Introduction

Suggesting that hyperinflation may be in our future, and that it is a danger we must prepare for, surprises many investors. Despite the unprecedented creation of trillions of dollars, euros and pounds by the US Federal Reserve, the European Central Bank and the Bank of England, most economists and financial advisors are not warning us about the threat of inflation, let alone hyperinflation. Then again, neither did they warn us about the housing crisis and the Great Recession it triggered. In fact, most of them predicted that the crisis would be restricted to subprime mortgages, that it would be over in a year, and that employment would bounce back starting in 2009.

This article shows why I believe that inflation is currently higher than the official CPI and why it is going to rise far higher within the next several years. Will this period of central banks printing money to finance enormous and rising sovereign debt in the US and throughout the world result in hyperinflation or in just years of double-digit (10-20%) inflation? I think hyperinflation is the more likely outcome. Either way, you can use a similar investment strategy to avoid serious losses and take advantage of substantial profit opportunities.

That investment strategy is based on owning European and American pre-1934 gold and silver coins. Before we get into the question of hyperinflation itself, let’s talk about gold as a measure of inflation and the current bull market in gold.

Full disclosure: I’ve been a rare coin and precious metals dealer for 50 years, and I’m going to recommend that you invest in items that I buy and sell. As a believer in investing in precious metals and rare coins, I try to maintain a large inventory. I put my money where my mouth is: 80% of my personal assets are invested in precious metals and rare coins. I am a market maker, not a broker. I buy precious metals and rare coins— sometimes in very significant quantities—whether or not I have a buyer lined up. To further provide liquidity, I generally have the lowest bid/ask spreads in the industry (it helps that I don’t have commissioned salespeople making endless phone calls and that I don’t advertise on TV or in print). During the past five decades, I have encouraged my clients to sell and take a profit when I saw evidence that the market would turn down. I have also recommended swaps, such as platinum for gold, gold for platinum, and gold for silver, when I felt they would produce a better return. I am proud to say that over my career I have helped thousands of clients earn hundreds of millions of dollars. And I am grateful to my clients for raising questions that have made me better in my profession.1

(1 The research that resulted in this article started by my attempts to answer two questions raised by several of my clients. They wanted to know (1) if there was any likelihood of a government confiscation of gold, such as happened in 1933, and (2) whether it was possible that the US would stabilize the dollar by a return to the gold standard, which was ended domestically in 1933 and internationally in 1971. (I’ll discuss both of these possibilities later in this article.) I discovered that severe inflation was the only scenario in which either of these outcomes was likely, and therefore sought to discover whether severe inflation was probable.)

The same concern about possible conflict of interest arose in April 2004 (a month in which gold averaged $408 per ounce), when I wrote and published an article entitled “The Perfect Golden Storm.” It began, “An array of forces is converging to drive gold toward and probably beyond its 1980 peak of $852 per ounce, creating exceptional opportunities for investors.” The article went on to describe those forces in detail. Four years later, with gold at just over $1,000 per ounce, I followed up with another article, entitled “Gold: $2011 by 2011.” That article showed why the forces propelling gold to new heights would continue for years.

So far in 2011, gold has ranged from a low of $1319 in January to a high of $1895 in September, before correcting to the $1600s. Those figures are from the London PM Gold Fix. CME Exchange spot gold went over $1900 several times. With the advent of the fall Asian buying season, gold may yet reach “$2011 by 2011,” although it may take a little longer than I thought, for reasons noted below.

Clients of Stuppler & Co. who acted based on my analyses in 2004 and 2008 were and are pleased, to say the least. I hope that if you find the evidence in this article compelling, you too will act on your convictions. In 2005-07, a small minority of investors saw through the prevailing euphoria and recognized that home prices were in a bubble that would soon burst. However, even within that minority, fewer yet were able to bring themselves to break with the herd and act, such as by reducing their exposure to real estate and/or shorting mortgage brokers, financial institutions, and homebuilders. Smart and courageous investors who act on emerging trends before they are obvious to everyone are the ones who avoid losses and make profits— especially in difficult and tempestuous times such as the present.

Gold price as a measure of inflation

As someone who paid for our children’s college tuition, buys health insurance for my family and my employees, and purchases food and gas, I’ve seen ordinary inflation developing for quite some time. As we will see, many factors are contributing to a decline in the purchasing power of the US dollar (USD). The dollar price of gold is the best way to track the value of the USD, for several reasons:

• It takes fluctuations in other currencies out of the equation.
• Gold is far less subject to supply interruptions than commodities such as oil, which is highly sensitive to global political developments, and agricultural products, which are significantly affected by weather and use in bio-fuels.

When I wrote “Gold: $2011 by 2011” in 2008 I felt that we would be in Phase II of the gold surge by late 2010-early 2011, and that we would reach $2,011 in Phase III by the third quarter of 2011, followed by a dramatic correction before further advances. My projections have been modified by the financial bailouts of 2008, 2009, and 2010 and by continuing high unemployment and declining home prices in the US.

First of all, what do I mean by describing gold bull markets as having three phases?

The charts above show the previous bull market in gold. As you can see, there is a period of gradual increase from early 1977 to July 1979 (Phase I), followed by a period of accelerating increase from July 1979 to the end of 1979 (Phase II), followed by a near-vertical ascent in January 1980 (Phase III). The table below summarizes these phases.

Gold price increases from 1977 to 1980 (the previous all-time high)

Phase I
Date	Price	Change/Time
Jan 1, 1977	$134.50
Jan 1, 1978	$169.20	+25.79% in a year
Jan 1, 1979	$226.00	+33.56% in a year
July 1, 1979	$277.50	+22.78% in six months (45.56% annualized)
Phase II
Jan 1, 1980	512.00	+84.50% in six months (169% annualized)
Phase III
Jan 21, 1980	$850.00	+66.01% in 20 days (1,204% annualized)

The chart and table (below) of the current bull market in gold shows that through December 2010, this run
up was more prolonged and more gradual.

Gold price increases from 2001 to 2010

Phase I
Date	Price	Change
Dec 2001	$276.50
Dec 2002	$348.10	+25.90%
Dec 2003	$415.70	+19.42%
Dec 2004	$437.50	+5.24%
Dec 2005	$517.10	+18.19%
Dec 2006	$638.00	+23.38%
Dec 2007	$833.20	+30.60%
Dec 2008	$878.30	+5.41%
Dec 2009	$1096.50	+24.84%
Dec 2010	$1422.00	+29.68%
Average annual increase		+20.29%
Phase one has yet to end.

When I wrote the first edition of this article, in March 2011, I concluded, “Phase I has yet to end.” Now, please look at the chart for 2011.

As you can see, the rate of increase accelerated sharply at the beginning of July. Here are the monthly high/low figures.

Gold 2011 (London PM price fix2)

	Jan	Feb	Mar	Apr	May	June	July	Aug	Sep
Low	$1319	$1328	$1400	$1418	$1478	$1498	$1483	$1623	$1689
High	$1388	$1412	$1447	$1536	$1541	$1552	$1628	$1878	$1895

The rate of increase from the January low to the June high was 17.66%, annualized to 35.33%, higher than the rate for any of the previous ten years but still in the Phase I range.

On the last trading day of June, gold was at $1506. On the last trading day of August, it had risen to $1825— an increase of 21.18% in two months, annualized to 127.09%. Intraday gold rose above $1900 several times in August and September. This was especially remarkable because May through August is usually the period when gold is flat or declines in price. The fall, from mid-September through December, driven by Asian buying of gold jewelry, is typically the boom time for gold3. Furthermore, from January 2011 through July 2011, there was not one day when the Gold market had a $40 move up or down. Yet August 2011 saw three days with a $40 move and one day with a $100 move; and September 2011 had seven $40 days and one $100 day. The price surge in the summer plus this increased volatility shows that, despite the sharp correction in September back into the 1600s, we are at the beginning of Phase II of the current bull market.

Asian and Middle Eastern demand for gold

Over the past three years, demand for gold changed. It now comes mainly from China, India, and the Middle East, rather than from the US and Europe. I believe this trend will continue and intensify, with demand from these three areas increasing dramatically because of fear of inflation and lack of faith in paper money.

Chinese demand for gold comes from the central bank and from the increasing segment of the Chinese population that has money to invest. That segment is already larger than the entire US population. This diplomatic cable released by Wikileaks explains the Chinese government’s motivation for buying gold:

“The China Radio International sponsored newspaper World News Journal (Shijie Xinwenbao) (04/28[2011]): ‘According to China's National Foreign Exchanges Administration China 's gold reserves have recently increased.…The U.S. and Europe have always suppressed the rising price of gold. They intend to weaken gold's function as an international reserve currency. They don’t want to see other countries turning to gold reserves instead of the U.S. dollar or Euro. Therefore, suppressing the price of gold is very beneficial for the US in maintaining the US dollar’s role as the international reserve currency. China’s increased gold reserves will thus act as a model and lead other countries towards reserving more gold. Large gold reserves are also beneficial in promoting the internationalization of the RMB [renminbi].’"

(2 The London gold fix is calculated in 50-cent increments. We’ve rounded to the nearest even dollar. For example, 1801.50, 1802, and 1802.50 all appear as 1802; 1803.50 appears as 1804.
3 India is the world’s number one consumer of gold. Gold jewelry is the traditional wedding gift, and is considered a store of family wealth. Buying gold for the Indian fall wedding season runs from late September into December. Similar traditions in several other south Asian countries increase the seasonal demand for gold.)

A growing number of Chinese people—already about 2 million—purchase gold and silver on a monthly accumulation program. Regardless of the price of gold and silver, they purchase a set amount each month and the bank stores their metal.

Ten years of 20%+ average annual increases in the price of gold have built an exceptional base for the Phase II and Phase III surge. I believe that during Phase II we will see the average yearly increase double to 40% over a period of about three years, with a number of $50 and $100 up and down days. Phase II started in August 2011 with gold at $1,621. Compounding annual appreciation at 40% for three years will take gold to $4,448 per ounce. Phase III, with its much higher rate of change, will see gold reach a minimum of $6,000 per ounce within six months or less. I believe my price estimates are conservative, and that Phase III will occur before or during 2015. A US government decision to adopt a gold standard or start a gold confiscation program would accelerate this timetable.

No other asset class has increased over 20% every year, or is up over 300% from 2004 to 2011. As I wrote near the end of “Gold: $2011 by 2011,” “As long as the interrelated forces I have labeled limited supply, declining US dollar, interest-rate bind, investment climate, and global instability remain in place, they will continue to drive the price of gold higher. I believe I have shown that these forces do remain in place and are, in fact, intensifying. The Perfect Golden Storm continues. Your opportunity to profit from it remains.”

