Last December 6, Deak & Co.—holding company for a worldwide network of Deak banks, foreign-exchange brokers, and precious-metals dealers—filed for government protection from its creditors under Chapter 11 of the US Bankruptcy Code. Included in the filing were two key subsidiaries, Deak-Perera Wall Street and Deak-Perera International Banking Corporation. Listing liabilities of $95 million and assets of $62.2 million, Deak & Co. cited "severe liquidity problems."
In the ensuing months, two separate groups of indignant creditors, many of them overseas individuals who had deposited money with Deak subsidiaries, have been seeking control of the company's assets. Deak's Far East offices have been closed under a cloud of controversy. The Hong Kong government has charged the Deak office there with illegally accepting deposits and in March issued a warrant for Nicholas Deak's arrest. Some have alleged that the New York headquarters "looted" depositors' funds to finance other operations.
Deak & Co., as well as its Foreign Commerce Bank (a Swiss bank, 86 percent owned by Deak & Co.), is known to be up for sale. As this article went to press, the bankruptcy court had not taken the company out of the Deak family's control. Meanwhile, some holders of precious metals under Deak's pioneering precious-metals certificate program and depositors in its banks have panicked and started to withdraw their holdings, compounding the company's liquidity problems.
How did the mighty Deak-Perera Group, as it is known, come to be laid so low?
R. Leslie Deak—Nick Deak's 33-year-old son and the holding company's executive vice-president—blames the trauma primarily on adverse publicity stemming from a government investigation of laundered narcotics money from Latin America. He claims that competitors used a report issued last October by the President's Commission on Organized Crime, implicating Deak-Perera, to frighten and steal its customers. "The damage we have suffered from maliciousness in that report to a very great extent caused the downfall of a very fine firm and the damage to a very fine man—my dad," said Deak, who is president of Deak-Perera U.S., to the New York Times.
But others with intimate knowledge of the company told me that is only partly true. The company's problems, they claim, go back years and have more to do with internal mismanagement, bad business strategy, and personalities than with any government harassment of predatory rivals. (Neither of the Deaks would make himself available for comment.)
The younger Deak's explanation is "complete bullshit," one former Deak-Perera executive told me. "It's mismanagement, that's what it is—and overexpansion."
Other former high-ranking Deak-Perera officials interviewed said that Leslie Deak antagonized his lieutenants with his abrasive manner and, worse, by abolishing the company's profit-sharing plan a few years ago. "People who were critical started to leave in droves—key people to the success of the company," said Glen Kirsch, former manager of Deak-Perera Washington. "Whatever Leslie touched turned to…well, not gold," said another ex-Deak executive. Leslie Deak refused to return my phone calls.
Besides a brain drain, Deak-Perera suffered from a drain of funds. Long before the crime commission report, knowledgeable sources say, competitors had been sapping the deposits that had long been the mainstay of Deak-Perera's corporate finance: "flight capital" that nervous Latin American investors wanted to get out of their unstable countries.
At the same time, the company, still trying to expand, was hit hard by the collapse of gold and silver prices in the early '80s. Adding to Deak-Perera's woes, noted former Deak officials, was the invasion of its traditional foreign-exchange preserve by giants like Bank of America and Citicorp, which bid away many of the company's treasured airport locations.
Whatever the reasons, it's a sad fate for a great company and its fascinating founder.
Nick Deak, a vegetarian who at age 80 still runs five miles a day and as chairman remains the company's ultimate decisionmaker, always seemed to personify the American ideals of individualism, entrepreneurship, and defiance of intrusive government. Above all, Deak stood for sound money. A long-time advocate of the gold standard, he was one of the first, beginning in the 1960s, to recommend "hard money" investments such as gold, silver, and Swiss francs. The hallmark of the Deak-Perera Group—lending a certain irony to some of the current charges against the group—was its commitment to protecting its customers' assets and their financial privacy.
Deak began his empire in 1939 after emigrating from Hungary. There he had studied international trade and finance at the Royal Hungarian Trade Institute before taking a doctorate at the Swiss University of Neuchatel and serving in the Economics Department of the League of Nations in Geneva.
Soon after beginning his foreign-exchange business in New York, war broke out in Europe and Deak joined the US Army. He quickly came to the attention of the infant Office of Strategic Services (OSS), predecessor to the CIA.
For four years he used his linguistic and paratrooper abilities in the service of "Wild Bill" Donovan on dangerous missions in the eastern Mediterranean and the Far East. As a major, he personally accepted the surrender of Japanese troops in Burma.
In another exploit he likes to recall, Deak masterminded and carried out the wholesale smuggling of some 1,000 railroad freight cars out of Russian-occupied Hungary to the West at the end of the war. Later, such tactics were to be used in the service of Deak customers who wished to remove their money from economically or politically inhospitable countries.
In 1946 Deak restructured his foreign-exchange firm and incorporated as Deak & Co. A few years later he acquired his major competitor, the Perera Company, which had been the number-one name in foreign exchange in Latin America. By 1967 Deak had bought a small-town bank in upstate New York and changed the name to Deak National Bank; had broken into the preserve of the "Swiss gnomes" by opening his own bank in Zurich, Foreign Commerce Bank (affectionately known as Foco Bank); and had bought a bank in Vienna, changing its name to Bankhaus Deak (since folded into Foco Bank).
Meanwhile, Deak was opening foreign-exchange offices all over the country and around the world. These offices bought and sold banknotes from nearly every country on earth and handled remittances, foreign collections, and other international transactions at a fraction of the cost charged by most banks.
Over the years, Deak was the first to introduce many financial services. Its airport offices pioneered currency vending machines. Along with conventional services, Deak National Bank offered certificates of deposit denominated in foreign currencies, checking accounts denominated in gold or silver, gold- and silver-collateralized loans, and "OMNI" checking accounts, by which checks could be written in any currency.
When gold ownership by US citizens was legalized in the mid-'70s, Deak-Perera quickly geared up to meet the growing public demand for bullion and bullion coins. Later it began a precious-metals certificate program, allowing investors to buy a specific but undivided interest in gold or silver (and later platinum and palladium) stored in Switzerland or Delaware.
Deak-Perera also became renowned for its ability to move money through a variety of often byzantine "blocked fund" transfers to get around foreign governments' currency restrictions. But Deak's methods have occasionally landed him—or at least his employees—in trouble.
In the early '70s, it was Deak-Perera that acted as a conduit for $8.3 million in bribes paid by the Lockheed Corporation to Japanese officials. The scandal, which resulted in 1983 in the criminal conviction of former Prime Minister Kakuei Tanaka, demonstrates what a former employee termed the elder Deak's "cavalier attitude" toward the law and his "ruthlessness."
When a priest who was acting as the courier for Deak was finally caught carrying the Lockheed payments into Japan in a flight bag and appealed for help, Deak's Hong Kong office telexed Deak in New York. A former Deak-Perera Far East employee told me that Deak telexed back, "Tell him we'll pray for him."
In 1978, Deak again escaped personal responsibility for his underlings' actions when a vice-president in one of Deak-Perera's offices was convicted of failing to report large currency transactions, as required by federal banking regulations.
So it was little surprise when it was charged last year that Deak-Perera had failed to report millions of dollars' worth of alleged cocaine profits it received as deposits. "Deak has an OSS mentality," said one former manager. "The ends justify the means."
Libertarians may smile on infractions of federal currency-reporting requirements and regulations governing who may and may not accept deposits. But less savory is the possibility that Deak-Perera misappropriated customer funds.
The Hong Kong government has issued a warrant for the arrest of Nicholas Deak and Otto E. Roethenmund, president of Deak & Co., and is seeking extradition. Anthony Pong, former manager of Deak-Perera Far East, was arrested in March and charged with accepting deposits in contravention of Hong Kong law.
