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25 reasons why gold will rise:
The vicious circle behind the US Dollar decline

Jim Willie CB
November 12, 2002

Introduction:

After observing the ideas of Jim Willie CB over the last six months on Silicon Investor, I have come to the conclusion that the global precious metals community should hear what he has to say. Upon reading his debut report, I am sure that you will agree with me.--4FigureAU

The last 22 years has seen a remarkable bull market in stocks, followed by a bust that has been painfully unfolding since early in the year 2000. Now yet another bull market is well underway, as capital has been induced to seek safety in bonds. This much is undisputed. However, much controversy has emerged regarding the management of the economy, the role and value of the USDollar, the use of the US Treasury Bond as world store of value, monetary policy dictated by the Federal Reserve, international relations with major trade partners, and the former standard of money known as gold.

I do not intend to engage in any debate of controversial policy or structure, all of which are deeply embroiled in politics. Further suspicion has been directed at the press & media, whose affiliation with advertisers might raise questions about objectivity in reporting on a host of issues. Nor do I intend to discuss the cabal of economists whose community is best described as replete with ineptitude, bereft policy, heretical assumptions, flawed analysis, distorted reporting, cliquish political influence, and vacant understanding of history. Their lack of guidance and stewardship might have led this nation and other industrialized nations into making enormous errors, while allowing their citizens to suffer tragic losses due to speculation amidst ignorance and extensive illiteracy concerning all things financial. Instead, 25 powerful forces are cited which serve to strengthen the value, if not the role, of gold in the near future.

Grand illusions have been cultivated in recent years regarding creation of wealth, employing the means of debt accumulation. Credit has somehow been confused with wealth, while legal tender has been confused with money. An extreme irony appears to me. The US Treasury stood for almost two centuries as an institution where a treasure of gold was secured. Now the US Treasury exists as a factory to spin debt issuance into the fabric of guaranteed securities. The dollar and its government securities work hand in hand since foreigners use one as the flipside of the other. The TBond is traded as a US currency offering a return on investment. Debt creation, banking foundations, government spending, and vast systems of inter-dependences are running amok. A clearly identified volatility in the world economy and financial markets has been the reward from the consensus departures from a gold-backed currency. Many wonder if we have developed conditions whereby a "revenge of gold" will come to pass.

Strong countervailing forces govern gold with respect to financial securities and economic environments, hotly debated now. I cite certain inter-relationships at work in determining the price of gold, after observing the financial world for almost 30 years as both a student and a professional in the corporate world. Gold competes with the US Dollar as a worldwide store of value. Within the United States, a declining currency indicates rising inflation of finished goods, commodities, and possibly services available to our economy. Gold also competes with the US Treasury securities (bonds, notes, bills) as a worldwide store of value, attracting investors for its yield. Inflationary economic environments accompany a rising gold price. Despite many common beliefs, deflationary environments also accompany a rising gold price, as debts and indebted currencies are put at risk of writedowns or default. A review of American history in the 1930 decade bears this out. Against such a backdrop, I offer a cornucopia of reasons why gold will rise in value. Forces generate movement, setting into motion a dangerous and risk-filled sequence of events. The USDollar has never experienced correction in an environment filled with such wide-reaching imbalances.

As gold rises in value, the predominant engine will be decline of the USDollar in a correction process. Twenty years have produced historically unprecedented imbalances within the US economy and the structural dynamics across the world economy. Rubin's heralded but destructive Strong Dollar policy has heaped havoc equally upon the world of finance and major economies, attracting capital to and repelling manufacturing capacity from the United States, prying deep dislocations. Greenspan's knighted but injudicious Easy Money policy produced an asset bubble, which worked synergistically with the rising dollar. Now the bubble's unrelenting collapse will tether our currency toward an uncertain fate. Regardless of how an ultra-strong valuation was engineered, the USDollar's corrective adjustment will not occur quickly or easily, but instead will aggravate markets and economies, exposing hazards, raising the prospect of chaos. I believe that as US political and financial leaders lose control, or feign benign neglect, the USDollar will gradually become more and more unstable. Eventually, a Vicious Circle will be encountered whereby a declining dollar will result in an increasing exodus of foreign investment from our capital markets. The consequent stress to the bear market in stocks will undercut the economic balance, rendering an upcoming recession as inevitable. The typical gateways to recession have been the automobile and housing sectors. Initially stock bust beneficiaries, these key sectors are now exhibiting a critical level of strain. The exodus of foreign capital could easily lead to rising longterm interest rates, exacerbating a recession.