Gold prices and global instability

Investment demand for gold rises with global instability, which is accelerating as destabilizing events become more frequent, more intense, and more interrelated. The earthquake and tsunami in Japan exposed weaknesses in nuclear-power generation, the growth of which had been seen as part of the strategy to contain oil prices. The “Arab Spring” has ousted dictatorial regimes in Tunisia, Egypt, and Libya, but it is far from clear what forces will prevail in those countries or in countries where dictators have managed to hold onto power by suppressing social protest, such as Syria and Bahrain (where the king retains power only with the aid of the Saudi Arabian army). Osama bin Laden and other senior al-Qaeda leaders have been killed, but in several countries, such as Pakistan, Yemen, and Somalia, al-Qaeda or organizations affiliated with it continue to be destabilizing factors. Not since the overthrow of the Shah of Iran has control of Mideast (and North African) oil been more in doubt.

Sovereign debt crises in Europe are also major sources of global political and economic instability. Despite the efforts of the European Union (EU) to prevent it through bailouts, Greek default on its debt seems more likely every day, with devastating consequences for French, German, Belgian and other banks that hold Greek debt. (By Sep., 2011, Greek 2-year notes had become so unmarketable that the interest rate had soared to 70%. Through credit default swaps, you could insure $10 million of Greek debt for five years by paying $5.65 million upfront—seriously—plus $100,000 annually.) US stock markets react negatively to fear of Greek default because they know the contagion could spread to US financial institutions and reduce US exports to Europe. And, if the EU cannot rescue Greece, how can it save the other “PIIGS”—Portugal, Italy, Ireland, and Spain—from default? Each of these countries suffers from a serious sovereign-debt problem. Italian national debt, at €1.9 trillion ($2.58 trillion)—115% of Italian GDP—is so large that it is hard to envision any source of bailout funds. And unlike the US, which can at least temporarily stave off default by printing dollars, none of the European countries can print euros.

The EFSF (European Financial Stability Facility), which was set up in May 2010 to bail out Ireland and Portugal, can lend governments enough euros to recapitalize their banks. Think back to 2008 when the Troubled Asset Relief Program (TARP) was passed by the Congress to recapitalize US banks. Then multiply the problem by five PIIGS countries, with approval needed from 17 eurozone nations. A little addition is required as well. TARP required “only” $700 billion. It’s estimated bailing out the PIIGS and the banks that hold their sovereign debt will cost €3 trillion ($4 trillion) over the next 2-3 years. (The fact that most of the US banks that received bailouts paid back TARP with interest helped secure passage of AFSF)

We’ll talk about the possibility of default (or avoiding technical default by paying off lenders with hyperinflated currency) on US debt a little later. Suffice it for now to say that the gridlock in the US Congress over increasing the debt ceiling, which came close to causing default in July 2011, substantially contributed to global instability. That, along with the realization that the US has no realistic plan to avoid continuing to add to the national debt unnerves investors and led to the unprecedented lowering of the US’s debt rating from AAA to AA+ by Standard & Poor’s. The US Congress Joint Select Committee on Debt Reduction, aka the Super Committee, is charged with recommending $1.5 trillion in budget cuts over the next 10 years, a part of eventual agreement on $4 trillion in cuts. But the federal deficit is projected to increase by at least $1.3 trillion in just the fiscal year ending in September 2011! Projections for 2012 are as follows, according to the US Office of Management and Budget (for the Obama plan) and the United States House Committee on the Budget4 (for the Republican plan): “The Obama administration's original budget request contained $2.627 trillion in revenues and $3.729 trillion in outlays for 2012. The April 2011 Republican plan contained $2.533 trillion in revenues and $3.529 trillion in outlays.” In other words, the Obama 2012 budget envisions a deficit of $1.1 trillion; the Republican a deficit of $1 trillion. Projections for future years are similarly well above the planned cuts. And deficit projections are notoriously low, because they tend to be based on overly optimistic estimates of federal income and expenditures.

The role of silver The price of silver has a general tendency to correlate with the price of gold. The same month that gold hit its previous all-time high of $852, in January 1980, silver streaked to a peak of $50.50 per oz. It quickly dropped back into the single digits, where it lingered for many years. In 2003 silver entered its current bull market, reaching a high of $48.70 in April 2011. Unlike gold, silver has yet to surpass its 1980 high. Much of the reason for that is that the 1980 price was artificially boosted by the attempt of the Hunt brothers to corner the silver market through huge margin purchases. Like gold, silver is an investment vehicle. Unlike gold, a significant part of the demand for silver is industrial. Therefore while the two precious metals tend to rise and fall together, they are by no means in lockstep. Currently, the ratio of the gold price to the silver price is the area of 45 to 1. Since 1940 that ratio has been as high as 94 to 1 and as low as 22 to 1. Robin Bromby in The Australian magazine (July 15, 2011) reports that silver demand is expected to climb dramatically over the next nine years as demand from healthcare, clean energy and water purification increases. New technologies like crystalline silicon solar cells, radio frequency identification tags, and biocide (an agent capable of destroying harmful organisms) plus bacteria removal in new water purification systems are expected to increase silver demand by 6,600 metric tons in the next nine years.5 Along with gold, silver can be a good hedge against inflation for two reasons: 1) Diversification within the precious metals. For example, during 2010, the price of silver rose 63%—far faster than the price of gold that year. 2) To pay for daily expenses, silver lends itself to much smaller transactions than gold.

The price of gold and interest rates

In the 1977-1980 gold bull market, the price of gold rose even while the prime interest rate reached 11% and tripled with the prime at over 15%. That bull market ended without hyperinflation. A combination of historically high interest rates and wage and price freezes sent the country into a recession and gold into a bear market.

(4 Both quoted in Wikipedia entry on “2012 United States federal budget.”
5 See The Australian article at www.mintstategold.com/investor-education/silver_soaring/.)

How high did interest rates have to go to win investors to sell gold and buy bonds or CDs? When gold peaked in January 1980, the prime rate—the rate at which banks loaned to their most creditworthy customers—was 15.75%, rising to a high of 20% by April. The United States is in a very different place today, facing much stiffer global competition, much higher federal deficits and national debt, and much more committed to stimulating the economy through prolonged low interest rates. In 1980 the US federal debt was below $1 trillion. With its debt now approaching $15 trillion—and having to constantly borrow money to make debt payments—it’s virtually inconceivable that the federal government would allow interest rates to approach those levels. Federal Reserve Bank Chairman Ben Bernanke even took the unprecedented step of announcing that the federal funds rate6 would remain in the 0.5-0.25% range for two years, through August 2013. Never before has the Fed told investors how long a rate would be in effect. Such a funds rate will hold the prime rate around 3.25%—a far cry from the 15-20% rates that helped kill the gold bull in 1980. We should also note that it would take substantial “real interest rates” to halt the current gold bull market. The real interest rate is the difference between the nominal interest rate and the rate of inflation. So, if say in 2015 the interest rate has risen to 15% but the rate of inflation is 20%, making the real interest rate minus 5%, the gold bull market would probably be surging rather than ending.

Recent trends in Chinese gold demand illustrate this point. During the first three months of 2011, one quarter of the gold sold in the world was bought in China, second only to India. Chinese gold consumption was up 47% over the same period the year before—despite four increases in interest rates. To combat inflation, the Chinese government raised interest rates on 12-month bank deposits from 2.5% to 4.5%. Yet the number of tonnes7 of gold purchased by Chinese citizens increased, as did the price of gold in yuan. However, in Q1 2009, when the real interest rate spiked sharply, demand for gold decreased sharply.8

Economist Vincent Reinhart, a former director of the Federal Reserve Board’s Division of Monetary Affairs, says Fed policy may be moving toward “Generate Inflation Now,” a play on President Ford’s “Whip Inflation Now” campaign. Reinhart says Bernanke, along with Bank of England (BOE) Governor Mervyn King, are considering holding interest rates at or close to zero even if inflation rates rise above their 2% “target rate.” Sure enough, on Oct 6, 2011, BOE announced it would buy £75 billion of government bonds in a fresh bout of quantitative easing aimed at stimulating the UK’s stagnant economy. BOE’s Monetary Policy Committee agreed to finance a second round of asset purchases with newly created central bank money to ensure that the inflation rate didn't fall below its 2.0% target over the medium term.

Hyperinflation happens

Most of us think of hyperinflation as something that happens in other countries. Actually, we’ve had two episodes of hyperinflation in the US, but they were a long time ago, during the Revolutionary War and the Civil War.

During the 20th Century, 30 countries experienced hyperinflation.9 In every case, horrifying price increases that quickly wiped out the value of savings and of most forms of investment took people by surprise. A few politicians, economists and investment strategists issued warnings that were ignored by governments and by almost everyone else, until they were suddenly caught up in the daily struggle for survival. Prices increased every week, or every day, or even every hour; incomes lagged far behind. Business stagnated as it became difficult or impossible to plan production and make a profit. Unemployment rose, and for those without jobs and for retired or disabled people living on fixed incomes, hyperinflation was a hypernightmare that often led to homelessness and starvation.

(6 The federal funds rate is the interest rate (annualized) that banks charge each other for overnight loans.
7 Large quantities of gold are measured in tonnes. Unlike the US ton (2,000 lbs.), a tonne, or “metric ton,” is equal to 1,000 kilograms, or 2,204.62 lbs. Smaller quantities of gold are measured in troy ounces. One troy ounce is equivalent to 1.09714 of the avoirdupois ounces commonly used in the US. Throughout this article, gold and silver prices are expressed in troy ounces.
8 See article by Ben Traynor in BullionVault, May 23, 2011.
9 See “Hyperinflation” in Wikipedia.)

Many of the factors that have led to hyperinflation in the past are present in the United States today. We’ll analyze them in detail later. Two of the most important are rapid increases in national debt and in the creation of money. In March 2006 Congress raised the national debt limit for the fourth time in five years, to what then seemed an astounding $9 trillion. By May 2011, after several more limit increases, the national debt had risen to the debt ceiling—$14.3 trillion—a rate of increase of just over $1 trillion per year. Then, in July 2011, after prolonged debate that shook equities markets throughout the world, Congress avoided a US default by authorizing an increase in the debt ceiling to $16.4 billion. By October 2011 the national debt had risen to $14.8 trillion. The national debt per taxpayer is $131,000 and rising.10 The chart below shows the national debt through September 2009. Since then the debt has increased another $2.9 trillion.

Since 2008, the Federal Reserve Bank (the Fed) has injected trillions of dollars to “stimulate” the US economy. One of its methods, known as “quantitative easing,” involves creating money to buy up US debt. Increasing the money supply to buy Treasury Bonds is known as “monetizing the debt.” Monetizing national debt has also been a key forerunner in most instances of hyperinflation.

The Fed creates money in the form of fiat currency: money backed not by silver or gold, but only by confidence in the government and economy of the United States. This form of creating money is often referred to as “printing money.” However, in the electronic age, the Fed creates money with just a few keystrokes. For example, to buy Treasury Bonds under “QE2” (the second quantitative easing program), the Fed electronically sent the US Treasury billions of dollars that did not previously exist. That money then streamed into the general economy as the federal government used it to pay salaries and bills.

(10 See “U.S. National Debt Clock,” .)

