Earlier this month, James Rickards, a well-known investment banker and risk manager, published several newsletters alleging that the Federal Reserve, the central bank of the United States, is insolvent. He believes if you look at the Fed's balance sheet, you'll see that the debt the bank has issued vastly outweighs the assets backing it.
If Rickards is right, the Fed is in the same predicament as millions of homeowners -- it's underwater.
He goes on to say, "In short, it’s all debt. Wealth is illusory if it involves a claim payable in dollars which are but a claim on an insolvent central bank backed only by its ability to print more debt."
And just to clarify, the Fed's "debt" takes the form of Federal Reserve Notes, also known as the paper money sitting in your wallet, under your mattress, or electronically in your bank account.
His solution?
The United States should re-adopt the gold standard. Not only should, but must, and eventually will be forced to do so. Based on the number of dollars vs. the ounces of gold held by the Fed, he thinks it would take about $5,500 to equal roughly one ounce of gold.
Today, the call for a return to the gold standard is largely made by gold bugs, fringe economists and Congressman Ron Paul. Though it gets a lot of press, it is not a mainstream idea by any stretch of the imagination.
But it's an interesting assertion when you consider that Rickards is not your typical gold bug. He is the former general counsel for Long Term Capital Management (LTCM), the infamous hedge fund which, after making spectacular annualized returns of +40%, crashed and lost billions after the Russian financial crisis in 1998.
His experience at LTCM may have given him unique insight into the gold market. When LTCM imploded, it was rumored to be short 300-400 metric tons of gold with no possible way of getting its hands on enough physical gold to cover its short position.
The rumors go on to say that in order to prevent utter chaos in the gold market (can you imagine the price explosion on rumors of a gold shortage?), an event that most likely would have spilled into other financial sectors, the New York Federal Reserve secretly arranged for a handful of investment banks to quietly bail out LTCM. In exchange, LTCM principals were forbidden from ever discussing it.
LTCM had racked up massive amounts of debt that it couldn't repay. Rickards is saying that the U.S. government is in the same predicament.
The Barbarous Relic
Gold has a pretty dramatic history, and it has a tendency to baffle modern investors. It throws off no dividends, has little industrial value, and confers ownership only in…itself. How strange that anyone would want it at all.
But the argument always comes back to one simple fact: for whatever reason, for thousands of years, people have considered gold to be money.
To put the equation "gold equals money" in context, consider that an oft-mentioned rule of thumb is that one ounce of gold should be approximately equal to the cost of one high-quality man's suit. This relationship seems to have held for centuries. Brett Arends, contributor for the Wall Street Journal recently mentioned it when he wrote about a London hedge fund manager who argues that the rule dates all the way back to ancient Rome, when a well-to-do citizen could spend one ounce of gold to buy a top-of-the-line toga.
Artie