In fairness to Deak, it was well known that the company had been accepting deposits in Hong Kong for years, and the Hong Kong government looked the other way. So the British colony's belated action amounts to an effort to appease a hornets' nest of Deak depositors.
Well they might. For when Deak-Perera Far East shut its doors the day after the US company filed for bankruptcy, an estimated $25–$30 million in customer funds were put out of reach of furious depositors. And knowledgeable sources charge that some of those monies had long since vanished—drained out of Hong Kong into Deak's US operations.
What's more, reports from Hong Kong quoting government officials there raised fears that investors who had bought gold and silver through Deak-Perera Far East's independent precious-metals certificate program would lose their investments. Because the metals are registered in Deak-Perera's name, the officials said, they might be subject to seizure and sale to meet the company's general obligations. Before Hong Kong officials decided otherwise, such speculation gave rise to an exodus from Deak's much larger US certificate program.
James Hildebrandt, senior vice-president of Deak-Perera Washington, in a December client letter, assured certificate holders that "the metal is your asset, not ours, we are merely your custodian. Therefore, in the unlikely case that we were to become involved in the (bankruptcy) filings, your metals would be free from the claims of our creditors." Nevertheless, at the urging of competitors and many investment advisors, at least 1,000 of an estimated 15,000 investors are believed to have cashed in their certificates or taken delivery of their metal.
Similar assurances have been given by Foco Bank, which is 86 percent owned by Deak & Co. and 9 percent owned by Nicholas Deak and Deak & Co. president Roethenmund. "Foco Bank and its affiliated banks are in no way affected by the insolvency of their majority shareholder, and there are no financial obligations of any kind between them and the Deak group companies in question," stated a press release the bank issued last December in Zurich.
And Erich Stoeger, manager of the Vienna branch of Foco Bank, told me that Deak creditors can only press for the sale of Foco Bank stock held by Deak & Co. in order to raise cash and to get compensated for their claims. On Foco Bank, he noted, "this has the same impact as if some Citibank shares on the stock exchange change hands, but definitely not more."
Nevertheless, sources say that Foco Bank has been hit by a run on its deposits of some proportions. Although the bank has a sterling reputation as a profitable, well-managed institution, many depositors fear the Deaks (or a court-appointed trustee) may find a way to tap its assets.
A number of bids to buy Foco Bank have been reported, and others have been rumored. "Every day that goes by, it's worth less and less," observed a former top corporate officer in the New York headquarters.
The connections are complicated. Within the last two years the Deaks sold 49 percent of Deak-Perera U.S., which runs the company's retail currency and precious-metals operations, to Foco Bank to raise funds. "If Deak & Co. owns 100 percent of Foco Bank and Foco Bank owns 49 percent of Deak-Perera U.S., it's not really an arm's length deal," averred a former financial officer for the company. "Maybe there's a way (for Deak & Co.) to free up some funds from Zurich." And that's what worries many depositors.
But most observers agree that it was the company's apparent inability to tap Foco Bank to compensate for the loss of other sources of money that led to the bankruptcy filing in December. Sources close to the Deak operations claimed that the supply of Latin American funds being funneled into Deak-Perera U.S. had long since started to dry up—falling from $40–$60 million several years ago to below $5 million in the last year, according to one estimate. The crime commission report and the attendant adverse publicity came out long after the Latin American well ran dry, these sources said. "If you examine the books, the money was leaving in droves before that ever came out," said one.
One former Deak officer attributed the loss of funds to new competition, including former Deak employees, and to Deak-Perera becoming "less flexible in their dealings with the cambio (exchange) dealers, so they started looking elsewhere to place their money." In fact, a sort of managerial hardening of the arteries seems to have set in throughout the company.
Ironically, the ex-Deak employees I talked to uniformly asserted that the rigidity and skin-flintedness came with the passing of the mantle of control to young Leslie in 1980. Beginning about that time, former managers said, day-to-day decisionmaking was increasingly centralized in New York and Leslie Deak. Instead of everything flowing up from relatively independent offices, everything now flowed down. The local managers were also removed from the board of directors.
"The company was always able to innovate, because we didn't have a lot of restrictions on us," said one former manager. "But over time we were left with the responsibility, but they took away our authority to innovate. Everything was supposed to come down from the top, and there were no ideas coming down from the top. They got bogged down and were not able to innovate in the foreign-exchange and precious-metals group" (Deak-Perera U.S.).
Another key element of the Deak-Perera organization had always been its compensation package. Managers earned relatively low salaries but were rewarded with a share of the profits (15 percent) if the company was successful. But Leslie Deak began phasing this out in 1981 and eliminated it entirely in 1982, insiders say. "Leslie made a big mistake by taking the incentives away," said one former manager, "because the people who made the company a success over the years left."
"Right now they need their experienced people the most," remarked Glen Kirsch, who developed the company's tremendously successful precious-metals certificate program and now runs a precious-metals firm in Virginia. "And where are they? They're in competition with them."
Along with the loss of managerial talent and sources of financing, Deak-Perera was beset by a host of other problems in the '80s. The company had faced changing market conditions before and adapted to them, but this time Deak-Perera failed to do so.
Large banks began getting involved more heavily in the wholesale banknote business. Worse, they began outbidding Deak-Perera by large margins to run foreign-exchange concessions at key airport locations in order to gain a foothold in those cities in anticipation of interstate banking deregulation. Deak-Perera is already out of the airports in Los Angeles, Miami, Honolulu, and San Francisco and may soon be out of others as contracts come up for renewal.
Another major problem was overexpansion in the teeth of a collapse in the prices of precious metals, which had become one of the company's staples. When precious metals began their big run-up in the late '70s, Deak-Perera responded by expanding existing offices and opening new offices in such unlikely places as Denver, Las Vegas, and San Diego. Expensive computer equipment was bought, and scores of new employees were hired to make "cold calls" to potential clients and to handle an increased volume of paperwork. But when gold and silver peaked in early 1980 and began their steep decline, Deak-Perera found itself unable to retrench fast enough.
Finally, former top company officials said, much money was wasted on what one called "feeble attempts at getting into other areas," such as securities and commodity futures. "So much of what they told us to do was totally nonprofitable," winced one ex-Deakette.
Certainly it didn't help that the federal government spooked some of Deak-Perera's customers, but the bottom line to the company's downfall seems to be as former Deak manager Kirsch stated it: "It was decay from within, and it was just a matter of time."
Steve Beckner was the editor of Deaknews from 1976 to 1981. He wrote "Making Money from Sound Money: The Nicholas Deak Story," in REASON's June 1977 financial issue. He has been a financial reporter on the staff of several newspapers, most recently the Washington Times, which he left recently to pursue free-lance writing.
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]]>Once again, the federal budget deficit will be very high, although probably not as high as the fiscal 1983 deficit of $195 billion. The trade deficit will probably greatly surpass last year's $70 billion. The budget deficit tends to keep the trade deficit high by pushing up interest rates and in turn the dollar, making US goods less competitive.
Notwithstanding the deficits, though, the economy should neither slip back into recession nor into inflation—not yet, anyway, for the economy has a number of buffers protecting it. One of these buffers is an unexpectedly large increase in business savings. Despite Federal Reserve chairman Paul Volcker's recent warning that Treasury and private credit demands are already straining the money markets, business as a whole actually has large amounts of surplus cash and thus does not need to borrow.
Thanks to rising profits, low inflation, wage restraint, and the 1981 business tax cuts, corporations are enjoying record cash flows, which enable them to invest heavily in Treasury securities even after making their own capital investments.
Economist Allen Sinai estimates that business savings due to President Reagan's reduction in corporate income taxes and accelerated depreciation schedules will have reached $181.7 billion by 1985—nearly $65 billion in 1985 alone, after savings of $37.6 billion in 1983 and $51.8 billion in 1984. So, despite the federal drag on the economy, business is planning a 9.4 percent increase in spending on plant and equipment in 1984.