What Is Hyperinflation?

Consumers know they are experiencing hyperinflation when the focus of their existence becomes dealing with rising prices and the attendant shortages of critical commodities. Life is a race to find food, fuel, medicine and other necessities and buy them before the price jumps higher.

Economists have tried to develop more objective definitions. The International Accounting Standards Board defines hyperinflation as “a cumulative inflation rate over three years approaching 100% (26% per annum compounded for three years in a row).” At that rate, an item that costs $10 today would cost $20 three years from now. Your income would have to double in three years to maintain your standard of living. Your investments would have to double in three years to maintain their value. In 1956, economist Phillip Cagan famously defined hyperinflation as an average monthly price increase of 50% or more. At that rate, your $10 item would cost $1,946 just one year later. Unfortunately, most of the 31 nations that suffered from hyperinflation in the 20th Century followed the Cagan model.

“It Can’t Happen Here”

The specter of hyperinflation is frightening. We can make ourselves feel better by pooh-poohing the possibility of hyperinflation happening in the United States in the 21st Century. Reality, however, does not respect wishful thinking. Think back to 2006-2007, when housing prices began to drop. An endless stream of bankers, economists, politicians, and journalists assured us that the crisis would be restricted to subprime mortgages and would be over within a year. In 2008, they assured us that within a year we would see a marked decrease in unemployment and an upswing in the housing market. Today, many of these pundits assure us that inflation, let alone hyperinflation, is not a problem.

If you believe that hyperinflation is coming—and we believe that after examining the evidence in this article you will—why put your head in the sand? Instead, obtain true peace of mind by preparing to survive and even prosper. Such preparation is especially sound because it protects you from the ravages of plain ordinary inflation, which is already upon us. Yes, the federal government assures us that inflation is not a problem. We’ll show later how similar that assurance is to pre-crash announcements that “the economy is fundamentally sound.” For now, we’ll simply ask, “Have you been to a supermarket or gas station lately?”

Let’s look at three examples of hyperinflation and see what we can learn from them.

Do You Own or Manage a Business? After analyzing hyperinflation and related matters, such as the possible confiscation of gold and/or a return to the gold standard, this article will focus on how to prepare as an investor. If you are a business owner or manager as well as an investor, we urge you to read a short (82 pages) book by University of Arizona economist Gerald Swanson, The Hyperinflation Survival Guide. Dr. Swanson and his team studied the strategies that enabled some businesses in Bolivia, Brazil, and Argentina to succeed during hyperinflation while others went under.

The History of Hyperinflation

Germany
The German experience demonstrates that hyperinflation can occur in a large country with a democratic government and a highly developed capitalist economy. We will therefore examine it in some detail

In 1914 the German mark, like most other currencies, was redeemable in gold. When Germany went to war that year, its central bank, the Reichsbank, suspended redemption. Rather than alienate its population through increasing taxes, Germany financed its war by borrowing. Unable to sell enough bonds on the market, Germany monetized its debt by having the Reichsbank buy bonds. The Reichsbank could print unlimited amounts of fiat money to do so.

When World War I ended in November 1918, Germany’s national debt had increased 1,700% and money in circulation had increased by a factor of four. By 1918 the consumer price index (CPI) was up 140%— less than one might expect given the run ups in the debt and the money supply. Price inflation had been kept down by rationing & low demand. Millions of soldiers in the trenches were not in the marketplace. Civilians, hard at work to support the war effort, had little time for leisure. Money was piling up and not being spent.

The German government had expected to win the war and force the defeated countries to pay its debt. After losing the war, there was great incentive to continue printing money to monetize the debt and finance promised social programs. From November 1918 to February 1920 prices shot up another 400%.

After 15 months of relative stability, prices surged again, rising 700% in 14 months. France, claiming Germany was not living up to its agreements to pay reparations for war damages, occupied the Ruhr. Germany sponsored “passive resistance” and paid citizens in the Ruhr not to work under French occupation.

Germany injected so much money into the economy that business everywhere but the Ruhr were operating at full capacity, with full employment. However, prices rose so quickly that, despite frequent wage increases won by unionized industrial workers, real wages plummeted. Farm workers, white-collar workers, and professionals lost ground even faster. Germans, losing all confidence in the mark, immediately spent every mark they could get their hands on. If someone could buy 10 jackets, he’d do it, knowing that they would keep their value and could be used for barter.

By 1923, Germany was printing notes with denominations as high as 100-trillion marks. At the height of hyperinflation, in December 1923, a 100-trillion mark note would get you US$23.81 at the official rate.

Housewives burned 100-million-mark notes for heat; it was cheaper than buying fuel. Business owners turned into speculators in commodities. Farmers kept their produce rather than sell for marks that lost half their value in two days. Food riots broke out; groups of workers went to farms and seized food. Businesses closed; unemployment surged; chaos reigned.

The German government passed monetary reform decrees that forbade the old central bank from buying government bonds, thus stopping the printing of marks. It also created a new bank, the Rentenbank, which issued a new currency, the Rentenmark. To build confidence in the Rentenmark, the quantity in circulation was regulated. The goal was to have sufficient currency for government and commercial transactions, but not to issue credit to the government or speculators.

The Rentenmark was supposedly backed by mortgages on land and bonds on factories. However, the land and factories could not be turned into cash or used for foreign exchange. What gave the new currency real strength was gold. Although the Rentenmark was not redeemable in gold, it was backed by bonds indexed to the price of gold. The value of these “gold bonds” was defined at the same fixed rate as pre-war gold marks, 2,790 per kilogram of gold.

Paper marks and Rentenmarks circulated together, with up to 1,200 quintillion11 paper marks in circulation. In 1924 the German treasury issued a new currency, the Reichsmark, equal in value to one Rentenmark. A monetary law permitted the exchange of a trillion marks for one new Reichsmark. This rate of exchange gave back to people a fraction of what they had lost, because 3-trillion marks were the equivalent in purchasing power of one new Reichsmark.

Krupp, Thyssen, Farben and other major German industrial conglomerates emerged strong from hyperinflation. They had supported the government’s inflationary policies because a weaker mark made their products cheap to foreign buyers, enabling them to increase exports. Their exports were paid for in sound foreign currencies with which they could buy raw materials to import into their plants in Germany. Millions of middle-class people, workers, and farmers, however, saw their savings wiped out and their lives destroyed. Embittered, many of them supported the Nazi party in its rise to power.

Argentina

Under a military dictatorship from 1976 to 1983, Argentina went into debt to finance the Falklands war, government takeover of the debts of failed banks, and projects that were not finished (and therefore produced no revenue). Unemployment reached 18%. The military junta became extremely unpopular and ceded power.

(11 A quintillion is 10-million trillion.)

As part of its plan to stabilize the economy, the newly elected civilian government introduced a new currency, the austral, and took out new loans. Tax revenue did not increase quickly enough to pay the interest on the debt. The central bank reacted by printing money and monetizing national debt, using a variety of tricky financial maneuvers to conceal its actions.12 Despite the deception, public confidence in the austral plummeted. Prices increased by 10 to 20 percent per month. July 1989 saw a sharp increase in the monthly inflation rate—to 200%. For the year 1989, prices went up 5,000%. Real wages fell 50% from 1983 to 1990. Rising prices and declining real wages led to riots and the resignation of the president in favor of the president-elect.

Hyperinflation continued into 1990. In 1991 the Argentine government stopped inflation by fixing the value of the austral at 10,000 to the US dollar (USD), with full convertibility. Later, a new Argentine peso replaced the austral, and convertibility was fixed at one peso to one USD.

Convertibility created a new set of problems. The fixed exchange rate made many imports more affordable than domestically produced products, causing a constant outflow of dollars. The central bank had to buy dollars to support convertibility. Meanwhile, the flood of imports caused factories to close and unemployment to rise. Public spending on unemployment benefits and on corrupt payments to private corporations and wealthy individuals rose, causing the national debt to continue to grow. Widespread tax evasion exacerbated the problem.

Argentina sold off many state companies at prices favorable to the buyers, who were cronies of government officials. The revenue generated by this 1-time fix was quickly spent. Argentina then financed its debt largely by external borrowing, particularly from the International Monetary Fund. By 1999 the economy was in a recession that lasted three years.

By 2001, foreign investors were withdrawing funds from the country and Argentineans, fearing the worst, started withdrawing money from their savings accounts and sending dollars abroad. To stop the run on the banks, the government froze all accounts for 12 months, except for withdrawals of small sums. This led to a new form of protest—masses of people in the streets banging pots and pans. The crowds also smashed windows at banks, privatized companies, and European- and American-owned businesses.

In 2002 Argentina defaulted on its debt and abandoned the fixed 1-to-1 exchange rate. Hyperinflation returned. The peso quickly devalued to about 4 to the USD, with no increase in wages. Businesses failed; unemployment reached 25%..

A recovery started in 2003. Exports surged due to the devalued peso, which also discouraged imports, strengthening those local businesses that had survived. Rising soybean prices and huge exports of soybeans to China brought a flood of foreign currency into Argentina. Simultaneously, the government took measures to increase revenue by strengthening tax collection.

Brazil

Brasília—the futuristic city that replaced Rio de Janeiro as the capital of Brazil—was built in four years, from 1956 to 1960. It was a remarkable achievement: the unpopulated, arid area in the interior of the country had resembled a desert. A problem became apparent years later. The government of Brazil did not have the funds to finance the project. It paid the bills by printing money.

Unfortunately for the Brazilian people, the unfunded construction of Brasília was not a 1-time extravagance. It started—or at least reinforced—a trend that continued for decades. Public projects included a “bridge to nowhere.” Unlike its never-built Alaska counterpart, this bridge reached halfway across a canyon before construction was stopped. Corruption was also rife: a high government official diverted public fund to build privately owned (by him) apartment buildings, and never went to jail.

(12 See Argentina: From Insolvency to Growth, A World Bank Country Study, pp. 180-185, available on Google Books.)

Brazil’s federal debt also increased when the government:

• Had to make good on guarantees to the Mortgage Assistance Fund.
• Was unable to collect on debts that had been listed as assets on its balance sheet.
• Bailed out failing banks.

To pays it debts with devalued currency, Brazil cranked up the printing presses higher and higher. The table below shows the effect on prices.

Price Levels in Brazil, 1980 to 1997

Year	Consumer Price Index
1980	4
1981	8
1982	16
1983	38
1984	111
1985	362
1986	895
1987	2,940
1988	21,435
1989	328,113
1990	100,000,000
1991	500,000,000
1992	5,600,000,000
1993	113,600,000,000
1994	2,472,400,000,000
1995	4,104,400,000,000
1996	4,751,200,000,000
1997	5,080,300,000,000

Source: International Monetary Fund Financial Statistics

People became used to living with a high rate of inflation. Some forms of income, such as some wages and interest, were even indexed to the CPI. But the effects of compounding plus loss of confidence in the currency brought hyperinflation, destroying businesses, jobs, and savings. As the table shows, in 1981 prices were “only” double what they had been in 1980—a 100% increase. By 1985 the annual rate of increase was over 200%. 1989 saw a huge jump, to 1,400%, followed in 1990—the worst year—to 30,000%.