Unlike Japan, the United States cannot experience an interest rate convergent to zero. Our dependence on foreign capital to finance both the monstrous federal debt and equally gaping current account deficit (trade gap) distinguishes us from our fellow busted bubble allies in Japan. Our outsized debts also set us apart from the Japanese nation of savers. Corporate failures, including a few spectacles, have hurt debt issuances and led to defaults. Furthermore, job insecurity and consumptive exhaustion have begun to fracture the foundation of other debt obligations, with cracks forming from mortgage to credit card defaults. These combined effects require a risk premium to be installed within the credit market, both public and private. The slowing economy and increasing pursuit of safety is racheting interest rates toward zero. Hence, a volatile bottom will be witnessed for interest rates as haven-seeking capital collides with debt risk, underscoring the Treasury credit market vulnerability to a currency decline.

As the USDollar decline feeds upon itself, the investment climate within the United States is very likely to worsen, resulting in more federal fiscal stimulus and support (inflation), more monetary expansion (inflation), rising import prices (inflation), further stock declines (deflation), more debt default (deflation), and a potentially deepening recession (deflation), leading to further writedown of our debt-backed currency. The cycle then repeats itself, with our currency acting as the control lever for the cycle. A climax chapter could likely follow any disruption to the Treasury Bond market. I believe a US Dollar decline will erupt into a crisis when the power of this Vicious Circle unleashes its fury. Few appear to expect it. Moreover, fewer seem to understand how insensitive and unresponsive our trade imbalance is to devaluation in the currency. Many internal components of American-made products come from Asia. The latent risk to the world financial system is for the Vicious Circle to threaten the standard bearer USDollar itself.

Those who profess opinions and arguments in favor of an orderly and stable adjustment to the extreme imbalances in the currency markets, credit markets, trade accounts, and stock markets are in for a rude awakening. I believe a crisis will unfold, the likes of which we have never seen before. Some like Jim Puplava contend that a Perfect Storm will develop. I can appreciate their perspective and justification. Our stock bubble was orders of magnitude larger than the 1930's. Our current levels of debt are also orders higher. Our dependence upon foreign capital is staggering, rendering us vulnerable. Our import trade for both product components and finished goods is also dangerously high. World banks have structured reserves upon our debt at their peril. It is my considered opinion that the dollar adjustment cannot avoid becoming out of control. Most governmental response to a deteriorating situation could actually worsen any crisis. The natural course of a correction among multiple financial markets might have occurred in 1998. But since we demand, expect, and celebrate an interventionist policy, whose involvement hopes to pre-empt natural cleansing processes, our markets will probably experience far worse corrections in the near future. The historical role for gold has been to serve as the ultimate arbiter and controlling mechanism for both currency debasement and trade imbalance. Since gold has been formally removed from this role, a giant coil might be poised to spring gold into the picture. If a financial storm ensues, gold will certainly operate as its barometer. Thus GOLD will emerge to front and center stage, much like an undesired festering boil!

Against this entire backdrop, many cold forces are at work and transformations in progress. I do not insist on a gold standard for currencies. But I can see a sequence of frightening events unfold which might compel a partial gold-backing in order to secure stability to the world currency system. Concurrent with such events we are very likely to see a spectacular resurrection of gold. The outline below attempts to cover a long list comprehensively, but I surely have overlooked some valid forces. It begins with bonds, then federal/ fiscal policy, politics, banking, mining, trade, commodities including currencies, economic cycles, with a final point reflecting on history.


BONDS:
1. Real rate of interest has been near zero since Oct 2001

  • Real rate of interest defined to be 3-month TBill yield minus CPI rate
  • Extreme economic weakness requires longer period of nil real rates
  • Bond disincentive leads creditors toward other asset groups
  • No real return on investment, with shorterm bond yield nullified by inflation
  • Gibson's Paradox describes the relationship between rising gold and shrinking real rates
  • Credit market represents a very large capital pool, 5x larger than stock market
  • Strong historical precedent for rise in gold in such an environment, a trend change

2. Rise in foreign holdings of US assets increases our vulnerability to foreign abandonment

  • Foreigners own 45% of US TBonds, 25% of US Corp Bonds, 12% of US Stocks
  • Foreigners also own substantial holdings of coastal real estate
  • Foreign dependence upon capital will probably result in higher prevailing interest rates
  • Gradually US leaders are losing control of our own economy (interest rate, value of dollar)
  • The world has begun diversification away from American financial instruments
  • US vulnerability to financial attack has escalated, with pressure point being the USDollar


FEDERAL/ FISCAL:
3. Money supply increased over 40% since Jan 2001, close to 100% rise since 1991

