“If we were to return to a gold standard today, each ounce of gold held at the Fed would have to back a breathtaking $39,000 dollar bills.”

“1980 gold price of $850 is equivalent to $2,200 in today’s shattered currency!”

Money Talks – Gold Shouts

The biggest change in the gold market has been the unwillingness of certain governments to sell their gold. Some powerful states, such as China, are beginning to hoard gold and to become net sellers of U.S. Treasury securities. In addition, private investors are buying so many gold coins that fabrication plants are months behind on physical deliveries. In short, individuals, institutions and governments are losing faith in paper currencies, particularly the U.S. dollar. Despite the opportunity cost associated with trading interest-bearing government securities for pay-to-store bullion, they are buying gold.

Throughout much of recorded history, gold has proved to be the ultimate form of money. Due to its inherent scarcity, it has been the bane of governments who wished to spend more that they had or could borrow. Certain governments even diluted the gold content of their coins in order to dupe buyers.

The United States entered into federation with a sole reliance on gold as its legal tender. It was not until the Civil War that the U.S. government issues its first paper currency. However, this was not fiat money. All currency issued was backed by gold, and later by silver. But over the years, the backing was withdrawn as government looked to expand the money supply. By 1933, every $20 note was backed by only one ounce of gold at the Federal Reserve. That year, the Fed refused President Roosevelt’s request to further dilute the gold backing of dollars. In response, Roosevelt confiscated gold from all Americans. The Fed acquiesced and printed more paper dollars.

Not content, Roosevelt devalued the U.S. dollar by 75 percent against gold the next year, unleashing a great inflation. Every American who had surrendered gold in 1933 lost 75 percent. Those who owned no gold proclaimed Roosevelt a hero.

In 1971, President Nixon broke the U.S. dollar’s last link to gold, prompting the second great inflationary wave. Inflation became so bad that gold rose from $35 to $850 an ounce by 1981.

In more recent history, President Bush II and former Fed Chairman Alan Greenspan elevated the process monetary debasement into an art form, creating the largest asset boom in history and sowing the seeds of collapse in the financial system. They left the U.S. dollar so debased that the 1980 gold price of $850 is equivalent to $2,200 in today’s shattered currency!

It follows that, at $1,000 an ounce, gold stands at less than half its historic peak. In a recession, when cash is scarce and price levels are falling, it is amazing that gold stands as high as it does. One can only guess where the price will go when the trillions of dollars of electronic government bailout dollars start vigorously circulating.

If we were to return to a gold standard today, each ounce of gold held at the Fed would have to back a breathtaking $39,000 dollar bills. It is a far (1,950 times) cry from the $20 for each ounce of gold of just seventy-six years ago! Is it any wonder that the euro, the currency of the nascent European Union, stands just a shade below its all time high of $1.45?

These signs of chronic monetary decay have not been lost on individual investors or governments holding U.S. dollar surpluses. The key player in this respect is China, the largest holder of U.S. Treasuries – and now the world’s largest gold producer.

Recently, my friend Ambrose Evans-Pritchard reported in the London Telegraph on his interview with Mr. Cheng Siwei, Vice Chairman of China’s Communist Party’s Standing Committee. According to Evans-Pritchard, Mr. Siwei said, “Gold is definitely an alternative, but when we buy, the price goes up. We have to do it carefully so as not [to] stimulate the market.”

This single statement should send shivers down the necks of all who believe in the paper currencies of debtor countries. Similarly, it should warm the heart of all those who already own gold. China has indeed resisted upsetting the international gold market with massive purchases. Quietly, she has merely ‘diverted’ part of her own production into her treasury vaults!

Also, China has sought to protect its citizens from the debasement of paper currencies by lifting restrictions on its citizens’ ownership of precious metals. They can be expected to be large buyers of gold and silver (‘poor man’s gold,’ at only $15 an ounce).

In order to protect themselves from the ravages of governments who believe in massive deficit-financed entitlements, Western citizens should think carefully about whether to trust paper currency over real money. Its an easy decision to reach.

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A light goes on in Russell’s brain — Driving back from a restaurant last night we were listening to National Public Radio from China. They were interviewing many Chinese who had lost their jobs in the big cities and were heading back to be with their families in the country. We noted what terribly hard lives these Chinese lead. The problem the Chinese leaders have — is to keep the populace employed or at least semi-content and not in a revolutionary mood.

I have been wondering why the Chinese government has been almost pleading with the Chinese people to buy and hold gold and silver. And it suddenly occurred to me that the Chinese government sincerely believes that gold and silver are heading substantially higher. The Chinese leaders want the Chinese people to benefit from any higher prices of the precious metals.

The idea is that if the people are happy and richer by holding gold and silver, the leaders will be that much safer. The one thing the leaders of the Communist party want is a peaceful, contented (and richer) population.

So far, the leaders of China have been very smart, and it occurs to me to tell my subscribers — “Do likewise.”

Question — Russell, I don’t get it. You keep talking about deflation taking over. If so, why has gold been going up?

Answer — Like everything in the markets, gold is in a discounting mode. Gold is looking past the current deflation — and into the future at the almost incomprehensible debts the US has been building. Gold knows and the world knows American monetary history under the Federal Reserve. I can tell you it’s history in a sentence, “Inflate or die.” But with our growing debt rising into the trillions, the amount of inflation that lies ahead can only be imagined.

The national debt is now $11 trillion dollars. In 10 years it will be $20 trillion, according to the amount that Obama plans to add to the national debt.

What is a trillion? If a stack of one dollar bills is placed in a column, that column would reach to the moon and back twice. A trillion seconds is over 30,000 years!

Ed Note:

A million seconds is 12 days.
A billion seconds is 31 years.
A trillion seconds is 31,688 years.

The headline on this New York Times piece may be a bit oversold, but it would appear that Berkshire Hathaway (BRK.A) and Warren Buffett are taking a cautious approach to investing in equities now. In fact, fixed income seems to be getting quite a bit of attention from them right now, along with selected stocks. Also, I imagine he is doing some pruning now that many holdings have bounced back from their lows [emphasis added]:

Closely Watched Buffett Recalculating His Bets (New York Times, September 7, 2009, Graham Bowley)

…When so many others were running scared last autumn, Mr. Buffett invested billions in Goldman Sachs (GS) — and got a far better deal than Washington. He then staked billions more on General Electric (GE). While taxpayers never bailed out Mr. Buffett, they did bail out some of his stock picks. Goldman, American Express (AXP), Bank of America (BAC), Wells Fargo (WFC), U.S. Bancorp (USB) — all of them got public bailouts that ultimately benefited private shareholders like Mr. Buffett.

Buffett Beats Out U.S. Treasury on Goldman Deal

I wrote last Fall that the way to bail out the banks was not to have the U.S. Treasury invest directly. Instead, a better plan would have been for the Treasury to create a structured investment with Warren Buffett or Bill Gross or both in charge of structuring the deal.

In this approach, the government would give private investors a significant tax break on any capital invested in approved banks. Then, the government would step aside and let private investors put in capital as they see fit. In this scenario, investors would have gotten a good deal, banks would have gotten the capital they need and the U.S. Treasury would not have been on the hook for anything.

To see why this would have been better, here is a comparison of how Buffett’s Goldman Sachs deal compares to the Treasury’s Goldman Sachs deal. This chart from Barry Ritholtz’s excellent blog illustrates the points made in a fascinating Bloomberg piece (see below):

….read more and see chart HERE (scroll down)