In addition, recovery-generated increases in revenue and diminished demands for social services should reduce the deficit by at least $20 billion. At least through 1984, then, the government should be able, in effect, to get away with running large deficits. Therefore, federal financing pressures figure to be considerably less onerous than generally anticipated.
If, in addition, inflation remains moderate, interest rates should come down, relieving pressure on the dollar and making American goods more competitive. Lower interest rates would also mean lower servicing costs on the national debt.
Expect the Federal Reserve to do everything in its power this year to reduce interest rates. It will have relatively favorable conditions to do that this year, given the factors mentioned above plus the slowing of the recovery. But it will do so at the cost of long-range inflationary dangers.
Yet another potential buffer for the American economy is the emerging global economic recovery. Worldwide economic growth will not be dramatic in 1984, but any increase will redound to the benefit of the United States in the form of increased demand for American goods.
Looking beyond 1984 and the probable landslide reelection of Reagan, the outlook is not so rosy. As Lawrence Kudlow, former chief economist for the Office of Management and Budget, writes in his Foxhall Review, a budget "strategy where outlays will absorb 24 percent of GNP, deficits absorb 5 percent of GNP and 81 percent of net private savings, is not compatible with strong growth, moderate inflation and falling interest rates."
At some point late this year or early next, we will suddenly realize that both the recovery and disinflation have been undermined by the pressures of the deficit. Without major fiscal policy changes, which are unlikely, a number of things will happen as the recovery matures. The conflicting demands of the public and private sectors will begin to put inexorable pressure on interest rates. Bank and corporate demand for Treasury securities will evaporate. The Fed will be forced into the breach to make sure there is enough money and credit available to finance the deficit while keeping the economy alive.
As interest rates are kept artificially low, while the balance of payments continues to look sickly, the overvalued dollar will finally begin to fall—and fall dramatically—with two effects. First, no longer will we be able to buy foreign goods at bargain prices: more costly imports will feed directly into higher producer and then consumer prices. Second, the influx of foreign capital will halt and then reverse, making the deficit even harder to finance without resort to expansionary monetary policies.
What does all this mean for the investor? For most of 1984 it means prospects for more good profits in the stock market. There's also a good chance for a substantial bond rally as the Fed gets interest rates down around mid-year, if not sooner.
The best bet will be growth stocks. And most of the growth will be in the technology area. "About halfway through 1984 investors' focus will shift to earnings prospects in 1985 and beyond," says the California Technology Stock Letter. "That's when the technology stocks, with their long-term growth rates of 15–50 percent, will stand out."
Another good bet for 1984, for perhaps 10 percent of a portfolio, is foreign securities. The generally good performance of foreign stock markets in 1983 should be repeated in 1984, as recovery abroad picks up speed. The best bet is Japan.
Later in 1984, the worm will begin to turn in favor of inflation hedges. Inflation will not return to double-digit levels this year, but the markets will begin to anticipate it. Gold, silver, and the platinum-group metals will finally start their long-awaited resurgence toward year-end.
The dollar will probably begin its slide even before then. Those with a speculative turn of mind will be able to make large profits going long in such currencies as the Japanese yen, German mark, and Swiss franc. The less speculative can hold foreign-currency-denominated CDs (certificates of deposit) abroad or invest in foreign securities.
The one thing that could nix this admittedly gloomy forecast is if the Fed simply refuses to permit another resurgence of inflation and takes the politically unpopular course of letting the economy lapse back into recession. But if it tried such a policy, the Fed would likely have its hand forced the other way.
Steve Beckner is a financial reporter and columnist for the Washington Times and the author of The Hard Money Book.
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]]>After one of the longest and deepest recessions since World War II, you might think that everyone would be happy to just let her rip. But no. Indeed, the Federal Reserve avowedly set out to slow the recovery. And evidently it succeeded. Most forecasts for economic growth for 1984 are in the 4–5 percent range.
The reason for this perverse economic attitude, of course, is fear of inflation. And the fear is justified. The kind of monetary expansion permitted by the Federal Reserve from August 1982 through May 1983 to get the economy growing was, and to some extent remains, a very real inflationary time bomb.
Slowly, however, the tide of opinion seems to be shifting back toward concern about setting off another recession. The Reagan administration has loudly voiced its opinion that the Federal Reserve has become too tight. The danger is that, in responding to election-year political pressure, the Fed will overreact and return to excessive money creation.
As it is, monetary policy has probably been just about right—for once. The Fed's monetary aggregates were, in the final quarter of 1983, within a none-too-restrictive 5–9 percent target growth range. Looking at it from a longer-term perspective, both M1 (currency in circulation plus checking deposits) and the monetary base (cash plus bank reserves) had grown nearly 10 percent over the one-year period ending in mid-November. M2, a broader measure including savings and time deposits, had grown even more.
In the latter part of that year, the money supply was growing at 5 percent or less. If the Fed sustains that rate, there is some hope of maintaining the low (3–4 percent) inflation rate without damaging the economy too badly.
Unfortunately, there is a high likelihood that the Fed will veer from this moderate course because of (you guessed it) the budget deficit, which is expected to remain at least $185 billion next year even with the recovery-induced increases in revenues. The deficit will probably continue to absorb at least 75 percent of net national savings. Treasury financing will increasingly clash with private credit demands as the recovery matures. Long-term capital projects in particular will suffer, as indeed they have been neglected for some time.
Lawrence Kudlow, the former associate director of the Office of Management and Budget for Economic Policy, who now heads up an economic consulting firm, says that the budget deficit presents the Fed with a monetary policy choice "between bad and worse." Either "low money growth to fight inflation will clash with heavy borrowing, keeping real interest rates high and real growth low," says Kudlow, "or loose money to accommodate the deficits and produce faster growth will reignite inflation, with a flight from dollar assets and a financial-market crisis."
The Fed's choice, most likely, will be to risk inflation in an attempt to forestall another recession. And traditionally, the Fed does inflate during election years.
What does this mean for investors? It probably will mean that those good yields on money-market accounts and Treasury bills will diminish even if interest rates rise somewhat. The real interest-rate premium cannot remain as high as it is.
That means that the dollar, which will also be increasingly buffeted by soaring trade deficits, will (finally) fall dramatically. It also means good news for precious metals. The November fall of gold and silver to under $380 and $8.50 per ounce, respectively, was probably the last bit sell-off and probably the last time we will ever see those metals so low—before the bull trend takes hold. Some analysts see precious metals at twice those prices within a year's time.
Ironically, a recurrence of inflation may not unduly damage the stock market. So long as the recovery continues, the bull market on Wall Street could continue.
Louis Rukeyser, host of the Public Television System's Wall Street Week, sees inflation coming back with certainty. Nevertheless, he forecasts a strong economy and a strong stock market for the remainder of the decade.
"The rich people of 1993 are buying stocks in 1983," Rukeyser told me in a recent interview. Despite the huge runup in stock prices that has already taken place over the past year, he thinks "we're still in the early stages of an historic bull market."
"To succeed in investing you don't have to get in at the bottom and get out at the top," he told me. "You just have to determine whether we're closer to the basement or to the roof." His conclusion is that "we're no longer in the subbasement, but we're still on the ground floor."
Although it doesn't seem plausible that stocks and metals should rise together, there is precedent for it. At any rate, it's wise to carry a balanced portfolio and be prepared for either to move.
Steve Beckner is a financial reporter and columnist for the Washington Times and the author of The Hard Money Book.
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]]>Those who pooh-pooh fears of renewed inflation cite last year's reactionary decline in the velocity of money—that is, the rate of turnover in the money supply, usually calculated as the ratio of the gross national product (GNP) to the money supply. Velocity did fall at a 2.3 percent annual rate last year, after rising an average 3.2 percent annually over the previous 22 years. High returns on dollars caused an increase in demand for money and a corresponding decline in velocity. This helped dampen inflation.