  • Monetary inflation plants seeds of eventual price inflation
  • USDdollar printing might represent a govt-sanctioned legalized counterfeit operation
  • Central Banks worldwide will fight deflation with further monetary expansion
  • Monumental imbalances and instability have become endemic in the last two decades
  • Gresham's Law: bad money displaces good money
  • Gold's role is to control monetary responsibility and trade imbalances, restore stability

4. Return to federal deficits from recession and wartime economy, with more security spending

  • Increased supply of bonds leads to reluctance to purchase new issuances
  • Increased supply of bonds might soon be monetized if bond demand evaporates
  • Federal bailouts of large failed corporations might substantially increase deficits
  • Deficit spending and stimulus will continue to undermine the USDollar


POLITICS:
5. Rising world tension, desire for safer safe haven, the geopolitical threat to peace

  • Threats of terrorism (conventional, biological, chemical, nuclear)
  • Middle East ebb & flow of tensions shapes a constant landscape
  • Retaliation by Al Qaeda, HezBollah, and Iraqis, who might have begun coordinated action
  • Potential spread of violence to Asia and Europe, e.g. Russia, Bali in Indonesia

6. Glass-Steagal Law repeal now heightens risk of financial cluster failure

  • Risks now are shared across banking, brokerage, and insurance sectors
  • Bank sector is at risk from debts, recession, low rates, and derivative losses
  • Brokerage sector is at risk from reduced trading, IPO issuance, and shareholder lawsuit
  • Insurance sector is at risk from WTC attack, droughts, and floods
  • Insurance sector has a baseline of risk from asbestos, accident, death awards
  • The merger mania of the 1990's plus the Glass-Steagal Law repeal exposes systemic risk

7. World perception of American institutionalized dishonesty

  • Scandals, broker conflict of interest, accounting fraud, exaggerated earnings
  • Prosecutions and corporate failures highlight the broadly reported fraud
  • Participating collusion by the press/media might have roots in advertising revenues
  • Consequent resentment of American hegemony, wide military presence, lost trust


BANKING:
8. Likelihood of systemic banking shock waves from debt collapse and derivative chain reaction

  • Debt failure, loan loss reserves, low rates all hurt profits, impairing capitalization requirements
  • Every single financial niche is under great stress from poor profitability, incurred losses
  • Corporate bond spread over Treasury yield indicates withheld availability of capital
  • Extreme stress to bank sector from derivatives linked to yield spreads
  • Derivative pyramid exists, dangerously exposing entire financial system to meltdown risk
  • JPMorgan has become the ultimate source of offloaded risk, both in banking and insurance
  • JPMorgan may have abused gold leasing in order to sustain gradually failing derivatives

9. Reduction of USDollar usage as both store of value, banking reserve asset

  • USDollar is backed by debt, thus represents a denominated debt instrument
  • Its collateral (gold) is in process of depletion, perhaps 50% depleted in US Treasury
  • China has announced intention to balance 1/3 of reserves across US TBond, EuroBond, Gold
  • Foreign banks use the USDollar as basis for fractional banking reserves
  • Faulty US TBond deposit base places entire foreign banking systems at risk
  • Full circle possibly coming toward currency backed by debt-free gold (Gold Cover Clause)

10. Sharp increase of savings across Asia in the form of gold

  • Japanese savings guarantees are on again, off again, leaving citizens uncertain
  • China recently opened the Shanghai Gold Exchange for private purchases
  • India plans to open its own Gold Exchange, facilitating purchases
  • Arabs and Russians are increasing their gold purchases
  • Worldwide trend of private investors now includes USA, Canada, Australia, Germany

11. Islamic world is planning gold-centric international commerce, distancing from USDollar

  • Iran has announced pending demands for crude oil payment in Euro currency
  • Redirected flow of petrodollars has been seen into Europe since spring 2002
  • Planned Dinar currency and coin is gaining ground for pan-Islamic commerce settlements
  • Dinar might eventually become gold-convertible, offering strong competition to USDollar
  • Obstacles must be overcome whereby IMF rules forbid settlement outside dollar standard
  • A Chinese Yuan gold-convertible currency would strongly complement the Dinar
  • The stage is being set for potential Islamic financial warfare directed at US dollar
  • If conflict escalates into military war, crude oil payments may be demanded in gold

