Like It or Not, All Your Wealth is Digital
Today we continue our chat with Jim Rickards. And he’s given us something to ponder…
Total monetary ‘resets’ happen more often than you think. They’ve actually occurred three times in the last 100 years.
The first after World War 1, the second at Bretton Woods after World War II, and then once again 1971 when President Nixon severed the dollar from gold once and for all.
These systemic ‘monetary 180’s’ happen every 40 years on average. According to Jim, we’re well passed our due date for the next one.
And a cursory look at the numbers and you’ll see Australia isn’t in a good position if and when it hits.
Let’s get to it…
DR: Australia’s first gold rush was in New South Wales in 1851. Today Australia accounts for around two-thirds of gold mine reserves. Yet the Reserve Bank of Australia has a relatively tiny inventory of gold. Should the RBA be stockpiling more aggressively?
Jim: When it comes to gold, gold in the ground and gold mining, there’s no question that Australia is a super power.
In terms of its gold reserves, they are large. In terms of its gold mining output, it’s one of the 10 largest producers in the world and has been for a long time. So Australia is a gold super power in that respect.
But that’s very different from official gold or government reserves…
When it comes to government reserves the RBA is actually pathetically small, relative to the size of the Australian economy.
Now, because Australia’s economy is significantly smaller than, say, China or the United States, of course it doesn’t need as much gold.
But if you just do a ratio of gold to GDP — because that gives you an ‘apples to apples’ comparison across the board — Australia has very little gold relative to the size of its economy, which is a significant size.
So you have this disparity between private gold, gold mining on one hand…and official gold on the other. Official gold is what counts if there is a collapse in the international monetary system, which I do expect.
And by the way, that’s not an extreme statement. The international monetary system actually has collapsed three times in the past 100 years, and it does seem to happen every 30 to 40 years. It’s been over 40 years since the last one in the mid-1970s.
That doesn’t mean there’s going to be a collapse tomorrow, but it does mean that no one should be surprised if there is. That seems to be the shelf life approximately of the international monetary system.
And when the collapse comes you have to reform the system. Now I’m not saying it’ll be the end of the world and that we’re all going to be living in chaos, eating canned goods.
But the major powers in the world will sit down around the table as they did at Bretton Woods in 1944, and at the Plaza Hotel in 1985, and at the Genoa Conference in Italy in 1922.
They’ll sit down and they’ll reform the international monetary system.
The question is, how big is your seat at the table? How much voice do you have?
The more gold you have, the bigger the voice you’re going to have.
And just because there’s a lot of gold in the ground in Australia, that doesn’t mean it’s easy to dig up. It’s actually very costly. Australians know more about mining operations than most people around the world because it’s such a large part of the economy.
So it’s good that the gold’s there, but it’s not cheap or easy or quick to get it out of the ground.
The RBA should be increasing its gold reserves. Otherwise they’re not going to have a very big seat at the table when it does come the time to reform the system.
DR: An Aussie investor who likes gold might be worried they’re going to make the same mistake in 2017 that gold investors made in 2015. Would you say that it’s wrong to look at gold as a trade? Instead, you should own gold as a store of wealth, or as a way to ‘repudiate the dollar’?
Jim: Although there are people who trade gold, I don’t think of gold as a trade. There are people who trade what I call paper gold – that’s gold futures, gold derivatives, gold contracts, and ETFs of various kinds.
If you think you’re smarter than the market, and you want to be in and out of gold trading lows and highs (which is easier said than done)…that’s fine. I have nothing against that, but that’s not why I talk about gold. It’s not why I recommend gold.
I talk about gold as an investment. But to me, it’s much more than an investment. It’s really a form of money. That’s why I say to people: ‘If you want money, you should have some gold.’
Gold is a form of money. The US dollar is a form of money. The Australian dollar is a form of money. Bitcoin can be a form of money. There can be many, many kinds of money.