But as John Tatom observed in a recent article in the St. Louis Federal Reserve Bank Review, "It is not unusual for velocity to decline in a recession. It is, in fact, quite typical. Given the length and severity of the recent recession, it is not surprising that velocity registered the largest decline in post World War II recessions." So it would be a mistake to think that last year's drop-off in velocity insulates us from the proven inflationary effects of monetary expansionism.
Velocity has been used lately as a fudge factor to discount the expansionary nature of Federal Reserve policy. Changes in velocity certainly cannot be dismissed, but regardless of what happens to velocity, it's wishful thinking to believe the money growth we've been experiencing will not have an effect on prices.
We can expect lower interest rates and the increasing demand for goods stemming from the recovery to decrease the demand for money and increase its velocity. That means high rates of money growth will increasingly affect prices.
The 3–4 percent inflation rate we're now enjoying is unsustainable given the rate at which monetary quantities have been growing over the past year. M1—currency in circulation plus checkable deposits (including NOW accounts)—grew nearly 12 percent between the third quarter of 1982 and the third quarter of this year. The monetary base, probably a more accurate measure of Fed policy, grew by about 9½ percent over the same period. And these rapid growth rates encompass a summer slowdown in monetary growth that greatly alarmed Reagan administration officials. Since August, it appears the Fed has adopted a more-expansionary course, under great political pressure, in an attempt to bring down interest rates.
Donald Maude, executive vice-president and chairman of the interest-rate committee of Merrill-Lynch, says there's no longer any debate over whether or not the Fed has eased credit. "The only question," he says, "is the dimensions by which the Fed has eased." He cited a large decline in net borrowed reserves, which means that the Fed has been pushing more money out through its securities buying ("open market") activities and relatively less through the discount window.
Economist Allan Meltzer observed in an interview that "the Fed is trying to keep money growth as high as it possibly can, but every once in a while the market disciplines them." Meltzer is cochairman of the Shadow Open Market Committee, a group of generally free-market economists that monitors the Fed's actions. The Shadow Committee recently predicted that inflation could go as high as 7–9 percent by late 1984. Asked recently about Meltzer's inflation prophecy, Federal Reserve Chairman Paul Volcker declined to comment on the specific numbers but told me his view of the Shadow Committee: "a little extreme."
One of the unheralded reasons why our inflation rate is so low is that the value of the dollar is so high relative to other currencies. The fact that the dollar is overvalued by approximately 30 percent, according to various estimates, may be killing American exports, but it keeps the cost of our imports quite low and puts downward pressure on our price levels.
The dollar's strength will probably change soon—perhaps by a lot. In fact, a substantial dollar downtrend against the traditional hard currencies appears to have started already. Ironically, it began after the US and foreign central banks in August abandoned their joint intervention in the foreign-exchange market to soften the dollar.
There is apt to be some convergence in the coming year between lower interest rates and higher inflation, which will make real dollar yields much less attractive in world capital markets. Merrill-Lynch's Maude predicts that long-term interest rates will be brought down to 10–10½ percent and possibly below 10 percent, while short-term rates could go as low as 8 percent. They will begin to go back up, he predicts, only after the second quarter of 1984, as Treasury borrowing begins to "crowd out" private borrowers.
The factor that won't go away, though it may diminish somewhat, is the federal deficit. How is it to be financed? Currently, large capital inflows from abroad are helping. As economist Meltzer put it, "Bonds have become our major export."
But this deficit is going to put enormous pressure on the Fed as public and private demands for credit clash. Will the Fed allow budgetary financing to kill the recovery, or will it accommodate the Treasury? Volcker will try to walk a fine line between those two courses, but that will be particularly hard in an election year.
All things considered, it's difficult to imagine the Fed being able to keep the growth of the money supply near even the upper reaches of its current 5–9 percent target range. Money created over the past year is in the pipeline, and it will begin to increase inflation by the third quarter of 1984. Further relatively large rates of money growth will lead to higher rates of inflation beyond.
The commodities markets have only begun to anticipate these developments. In the coming months, they could explode. Are you poised, investors?
Steve Beckner is a financial reporter and columnist for the Washington Times and the author of The Hard Money Book.
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]]>The new regulation requires precious-metals dealers to keep records of customers' transactions and to provide the IRS with names, addresses, Social Security numbers, and the amounts paid. For the time being, dealers—whom the IRS defines as commodity "brokers" subject to the reporting requirements of last year's tax act—need report only their purchases of metal from customers, but not their sales to customers. An IRS official claimed that the agency has the statutory authority to demand reporting of all transactions, but "in an effort to lessen the burden we're not requiring that."
For the first year, precious-metals dealers can file "aggregate" reports of each customer's total annual sales. But in 1984, they must begin reporting each individual transaction.
Numismatic coins—coins that trade for a substantial premium over their metal content due to their rarity—have enjoyed a price surge in the wake of the new regulation. That's because, as the IRS official confirmed, the regulation "has no effect at all" on rare coins. The result was inevitable: "You can't even touch US gold coins," observed Mark Watts, owner of Gaithersburg Coin Exchange in Maryland. And Walter Perschke, president of Numisco, Inc., of Chicago, estimated in June that common-date US gold coins had risen by 20 percent within three weeks "entirely" due to the IRS regulation.
Despite all this, however, potentially useful ambiguities abound in the new regulation. For example, there is considerable dispute between the IRS and lawyers for major metals dealers over whether the law or the regulation really applies to bullion coins such as the Krugerrand or even to pre-1965 "junk silver" coins. Also, Section 311 of the Tax Equity and Fiscal Responsibility Act seems to apply primarily to stock and commodity brokers. But precious-metals dealers complain that the IRS has gone beyond the intent of Congress in defining them as "brokers."
"It's a clear case in which the IRS has gone far beyond the intent of Congress and created a nonenforceable regulation," declared Joe Cobb, a minority staffer on the House Banking Committee. "The intent of the law seems to apply to futures contracts, but the regulation is written to apply not only to commodity contracts but to the physical trading of anything the contract covers."
According to an official in the IRS Legislation and Regulation Division, a person who buys Krugerrands is "really buying and selling a commodity. It's a gold transaction, not a coin transaction." Burnett Anderson, Washington correspondent for Numismatic News, concurs. "Congress made it sweeping," he said. "It's clear they wanted to get at these big profits in hard assets."
But others maintain that the IRS's own regulatory language exempts bullion coins from the reporting requirement. The IRS defines "commodity" as "any type of personal property or an interest therein…the trading of regulated futures contracts in which has been approved by the Commodity Futures Trading Commission."
Well, there are no futures contracts in Krugerrands or any other kind of gold coins. An application was made to the CFTC last year but was withdrawn. There used to be a contract for bags of silver coins, but that contract has long since gone into suspension.
For that reason, James Hildebrandt, manager of Deak-Perera (Washington), declared, "We're taking the view that bullion coins are not reportable. We will not take [names and identification] unless we're required to." He added that the IRS "may have thought they wrote the regulation [to encompass bullion coins], but that's not what our lawyers say."
The regulation doesn't change the legal obligation to report capital gains in gold, silver, platinum, and so forth. Presumably it will make it easier for the IRS to enforce collection. But the IRS will be snowed under with masses of undigestable reports from every mom-and-pop coin shop right up to the big-time dealers. Then, too, at least until the IRS begins requiring the reporting of both ends of the transaction, it must rely on taxpayer oaths—the taxpayer's own unprovable assertion as to his original purchase cost—as the "basis" for determining gains or losses.
Luis Vigdor, the head of the recently formed Industry Council for Tangible Assets (ICTA), thinks that many precious-metals investors who believe in paying their taxes will nevertheless be loathe to subject themselves to the reporting requirement because of privacy considerations. Not only is there an element of risk in having your name, address, and holdings on record for any number of people to see, but many "really don't want to be on record because they remember that gold was once confiscated."