12. Bank for International Settlements has targeted the US dollar for a corrective decline

  • BIS embodies the central bank for central banks, subject to no laws or oversight
  • BIS power originates from pre-WWI Swiss central bankers who resent USDollar debauchery
  • Swiss desire to install Euro (or SWFranc) as new gold-backed currency
  • They hold more gold than several central banks combined
  • We have now officially seen an end to yen carry trade, and to gold carry trade
  • Their previous objective in restoring stability was the destruction of the Soviet Union
  • They now regard USDollar profligacy as a threat to world economic stability


MINING :
13. Reversal of miner hedges, end of gold leasing, reducing supply

  • 1000 ton annual supply shortfall over current demand
  • Eventual central bank discontinued selling, as per Washington Agreement
  • Gradual lost control by Gold Cartel (central banks, bullion banks, hedged miners)
  • End of gold leasing program, as counter-party risks rise, debt downgrades continue
  • Unwinding of largest naked short position in history (3 years supply)
  • End of trashing of South African Rand (world's leading gold supplier)
  • As large miners acquire smaller firms, they must unwind purchased hedge books

14. Dismantled mining supply apparatus, from systemic price below production

  • A reported equilibrium price of around #600 gold price
  • At least 2 years required to re-activate operations and produce gold in a shutdown mine
  • Perhaps 4-5 years to begin production of a new mine from the start
  • After decades of neglect, lowest CPI-adjusted prices for commodities since 1930

15. Paradox: High gold price leads to higher demand, and high price leads to lower supply

  • Typical supply & demand relationship with price absolutely does not apply
  • However, gold jewelry demand does conform to obey the standard demand curve
  • Investment demand drops during price declines, even nonexistent at lowest prices
  • As price rises, a worldwide fever develops and gains momentum, lifting demand
  • Supply was enormous at gold's lowest prices with carry trade and miner hedge sales
  • As price rises, hedge sale cash flow diverts capital to cover forward contracts
  • Legitimate operations suffer from reduction in cash reserves, inhibiting production
  • Ironically, gold mining firms have become buyers on the world markets !!!


WORLD TRADE:
16. Trade tariff resumption discourages global trading village concept

  • Tension leads to reduced trade, retaliation, cutbacks in dollar exchange
  • Distrust in USA could result in reduced commerce with the United States
  • Rising protection trends worsen economic slowdowns worldwide, causing inefficiencies
  • Unintended effects often come in the form of higher domestic prices
  • Such tariffs and increased taxation repeat the protectionist path taken in 1930

17. US Dollar correction to relieve the trade imbalance could result in a currency crisis

  • US national trade debt has now surpassed 5% of US GDP
  • Strong historical precedent for US dollar decline in an attempt to correct imbalances
  • Symptom of chronic overvalued dollar is lost competitive position for export trade
  • Another symptom is excessive Asian economy dependence upon US markets
  • Pervasive foreign imported components renders correction to lower dollar difficult
  • 1990 decade saw huge benefits from cheap imports, now to reverse painfully
  • US Mfg base has either shifted to Asia, or set up assembly plants to Mexico (NAFTA)


CURRENCY & COMMODITIES:
18. Accelerating worldwide currency turbulence

  • Japan, South Africa, Argentina, Brazil, Mexico, Taiwan, PacRim, Turkey
  • Unbacked indebted currencies acting as hot money could create isolated airpockets
  • Standard reaction to each nation's economic slowdowns is to provide monetary stimulus
  • Central bank debasement of major currencies is underway in USA, EU, Japan

19. European currencies offer more attractive alternatives to US Dollar, with Swiss Franc leading

  • Low US TBill yield undermines the US dollar on comparative basis (now 2.0% differential)
  • 50 bpt rate cut in November 2002 further accelerates dollar flight to Europe
  • Coordinated European rate cuts temporarily stem the capital flight
  • Euro currency has better competitive position (slight trade surplus, 15x gold backing)
  • Euro also benefiting from diversification by other nations (e.g. China, Asians, Arabs)

20. The calendar date Sept 11th marked the turning point for US Dollar in two critical years

  • In the year 1989 the fall of Berlin Wall presaged a rise in the dollar to current stretched highs
  • In the year 2001 the World Trade Center attack presaged a correction after a blowoff top
  • Dollar-based assets are now seen as more vulnerable, especially if located inside USA
  • Saudi lawsuits only accentuate the risk of foreign capital residing within the USA

21. Rising costs from entire energy complex (crude oil, natural gas, heating oil, gasoline)

  • Political, legal, community, environmental obstacles to increased supply are daunting
  • Kyoto Accord sets up international obstacle for increasing production outside Middle East
  • Public utilities and regulated industries are under dubious management
  • Entire utility sector is suffering from debt implosion, and growing derivative risk centers
  • California price fixing to wholesalers is now being repeated in Arizona, Oregon, Nevada
  • Natural gas production is in decline, despite jump in drill rigs and investment spending
  • Gold is highly correlated with the energy complex, as its counterpart financial commodity

