Political Metals

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It scares me!

Gold punched through $1,900 today. If the current financial system can withstand the stress and remained intact till the day gold trades at $20,000 an ounce, what will life be like then?

If we’re holding gold at that time, we may be doing fine but we are not likely to be 10 times richer. That’s because nothing much has happened to our gold. Rather, paper currencies would have lost so much purchasing power that it would take 10 times more of the same to buy what we could buy today. A Big Mac will most likely cost around $43 in the US. In Malaysia, NZ and Britain, it’ll like be  around RM76, NZ$54 and £25 respectively (estimates based on Big Mac Index). When a basic meal costs that much, life can be very tough for savers who continued holding on to their paper currencies or other paper assets.

Many of my friends and relatives, from retired professionals to missionaries have been ill advised to rely on supposedly safe or high yielding investments like mutual funds, government managed pension schemes, term deposits or hot stocks to generate passive income or preserve the value of their retirement funds. Despite being presented with information from this website and elsewhere, there’s little affinity shown towards gold or silver. This scares me and for their sake, I hope gold does not get anywhere close to $20,000 before they get on board.

What’s even scarier is the fact that an enormously huge segment of society do not have the means to get on board, even if they wanted to. We’re looking at the 1.4 billion people living on less than NZ$2.25 a day. That’s less than 0.05 ounces of silver! They worry not about the Fed nor the Cartel but about how to provide food, clothing, housing and healthcare with that amount each day. It’s about survival, not savings. Pause for a moment to imagine their plight when gold hits $20,000.  Spare them a thought today, and check out their appeal for assistance.

Why $20,000 gold?

In this recently released documentary, Mike Maloney presents the case for $20,000 gold by stepping back and looking at the big picture. He takes us back, very far back, and paints us a very big picture. This excellent educational video is a must watch, especially if you’re new to the Political Metals space. It’ll be your 90 minutes well spent.

But if you can’t spare the time, I’ve highlighted some of his key points with some new charts below for a quick read.

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Dow/Gold Ratio Chart: Where are we in the Wealth Cycle? 

Using the Dow Jones Industrial Average (Dow) as a measure of performance of the equities market in general, the ratio of the Dow to the price of gold indicates the performance of equities market relative to gold. Currently each point of the Dow is worth about 6oz of gold. During the process of correction after the biggest stock market bubble in history, the ratio is expected to head towards the historical mean (4oz) and overshoot it before finding its fair value again.

The bigger the bubble (deviation from mean), the larger the overshoot. During the present cycle, Mike expects the overshoot to touch 0.5:1 (1 oz of gold worth 2 points of Dow). In its extreme, the Dow would have to collapse from 11,000 to 950 if the price of gold remains at current level of $1,900. Conversely, gold will increase to $22,000 if the Dow remains at current levels.

Relative performance of Dow Vs Gold & Silver since Jan 2000
(Worst reference point, at peak of stock market bubble)

Relative performance of Dow Vs Gold & Silver since March 2009
(Best reference point, at the start of QE1)

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Currency Supply Chart: Where are we in the Inflation/Deflation Cycle?

For simplicity, “money” & “currency” are used interchangeably here. Watch the video to see the difference.

Monetary inflation is the increase in money supply resulting in price inflation (rising prices of goods & services), with a time lag between the former and the latter. The reverse applies to monetary deflation and price deflation. Studying the trend in money supply or the total amount of currency in circulation (CinC) over a period of time gives us an idea of where we are and where we’re heading in terms of inflation and deflation.

Money is created in two stages. The initial Base Money is created by the Fed (or other central banks). More new money is then created (up to 9 times the initial Base Money) within the private banking system through credit. It is loaned into existence. Watch the video to learn more about the money creation process.

The chart above  represents the amount of CinC that’s exclusively created by the private banking system. The highlighted area indicates that this component of the overall money supply has dropped by $1.7T since the 2008 crisis. This is the Debt Collapse or Credit Contraction. Less lending by banks results in less money chasing goods and services, leading to price & asset deflation. It is evident from the chart that a contraction of this magnitude has never happened since 1960. The last time it happened was just before the Great Depression of the 1930s.

In response to this credit contraction, and in an attempt to prevent another Great Depression, the Fed has been rapidly increasing the Base Money supply by creating new money. The recent rate of increase is unprecedented. The first trillion dollars was created over a period of about 90 years. The next $1.4T came into existence over the last 2 years!

This rapid increase in Base Money (red chart) was an attempt to offset the decrease in the credit money (blue chart). When we add these two components of money supply together, we obtain the total CinC (Base Money plus Credit Money) as shown in the chart below.