At the peak of hyperinflation, price increases were measured in hours. Storeowners and managers could not change price tags to keep pace. Instead, they put colored stickers on products, and changed prices all at once on color-coded charts displayed on walls and at cash registers. (Such crude measures will not be necessary when hyperinflation strikes the US. Some supermarkets and other large stores have already introduced electronic pricing. An employee at a computer can remotely change the price of any, or every, item in a store, or in an entire chain of stores. The price tag at the register changes simultaneously with the price tag on the shelf. Talk about anxiety on the checkout line!).

Brazilian hyperinflation was brought under control in the late 1990s through a number of measures that included raising taxes and interest rates, reducing government spending, and introducing a new currency, the real, that was indexed to the USD.

Common elements

The three examples of hyperinflation above had features particular to each country. I’m sure, though, that you were struck, as I was, by the elements they had in common. Hyperinflation in Germany, Argentina, and Brazil was characterized by the following:

• Fiat currency not backed by gold and not pegged to another, stable currency.
• National debt increasing at an accelerating pace, not sustainable without major increases in tax revenue and major cuts in spending.
• Financing of wars through debt (Germany and Argentina).
• Government bailouts of failed financial institutions (Argentina and Brazil).
• Printing ever-increasing amounts of currency, ultimately resulting in total loss of confidence.
• Central bank monetizing government debt (Germany and Argentina).
• Sudden, unexpected change from ordinary levels of price inflation to hyperinflation. (A Brazilian businessman described it as “waking up on a roller coaster.”)

28 other episodes of hyperinflation (see table below) in the 20th Century show the same common elements.

Countries that experienced hyperinflation in the 20th century

Country	Period	Ratio of hyper-inflated currency to currency issued to curb hyperinflation
Angola	1991-1995	1 billion to 1
Argentina	1975-1991	1 billion to 1
Austria	1914-1923	N/A
Belarus	1994-2002	1,000 to 1
Bolivia	1984-1986	1 million to 1
Bosnia & Herzegovina	1992-1993	N/A
Brazil	1986-1994	2,750,000 trillion to 1
Bulgaria	1996-1997	3,000 to 1
China	1948-1949	10,000 to 1
Free City of Danzig	1922-1923	10,000,000,000 to 1
Georgia	1993-1994	1,000,000 to 1
Germany	1922-1923	1,000,000,000,000 to 1
Greece	1942-1944	50 trillion to 1
Hungary	1922-1923	N/A
Hungary	1945-46	4x10^29 to 1
Israel	1971-1985	N/A
Krajina	1992-1993	50 billion to 1
Mexico	1982-1993	1,000 to 1
Nicaragua	1987-1990	50 billion to 1
Peru	1988-1990	1 billion to1
Philippines	1942-1944	N/A
Poland	1921-1924	1.8 million to 1
Poland	1989-19991	10,000 to 1
Republika Srpska	1993	N/A
Romania	1990s	10,000 to 1
Russian Federation	1921-1922	1,000 to 1
Taiwan(13)	1940s	40,000 to 1
Ukraine	1993-1995	100,000 to 1
Yugoslavia	1989-1994	10^27 to 1
Zaire	1989-1996	3 × 10^11 to 1
Zimbabwe	2006-2008	10^25 to 1

(13 Prior to the arrival of the Kuomintang.)

China’s Concern about inflation

Have you wondered why the Chinese government is quick to raise interest rates and restrict credit to keep their economy from growing too fast? As the table above shows, hyperinflation struck China in 1948-49. Tens of millions of Chinese peasants, workers, and professionals blamed the Kuomintang government for the financial losses they suffered from hyperinflation and threw their support to the Chinese Communist Party (CCP). On October 1, 1949, in control of most of the countryside and almost every major city on the Chinese mainland, the CCP established the People’s Republic of China.

Even before that, in December 1948, the CCP issued the original renminbi as part of its effort to control inflation in the areas it governed. To this day, the leaders of China are acutely aware of the fury of the masses against their government when hyperinflation strikes. Therefore they try to walk a fine line between controlling inflation and keeping employment high.

The Chinese people are also acutely aware of the dangers of hyperinflation—they’ve heard about the suffering from their parents and grandparents. That’s one reason why they are so motivated to own gold and have been buying it at an accelerating rate since it became legal for them to do so in 2004.

The Path to Hyperinflation in the United States

First Step toward Fiat Currency

In June 1933 the United States House and Senate, acting jointly, passed House Joint Resolution #192. In response to the “existing emergency,” i.e., The Great Depression, the resolution terminated the right of people, corporations, and governments in the US to demand payment of financial obligations in gold. Instead, US dollars, no longer backed by gold, were to be accepted as “legal tender for all debts, public and private.”

Prior to that resolution, in April 1933, President Franklin Roosevelt had issued Presidential Executive Order 6102. This order confiscated gold. It required virtually all gold and silver coins, bullion, and gold certificates (US paper currency redeemable in gold) to be turned in to the Federal Reserve Bank or its branches or agents, in return for an equivalent amount of US currency not redeemable in gold. Failure to turn over gold and silver was punishable by a $10,000 fine and/or 10 years in prison. Rare coins, jewelry, and metals needed for industrial use were exempt from this order.

By taking gold and silver out of circulation, Roosevelt’s order eliminated the competition to fiat currency, leaving people with no choice but to accept paper dollars backed only by government decree. A US dollar could now be created without the necessity of acquiring a dollar’s worth of gold to back it. Devaluing greenbacks was seen as a way to get out of the Depression by stimulating commerce and, especially, by making US exports cheaper and therefore more competitive. However, in a “beggar thy neighbor” policy, every other major capitalist country also abandoned the gold standard.

Ending the gold standard opened the door to price inflation by allowing more money to chase the same amount of goods. Here’s one easily comparable example. In 1933 the price of a first class postage stamp was three cents. In 2011, it takes 44 cents to mail the same 1-oz. letter. That’s an increase of 1,367%. (And the US Postal Service still can’t make a profit and plans to cut services and raise rates.)

Completing the transition to fiat currency

After 1933, people within the US could not convert dollars to gold. US trading partners, however, could and sometimes did.

After World War II, international financial exchange was governed by the Bretton Woods Agreement. That agreement required each country to adopt a monetary policy that tied the value of its currency to the value of the US dollar (USD), at a fixed rate of exchange. The US in turn tied the dollar to gold, agreeing to stabilize the system by buying gold from its trading partners, or selling USD to them, at $35/oz. of gold.

This agreement worked reasonably well until about 1970. By then, several factors, including rebuilt, modernized industrial capacity in Japan and West Germany and the cost of the Vietnam War, had led to the United States running trade and balance-of- payments deficits. In response, the US printed more money. European nations, seeing that each dollar was backed by less gold, began to lose confidence in the USD. Not wanting to risk inflation by devaluing their own currencies, their demands to convert dollars to gold increased sharply.

On August 15, 1971, President Richard Nixon closed the US Treasury’s “gold window.” The USD was no longer redeemable in gold by anyone, inside or outside the United States. The era of fixed exchange rates and a fixed price for gold was over.

At the same time, in an effort to reduce inflation in the US, Nixon imposed temporary wage and price controls. The 90-day controls were extended three times. By 1973 they had been in effect for almost 1,000 days. These controls helped create temporary shortages of some commodities (you may remember the gas lines of 1972-3) but essentially failed to stop inflation in the long run.

The word “stagflation,” first used in Britain in 1965 to describe a period of rising prices but negative-to-low growth, became widely used in the US at this time. It summed up the economic conditions here in the early 1970s and at several times since. Previously, most analysts of the US economy had believed inflation occurred only during periods of strong economic growth.

Current monetary inflation

According to Bloomberg News (February 24, 2009)14, “the U.S. government has pledged more than $11.6 trillion on behalf of American taxpayers over the past 19 months.” The article includes a table detailing the bailouts and stimulus spending.

Even before the current Great Recession, the US Federal Reserve was engaged in monetizing national debt: it held $700 to $800 billion of Treasury notes. In late 2008, the Fed started buying $600 billion in mortgagebacked securities (MBS). Within four months, it held $1.75 trillion of bank debt, MBS, and Treasury notes, which grew to $2.1 trillion by June 2010. This “quantitative easing,” a euphemism for monetizing national debt, became known as QE1—because it was followed by QE2.

In November 2010 the Fed announced QE2, a stimulus program in which it would buy $600 billion of Treasury notes, at approximately $75 billion per month, ending in June 2011. Like QE1, QE2 aimed at keeping interest rates down. Low interest rates enable businesses to more easily borrow money to finance expansion. They also keep mortgage rates low. The fear is that the housing market, which shows no signs of recovery, will be plunged even lower if mortgage rates rise.

Confidence in the USD was so low that interest rates on 10-year Treasuries climbed despite the Fed’s purchases. The yield rose from 2.5 percent on Nov. 4, 2010, when QE2 was announced, to 3.46 percent on April 10, 2011. That was a 38% increase in five months: a huge change in the normally slow-moving bond market. According to US News (March 15, 2011),15 “Bond guru Bill Gross, who manages the world’s largest mutual fund, PIMCO Total Return, is forecasting a spike in treasury yields. Gross has sold off all of the T-bills in his flagship fund because of his concerns about the end of QE2. In his investment outlook for March, Gross writes, ‘Bond yields and stock prices are resting on an artificial foundation of QE II credit.’ He adds: ‘Who will buy Treasuries when the Fed doesn’t?’”

An article in the Wall Street Journal (April 15, 2011) supported Gross’s view: “…the Fed has purchased the equivalent of more than two-thirds of Treasury issuance since last fall. The worry is that when the central bank stops buying, no one else will step up, forcing rates higher.”

(14 http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aZchK__XUF84
15 http://money.usnews.com/money/personal-finance/mutual-funds/articles/2011/03/15/what-happens-after-qe2-ends)

Of course, since the end of QE2, we’ve seen the opposite happen. With Greece on the edge of default and the sovereign-debt crises spreading throughout Europe, the euro has been dropping like a rock against the dollar. Fear of another failure of major banks, this time starting in Europe, has led to extreme volatility on the world’s stock markets. Investors have fled equities and the euro into what they regard as the relatively safe haven of US Treasury Bills, keeping the cost of Treasuries high and pushing 10- and 30-year yields down to record lows. (A sign of the times: Bank of New York Mellon, which specializes in holding cash for large corporations, announced that it would begin charging a fee to hold deposits of over $50 million. In other words, a negative interest rate!) To top it all off, in September 2011 the Fed announced a shift from holding short-term to long-term US sovereign debt. This policy, known as “the Twist,” is supposed to encourage banks and other investors to lend to businesses—or buy stock—by keeping the return on government bonds low into the foreseeable future. (This is unlikely to be more than a blip in the long-term decline of the value of the USD, which we discuss later in this article.)