22. Commodity trend reversal has begun, the beginning of a new longterm trend

  • The Commodity Research Bureau (CRB) chart resembles lagged inverse to S&P500 chart
  • The Gold chart reversal from longterm downtrend is confirmed by the CRB reversal
  • Grains, precious metals, energy complex, cocoa are leading groups now
  • Lumber, base metals are the groups which have yet to see price improvements
  • If/when gold price surpasses #330-340, a new longterm bull trend will be established


ECONOMICS:
23. Kondratieff Winter is gathering speed and force

  • Evidence in stock market broken asset bubbles, massive debt collapse, world recession
  • Famous Russian economist identified 60-70 year cycles of boom and bust
  • End to long expansion cycle of economic prosperity, begin new cycle after correcting excess
  • Full cycle can be tracked by debt expansion, wars of popular and unpopular types
  • During K-Autumn, ill-advised repeal of calamity safeguards (e.g. Glass-Steagal Law)
  • K-Winter occurs one human lifetime later, after zero recollection of previous K-Winter
  • Confirmation is refusal and reluctance for economies to respond to standard stimulus
  • This recession is atypical: excess goods & capacity, debt collapse, price deflation
  • 100 telecom bankruptcies joined by countless corporate bankruptcies
  • Personal bankruptcies are now approaching 400,000 per quarter
  • High profile failures with KMart, Global Crossing, Enron, WorldCom, Adelphia, JPMorgan?
  • Upcoming Double Dip recession will likely be led by automobiles and real estate
  • Typically results in destruction of world's monetary standard (1930 = gold, 2000 = US$)

24. Divergence toward deflationary credit-based economy, inflationary cash-based economy

  • Overcapacity of capital equipment and mfg plant has characterized this economic recession
  • Recession has led to reduction in corporate cash flow necessary to service debt
  • Debt collapse has led to widespread deflationary economic conditions
  • Monetary expansion compensates for "burned capital", but at expense of wider imbalances
  • Public mismanaged energy industry has shortages, aging infrastructure, rising prices
  • If monetary expansion prevents a yield curve inversion, that signals harsh recession
  • If monetary expansion upholds a yield curve steep, that forecasts future price inflation
  • Currency jetstream now moves toward the diverging high and low pressure zones
  • Path of least resistance for fresh capital offers highest potential in un-indebted commodities
  • These three ingredients might produce a "Perfect Storm"


HISTORY:
25. The parallel between gold's rise in the 1970's and 2000's has many components

  • The London Gold Pool eventually failed in defending a $35 price in 1971
  • The previous 1960 decade marked a strong bull market for stocks
  • A vicious bear market lingered through most of the 1970 decade
  • Reflation urgently required following OPEC energy cost shock and its recession
  • New cycle has begun with the breakdown in the Dow/Gold or S&P/Gold ratio
  • The year 2000 ratio saw an extreme ratio achieved, marking highs in "paper" assets
  • The year 1981 saw this ratio in Dow terms reach parity
  • Huge upside gold potential exists for gathering new supporters, advocates, investors
  • Gold will slowly work through obstacles of suppressed and distorted information
  • Gold will slowly be better understood, overcoming decades of conditioned beliefs
  • Gold will slowly find appeal as an maverick, alternative, debt-free asset group
  • Gold will slowly grow a counter-culture, standing in opposition to a corrupt Wall Street
  • Gold will gradually rise in value in proportion to the degree it is hated and feared
  • Gold coins can be held in one's hand, in stark contrast to electronic entries with securities
  • Demand for this small $70B sector could result in tremendous "dotcom-like" valuations

Jim Willie CB
November 12, 2002

Jim Willie CB is a pseudonym used since Silicon Investor in 1998 allowed me to share facts and opinions, to learn from many brilliant people, and to disabuse others of their opinions. Two decades of experience in the business world followed earning a PhD in Statistics, enhanced by two years of college teaching. Practice has been in the computer industry, retail sector, and a consulting firm, in positions directed at quality control, marketing research, and sales forecasting. Macro-economics has been a personal interest for many years. Deep disappointment is felt in both leadership and policy decisions, which have resulted in a voyage full-circle from 1930 to today. Even patriots can foresee a painful transition before our nation's strength is restored. A private website is in the formative stages to cover the financial hot buttons, which will most likely be operating under the name: www.goldenjackass.com.

321gold Inc