Notice the contraction at the top of the chart, albeit a smaller one. It is evident that despite the frantic pace of money printing by the Fed, it has not succeeded in offsetting the reduction in money supply due to credit contraction.

The Fed has little choice but to continue creating money.  With such a large perturbation in total currency supply and due to the complexity and size of the monetary system, it is not possible for the Fed or anyone else to create just sufficient money at just the right rate such that the total CinC won’t overshoot its long term trend. The principle that the larger the deviation from the mean, the larger will be the overshoot during the correction applies here as in the stock market above. The fact that there’s an undetermined time lag, between monetary inflation and price inflation further adds to the likelihood that the next round of money printing will result in a massive overshoot. Coupled with other factors, hyperinflation could be just round the corner.

In his book, Rich Dad’s Advisors: Guide to Investing In Gold and Silver: Protect Your Financial Future, and again in his presentation, Mike predicted the following sequence of events:-

1. Threat of deflation - At the onset of the 2008 crisis (Past)
2. Money printing - TARP, QE1, QE2 (Past & more to come)
3. Big inflation - Here and now (anyone disagree?)
4. Real deflation - Asset deflation in real estate & stock market (The severe but short deflation  is ahead)
5. Hyperinflation - Just round the corner?

How does gold perform under inflation and deflation environment? Check out the study by Oxford Economics: “Impact of inflation and deflation on the case for gold”.

Related Resources:

• Fractional Reserve Banking - Two short video clips on money creation
• Crash Course on Banking, Finance & Economy. By Chris Martenson
• Central Banking and the Federal Reserve System (Fed)

An article lifted off The Gold Standard Issue #6 ● 15 June 2011 published by the Gold Standard Institute.

Inflation!  Inflation Everywhere!

Over the years, many in Malaysia have experienced continuous surges in the prices of food, energy and houses. Based on data in the official website of the Department of Statistics, Malaysia, the average inflation rate is 2.2% p.a. or a total inflation of 24.4% compounded over ten years from 2000 to 2010.

In the first quarter of 2011, inflation rate was 2.8% y.o.y. and in March 2011, 4.7% y.o.y. for food. Many Malaysians doubt the official inflation figures, as their personal experience indicates much higher rates of increase for grocery energy and housing bills.

As a result, many young people complained rapid inflation has put house ownership beyond them.

According to the National House Buyers Association, the property prices in urban areas in Penang and Kuala Lumpur rose by up to 40% last year, mainly fuelled by low interest rates and a surge by speculative buying. The average price of a Kuala Lumpur house is now about RM485,000 or roughly 9 times the average urban household annual income of RM54,000.

The Demographia International Housing Affordability Survey rates property prices of 5.1 times or more on median income, as “severely unaffordable”.

Many with savings feel that their money is buying less and less. Many Malaysians have used a number of ways to protect their savings against inflation. The following are some common and popular methods.

Note:  As the effect of debasement of currency on prices is not always immediate, we should not be distracted by short term volatility of rates and prices, hence only the long term average rates (compounded) over the last 10 years are used  to discuss their effectiveness.

1. Buying houses

Many in Malaysia have bought houses to live in as well as for investment. One can put down 10% deposit, and gets a housing loan if one’s income qualifies for it. The current mortgage interest rate is about 5% per annum. The rental yield ranges from 4% to 7% p.a. which is sufficient to cover interest payment.

Over the decade (2000-2010) the average rise in price of houses is 3.5% p.a. (Data source: Valuation and Property Services Department, Malaysia-JPPH). This rate is slightly higher than the average official inflation rate of 2.2% p.a.

In the last 12 months, the price of houses have surged, with Kuala Lumpur house price index Surging  by 9.9% y.o.y. in Q3 2010.

Many speculators have bought houses using flexible housing loan requiring only minimum monthly repayment of interest), resulting in a levered gain of 10 times in a rising market over last 10 years.

On average, an investment of RM100,000 in a million Ringgit house in Malaysia in 2000 will yield a gain of RM410,000 in the year 2010 (compounding effect). This figure does not take into account the maintenance cost of the house and local taxes such as quit rent and assessment.

2. Bank fixed deposit

The bank fixed deposit is currently paying less than 3% interest p.a., which hardly covers the price surge of essential goods, and housing. Many still put money in fixed deposit for liquidity purpose, as it takes only 5 minutes to get cash from them compared to 4-10 months required to liquidate a house.

3. Stock Market

Many investors also put some savings in stocks and shares in Malaysia, and over 10 years, (2000-2010), the Kuala Lumpur Composite Index rose an average rate of 3.2% p.a. (compounded and without taking dividend into account), which is only slightly above the official inflation rate.