Because of such concerns, it is very likely that a black market in unreported precious metals will spring up. People will sell their holdings through the want ads, through underground dealers, and in Canada. Unfortunately, this will hurt many of the sound, existing firms. "What's going to happen is that the larger and better organized dealers' business is going to fall off dramatically," predicted Cobb, "because people are going to start looking for the most surreptitious ways of buying and selling."
On the other hand, Watts suggested, "Maybe people will resent it so much they'll go after gold even more." Glen Kirsch, partner in International Financial Consultants of Bethesda, Maryland, observed, "If people want something bad enough they'll get it. Sooner or later, someone finds a loophole." The numismatic loophole, through which many have already climbed, is a potential area for further profit, particularly once underlying gold and silver prices begin to rise with the likely revival of inflation next year.
So if you intend simply to buy and hold, or if you swap in and out of gold and silver, you probably need not have your transactions on record.
Steven Beckner is a financial reporter and columnist for the Washington Times.
The post Money: Policing Precious Profits appeared first on Reason.com.
]]>If, for instance, you think that now is the time to be in the stock market, instead of in money market instruments or commodities or real estate, then choosing which companies' shares to buy can be done with relative disregard for broad federal economic policies. Naturally, even individual companies can be sharply affected in different ways by government regulations of various industries, but that is a different matter.
It's the initial investment strategy decision that's tough, though. And at the moment it's becoming increasingly tricky, because the fiscal irresponsibility of Congress makes the medium- and long-term economic outlook very uncertain.
You may be inclined to think that the stock market boom will go on indefinitely. From last August through early May, the Dow Jones Industrial Average rose nearly 60 percent. Then, after reaching a record high of 1232.59 on May 6, the Dow suffered a 60-point fall, only to recover by mid-June, surpassing the previous record. And each week seems to bring fresh evidence of strong economic recovery. But, while it is too early to pronounce the stock market boom over, the increased volatility of the market should give one pause.
Most market observers seem to think that stock prices could rise by another 10 or 20 percent during the course of the recovery. But many of those same people forecast that the recovery will be short-lived, that it will be interrupted sometime in 1984. Few believe that we can continue to have a bull market of the speed and dimensions we've seen since the summer of 1982. At best, further uptrends are apt to be marked by continued interruptions, which make the market more treacherous than before, though not necessarily unprofitable.
The doings on Capitol Hill have given Wall Street ample cause for doubt and should spur all investors to reevaluate their investment stance for the longer term. The Dow's volatility has coincided with signals from a stubborn Congress that it has no intention of controlling its voracious spending appetite or of doing anything—other than raising taxes—to narrow its ever-widening budget deficits.
The fiscal 1984 budget resolution in the works as this was written will likely call for at least $75 billion more taxes over three years, protect entitlement programs, increase military spending by a real 4–6 percent, and call for a deficit of at least $175 billion. Given that the fiscal 1983 deficit had already hit $130 billion with five months to go in the year, that is likely a very conservative projection. Even the Republican-controlled Senate refuses to deliver a sane budget. One can only hope that President Reagan wields his veto power fast and furiously come appropriations time.
The market can be forgiven for interpreting this mindlessness as meaning either that heavy federal borrowing will drive up interest rates, drive out private credit seekers, and stifle the recovery or that it will force the Federal Reserve into accommodating monetary expansion. And in fact, the money supply jumped by $11.4 billion in a two-week period in early May, after earlier showing signs of tapering off. Seen as a reaction to this, the Dow's precipitous drop in May is not all that surprising.
It is becoming increasingly difficult to maintain that the rapid monetary expansion of the last three quarters reflects solely definitional changes in monetary statistics and the creation of new banking instruments. The monetary base, a fairly neutral measure of the basic money supply, consisting of currency in circulation plus reserves at member banks, grew nearly 13 percent from January through May. And adjusted reserves, which subtracts currency held by the nonbank public, were growing even faster.
History suggests, and current behavior seems to confirm, that the nation, via the government, will choose inflation over the pain of resisting it. No matter who's in charge, the Federal Reserve cannot long maintain monetary restraint in the face of prolonged and heavy Treasury borrowing and simultaneous pressures to sustain a growing private economy.
That's why the consensus that we are living in a "disinflationary" period will prove to be wrong. Our society, or the aggregation of special-interest groups that makes it up, is unwilling to reduce its demand for government programs and at the same time is unwilling to pay more in taxes to finance its demands.
By the beginning of 1985, at the latest, look for the beginning of another surge in the price of "hard assets." As it is, those old reliables gold and silver have shown surprising strength in the face of greatly reduced inflation and high real interest rates. It's too early, alas, for the nation to return to the gold standard; but for individual investors, the time is coming.
Steven Beckner is a financial reporter and columnist for the Washington Times.
The post Money: Treacherous Profitability appeared first on Reason.com.
]]>For instance, take the sudden and dramatic fall in the price of the yellow metal that occurred in late February—a slide of over $100 per ounce in little more than a week's time. This "collapse" was the occasion for the eleventy-fifth declaration that "gold is dead"—or had "turned to lead" or "lost its luster." You can choose your own cliché.
As usual, the Cassandras were wrong, possibly because their market perspective is blinded by moral outrage. One financial writer recently suggested to me that it's evil for people to invest in a nonproductive asset like gold at a time of high unemployment.
True, it looked pretty grim for a couple of days as gold, which had been trading in excess of $500, briefly traded under the $400 mark. In a single day, gold dropped by $42.50 per ounce. Its cousin, silver, also took a plunge of $4.30 per ounce from its 1983 high of $14.66.
But, after testing the $400 level, gold bobbed right back up—"just like Ivory Soap," as Wray Kunkle, a futures trader for Voss & Co., likes to say. As this was written in mid-March, gold was trading at around $426. Silver was back up to $11.28 per ounce.
There was a point last summer when it really did look like the precious metals were breathing their last. In August, silver had, almost unimaginably, traded briefly below $5 per ounce—compared to an equally unimaginable high of $50 per ounce back in January 1980. Gold had gone down in August to $289 per ounce. Here's hoping you bought at the lower prices, but the tendency for all too many investors is to get the buying fever near the peak and to avoid the metals like a plague when they seem to be going down for the count.
Asked to explain why gold and silver bounced back from those August lows to over $500 and $14 per ounce respectively, precious metals expert Glen Kirsch of International Financial Consultants joked, "More buyers than sellers." That's actually probably as good a reason as any, given the wildness and unpredictability of the markets these past few years.
Seriously, Kirsch said it is "very natural to expect it to buoy after such a drop." Ordinarily, commodities make a 50 percent retracing of both up and down moves. In coming back from its low last year, he said, the metals overshot that measuring stick and were therefore due for a correction. But then, of course, the March rally from February lows could be explained in the same technical fashion.
For the more fundamentally inclined, gold and silver reached their depths last summer as interest rates had peaked and inflation rates were beginning to scrape bottom. Then, about the time, oddly enough, that the stock market began its historic rally, the precious metals began rising.
The Federal Reserve was pushing down interest rates, making nonearning metals relatively more attractive to finance and hold. Rapid monetary growth and expectations of recovery also increased demand for precious metals. It doesn't take many people worrying about renewed inflation or dollar weakness to get gold moving.
Silver moved along with gold, but with an added impetus. For one thing, it was undervalued relative to gold, in terms of traditional price ratios. For another, being a widely used industrial metal, hope of recovery spurred demand for silver more than for the monetary metal, gold. Finally, depressed copper production constrained supplies of silver, a byproduct. The net result was that, while gold rose 75 percent through January, silver nearly tripled.
As for the subsequent price "collapse," there have been all kinds of explanations and speculations in addition to the strictly technical ones. One has the Soviets and Saudis dumping gold, out of opportunism in the first instance and financial need in the second. Some of both is probably true.
