Yet again another great articleMore On the New Monetary System ...
by Larry Edelson
Dear Tom,
Not surprisingly, my Money and Markets column last weekabout a new monetary system based on an upward revaluation of the priceof gold set off quite a buzz all over the world. It was picked up byCBS MarketWatch, The Financial Times, dozens of blogs, and more.
Some Think I'm Crazy,
That I've Lost My Mind.
No Problem.
They can think and say whatever they want. I have thick skin.
Moreover, I havehistory on my side — Franklin Roosevelt's 1933 confiscation andrevaluation of gold and subsequent devaluation of the dollar.
I also have company in my camp: Take a look at Fed Chairman Ben Bernanke's comments on the subject ...
" ... it's worthnoting that there have been times when exchange rate policy has been aneffective weapon against deflation. A striking example from U.S.history is Franklin Roosevelt's 40 percent devaluation of the dollaragainst gold in 1933-34, enforced by a program of gold purchases anddomestic money creation. The devaluation and the rapid increase inmoney supply it permitted ended the U.S. deflation remarkably quickly... the episode illustrates that monetary actions can have powerfuleffects on the economy, even when the nominal interest rate is at ornear zero, as was the case at the time of Roosevelt's devaluation."
Also consider GeorgeSoros' recent proposal for a new monetary system involving the SpecialDrawing Rights, or SDRs, at the IMF: Currencies would be devalued ...then repegged to each other and to SDRs ... and then SDRs would becirculated as an international currency.
For Soros' proposal to work, though, it's my opinion that gold would have to play some sort of role.
Given the importanceof all this and the high probability that some tinkering by the G-20 isalready in the works, I'd like to elaborate a bit more on the subject,and then answer some questions I've received.
But first, let me cover the main points of my previous column ...
Point #1: It's simple: If current efforts to prevent a debt-deflationary spiral and depression won't be effective, central banks and governments around the world have the ability to change the rules of the game.
Or as I put it in last week's Money and Markets column, "if they can't print money fast enough, they can resort to changing the value of the money (devaluing)."
History is squarelyon my side here. I've already explained to you how Roosevelt did it.But now take a look at other historical precedents in the table I havefor you today.
It proves, unequivocally, that devaluations work, and that devaluations can occur simultaneously across countries.
Note the 12countries that either came completely off the gold standard or devaluedtheir currencies by 1933 (via raising the price of gold): All of them came out of the Depression almost immediately.
Australia and New Zealand came out of the slump first, barely one year after the Depression started.
The U.S. came out ofthe Depression much later, largely because it stubbornly defended thegold standard by keeping and even raising interest rates during theDepression (to prevent loss of gold reserves).
Meanwhile, of thefive countries that unbendingly clung to the gold standard, refusing todevalue their currencies until much later, as late as 1936 — they all stayed in the Great Depression much longer, an average of 2.33 years longer.
Point #2:For multiple currencies to be simultaneously devalued to help reflateassets, a benchmark must become part of the system.
As you can also seefrom my table, several countries revalued or left the gold standardsimultaneously, devaluing their currencies. That was only possiblebecause there was a benchmark at the heart of the system back then ... gold.
To do the sametoday, some stable benchmark would have to be reintroduced into thesystem, even if only temporarily to help make the transition.
There are severalchoices and proposals out there, including the SDRs at the IMF, and theWorld Currency Unit (WCU) proposed by Lok-sang Ho, Professor ofEconomics and Director of the Centre for Public Policy Studies, LingnanUniversity.
Both proposals havetheir advantages. But they also have inherent disadvantages: The valueof the SDRs already in existence fluctuates daily. So they would haveto repeg SDRs to a third party benchmark (likely gold).
The WCU uses anation's GDP to value and allocate money supply. But that givesinternational businesses and investors an advantage over domesticinvestors due to Purchasing Power Parity (PPP) quirks.
My view: Ironically,after years of panning it, leasing it, loaning it out, and even sellingit — gold will have to play some sort of role in the new monetarysystem (although as I noted last week, it need not be confiscated).
Point #3: Gold, whether it's directly or indirectly part of a new monetary system or not — is extremely undervalued.
At its current priceof about $735, in today's dollars gold is 67% cheaper than it was in1980. For gold to reach its 1980 high in today's dollars, it would haveto trade at $2,270 an ounce.
And as I pointed outlast week, if there's even the slightest role for gold in a newmonetary system, it can trade even higher — I figure as high as $5,100an ounce, which would be the equivalent of monetizing about 10% of themassive $53 trillion of debts in the U.S.