4. Gold

In order to encourage local Malaysians to save in gold, the Malaysian Government

started,  in July 2001, to issue the locally minted coins in pure gold (9999) called Kijang Emas (The golden Mouse Deer). These coins in ¼ oz, ½ oz and 1oz are minted by Bank Negara Malaysia and made available throughout Malaysia at the Malayan Banking (Maybank) branches which sell the gold coins in Ringgit at rates published daily.

In July 2001, the price of a 1oz Kijang Emas was RM1082 and by Dec 2010, it was selling at RM4,624. Using the average yearly price over the last ten years (2001-2011), the price of local gold coins have risen at an average compounding rate of 15.7% p.a.

Coins bought in 2001 and sold them in 2010 would get a good appreciation of 15.2% p.a. or total gain of 258% in Ringgit value (taking into account the 4% spread). This rate is definitely higher than the official inflation rate.

Preferred Method by Malaysians From the amount of money invested, it is obvious most Malaysians with high savings prefer to invest in houses over the hoarding of gold as a method to protect their savings from losing their purchasing power. The main reasons are:

1. Banks are keen to make housing loans to Malaysians to invest in houses, and will never lend money to people to buy gold. Hence house buyers get leverage in the return on their investment in a rising house market

2. Most people do not understand how the fiat monetary system functions, and they do not understand the importance role of gold in the monetary system. Many Malaysians are influenced by Warren Buffett and his most famous quote about gold:

Gold gets dug out of the ground in Africa, or somewhere. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.

Note: on a yearly average basis, Berkshire Hathaway appreciated in USD value of 22% p.a. over the last 44 years (1966  – 2010), and Warren Buffett was voted by money managers as the greatest investor of the last century. However, over the last 9 years (2001 to 2010) his average yearly performance of 5.3% p.a. was consistently beaten by gold’s 15.7% p.a. appreciation in Ringgit value.

When confronted with the above quotation of Warren Buffett (WB), my friend Mr.GB would always reply with the following story:

One day, two aliens from the Planet A.S. (All Saints) visited Earth, and they met Earthling GB.

Alien WB said, “I am amazed by the practice of you Earthlings. Why would you use locks to lock your doors? Why do you use gold as money?”

Earthling GB: “We use locks to keep thieves out.”

Alien WB: “In Planet A.S. throughout all generations, people are honest and we have the DNA of the Saints. The A.S. people including our leaders are honest, and always have the interest of their people in their hearts. There is no crime or thief in A.S., hence no locks, no policeman or security guards. They have no utility in our Planet A.S. We do not need to elect our leaders. It is a waste of time & resources, and we definitely do not use the gold standard, as our leaders  are perfectly honest and have infinite wisdom; they know how much money to print and will not steal the savings of the people via the stealth tax or printing of more fiat money than necessary.”

Alien CM said: “You can’t eat locks! In Planet A.S. those who bought locks are irrational and immoral. These lock bugs are jerks.”

Earthling GB: “But here on Earth, we need locks, policeman, security guards, and gold to prevent theft of our properties including our savings. Only the thieves and crooks in disguise always discourage us to invest in locks. We have very few Mother Teresas on Earth. We must have frequent elections of leaders. We use gold standard as a fair accounting tool, and I can tell you these activities are not a waste of time or resources as they improve the quality of life and productivity of society.”

Conclusion

In the last 10 years it appears that a good way to protect savings against inflation in Malaysia is by converting saving into gold coins or investing in houses by taking a mortgage.

Using leverage of a housing loan, one can gain wealth faster in a rising housing market, but then history tells us all bubbles will pop one day.

With the house price affordability of 9 times over the median household income, we in Malaysia may run out of buyers one day and when the housing bubble pops, many leveraged investors  will find their wealth shrinking faster than it rose in the last decade.

Philip T

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How to buy Kijang Emas and other gold (& silver) coins in Malaysia.

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Hugo Salinas Price is a successful, retired businessman who lives in Mexico and has been a follower of the Austrian School of Economics since his youth. As President of the Mexican Civic Association Pro Silver, he has been actively lobbying the Mexican Congress to approve legislation, which will institute the pure silver “Libertad” ounce as money.

As a follow through of my article discussing the merits of using PMs as a store of wealth (savings), here’s an idea from Price on how silver can be monitized, used as a reliable store of wealth and circulated alongside existing paper currencies.