And people say, ‘well, you know, they’re not backed by anything.’ Bitcoin’s not backed by anything, and the Aussie dollar is not backed by anything. My answer is they’re all backed by one thing: confidence.
But confidence is extremely fragile. It can be lost. And once it is lost it is very hard to regain. But people have never lost confidence in gold.
So my advice is not to load all up on gold. Don’t need to have 100% gold, or anywhere near it. But I do recommend a 10% allocation of your investible assets in gold.
If gold doesn’t do much, then 10% is not going to hurt you very badly.
But if it goes up 2, 3, 5, or 10 times, which I do expect, then the 10% allocation could compensate you for losses that are probably occurring in other parts of your portfolio.
My point is, gold has its place. I don’t see it as a trading instrument.
I DO see it as a form of money. I do see it as the one form of money people do not lose confidence in, and that’s a very good reason to have it in your portfolio.
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DR: In Sydney in 2012 you did some rough maths that came up with the figure of $44,000 an ounce for gold by the time the endgame for precious metals plays out. Realistically, though, what would a gold super-spike look like if there is a reordering of the international monetary system?
Jim: Well, a super-spike in the dollar price of gold in the event of a reordering of the international monetary system is definitely a strong possibility.
I’m not saying it will absolutely happen. I’m not saying the world has to go back to a gold standard.
What I AM saying is that in the event of a global financial panic, which I fully expect, and the loss of confidence in other forms of money, which I also expect…people will turn to gold.
Now, what would the price of gold be if we were back to a gold standard?
Again, to be clear, I’m not predicting that we will go to a gold standard. There’s not a central bank in the world that wants a gold standard. But the point is, even if they don’t want it, they might have to have a gold standard to restore confidence.
In that world, what does the price of gold look like?
We actually have some experience in this. We don’t have to make it up. That $44,000 number that was from some math that I did and I can explain that very briefly.
If you go to a gold standard, you have to get the price right. This was the mistake in the 1920s, and it contributed to the Great Depression.
So just to give you a little history…in 1914, at the outbreak of World War I, countries went off the gold standard. They did that because they wanted to be able to print money and issue bonds to finance the war and they didn’t want to be constrained by gold.
It’s actually completely understandable. War is an existential crisis, and you have to do whatever it takes. And if that means printing money, getting your people to accept the money, then so be it.
But after the war, after the Versailles Treaty, and after the world was picking up the pieces and trying to put things back together again…there was a strong desire to go back to the gold standard. This is now in the early 1920s — 1922 to 1925.
Well, it begs a question: If you’re going to go back to the gold standard, what’s the price?
Before World War I, there was parity between gold and currencies. So a different currency is a different parity, but there was a fixed relationship between the two because of their common anchor to gold.
To pay for the war, countries doubled their money supply by printing enormous amounts of paper currency.
Now the war is over, and you want to go back to gold. You can do one of two things: you can come up with a new parity, which means doubling the price of gold…or you can recreate the parity by cutting the money supply in half.
But you have to do one or the other. You either have to increase the price of gold or decrease the money supply to get back to a parity.
Unfortunately, what you need to do is increase the price of gold. You’ve already printed the money. There’s no way to make it go away (actually, there is a way to make it go away, but it’s extremely deflationary. As I said, it led to the Great Depression.)
Most of the countries at the time, including France, Belgium, Italy, and others, increased the price of gold in their currencies. It was briefly inflationary. There was a very strong inflation in the mid-20s because of that.
The UK chose a different path under then Chancellor of the Exchequer, Winston Churchill. They chose the path of going back to the pre-World War I parity, cutting the money supply in half.
That was a blunder, and Churchill later admitted it. It was based on bad advice. It was extremely deflationary and it put the UK in a depression before the rest of the world.
A lot of Americans think of the depression as beginning in 1929, when our stock market crashed. But for the UK, it started in 1926, immediately after Churchill committed this blunder.