But don't focus onthe ultimate price of gold. Instead all you need to know is that nomatter how you look at it, gold is extremely undervalued and somethingyou want to own. Period.
Now, on to some of the questions
I've received, and my answers ...
Q:What role do you think silver will play in a new monetary system?
A: None. Silver is not a monetary metal and, contrary to wide belief, it is not in short supply.
Q: You notedthat the current official central bank price of gold is $42.22 anounce. What is the difference between that price and the market price?
A: He quoted you thecurrent price of gold. Central banks value the gold on their balancesheets at $42.22 an ounce, at cost. In my view, they will be revaluingtheir gold, much higher.
Q: Larry, Ithink your analysis is very well reasoned, but I have a question. Whathappens to things like wages if there is a currency devaluation likeyou describe?
A: The theory isthat the inflation a currency devaluation would spark would eventuallycause wage inflation as well, which is precisely what happened post the1934 dollar devaluation.
Q: So that I understand properly, what actually happens when currency is devalued?
A: Since each unitof new currency is worth less, it takes more units to buy an asset. Itcauses an asset reflation to occur and also eases debt burdens.
Q: How do you see gold stocks responding?
A: To the moon!
Q: Would it better to own physical gold or gold stocks?
A: A mixture of both, per my recommendations in the core gold section of my newsletter.
Q: Would gold and gold miner based ETFs move in concert with the rise in gold?
A: Yes, though theremay not be a 100% correlation. I would also expect gold and gold miningshares to move up sharply ahead of the news, in anticipation of arevaluation.
Q: Larry, Ibelieve you were the first and only one who years ago predictedcorrectly that central bankers and governments worldwide will be racingto devalue their currencies against each other.
My query is,what is the best time to get aggressive with gold and gold shares? Inthe Great Depression, it was after the crash into the 1932 low.
A: Simple. Don't try to time it exactly. Gold now!
Q: I comefrom Israel where the money was devalued endlessly since more than 50years ago. Savers lost their shirts — the value of their savings wasreduced.
Those whoowed money (mostly on mortgages) made a fortune because they owed thesame number of devalued currency units. Are you suggesting thatsomething similar is about to happen?
A: Exactly. Onlythis time, a huge portion of the world will participate and, instead ofdoing it over and over again, a very large devaluation will occur inone fell swoop.
Q: Could this end up causing hyperinflation?
A: Yes, it could.But if done properly, hyperinflation could be avoided — largely bygoing back to a fixed rate currency regime or via the introduction ofan international payments currency, such as the IMF's SDRs, as GeorgeSoros is proposing.
Q: When and how long do you think it will take to implement? It apparently did not come up at last weekend's G-20 meeting.
A: I am sure it'salready been discussed. If the global economy and deflation worsen bythe next G-20 meeting in April, I suspect the discussions on a newmonetary system will be accelerated.
I estimate it would take a year to transition to it.
Q: But Larry, gold is looking weak right now. What gives?
A: Don't focus onshort-term moves, in any market. Keep the long term in view. I suggestholding all of your gold, even if it falls back to $636, which is amajor long-term support level.
If that were to giveway, it would mean deflation is dragging on a bit longer, and we couldeven see $500 gold. But even then, I would be a buyer with both hands.
For core goldholdings, keep in mind that the upside potential of the precious yellowmetal is at least $2,270 ... and probably higher, to over $5,000 anounce.
Hence, even ifgold were to fall back to $500 first, your risk based on gold's currentprice is about $235 — compared to upside potential that ranges from$2,235 to over $4,200 per ounce.
That's a favorable risk-to-reward ratio — of as much as $17 for every $1 you risk.
Q: What isyour take on the huge disconnect between the exchange-traded or paperprice for gold and the drastically higher price (if you can even findany) for physical gold?
A: There is always apremium for physical gold over the spot futures price of gold. Itincludes the cost of fabrication into ingots, bars, or bullion coins.
In a bull market, the premium rises as dealers try to lift the markups and their profit margins.
Nevertheless, it isimportant to note that the physical gold market is getting very tight,with supplies dwindling and even the U.S. Treasury suspending sales ofAmerican Eagles.
In my view, that'sconsistent with how I see events unfolding. As I noted previously,central banks and treasury departments will stop lending and leasingout gold, then stop selling it ... and in the next stage, start buying.
Best,
Larry
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