During the last fifteen years I have devoted my efforts to one single aim, and that is to achieve the monetization of a silver ounce coin currently minted by our Central Bank. This coin has no engraved monetary value and is called the “Libertad” coin; it can very easily be turned into a monetary coin, that is to say, a coin with a monetary value. As such, anyone owning such a coin could, if he or she wished, be able to pay any bill or debt denominated in Mexican pesos.

The monetary value of this coin would be slightly higher than its bullion value; the monetary value would not fluctuate according to the price of the silver ounce, but its monetary value would be raised if the bullion price of silver rose and closed in on the monetary value. The Central Bank would give the coin its monetary value, according to a formula in the proposed legislation.

If the price of silver fell to $1 dollars an ounce, the monetary value of the coin would remain where it was last pegged. (But it would still be better money than any paper or digital money in the world!)

On the other hand, if silver should go to $50 dollars an ounce, this coin would remain in circulation, useable as money, because then its monetary value would be about $57 dollars, and stay there until a further rise in the value of bullion silver.

The monetized silver ounce would be an excellent refuge for savings and would attract them irresistibly. You don’t need a bank account, you don’t even have to know how to sign your name, to invest your savings in this simple and inflation-proof way.

This coin would be better money than the US dollar and I expect many Americans would be wanting to own these “Libertad” ounces once monetization is realized.

If this idea interests you, read his latest essay “A discussion of precious metals as money“ presented at The Cheviot Sound Money Conference, Guildhall, London on 27 January 2011. An excerpt from pages 20-21 is reproduced below [Emphasis mine].

The rupture of a paradigm is a rare event; entrenched ideas are hard to dislodge. A fresh approach leads to new avenues of action and opens up new horizons which can resolve the total dead-end confronting the world. The system of fiat money issued by banking systems has exhausted itself and cannot offer real alternatives to progress, but only such aberrations as QE 2. The first thing that will happen when the prevailing monetary paradigm is broken is that people will immediately begin to regard money in a different light: they will have an option, where there was previously no option at all.Britain would no doubt receive the monetization of a silver coin most enthusiastically. The demand for the coin would be enormous. If the bankers are allowed to have their way, there will be no monetized silver coin. They will adamantly oppose it. They will be frightened to death of the preference which the British would surely give to the silver coin. They will allege that if the silver coin becomes a reality, Britain is doomed. The bankers are prisoners of their paradigm and can think in no other terms.No one can foresee all the consequences of introducing a silver coin into circulation in parallel with paper and digital money. Churchill once said, “In politics, experimentation is revolution.” However, real silver money has been the rule in history, not the exception; thus a partial return to silver money as an option alongside paper and digital money is hardly an innovation or experimentation. In historic terms, what has been  experimentation – and QE 2 is avowedly experimentation – has been global fiat money created by bankers who quite evidently have had no notion of what they were doing and did not know or did not care what the consequences of their actions would be. The British would experience the joy of holding real money in their hands and saving money that will surely be worth something in the years to come: money that cannot be devalued. Revolution, for the bankers who have not lived up to the trust placed in them; for the people, it heralds peace of mind and hope for a better future, not revolution.

Here’s another of his interesting and related article. It’s his take on “Why the gold dinar and silver dirham have failed to take off in Malaysia“.

While Mahathir merely talked about the Dinar & Dirham, the Kelantan government actually acted on it. In August 2010, AsianTribune reported that “a Malaysian state has introduced the gold and silver coins as official currency, reviving a practice from early Islamic era. The Kelantan state of Malaysia has become the first to introduce the gold dinar and silver dirham for use.

But Malaysia is not the only country where individuals are beginning to return to the use of gold and silver as currency for ordinary daily transactions. In Indonesia, ordinary men and women on the street have realized that transacting and saving in gold & silver have maintained, and even increased their purchasing power compared to keeping paper currency. The gold Dinar and silver Dirham is being circulated alongside the official fiat currency - Indonesian Rupiah.

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Further reading: 

Integrating al-Rahn with the Gold Dinar: The initial building-blocks towards a gold-based economy - By Ahamed Kameel Mydin Meera.

Pursuant to arguments put forward by Meera and Larbani (2006) that the maqasid alShariah are unattainable within the present fiat monetary system and that real money systems based on commodities like gold and silver are indeed compatible with the maqasid, this paper presents a way to introduce a gold-based payment system within the fiat monetary environment. The most practical way is to introduce the gold-payment system as a dual system. In the initial phase, individuals and businesses should be made to own gold gradually and once the ‘critical-mass’ is there, thereafter to turn the gold ownership into a payment system. Integrating al-rahn, the Islamic pawn-broking, with the gold dinar is one initial building block that can be pursued. This paper attempts to provide the mechanisms for integrating al-rahn with the gold dinar payment system.

Full paper

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