All central banks, including the Fed, operate on the assumption that their chief weapon for fighting inflation is increasing interest rates. They also believe that even tiny increases in interest rates will curb inflation by slowing economic growth and giving investors an alternative to buying gold and silver. However, the yield on the 10-year Treasury note had to increase to 15.32% in September 1981—7.7 times the current yield— to hold down the price of gold and send the economy into a recession. (The federal funds rate—the rate at which banks lend each other money overnight—went to 19.1% in June 1981 compared to zero to 0.25% currently.) Under today’s conditions, it is hard to see the federal government allowing interest to go that high short of a USD already made virtually worthless by hyperinflation.

Federal budget deficit

The US national debt as of October 2011 is $14.8-trillion.16 US gross domestic product for 2010 was $14.7- trillion dollars. The federal government owes more than all the goods and services produced in the US in the previous year. The national debt has only once exceeded that ratio to GDP. In the midst of World War II, when the nation had one-third of today’s population and 14.5-million soldiers at war, the national debt reached 120% of GDP.

Emerging victorious from WW2 as the only major country with its industrial capacity intact, the US was in a position to rapidly reduce its national debt. By 1960 national debt to GDP was about 52%; by 1981 it had reached its modern low of about 33% of GDP.

The picture today is different. US corporations must fight for market share at home and abroad against many strong competitors, including Japan, China, South Korea, Brazil, India, and Germany, France and other EU countries. Among its competitors, the US is the only nation supporting a global network of military bases and significant, prolonged armed interventions.

As a result, the national debt is going up, not down. The budget deficit for fiscal year 2011 (October 2010- September 2011) was $1.22 trillion. For 2012, the estimated deficit is $1.1 trillion. These estimates are almost always on the optimistic side. They tend to make assumptions about economic growth that lead to overestimating tax revenue. They also make assumptions about the prices of everything from petroleum to money (i.e., interest rates) that tend to underestimate expenses. Interest payments have been an everincreasing component of the national debt. If interest rates on Treasury start to rise again, the national debt will be driven dramatically higher. Interest payments already constitute 5-6% of the federal budget—at today’s rock-bottom rates. Interest rates are being raised to curb inflation in Europe, China, Australia, Brazil and many other countries. Those rate increases will eventually attract capital away from Treasury notes. At some point, to finance its debt, the US will have to raise rates.

(16 See “U.S. National Debt Clock,” .)

At House Budget Committee hearings in February 2011, Rep. Mick Mulvaney [R-SC] confronted White House Budget Director Jacob Lew on the assumptions in the President’s 2011 and 2012 budgets. Mulvaney pointed out that the budgets were based on the federal government’s revenue coming in at 19-to-20% of GDP, which he said has happened only once or twice in the past 40 years, and that they assumed a rate of growth of the economy that “dramatically exceeds what the CBO [Congressional Budget Office] is assuming.”

State and municipal budget deficits

The problems caused by the surge of the national debt are compounded by the sharp increase in the budget deficits of states. The Center on Budget and Policy Priorities reports that 44 of the 50 states face budget shortfalls—despite years of accounting gimmicks, such as moving federal Medicaid funds from the next to the current fiscal year. The Center says that the total state shortfall projected for FY 2012 is $140 billion.

Total state deficit would be approximately double what it is if not for the federal American Recovery and Reinvestment Act (ARRA). Early in 2009, ARRA authorized $140B for states, in increased Medicaid, education and public safety funding over 2.5 years. In August 2010 the jobs bill extended some funding through June 2011.

In addition to state deficits, throughout the United States, endless numbers of counties, cities, school districts, and other public agencies face budgetary shortfalls. These problems compound each other. The states try to hold onto tax money coming in from counties; the counties struggle to get more of it back. States and municipalities try to extract more money from the federal government. States compete with each other for federal grants. States, counties, cities and school districts lay off workers, reducing federal and state tax revenues while raising the cost of unemployment benefits and other public services. States and municipalities raise fees, which has an inflationary impact, while cutting wages and hours and jobs—a recipe for stagflation. Stagflation is persistent high inflation combined with high unemployment and stagnant demand in a country's economy. All of this causes political turmoil, which we’ll address later.

Trade deficits

Every year since 1976 the United States has paid more for imported goods than it has received for exported goods. These negative balances of trade are known as trade deficits. Prior to 1976 the US almost always had the opposite, an annual trade surplus.

The US annual trade deficit tends to decrease during recessions, when people and businesses have less money to spend, and increase during periods of economic growth. However, as the chart below shows, the overall trend is for the annual trade deficit to increase (move deeper into minus numbers), particularly since the 1990s.

The effect of large trade deficits on prices is complicated. Importing oil contributes significantly to the trade deficit, particularly when the price of oil is high. High oil prices contribute to higher prices for gasoline and diesel fuel and almost everything else. Oil is used to make plastic and petrochemicals, to power tractors for agriculture and heavy equipment for construction, and to transport everything to market. However, another significant part of the trade deficit comes from flooding US markets with goods from China and other lowwage countries. That keeps prices for US consumers down, producing an anti-inflationary effect.

But there’s another, inflationary side to that coin. What do China, Japan, South Korea, Saudi Arabia and other net exporters to the US do with the dollars they accumulate? Until recently, they have been investing most of it in US Treasury notes, in mortgage-backed securities, and in other forms of US debt. They have been “enablers” of the federal government running a budget deficit, much as family members who loan money to a drug addict are enablers of their relative’s habit.

Now that the Federal Reserve has taken to printing (or rather electronically creating) previously unheard of amounts of money, China and the other creditors have cut back on their purchases of US debt. They, along with the EU, Australia, Brazil and even Canada are raising interest rates to hold down inflation and are urging the US to do the same. But with unemployment remaining high in the US, economic growth sluggish, and the housing market slumping further, higher interest rates here would contribute to stagflation. Decades of trade deficits have put the US in a bind.

Increase in the money supply

As we noted in discussing Germany, Argentina, and Brazil, a sharp increase in the supply of money is characteristic of hyperinflation. It’s happening here. There are a number of measurements of money supply, all known as “M”s. M1 includes notes and coins in circulation (but not in bank vaults), traveler’s checks of non-bank issuers, demand deposits (such as checking accounts) and other accounts on which checks can be written (NOW accounts). M2 includes M1 plus savings deposits, time deposits under $100,000 and moneymarket accounts of individuals. This chart shows the trend in each.

Commodity inflation

To justify keeping short-term interest rates at close to zero, the Fed has been reassuring us that inflation is not a problem. They support this claim by citing the Consumer Price Index (CPI). According to the Bureau of Labor Statistics (BLS), the CPI (average annual expenditure for all items in the index) rose only 1.6% from 2009 to 2010.17 The BLS uses a lot of complicated social assumptions and mathematical calculations to arrive at the CPI. These assumptions and calculations have changed over time. According to Shadow Government Statistics, if the CPI were calculated today as it was in 1990, inflation would be running at about 5.5% rather than 2%. If the CPI were calculated as it was in 1980, inflation would be running at just under 10%.18.

(17 http://www.bls.gov/cpi/cpid10av.pdf
18 http://www.shadowstats.com)

When our friends, and family members talk about what they actually spend money on—food, gasoline, medical care/medical insurance, utilities, housing, college tuition—their experience seems more in accord with the Shadow CPI than with the official CPI. Some prices, such as for certain clothing and electronics, have come down or held steady as a result of retailers desperate to bring people into their stores. And new and existing homes sell for well below the prices they went for during the housing bubble. Of course, if you have cut back on clothes and electronics purchases, and you are not in the market for a house (as few people are these days), those numbers have little influence on your “personal CPI.”

What is undeniable is the run up in almost all commodity prices. In fact, the Wall Street Journal (April 12, 2011) reports, “China on Sunday registered its first quarterly trade deficit in seven years, reflecting the rising prices of imported commodities.” Manufacturers, builders, and investors are paying far more for almost everything that comes out of mines, wells, and farms than they did a short time ago. Just look at this table (units explained in footnote). 19.

Commodity	March 2001	March 2011	Change
Gold	263	1,424	+441%
Silver	4.40	35.94	+716%
Copper	1,742	9,503	+445%
Iron ore	0.12	1.69	+1,308%
Aluminum	1,512	2,555	+69%
Tin	5,049	30,590	+505%
Oil	25	109	+506%
Coal	33	137	+413%
Wheat	130	316	+143%
Sugar	0.22	0.36	+64%
Soy Beans	164	499	+204%
Coffee	0.31	1.22	+294%
Pork	0.63	0.81	+28%
Beef	0.91	1.88	+106%
Salmon	3.10	7.27	+134%
Cotton	0.55	2.30	+318%
Commodities Index	60	199	+230%

Source: http://www.indexmundi.com/commodities

We are often told that these changes in wholesale prices have not been or will not be passed on to consumers. It is inconceivable that increases of this magnitude would not be reflected in retail prices, unless manufacturers are content to accept enormous losses over long periods. Therefore, we have all the more reason to look with skepticism at the official CPI.

What difference does it make? Hyperinflation does not spring from nowhere. It is always the child of unchecked ordinary inflation. Those in a position to influence the economy—the Administration, the Congress, the Fed—either oppose inflation or abet it. When they pretend that price inflation is not happening, it’s clear which path they have chosen.

Economic analyst Peter Ferrara wrote in the American Spectator online (March 23, quoted in the March 24 Wall Street Journal), “The Producer Price Index rose 1.6% in February, an annual pace of nearly 20%. Over the last 5 months, the index has increased by nearly 5%, an annual pace of over 10%. The index for food increased by nearly 4% in February alone, the largest one month rise since November, 1974…. This trend is now beginning to show up in the Consumer Price Index as well…[and] the CPI is arguably understating inflation today because 40% of it is now represented by housing, which is still in a recession.”

(19 All prices wholesale, in USD, rounded off to nearest dollar except when cents are statistically significant. Units: gold and silver per oz; base metals and coal (Australian thermal) per metric ton; oil per barrel, simple average of Dated Brent, West Texas Intermediate, and the Dubai Fateh; wheat per metric ton; sugar, US import price, per pound; soy beans per metric ton; coffee, robusta, per pound; pork, beef, salmon, cotton per pound. Commodity price index includes all commodities, 2005 = 100.)

Most G-20 governments, however, express great concern about inflation and are taking measures to stop it before it runs away. The Wall Street Journal (April 15, 2011) reported, “China's premier, Wen Jiabao, warned last month that inflation is like a tiger—once unleashed, it is ‘very hard to cage again.’”

Loss of confidence in the USD

The US Dollar Index measures the value of the dollar relative to a weighted basket of six other currencies: the euro, Japanese yen, British Pound, Canadian dollar, Swedish krona, and Swiss franc. The formula was set at the start of the Index, in March 1973, to give the US dollar a value of 100.

