In the early 1970s I came across a small book with a seemingly big message that made a great impact on my impressionable young mind. It was called Fiat Money Inflation in France, and recounted the experience of the French in the late 1700s when the government's introduction of paper money not backed by gold or silver led to hyperinflation and economic disaster.
I was stunned as I read about the politicians making the same mistake—printing ever larger amounts of new money—over and over again. You can buy the book at Amazon, but why do that when you can download and read it for free here. Also, here's a video from GoldMoney that summarizes the history of the episode in an 11-minute presentation.
The story should sound familiar, as it is similar to the Quantitative Easing strategies of the Fed in recent years, flooding the economy with new money in an effort to offset the effects of the 2008 crisis and its aftermath. Knowing the experience of the French, as well as that of Weimar Germany, many observers, including yours truly, expected inflation in the U.S. to heat up and bond prices to drop. Obviously, that hasn't happened yet for reasons we've discussed previously. But we remain concerned, and have created new strategies to mitigate the damage if/when inflation kicks in and interest rates begin to rise in earnest.
Gold enthusiasts point to the experiences of France and Germany as cautionary tales of what can happen when there is no restraint on a government's ability and willingness to inflate a country's currency by simply printing more. Their solution? A gold standard:
The gold standard was a domestic standard regulating the quantity and growth rate of a country’s money supply. Because new production of gold would add only a small fraction to the accumulated stock, and because the authorities guaranteed free convertibility of gold into nongold money, the gold standard ensured that the money supply, and hence the price level, would not vary much. But periodic surges in the world’s gold stock, such as the gold discoveries in Australia and California around 1850, caused price levels to be very unstable in the short run....
Widespread dissatisfaction with high inflation in the late 1970s and early 1980s brought renewed interest in the gold standard. Although that interest is not strong today, it seems to strengthen every time inflation moves much above 5 percent. This makes sense: whatever other problems there were with the gold standard, persistent inflation was not one of them. Between 1880 and 1914, the period when the United States was on the “classical gold standard,” inflation averaged only 0.1 percent per year.
When we created our DAA strategy, we included gold as one of the six asset classes. As gold showed periodic strength from 2003-2011, it made frequent appearances in the DAA portfolio. It was last owned in April 2012, and was sold when gold was in the $1,650 area at the end of that month. Since then, gold has briefly traded as low as $1,150, a level 30% below where it was when sold. It's currently in the $1,200 area.
When gold once again shows superior relative strength compared to the other asset classes in the DAA framework—U.S. stocks, foreign stocks, real estate, bonds, and cash—it will once again find a home among our DAA recommendations. Meanwhile, we wait.
For those interested, here's an update on gold by U.S. Global Investors, one of the mutual-fund companies that sponsors a precious-metals fund. Obviously they have a bias, but that doesn't negate the points made in the article about the growing U.S. debt and the question of how that will ever be retired:
Forty-four years ago, when the U.S. made the switch to a fiat currency system, the federal government owed $399 billion. Since then, outstanding debt has ballooned 4,411 percent to $18 trillion—more than twice the amount of all the gold in the world. Such massive debt levels can be reached only in a fiat currency system, where money is easy, virtually limitless and unsecured by anything tangible.
Below, you can see how dramatically all debt in the U.S., both public and private, has been allowed to soar past economic growth since the end of the gold standard.
So how would any of this debt ever be settled were it called in tomorrow? The U.S. currently holds “only” 8,133.5 tonnes of gold in its reserves, a significant decline from the all-time high of over 20,000 tonnes in the 1950s. This amount calculates to about $340 billion—nothing to sneeze at, but a far cry from the current U.S. debt level....
Lately we’ve seen several central banks repatriate more of their gold reserves from foreign vaults, most notably Germany, Austria, France, Switzerland and others.... The fact that central banks still hold the metal has less to do with “tradition”—as former Federal Reserve Chair Ben Bernanke put it during a Congressional hearing in 2011—and more to do with confidence in gold’s enduring power.
The article also reports on a new study by Bank of America Merrill Lynch showing that gold has a seasonal tendency to bottom between mid-June and mid-July and rebound into the fall. "In all but two of the last 27 years, or 93 percent of the time, gold and gold equities enjoyed a late summer rally, thanks in large part to the approaching Indian festival and wedding seasons....According to BofA Merrill Lynch, from 2001 to 2014, the yellow metal gained 14.9 percent on average between mid-summer and mid-autumn." If that kind of rally materializes, perhaps it will get the attention of our DAA momentum indicators!