The most popular explanation attributes the price weakness in precious metals to that in oil. That certainly can't be ignored. It is undeniable that a gold-oil price relationship has developed since OPEC started manipulating the price of oil. But, as Kirsch notes, "That's old news. Oil prices have been declining for some time." Only if oil prices decline much further than expected, leading to lower expectations for commodity prices in general, is gold likely to fall out of bed.
Michael Checkan, assistant manager of Deak-Perera in Washington, notes that the latest OPEC flare-up caused "a lot of people to get burned and driven out of the market" as the news of oil price cuts precipitated a panicky sell-off that forced traders to sell out of their long futures positions. Whatever the reasons, both Checkan and Kirsch agree that silver at around $10 and gold at around $400 are excellent long-term buys. But Checkan advises investors to "stay away from the futures market."
Regardless of the oil price, there are growing signs suggesting that we are not, as the conventional wisdom now has it, in a "disinflationary" period. Somehow the federal budget deficit (en route to $250 billion or more in coming years) must be financed, since it is unlikely that Congress will do the right thing and cut spending. Overtly raising taxes or borrowing every available penny of private savings would create a stagnant economy. That isn't politically expedient.
Interest-rate pressures resulting from the collision of recovery and federal borrowing will tempt the Federal Reserve irresistably to accommodate the government and the private sector with inflationary monetary policies. It also looks increasingly likely that Congress will repeal tax indexation, which only makes sense if the government expects inflation to provide a windfall of revenues from bracket creep. It will be a while before reflation fully asserts itself, but it may not be long before the gold market begins anticipating it.
Steve Beckner is a financial reporter and columnist for the Washington Times and the author of The Hard Money Book.
The post Money: Gold Theories Devalued appeared first on Reason.com.
]]>From the first trading day of January 1982 through the close of trading on December 31, the Dow Jones Industrial Average rose more than 19 percent, even after falling 24 points from its December 27 high of 1070.55. Other measures of the stock market reflected this fairly impressive performance. The Nasdaq Composite index of over-the-counter stocks also rose more than 19 percent, while the Standard & Poor's Composite rose 15.25 percent.
It was an even better year for bonds. As interest rates fell during the year, long-term government bond prices rose 24.9 percent through December 1, according to Salomon Brothers. High-grade corporate bonds rose 29.27 percent during the same period.
Meanwhile, those who did not want to take risks in stocks and bonds did very well just earning interest on deposits. Even after the collapse of interest rates in the latter half of 1982, rates of return remained quite respectable. At year-end, some money market funds were still paying over 10 percent, and at least one of the new bank money market accounts was paying 12 percent.
Precious metals also performed surprisingly well in a climate of diminishing inflation. Gold rose 15.2 percent, to $456.90 per ounce on December 30, after reaching $462.50 a few days earlier. Silver did even better, appreciating 35.7 percent over the year, to $10.90 per ounce. It had hit a yearly high of $11.20 only days before New Year's. At one point during the late summer, gold threatened to break through the $500 level again, but silver reserved its big push for year-end.
These performance statistics for different investments are all the more impressive and meaningful because of the dramatic reduction in the inflation rate over the past year. An inflation rate of 3.9 percent made the real rate of return on all investments higher.
Of course, not all investments did well. Most commodity prices suffered, as did real estate prices. Then, too, just because stocks or other assets rose by a certain amount from January to December doesn't mean that your particular portfolio did that well. You may have done better or worse, depending on what you bought and when. It was a year of dramatic fluctuations. Stocks, as measured by the Dow index, traded in a 300-point range. Gold fluctuated within a band of nearly $200 per ounce. They were treacherous but interesting investment waters.
Well, what about 1983? The one thing that this year will likely have in common with 1982 is a great deal of economic uncertainty and, hence, market unpredictability. But that's nothing new. Amid growing signals of economic recovery, the stock market at year-end seemed poised to ratchet up further—or collapse, depending on which analyst you listened to. Although the market had risen at one recent point by nearly 300 points since August, even the most bullish stock traders were reluctant to pronounce it a "bull market." Most people persisted in calling it a "rally."
Barely two weeks before the Dow jumped to a record high of 1070.55 in early January (since surpassed), the bulls seemed to be on the run, as the index plummeted briefly below 1000. Once again, the shorts were foiled, and the market rallied. But how much longer the bears can be held at bay is unclear. The watchword is caution.
Bonds could be the best bet if, as seems likely, interest rates continue to fall. High-technology companies, as well as companies that make building products, are good stock bets once the recovery gets under way in earnest and the bears on Wall Street are finally routed. The answer meanwhile is to stay liquid and balanced. There is still some good, low-risk interest to be made. Use the new, competitive (and insured) money market accounts to remain liquid. When you're ready to invest, take a balanced stance. Divide your funds among securities in different industries. Mutual funds are good tools for doing this. Stock options and, soon, options on stock index futures are a further way of limiting risks.
Precious metals are a crapshoot, short-term. Inflation is not likely to rise enough to make gold and silver really soar in the first half of the year, although political events around the world could. The Federal Reserve seems to be doing its best to reheat inflation, but the economy is too weak to permit that just yet. Longer term, however, precious metals at these prices will prove to be very good hedge investments—and maybe sooner than we think. If, instead of the "moderate" recovery nearly everyone is expecting, we get rapid economic growth (not difficult given the low starting point), we could see the beginnings of a new round of inflation.
The Federal Reserve's expansive credit policy encourages powerful market elements (business and labor) to increase prices as business and consumer demand picks up. Other stimuli include the Fed's aggressive lowering of interest rates and the advent, at last, of a real tax cut in July. The Fed will find it difficult to return to monetary restraint, even if it wants to, because of looming budget deficits, estimated as high as $200 billion. Monetary restraint under such adverse fiscal conditions would mean forcing interest rates back up and killing off the nascent recovery. For all these reasons, it's anything but clear that we are in a long-term disinflationary cycle.
It's not certain that inflation is going to accelerate late this year or next year, but it's a strong possibility. One advance indicator may be the recent strength of precious metals and "hard" foreign currencies. After several years in the doldrums, the tide may be turning back in favor of hard money.
Steve Beckner is a financial reporter and columnist for the Washington Times and the author of The Hard Money Book.
The post Money: Pecuniary Prudence appeared first on Reason.com.
]]>Ten years after the publication of his prophetic book, Silver Profits in the Seventies, Jerome Smith has come out with a sequel, aptly titled Silver Profits in the Eighties. Whether this book will prove as far-sighted as the last one is questionable, given Smith's near-term prediction for $100-per-ounce silver and even higher prices beyond.
Coming out as it did when silver was below $10 an ounce and, at one point a few months ago, below $5 an ounce, compared to its January 1980 high of $52, Smith's book certainly hit the market at the right time. Whether or not his ambitious price forecasts are to be believed, readers who buy at current levels could hardly go wrong in the long run.
But caution is needed in reading Silver Profits in the Eighties. For this book filled with charts and tables makes some questionable assertions.
The thrust of Smith's argument, now as 10 years ago, is that demand for silver is rising and supply is falling. It is true that since 1946 there has been a gap of 100–150 million ounces between silver consumption and new silver production. But that gap has always been filled by above-ground supplies. It is true that available supplies, including new production, are becoming increasingly strained. But Smith goes too far in asserting, "There are no longer any sizable hoards of silver in the world."
In fact, a Bureau of Mines study, prepared by private consultants and for some reason not publicly released, estimated that in the United States alone there are private silver stocks amounting to 2.5 billion ounces. That's in addition to the government's 140-million-ounce stockpile.
Smith also contends that India, long a great source of smuggled silver, is drying up. It could be, but he would find plenty of argument to the contrary. Some experts estimate that there are probably still 3 to 4 billion ounces of the metal in India. That's a lot of silver.
The other side of the coin, according to Smith, is that silver demand is steady, if not rising. Curiously, in a large section devoted to gold, Smith stresses slackened demand for gold, thus buttressing his point that the gold-silver price ratio is out of alignment. But he fails to take account of similar evidence of slackened demand for silver.