On this Index, the US Dollar has reached as high as the 160s. It dropped below 100 in 2003 but always managed to stay above 80. Currency traders, economists, and others considered 80 to be a “floor” supporting the dollar. In late August 2007 the dollar fell below 80 for the first time, hitting a record low of 72.89 in March 2008. (At 80 the dollar had dropped to less than half of its highest value.)

DOLLAR INDEX SPOT CHART

May 2010-April 2011

Since 2008, the US Dollar Index has bounced back as high as 88 but has been falling rapidly since June 2010 and dipped below 74 in May 2011. With the fall of the euro, the dollar has moved up to 79. The Index underestimates the fall in the dollar’s value, because the comparison is to other fiat currencies that have also been falling in value. The basket of six currencies in the Index is weighted, with the euro alone accounting for 57.6% of the total. Confidence in the euro has also fallen with the debt crises requiring bailouts in Greece, Ireland, and Portugal, high levels of debt in some of the other EU members, and pressures that some believe might result in the breakup of the EU.

Relative to gold, the dollar has fallen 94% since 1973, the year the US Dollar Index was initiated. $16 will buy the same quantity of gold as $1 bought in 1973. In euros, just in the five years from April 2006 to April 2011, gold went from €440 to €1,047.

Wage freezes

Governments commonly use wage freezes and price controls in efforts to reign in inflation. As we discussed earlier, President Nixon used both. We have begun to see some price controls in this period, for example in the maximum payments allowed for particular services by Medicaid and Medicare and in the capping of some of the credit-card and debit-card fees banks can charge merchants and consumers. In November 2010 President Obama announced a 2-year wage freeze on 2.1 million federal civilian employees, as part of cutting the federal budget deficit. In April 2011 New York’s Governor Cuomo and a union representing 1,160 law enforcement officers agreed to a 3-year wage freeze, including eliminating “step increases” for longevity on the job. Cuomo called the agreement a “model” for other public worker unions negotiating contracts with the state.

Also in New York, in March 2011, a state board that has taken over management of Nassau County’s finances imposed a wage freeze on 8,100 county employees. In Connecticut, Governor Daniel Malloy has proposed 2- year wage freezes for 45,000 state workers. The Minnesota Senate passed a bill that would freeze state workers’ salaries for two years. The Nebraska State Senate is discussing a bill that would freeze public worker wages if they could be shown to be “above average.” Countless municipalities, school districts, community college districts, and public universities have also imposed or negotiated pay freezes, or plan to do so.

Social turmoil

I’ve mentioned that inflation always precedes hyperinflation. I should add that hyperinflation never arrives quietly. Inflation, stagflation, fiscal crisis, housing crisis—these economic concepts profoundly affect people’s lives. And people react. In February and March 2011 tens of thousands of workers and students demonstrated in Madison, WI and even briefly occupied the State House to protest the termination of collective bargaining rights. The demonstrations were followed by campaigns to recall eight Republican and eight Democratic state senators. Similar protests have taken place in Montana, Illinois, and Indiana. In California, New York, and other states, thousands of college students, faculty, and employees have demonstrated against cuts to education budgets. “Occupy Wall Street” has spawned similar movements in cities throughout the US.

The US demonstrations are part of a worldwide phenomenon. In many European countries, millions have marched and gone on strike against government austerity measures. In Greece, the most militant and radical elements have stoned police, smashed cars, and thrown petrol bombs at police and government buildings, including the finance ministry. In North Africa and the Middle East, demonstrations against food inflation and unemployment played a key role in driving the mass movements against dictatorial regimes.

Events in Libya have already, at least temporarily, taken much of Libya’ oil production off the market. Next door to Saudi Arabia, home of the world’s largest oil reserves, is Bahrain, home of the US Navy’s Fifth Fleet. Bahrain is in turmoil. A Sunni king is trying to maintain control over an up-in-arms majority Shiite population. Saudi armed forces have crossed the causeway into Bahrain to help keep the king in power. The situation is unpredictable; one or two more shocks could put oil back to its record $140 a barrel or beyond, with devastating effect on the non-recoveries taking place in the US and Europe.

SSocial unrest, demonstrations, and rioting tend to make governments leery of taking economic measures, such as raising interest rates and tightening up on credit that might create more unemployment and generate more protests. Often, it drives them toward papering over the problems with money, bringing on hyperinflation and even more social unrest.

Stocking up for upcoming hyperinflation

Perhaps your family has already made a plan for a natural disaster such as a hurricane, flood, or earthquake. If so, the plan no doubt involves stocking up on essentials such as drinking water, nonperishable foods, medicines and first aid supplies, toiletries, batteries, pet supplies and perhaps fuel and a generator.

Now think about an economic disaster lasting years rather than days, with constantly escalating prices compounded by shortages. You would want to have stocked up on as much as you can at today’s lower prices. And, depending on your finances and storage capacity, you might want to expand the list to include cleaning supplies, bedding, motor oil, tires, and perhaps even appliances. Money will lose its value but products won’t. Anything you don’t use you could barter. To figure out your family’s particular needs, review what you have spent money on over the past several years.

Many survivalists envision a period of hyperinflation, civil unrest, and panic in which US paper dollars become as worthless as 1923 German Marks and life’s necessities will be exchanged only for real money. Stocking up on one ounce .999 Silver Eagles or Trade Units and pre-1965 US Silver dimes, quarters and half dollars, which are .900 fine, will serve the purpose. I have heard of a neighborhood grocery store in rural Oregon that prices their goods in incremental amounts of silver. For example, a potato may cost .02 parts of an ounce—the equivalent of a dollar with silver at $50 an ounce. Such pricing may become more common as hyperinflation draws nearer.

Investing for hyperinflation

Based just on ordinary inflation and the beginnings of concern about hyperinflation (and of course the huge growth in demand in China, India, and other fast-growing economies) we’ve seen significant, sustained increases in the prices of gold and silver. Despite a remarkable 10+ years of increases averaging 20% per year—outperforming just about any other asset category by far—you would be hard pressed to find a story about gold on the cover of a magazine (even a business or finance magazine) or on the front page of a newspaper (even of the business section). This is in marked contrast to Phases II and III of the run-up to January 1980, when the gold mania resembled the Internet mania of the 1990s.

Investing in gold and silver therefore remains an excellent way to protect your assets and even profit from inflation today and hyperinflation tomorrow. Of course, when Phase III of the bull run arrives and everybody is buying, you would want to be selling or trading for gold and silver products that have less volatility and can protect you from what comes next.

There are many ways to invest in gold, from physical gold, gold ETFs, and gold mining shares to derivatives such as futures and options. Since 2004, I have strongly recommended to my friends and clients owning physical gold, because ETFs and mining shares have risks and problems that aren’t acceptable. Hyperinflation is generally accompanied by social, political, and economic turmoil. Often stock markets and banks are shut down by the government for periods of time, or withdrawals from bank accounts are limited by government decree. I advise my clients to store their gold in a home safe or safe deposit box providing direct, immediate access. I advise them not to allow third parties to hold, store, or delay delivery of their precious metals. More on the importance of holding physical gold appears below.

Prepare for gold confiscation

At the outset of this article I suggested that discussing the likelihood of hyperinflation coming soon to the United States might surprise you. Now that you’ve read this far, I hope you are seriously considering the evidence for hyperinflation and that you will be motivated to prepare for it. For most people, it’s hard to accept an idea that is out of the mainstream, and harder still to act on it—to “pull the trigger.” That’s why most people get swept along and harmed by “black swan” events and relatively few profit from them.

Now I’m going to raise another idea that might seem off the wall at first—the possibility of a gold confiscation. Of course, given that it’s happened before, it would be foolish to exclude the possibility without thinking about why it might happen again.

(By the way, gold has been confiscated twice in the United States, the first time under President Lincoln to help finance the Civil War.)

Let’s think about why the federal government might confiscate gold (motive) and then about how the government could do so (means).

Motives for gold confiscation

For motive we have only to look at the 1933 gold confiscation. The government wanted to print money not backed by gold and wanted it to be universally accepted as payment for all debts, “public and private.” But people were accustomed to currency that was convertible into gold. By and large they didn’t convert it, but they knew they could.

If gold coins and paper currency backed by gold were still in circulation, competing with the new fiat currency, which would people want? Sure, stores might accept the fiat currency because the law required them to, but a parallel market would likely have developed, with gold coins and gold-backed bills more desirable and therefore having more purchasing power than their face value. We’ve seen similar scenarios many times in countries suffering from high inflation. A parallel market denominated in a foreign “hard currency” (a fiat currency in which people still have confidence) develops. In the past, the hard currency was typically the USD.

In addition, in 1933 the government still needed gold to back dollars used in international trade. But the Federal Reserve was printing billions of fiat dollars. By confiscating gold coins and “paying” for them in fiat dollars, the federal government was able to increase its gold holdings at zero cost other than the expense of administering the program. The value of gold held by the Federal Reserve increased from $4 billion to $12 billion between 1933 and 1937.20 Some of that difference is presumably the result of the change in price from $20.67 to $35 per ounce. Adjusting for that, it appears that the confiscation brought in about 228,571,428 ounces of gold. The gold confiscation was essentially a bailout of the Federal Reserve. Like the recent bailouts of big financial institutions, it was publicly financed. The recent bailouts were financed through taxes; the confiscation through snatching gold from people?s pockets and purses and replacing it with paper.

Today, US residents are buying more gold than ever before. Together with gold buyers in China, India, the Middle East, and elsewhere, their demand is pushing the price of gold up relative to all currencies. US buyers are stocking up on the U.S. Gold Eagles & Buffalo, Canadian Gold Maple Leafs and popular European small denomination gold coins. Many financial advisors—even some brokers at Goldman Sachs, Morgan Stanley, and other major financial institutions—are advising their clients to put a small portion of their portfolios into gold. That’s an about face from the advice most were giving only a few years ago. As US inflation intensifies and confidence in the USD declines further, the trend toward investing in gold will accelerate.

One of the federal government’s motives for confiscating gold could, therefore, be the same as it was in 1933: to avoid competition for its fiat currency.

Another motive might be to increase revenues without seeming to raise taxes. How so? US residents forced to turn in their gold in1933 were compensated at $20.67 per oz. The United States Gold Reserve Act of January 30, 1934 ordered the Federal Reserve to turn the gold over to the US Treasury and changed the price of gold to $35 oz. (the price set for international gold-USD transactions until 1971). In the eight months from May 1, 1933 to January 30, 1934 the federal government made a profit of $14.33 on every ounce of confiscated gold. That’s a 69.3% profit. Annualized, it’s 92.4%. At $14.33 profit per ounce on 228,571,428 ounces of gold that comes to $3.28 billion. The entire federal budget for Fiscal Year 1933 was $4.6 billion.

In a modern confiscation, the same profit motive would apply, although it would work a little differently. The government would presumably pay the market price for gold, or a fixed price close to the market price. But the confiscation would occur at a time of an acutely weakening dollar and a sharply rising gold price, when holders of gold could likely have gotten a significantly higher price in days, weeks, or months. Furthermore, the very act of confiscating gold would increase the global price of the precious metal by taking gold out of circulation and putting more fiat dollars into circulation.

