscription offer.
CAVEAT
I expect to have positions in many of the stocks that I discuss in these
letters, and I will always disclose them to you. In essence, I will be
putting my money where my mouth is! However, if this troubles you please
avoid those that I own! I will attempt wherever possible, to offer stocks
that I believe will allow my subscribers to participate without unduly
affecting the stock price. It is my desire for my subscribers to purchase
their stock as cheaply as possible. I would also suggest to beginning
purchasers of these stocks, the following: always place limit orders when
making purchases. If you don't, you run the risk of paying too much because
you may inadvertently and unnecessarily raise the price. It may take a
little patience, but in the long run you will save yourself a significant
sum of money. In order to have a chance for success in this market, you
must spread your risk among several companies. To that end, you should
divide your available risk money into equal increments. These are all
speculations! Never invest any money in these stocks that you could not
afford to lose all of.
Please call the companies regularly. They are controlling your investments.
FINANCIAL INSIGHTS is written and published by Dr. Richard Appel and
is made available for informational purposes only. Dr. Appel pledges to
disclose if he directly or indirectly has a position in any of the securities
mentioned. He will make every effort to obtain information from sources
believed to be reliable, but its accuracy and completeness cannot be guaranteed.
Dr. Appel encourages your letters and emails, but cannot respond personally.
Be assured that all letters will be read and considered for response in
future letters. It is in your best interest to contact any company in
which you consider investing, regarding their financial statements and
corporate information. Further, you should thoroughly research and consult
with a professional investment advisor before making any equity investments.
Use of any information contained herein is at the risk of the reader without
responsibility on our part. Past performance does not guarantee future
results. Dr. Appel does not purport to offer personalized investment advice
and is not a registered investment advisor. The information herein may
contain forward-looking information within the meaning of Section 27A
of the Securities Act of 1933 and Section 21E of the Securities Exchange
Act of 1934. In accordance with the safe harbor provisions of the Private
Securities Litigation Reform Act of 1995, the statements contained herein
that look forward in time, which include everything other than historical
information, involve risks and uncertainties that may affect the company’s
actual results of operations. © 2004 by Dr. Richard S. Appel. All
rights are reserved. Parts of the above may be reproduced in context,
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