In 1981, according to the latest adjusted figures from the Bureau of Mines, US silver consumption, at 117 million ounces, was at its lowest since 1963. It was even lower than in 1980, considered a black year for the white metal. Consumption for the first half of 1982 was up about 7 million ounces from the same period the previous year—encouraging, but hardly exciting. And total 1982 consumption was still far below the peak consumption year of 1973, when the United States used 196 million ounces.
None of this means, of course, that silver prices aren't due to rise. Smith's valuable discussion of the history of price relationships among the precious metals and much of his other information, however flawed it is on occasion, leads one to the inescapable conclusion that silver is undervalued. But don't hold your breath waiting for $100 silver.
Steve Beckner is the author of The Hard Money Book and a reporter and columnist for the Washington Times.
The post How Rosy Is the Silver Picture? appeared first on Reason.com.
]]>The answer to both worries, according to many people, is Individual Retirement Accounts (IRAs) and Keogh plans (which can be funded for 1982 up until April 15, 1983, if the accounts were established in 1982). The Economic Recovery Tax Act of 1981 made these tax-deferred pension plans much more appealing by raising contribution limits and liberalizing eligibility standards. Since then, thousands of banks, brokers, and insurance companies have deluged the public with advertisements for a diverse array of IRAs and Keoghs.
New books by Jack Egan and William J. Grace, Jr., and a special guide to IRAs published by Money Magazine help clear up the confusion. Both compare types of accounts and provide guidance on which best meet the needs of different investors.
"At a time when it is no longer possible to depend on social security and many private pension plans are also on unsure footing, these personal savings and investment accounts are a virtual must," writes Egan in Your Complete Guide to IRAs and Keoghs (Harper & Row, $13.95). "In effect, the expanded eligibility for IRAs and Keoghs sets up a voluntary second national retirement system that parallels the mandatory but troubled Social Security system."
Somewhat less gushing in his praise, Grace writes in his ABCs of IRAs (Dell Paperbacks, $3.95): "IRAs were never meant to be the answer to your financial worries. But they are an important supplement to retirement planning for most people."
IRAs and Keoghs sound too good to be true. And just maybe they are. Let's be cynical for a minute. The main problem, especially for young people, is that no one knows what the government may do in future years to the tax code and to the value of our money.
IRAs, to which almost anyone can contribute up to $2,000 per year tax-free, and Keoghs, to which self-employed people can contribute up to $15,000 per year in addition to IRA contributions, seem like a marvelous way to build a nice retirement nest egg. Thirty years of maximum contributions compounding at 10 percent per year buys you a $329,000 IRA and a $2,476,000 Keogh. Hence the tantalizing hype of banks, brokers, and insurance companies that we can all become "millionaires." Moreover, you get to deduct your contributions right off the top of your income each year, keep that tax-deferred income working for you, and, so the presumption goes, pay taxes in a lower bracket when it comes time to withdraw that money for your old age.
The big doubt is inflation. It seems to be under control for now, although even a 6 percent inflation rate takes quite a toll over time. Assuming inflation of 6 percent and a 10 percent annual yield, those same 30 years of $2,000 contributions would be worth only $112,000 in today's dollars—only a third of the assumed $329,000 accumulation.
And what if inflation outpaces the yield? If you open a self-directed account with a broker or invest in a mutual fund group, and if your investments don't pay off, you could lose out altogether after inflation.
Even if you're in a savings account at a bank, there is no guarantee that the interest you earn will keep pace with inflation. It wasn't too long ago that a negative real interest rate (the rate of interest minus the inflation rate) was the rule in this country. And there are those in Congress who would like to take us back to those days by forcing the Federal Reserve to hold interest rates artificially low while pumping out inflationary quantities of money.
Along with inflation comes higher taxes under current law. The indexing of the federal income tax due to take effect in 1985 should greatly ameliorate the problem of bracket creep, but again there are those in Congress who would like to repeal indexing. Who knows what future Congresses may do? It's conceivable you could find yourself at retirement in a "millionaire's" tax bracket.
As it is, you must be careful when you start making withdrawals from an IRA or Keogh. As Egan writes, "Your withdrawal schedule should take into account how much you will wind up giving back to the government. With a lump-sum withdrawal, you may wind up giving half of it back in taxes, which will sharply diminish or virtually eliminate years of tax-deferred gains in your account."
Finally, there is the very real threat that Congress will simply change the rules of the game. It might, for instance, decide one day that those trusting souls who had the foresight to build up an IRA or Keogh retirement plan must forfeit the Social Security benefits they've paid for. "There is no predicting what steps Congress will take eventually if the funding situation becomes dire enough," Egan acknowledges.
All that having been said, IRAs and Keoghs are still a pretty good deal. They may just be an offer you can't afford to pass up. But, amid the trumpet blasts of their promoters, surely a little cautionary squeak can't hurt.
Steven Beckner is a financial reporter and columnist for the Washington Times and the author of The Hard Money Book.
The post Money: IRA Alert appeared first on Reason.com.
]]>The Dow hasn't come by its high profile by chance. After all, the index has been calculated and published for nearly 54 years. But can an index of just 30 industrial giants really tell the full tale of the tape?
For instance, while the Dow was skyrocketing 14.7 percent from its August 13 low of 777 to 891.17 on August 23, other market indices were lagging behind. The American Stock Exchange's 900 stocks advanced 10.2 percent over the same period. The over-the-counter market's 3000-issue NASDAQ index rose only 6.74 percent. The Standard & Poor's 500 index came closest, rising 11.8 percent. Conversely, on August 24, while the "blue chip" stocks that make up the Dow fell 16.27 points, smaller-company shares on the over-the-counter market and the Amex rose 2½ and 3½ points, respectively.
With such discrepancies, many analysts are calling the Dow misleading, if not obsolete. They note that until recently the last major change in the index came in June 1979.
"As far as I'm concerned it's useless," Herbert Saturn, Washington assistant manager of Drexel, Burnham, Lambert told me. "A perfect example is August 24. The Dow was down 16 points, and yet advances led declines 960 to 700. Ridiculous." He said many investors were calling to inquire why their stock languished while the Dow soared.
The Dow "is not nearly as good an indicator as the Standard & Poor's 500," maintains Washington financial adviser Barry Goodman. "It includes a heck of a lot more stocks and is a better indicator of the market in general."
But the Dow has its defenders. Monty Gordon, research director for Dreyfus Securities in New York, agrees that the S&P 500 is "a better indicator of what the broad market is doing." And he concedes the Dow is too limited at a time when "the market and the economy itself have gotten so much larger and more diverse."
But then Gordon ticked off a list of positives. Because of its "historical perspective," he noted, "the Dow is so identified with the market" that the "whole structure of technical analysis has grown up around it." Moreover, added Gordon, it includes "the leaders in different industries" that are "cyclically responsive" and "give a broader perspective on the market." Although its components were the focus of a heavy institutional buying panic in the third week of August, the Dow was "a pretty good indicator in that the market moved up broadly," Gordon contended.
No market average is perfect, argues Charles Stabler, assistant managing editor of Dow Jones's Wall Street Journal. "If a lake is an average three feet deep, it can be deeper than that in some places." In the long run, said Stabler in an interview, the Dow and other indices "really don't diverge." True, he said, second-tier stocks have lagged behind, but "it's perfectly reasonable" to expect that they'll catch up "when the move in the big capitalization stocks runs out."
Stabler also defended the Dow from the frequent criticism that it includes a utility, AT&T. "Although it's a large utility, it's also a large manufacturer through its Western Electric subsidiary. It also performs more like an industrial than a utility."
Asked if Dow-Jones is contemplating any future changes in its index's composition, Stabler said in late August, "We're constantly looking at it, but nothing is contemplated now." A few days later, a bankrupt Manville company was excised.