Given that the government might have two motives for confiscating gold—eliminating competition to fiat dollars and increasing revenue—would it have the means?

(20 http://en.wikipedia.org/wiki/United_States_Bullion_Depository.)

Means of gold confiscation

The 1933 confiscation was done by an executive order issued by President Roosevelt. The executive order was based on powers granted to the executive branch by the 1917 Trading with the Enemy Act. In 1971 President Nixon “closed the gold window” to international holders of dollars, also via an executive order. His act was known as the “Nixon Shock” because it was issued on a Monday morning before the US stock market opened and without consultation with US trading partners, the US congress, or anyone outside a small group of advisors in the executive branch.

Does the President still have the legal power to confiscate gold? Could he or she do it by executive order, without consultation with congress, and by surprise? In 2005, Chris Powell, of the Gold Anti-Trust Action.

Committee (GATA) wrote to the US Treasury Department essentially asking those questions. He received a reply from Sean M. Thornton, Chief Counsel (Foreign Assets Control) of the Treasury Department, dated August 12, 2005.21 Thornton referenced the Trading with the Enemy Act of 1917 (TWEA) as giving the President the power to confiscate gold or, basically, any other asset, to “prevent certain transactions that might be of advantage to an enemy during wartime.”

Powell had also asked if the President has the power to confiscate shares of gold- and silver-mining companies if some of the shares were held by foreign nationals or foreign governments. Thornton replied, “Under TWEA during times of war—and also under the International Emergency Economic Powers Act…during peacetime national emergencies—the president has broad powers to regulate property in which there exists a foreign interest.”

Talking about means of confiscation, we should note that ownership of gold through ETFs makes it easy. Rather than deal with millions of individual investors, the government can seize the gold from the ETFs’ storehouses, wire transfer money to each ETF, and let the ETFs pay off investors through their brokerage accounts.

Rare US gold and silver coins were exempt from the 1933 confiscation. This made sense because neither of the motives for confiscating the precious metals applied. Rare coins are by definition scarce, so there would never be enough of them to compete with fiat dollars as currency. Furthermore, while each modern 1-oz. US Gold Eagle bullion coin is “worth its weight in gold,” each grade of each type pre-1934 US gold and silver coin has a value in excess of it precious metal content due to its scarcity established over 77 years or more.

FFor the same reasons of scarcity and lack of uniform value, it would make no sense for the government to try to profit from confiscating rare coins. There aren’t enough of them and running the program to find them, buy them, and sell them would cost more than it would generate in revenue.

Therefore, part of a program to prepare for hyperinflation should involve investing in non-bullion gold and silver coins.22 I recommend buying only coins authenticated, graded, and encapsulated by NGC or PCGS, the most reputable third-party grading services. The US gold and silver investment quality coins I recommend are listed in the most recent CoinStats report. CoinStats is an in-depth statistical analysis of popular pre- 1934 gold and silver coin series that enables investors to identify the best values in certified rare coins. We are proud to offer this unique and outstanding investment tool exclusively to our clients. I also recommend many popular pre-1934 world gold and silver coins, which I consider low-premium, “bullion-plus” investment items. Many long-term gold and silver coin investors and collectors prefer owning US gold and silver type coins and rarities graded Mint State (MS) 63 or higher. These coins have shown excellent capital growth over the long term. There is a liquid market for investment grade coins, including electronic markets in which authenticated, graded, and encapsulated coins are traded sight unseen.

(21 http://www.gata.org/node/5606
22 By “non-bullion coins,” I mean relatively scarce gold and silver coins, mainly pre-1934 issues, which, because of their numismatic value, are worth more than the precious metals they contain.)

A gold and silver confiscation would almost certainly be kept secret until it was announced, so it makes sense to begin investing in non-bullion gold and silver coins now. Another reason for doing so is that the prices of US investment-quality certified gold and silver coins have lagged the recent rise in value of gold and silver bullion, due to the soft US economy. History has shown me that unusual situations of this type don’t last long.

As there is no right price for the wrong coin, financial advisors and investors should work with an experienced numismatic professional. Select a member of the Professional Numismatists Guild (PNG). PNG members have a minimum of five years’ experience in the field, submit to a background check, and are required to abide by a code of ethics and to submit disputes to mediation and arbitration.

A French preliminary to gold confiscation?

The French government (and financial institutions and investors worldwide) is nervous about the high exposure of French banks to Greek sovereign debt. Perhaps that is one of the reasons that France amended it’s legal code in July 2011 to grant the government the power to limit or ban bullion sales (on all metals) by decree, without having to pass an act of parliament.

Own physical gold and silver, not paper assets such at ETFs and mining shares

Many investors view GLD, SLV, and other exchange-traded funds (ETFs) that hold precious metals as easy ways to own gold. After all, you can buy and sell online, and there appear to be no storage costs. (Of course the half percent per year you pay in management fees includes storage.) We?ve already mentioned that in the event of a confiscation, the gold and silver bullion held by ETFs would be easy pickings for the government, while pre-1934 US gold and silver coins would be exempt and would shoot up in price. I want to give you nine other reasons why you would be better off owning physical precious metals than investing in ETFs. After that, we?ll talk about the dangers inherent in owning shares in gold and silver mining companies

9 Reasons why I do not recommend GLD, SLV or other precious-metals ETFs

The following information is based on GLD?s prospectus. SLV?s prospectus is similar.

1. Shares are not redeemable for physical gold except in “baskets” of 100,000 shares.
2. There is no hedge against volatility of paper assets, because GLD is a paper asset.
3. A depleting investment: fractions of gold holdings are liquidated to offset management and other fees, at approximately 0.5% a year, or $8.00 an ounce with gold at $1600; $30 an ounce with GLD at $6000. Each sale of gold by the trust is a taxable event to shareholders; therefore GLD shareholders receive a 1099-B every year with a tax liability. This diminishes the overall underlying assets per share, which leaves an investor with a share value of less than one-tenth of an ounce of gold over time.
4. Higher reporting requirements; less privacy
5. You receive an annual 1099-B and are taxed on the gross proceeds (see 3 above) less commissions.
6. Capital gains on gold and silver ETFs are taxed at 28%, rather than the 15% rate on long-term capital gains for other investments of one year or more.
7. Zero benefit in a worst-case scenario (see “9” below).
8. No outside independent audit of the quantity or quality of Gold is permitted
9. Counterparty risk: In A Dec. 14, 2008 article, “The Problem with GLD and SLV ETFs,” Trace Mayer writes, “The reassertion of counter-party risk is driving much of the risk in the current markets. Page 10 of the GLD prospectus states, „If the Trust?s gold is lost, damaged, stolen or destroyed under circumstances rendering a party liable to the Trust, the responsible party may not have the financial resources sufficient to satisfy the Trust?s claim.? On page 9, „The Trust does not insure its gold.? Further on page 12, „Gold held in the Trust?s unallocated gold account and any Authorized Participant?s unallocated gold account will not be segregated from the Custodian?s assets. If the Custodian becomes insolvent, its assets may not be adequate to satisfy a claim by the Trust or any Authorized Participant. In addition, in the event of the Custodian?s insolvency, there may be a delay and costs incurred in identifying the bullion held in the Trust?s allocated gold account.? Gold is not subject to counter-party risk or in other words the financial ability of a counter-party to pay. Clearly, GLD is impregnated with counter-party risk that may instantly and violently appear from within like the Alien.”

Bullion coins, however, do not require an annual 1099-B form, do not have management fees, and do not diminish in value by 0.5% a year.

The disconnect between bullion and mining stocks and funds

The price of most mining shares has lagged behind the rise in price of gold and silver. Many market analysts believe that this lag represents an anomaly in the market that will soon self-correct. They also note that some mining companies have hedged future production and are not benefitting from recent high prices. Another popular explanation for the lag is that the relationship between physical gold and mining stocks got disrupted when the financial markets went haywire in 2008, and equities tumbled while physical metal increased.

A May 2011 article by Peter Koven offers another theory: “…the analysts themselves are pricing in numbers that are much too low when they calculate what these companies are worth. While most analysts are using a gold price of roughly US$1,500 an ounce for 2011, their long-term targets are closer to US$1,000, which affects their earnings estimates.”

Although many of these market analysts are highly respected, my research leads me to say, “None of the above.”

I believe that the main problem is the increasing risk of higher labor costs and third-world producing countries hiking their export fees, along with the strong possibilities of union strikes and government nationalizations. These events will cause the price of physical precious metals to increase while mining stocks drop or continue to lag.

Let me provide a few examples of what concerns me about owning shares in mining companies:

We start with Peru, the world?s number-one exporter of silver and number-six exporter of gold. On June 7, 2011, President-elect Ollanta Humala suggested Peru could impose a windfall tax of up to 40% on mining companies and also raise the 30% rate that miners currently pay. Humala has stated that mining companies whose profits have swollen on lofty global commodities prices should fund social programs in a country where a third of the people are poor despite a decade-long economic boom. This feeling is shared by many underdeveloped countries with natural resources.

Chile has recently increased its tax on precious metal mines from 4-5% of operating profit to 4-9%. Chile plans to tighten its safety laws after the collapse of a mine at San Jose highlighted lack of regulation in its mining sector. This will add additional cost to gold and silver mining operations there.

In April some mining companies with operations in Bolivia sold off when President Morales stated that Bolivia was planning to nationalize mines owned by Pan American Silver. The unions demanded increases in compensation and requested that the government not take control of the mines.

Tanzania, one of Africa?s top gold producers, is considering a “super profit” tax on earnings from minerals as one of the ways to fund its 5-year development plan, according to documents seen by Reuters. The move follows similar steps in other producer countries that have sought to increase fiscal revenue from the mining industry and to take advantage of rising prices.

Australia was among the first to consider a hefty resource tax, but it had to climb down from initial proposals for a headline tax of 40 percent after pre-election talks with mining giants like BHP Billiton and Rio Tinto.

Venezuela, President Hugo Chavez nationalized Venezuela's gold mining industry in August 2011. His action gives the government total control over all gold produced and exploration within Venezuela. Chavez also repatriated $11 billion in Venezuelan gold reserves currently held by U.S. and European central banks.

The risk of continued wage inflation for miners is a global problem.

The reasons for cost inflation vary by region, but top precious and base metals producer nations South Africa, Australia, Chile and Canada all have strong domestic currencies, rising labor costs, and surging energy costs in common.

Barclays Capital analyst Gayle Berry said that one of the top causes of inflation has been labor, with an acute shortage of skilled manpower looming in some countries. Canada?s mining sector, she said, is forecast to have a shortfall of almost 100,000 workers in the next decade, with 65% of the hiring requirement simply to replace retired workers. Plugging that hole will be tough and expensive. “The first impact is on mine production costs, which are going to continue rising, and the second impact is the potential for delays to new projects, or at the very least a slower realization of projects in the pipeline,” Berry said. Once again, a combination that will increase the price of bullion but put downward pressure on the price of mining shares.