So that’s history. Now, come forward into the 21st century. Imagine that central banks having to go back to a gold standard in order to restore confidence. They are not going to repeat that mistake.
If they have to go to a gold standard, they’re going to have to raise the price of gold enormously in order to avoid deflation.
So the question is what is the implied non-deflationary price of gold in a new gold standard?
It’s not that hard to figure out. You just figure out how much gold is there, how much money is there, and you have to make a few assumptions:
What money supply are you talking about? Are you talking about base money, so called M0, M1, M2? You have to make a choice there.
And then how much gold backing for the money supply? Will it be 20%, 40%, 100%?
So there are some policy decisions that have to be made, but once you make those decisions and you do the math you get a range. By my estimate, if you use base money (M0) and you use 40% backing, the implied price is about $10,000 an ounce.
If you use a broader money supply, so called M2, with 100% backing (I don’t think that’s necessary by the way, but if you did), that price becomes $44,000 an ounce.
When I mention numbers like that, they’re not made up. I’m not pulling a number out of the air. I’m not trying to be provocative and get headlines.
This is eighth grade math, and you can actually look at it, and the data is available. We know how much money there. We know how much gold there is. It’s just a ratio – do the division based on a couple of assumptions, and come up with a price.
So there’s a range — at the low end, $10,000 an ounce and at the high-end, $44,000 an ounce — that you would have to pick somewhere in there in order to have a non-deflationary gold standard.
And that is why I expect the gold price to get there eventually.
DR: And finally, in your book The New Case for Gold, you look at how the smart investors are investing right now in physical gold to protect themselves from the complex economic forces and instability we face in 2017 and beyond. Can you summarise the ground you cover?
Jim: In The New Case for Gold, I cover some familiar ground. If people are interested in gold or have read about gold in the past, they’ve heard some of these arguments before.
But I also cover some new ground.
That’s why the book is called The New Case for Gold.
It’s really a 21st century analysis.
We know the traditional reasons for holding gold. It stands up very well against inflation, so governments always resort to inflation to get up and out from under the debts. When inflation comes, the dollar price of gold goes up significantly. So that’s one reason to hold it.
But I’ll give you a 21st century reason…
Gold, for example, is physical. Most people will say, ‘I’ve got money in the stock market and the bond market and various kinds of securities,’ and I say, ‘Really? Do you have money or do you have electrons?’ because what they have are electrons.
It’s digital money. Digital money, electronic money, or electronic wealth in various forms, including securities can be wiped out in a heartbeat.
Vladimir Putin in Russia has a 6,000-member cyber brigade working on hacking all the financial systems in the world.
They can get into these exchanges. They can get into these banks. They can wipe out your wealth in a heartbeat. Don’t think they can’t do it. They’ve already tried. They’re getting ready to again.
So if all your wealth is digital, it’s extremely vulnerable to these kinds of cyber financial attacks.
One of the things I like about physical gold is that it’s not digital. You can’t hack it. You can’t erase it. If you got it, you got it. And actually, the worse things get over on the digital side, the more valuable the gold will be.
So that’s an example of a 21st century threat. There was no real threat of digital, cyber financial warfare in the 1970s and 1980s, even in the 1990s.
Today, there is. In addition to all the traditional arguments for gold, namely it’s a hedge against inflation, it’s a hedge against wiping out or reputing any debts by government…it’s not anybody else’s liability.
Nobody has to perform for your benefit in order to make your gold valuable. You just own it.
It’s as simple as that – unlike a stock or a bond where somebody has to live up to a promise to secure your value.
Publisher, The Daily Reckoning Australia
P.S. As I said yesterday The New Case for Gold comes with a separate never-before-seen PDF Aussie chapter from Jim’s Australian investment director Nick Hubble.
In it, Nick has outlined eight specifics ways to leverage the potential gains in gold in the coming years.
A special hard copy has been reserved for you. But I need confirmation today. If you don’t want it, we’ll allocate it to someone else.
To find out more, click here.