Western Australia is a flashpoint for labor costs, with mining companies competing for skilled labor with several large natural gas projects. “Investors are wary of investing in new gold mining projects in Australia because of the high cost of achieving production in that region,” said John Meyer, a mining analyst at Fairfax.

In South Africa, the National Union of Mineworkers is demanding an above-inflation 14 percent rise in wages.

At the same time, the currencies of producer countries (including South Africa, Australia, Canada and Chile) have risen, eating into profits of companies that sell their metals in dollars and pay their costs in local currencies. The South African rand has gained 14 percent in the past 12 months.

Another fear of owners of mining shares recently became public. The US Department of Justice announced that Hecla Mining has agreed to pay more than $263 million to settle environment claims.

I continue to read more and more reports in mining publications and global newspapers of precious metal mining companies lowering production targets and seeing increases in production and labor costs. Add these negatives to the governmental risks and the picture for the value of mining shares does not look good.

Recommendation

Sell stocks and funds with mining operations in the many countries mentioned above and switch into physical gold and silver. Physical gold and silver will increase in price should there be nationalization of mining companies and/or as costs increase and production decreases. Prepare for a return to the gold standard

Prepare for a return to the gold standard

From 1792 until 1933 (or 1971 for foreign holders of USD), with the exception of 1862-1868 (during and immediately after the Civil War), the US Dollar was backed by gold or silver. Based on that history alone, it would be a mistake to assume without considering the evidence that the dollar will never return to the gold standard.

States take the lead in bringing back the gold standard

As typically happens when there are sharp and accelerating increases in money supply, people begin to question the value of their currency. State governors and state assemblies and senates are responding.

In May 2011 Utah passed the “Sound Money Act,” stating that US gold and silver coins could be accepted as legal tender. The law does not require that the coins be accepted only at their face value (much lower than their market value), leaving open the possibility of making purchases with the precious metals accepted at their full value. The same law eliminated state capital gains taxes on gold and silver.

Larry Hilton, a Utah Legislative attorney who wrote the Sound Money Act, has been a guest on my weekly KABC radio show. Larry and I have discussed putting together a blue ribbon panel of gold/silver, banking, and depository experts to advise Utah’s governor and legislators on how best to implement the legislation.

As the table below shows, at least 11 other states have proposed legislation similar to Utah’s. Although several of the bills lost in committee or in a full chamber of the legislature, they are likely to be brought up in future sessions.

STATES CONSIDERING GOLD & SILVER AS LEGAL TENDER

State	Status
Georgia	HB 3 and SB 116 introduced in 2011 session; still in committees.
Idaho	HB 633 passed 51-14-5 March 2011, referred to state senate.
Indiana	SB453 Honest Money Act introduced 2009, in committee.
Minnesota	HF 1664 introduced May 2011.
Missouri	HB 561 introduced 2009; currently not on calendar.
Montana	HB 513 voted down March 2011 in close vote, 48-52
New Hampshire	House Concurrent Resolution 13 passed March 2011 urges NH congressional delegation to support gold standard and audit federal reserve.
N. Carolina	HB 301 March 2011 referred to committee.
S. Carolina	H 4128 introduced April 2011; referred to Committee on Judiciary.
Tennessee	SJR 0098, to study feasibility of alternate currency, proposed February 2011.
Virginia	House Joint Resolution 557 left in committee Feb. 2011.

Gold standard raised in Washington and beyond

On June 28, 2011, Senators Mike Lee (R-UT), Jim DeMint (R-SC), and Rand Paul (R-KY) introduced the Sound Money Promotion Act, S. 1287. This bill would make gold and silver legal tender and eliminate capital gains taxes on gold and silver coins.

A return to the gold standard could result from federal legislation or a mandate from a majority of the 50 states. It would freeze the value of gold at a set price (estimated anywhere from $2,500 to $10,000 an ounce) at which the United States Government would buy or sell gold. The US would no longer be able to print money without a direct relationship to gold.

Is a return to the gold standard a fringe idea? Robert Zoellick is president of the World Bank. Before that he was a managing director of Goldman Sachs and a United States Deputy Secretary of State. According to Market Watch (Nov. 7, 2010), “World Bank chief Robert Zoellick said in an article in the Financial Times that leading economies should consider ‘employing gold as an international reference point of market expectations about inflation, deflation and future currency values.’ Zoellick made the proposal as part of reforms to be considered at this week’s G-20 meeting in Seoul. ‘Although textbooks may view gold as the old money, markets are using gold as an alternative monetary asset today,’ said Zoellick. He said such a reform would reflect economic realities and should be considered as a successor to the existing global currency paradigm known as ‘Bretton Woods II.’…Zoellick said a return to some sort of currency link to gold would be ‘practical and feasible, not radical.’”

Robert Zoellick is not a fringe player, and Alan Greenspan is not a fringe economist. Interviewed on Fox News (January 21, 2011), Greenspan said, “We have at this particular stage a fiat money which is essentially money printed by a government and it’s usually a central bank which is authorized to do so. Some mechanism has got to be in place that restricts the amount of money which is produced, either a gold standard or a currency board, because unless you do that all of history suggest that inflation will take hold with very deleterious effects on economic activity…. There are numbers of us, myself included, who strongly believe that we did very well in the 1870 to 1914 period with an international gold standard.” What’s behind this seemingly amazing reversal by Greenspan? The USD is under siege. It’s been able to function as the world’s reserve currency since the 1946 Bretton Woods Agreement, even after Nixon took the USD completely off the gold standard in 1971. The single most important manifestation of the USD’s reserve-currency status is petrodollars—the pricing of oil in dollars. Until recently, every buyer of oil in the world had to accumulate dollars with which to purchase oil. Oil is sold at the rate of about 88-million barrels per day. At $100 a barrel that’s $8.8 billion a day. But, more and more, oil producers are making deals to sell oil for currencies other than the USD, such as the euro or the Japanese yen, thus lessening the demand for dollars. Iran, for example, OPEC’s second largest oil producer, created a bourse that accepts payment for oil and petroleum products only in euros or Iranian Rials

Additionally, more and more countries are agreeing to direct exchanges of their currencies, eliminating the need to use the USD as an intermediary vehicle. For example, Russia and China recently initiated direct exchange between the renminbi (AKA yuan) and the ruble. According to Reuters (March 2, 2011), “China hopes to allow all exporters and importers to settle their cross-border trades in the yuan by this year, the central bank said on Wednesday, as part of plans to grow the currency's international role. In a statement on its website www.pbc.gov.cn, the central bank said it would respond to overseas demand for the yuan to be used as a reserve currency.”

To make the yuan acceptable as a reserve currency, the China’s Central Bank is believed to be accumulating gold through imports and domestic purchases. (China has recently replaced South Africa as the world’s largest producer of gold.)

Scholar and investment banker Lewis Lehrman was one of the original members of the United States Gold Commission, authorized by Congress during the Reagan Administration to study the possibility of returning to the gold standard. In October 2011 Mr. Lehrman gave a lecture in Washington DC, at the Heritage Foundation, in which he laid out a 5-step plan for returning to the gold standard.

If a return to the gold standard were to occur, it would have two effects on the price of gold in USD:

• significant additional increase in the price of gold. There are a lot of dollars to be backed. Assuming that the gold believed to be stored in Fort Knox is there, and hasn’t been leased out, it’s estimated that gold would have to be priced at over $6,000 per oz. to fully back each greenbacksignificant additional increase in the price of gold. There are a lot of dollars to be backed. Assuming that the gold believed to be stored in Fort Knox is there, and hasn’t been leased out, it’s estimated that gold would have to be priced at over $6,000 per oz. to fully back each greenback.
• An end to the appreciation in the price of gold, by returning to a fixed dollar-gold exchange rate.

Even the prospect of congressional action on a return to the gold standard would send investors searching for a liquid hard asset that could continue to appreciate. Once again, investment-grade pre-1934 rare US and world gold and silver coins provide an answer.

Conclusion: Action and timing

The massive debts of the US, the eurozone nations, Great Britain and many other countries are being dealt with primarily by devaluing the currencies involved. Given the political realities in these countries, it is unlikely they will be dealt with in any other way until severe inflation forces the issue. The currencies are being devalued through “printing”—actually electronically creating—money. The newly created money is used to bailout insolvent central governments, banks, states, municipalities and financial corporations. The process goes under many names, including quantitative easing (QE), bank re-capitalization, economic stimulus and even “job creation.”

It may take 3-4 years, but as the velocity of money going through our economy increases, it will drive down US unemployment and reenergize our real estate market. However, we will also see serious global inflation with a high likelihood of hyperinflation within the United States. By the time we reach that stage many of the central banks of economically strong nations such as China, India, Brazil and Russia will have exchanged much of their US Dollar holdings for gold, helping push the price of gold to over $6,000 per ounce. We are also likely to see some governmental regulations, restrictions, limitations or additional taxes on gold investors by that point, in an attempt to slow the exodus from paper money. The price of silver will be over $100 oz. How much over will depend on the strength and speed of the global economic recovery and any barriers to ownership implemented by western nations.

As chairman of the our industries Political Action Committee, < www.goldandsilverpac.org >, I will be speaking with legislators and lobbyist to closely watch how the US Congress, the controlling political party and the President deal with the dollar exodus and the onset of serious inflation. This will give me a better understanding of whether we are heading for gold confiscation or a gold standard. I’ll update you about such changes in my daily market reports on < www.mintstategold.com > and in my weekly market reports, which are emailed to clients every Monday.

I have shared with you why I believe our country will suffer hyperinflation soon. If your assets are stored primarily in US Dollars, you need to act now to protect your family, wealth, and future. I recommend that you invest a minimum of 35% of your financial capital in precious metals. (Most of the financial planners I work with are recommending 20-25%). Please see the insert in this booklet, or contact me, for a breakdown of the best way to invest in precious metals at the present time.

A gold standard would lead to a freeze on the value of gold bullion coins, as our government would set an official price at which it would buy or sell gold. Only pre-1934 rare coins with numismatic value could continue to appreciate in price. Gold confiscation would make ownership of bullion coins illegal; investment-quality coins would continue to be legal and freely traded—the only game in town.

Barry Stuppler, a professional numismatist for 50 years, is well known as an advocate for collectors and investors. He has helped thousands of first-time and experienced coin and precious-metals investors and collectors become successful. Barry is the immediate past president of the 30,000-member American Numismatic Association and currently serves as president of the California Coin and Bullion Merchants Association. He serves as a board member of the largest association of professional numismatists, the Professional Numismatist Guild. Barry co-founded and is a current board member of the Industry Council for Tangible Assets, which represents the Coin & Bullion community in Washington DC. He publishes articles and a daily blog (www.stupplerblog.com) on Stuppler & Company’s rare coin and precious metal website, www.mintstategold.com Barry Stuppler can be reached directly at 818-592-2800 or barry@stuppler.com.