No investor should "use the Dow alone," stressed Gordon, but as far as public perception is concerned, "the Dow as a surrogate for the market is not a misplaced confidence. If an individual is looking for some idea of what the market is doing, the Dow is a reliable indicator."
On October 1, four futures exchanges began trading options on commodity futures contracts (see my October column) for the first time since 1936. So far, investors can buy or sell options contracts in gold, sugar, and Treasury bills.
Unfortunately, after interminable bureaucratic delay, this "pilot program" of commodity options may not get a fair trial. Because the Commodity Futures Trading Commission (CFTC) has forced the exchanges to impose high margins on the writers (sellers) of options, there is concern in many quarters that options will not achieve sufficient volume to have a chance at success.
Although option buyers pay only a fixed premium for the right to buy or sell at a certain "strike price," option sellers face futures-like risks and must post margin equal to their premium income plus the usual margin on the underlying futures contract. This steep margin could dissuade many option writers from selling options at a reasonable price and discourage many investors from buying them.
Not so, says James Day, who heads the options department of Chicago-based Heinold Commodities. He predicts that despite the CFTC's "onerous and illogical" margin rules, options will be "in such demand that (commodity) markets will explode like never before." He says 20 million people who now trade options on stocks will be potential commodity option customers—particularly when stock futures options become available. "The benefit of knowing your risk in advance is a powerful drawing card," says Day.
Steve Beckner is a financial reporter and columnist for the Washington Times and the author of The Hard Money Book.
The post Money: Down on the Dow appeared first on Reason.com.
]]>Since a futures contract enables one, in effect, to fix the price at which one may buy or sell a commodity in the future, what does an option on a futures contract mean? In return for a "premium," an option will entitle (but not oblige) the investor to buy or sell a futures contract at a specified "striking price" within a certain period of time.
The various options will generally be traded for expiration months corresponding to the delivery periods of the futures contracts on which they are written. At any given time, options with four expiration dates will be trading. For each month's option, several different striking prices will be established—above, at, and below the going futures price. These striking prices will be quoted in the same terms as the futures contract and will be changed as the futures price changes.
There are basically two types of options, of course: "calls," which entitle one to buy at a certain price within a certain period, and "puts," which entitle one to sell at a certain price within a certain period. Both types will be offered (for different expiration dates and striking prices).
The value of the option—the "premium"—will be set by the market and will be largely determined by the relation of the striking price to the actual futures price and by the distance from the expiration date. An option that is "in the money" (above the futures price in the case of a call, below the futures price in the case of a put) will obviously cost more than one that is "out of the money." The option buyer also pays for time, with the premium rising as the expiration date looms into the future.
Since, as with futures contracts, it takes two to make a trade, both put and call options can be either bought or sold. The option seller receives the premium paid by the option buyer. Within this four-way breakdown are an endless number of options trading strategies.
For the buyer (though not always for the seller, or "writer") of puts and calls, the beauty of options is the prospect of highly leveraged profits with finite risk. To take a very simple example, suppose you're bullish on the price of sugar come January, when sugar is trading at 12 cents per pound. You buy a July sugar option with an "at the money" striking price of 12 cents per pound.
The Coffee Sugar & Cocoa Exchange hypothesizes a $1,000 premium for this example. If, after a few months, sugar has risen to 15 cents per pound, your option may have risen in value to $3,360 (3 cents × 112,000 pounds).
You would then have several choices. You could take your profit by selling an offsetting July call. You could continue to hold the option in the hope that further price rises would make the option even more valuable—remembering that options tend to cheapen as the expiration date approaches. Or, you could even exercise the call, acquiring a long position in July sugar futures. If you were wrong about sugar and the price declined, the most you could lose would be the original $1,000 premium, and you could probably salvage some of that outlay, since options usually have some value until the day of expiration.
If you're bearish on a commodity, you might instead buy a put, entitling you to sell at a given price. If you buy a put entitling you to sell, say, July sugar at 12 cents and it goes to 9 cents sometime before expiration, your option will roughly reflect the value of that three-cent move ($3,360).
Just as puts and calls can be bought for limited-risk speculation, so they can be used for low-cost hedging. If one has a long position in futures, it might make sense to buy a put in the same futures contract at or above your entry price. If the price of the commodity you went long on moves up, your futures profit will have been diminished by the cost of the option premium, but if the market moves against your long futures position, then you'll be able to sell at little or no loss other than your options premium. A good insurance policy! Likewise, if you are short futures, you can hedge by buying a call.
An alternative to the buying of options for hedging is writing "covered" options. Options writing is actually a different ballgame and can be highly risky, but when "covered" by a futures position, it can be both safe and profitable. Writing a call is not a substitute for buying a put for the investor who is long futures, nor is writing a put a substitute for buying a call for the short futures trader. Instead, it is a means of enhancing one's futures profits, under the right conditions. For example, if you are about to go long or are already long a commodity in the futures market, the writing of a call can effectively raise your futures price (if prices go up) and cushion your losses if prices fall.
One need not have a futures position to write options any more than to buy options. One can write uncovered, or "naked," calls or puts on futures contracts either to make premium income or to place an option spread. But, unlike covered option writing, the potential risks here are as great as in futures themselves, minus only the premium income.
Although options are correctly reputed to be a limited-risk investment, this is really true only of buying options. When writing options, if the price moves adversely, you would have to put up additional margin money.
Yes, there are some risks, but they are mild compared to the unbridled futures markets—and milder still compared to the shrieks of terror emitted by the congressional and bureaucratic opponents of options. More important, options will make the futures markets safer, more sophisticated, and stronger.
Steven Beckner is a financial reporter and columnist for the Washington Times and the author of The Hard Money Book.
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]]>Predictably, many would-be regulators branded the new futures instruments as a form of "gambling" that would drain and weaken the equity market. But there is every reason to believe that stock index futures will not only be a boon to investors but will strengthen the stock market. As they mature, the index futures markets—Kansas City Board of Trade's Value Line Average (VLA) index, Chicago Mercantile Exchange's Standard & Poor's 500, and the New York Futures Exchange's New York Stock Exchange (NYSE) composite—will probably attract more and more hedging interest from individual investors, pension funds, portfolio managers, estate executors, new issue underwriters, market makers, and specialists.
As Ira Haupt, a partner in the NYSE member firm of Haupt-Andrews and trader on the New York Futures Exchange, says, "[Stock index futures are] another form of risk transfer (in addition to stock options), and the more risk transfer you have, the more valuable the underlying stock market. It increases the liquidity of the stock market."
Each stock index futures contract has a minimum price move of 5 cents, and since the value of each contract is $500 times the spot index, a minimum price move is worth $25 per contract. A full point move is worth $500 per contract. None of the markets, incidentally, have maximum ("limit") price moves, a welcome change from disruptive past practice.
At the indices' recent spot levels (132.11 for the Value Line Average of 1,685 stocks, 118.22 for Standard & Poor's 500, and 68.20 for the New York Stock Exchange composite index of 1,532 stocks), the Kansas City contract is worth $66,055; the Chicago Merc contract, $59,110; and the New York Futures contract, $34,100. Exchange minimum margins vary—from Kansas City's $6,500 to $6,000 on the Chicago Mercantile Exchange and $3,500 on the New York Futures Exchange. That works out to approximately 10 percent.
If you are of a speculative frame of mind, stock index futures are a highly leveraged way of trading the stock market. "A guy with $100,000 who wants to speculate in the stock market, instead of going to his broker and buying all these stocks, can now just buy the market," observes Dr. Wray Kunkle, manager of Richardson Securities in Washington. "Plus, he can control $1 million with $100,000." (The margin on stock purchases is 50 percent.)
The simplest stock futures plays are outright long or short positions. If you think the stock market is going to rise generally between now and the end of the year, you can go long and buy a December NYSE contract, which traded recently at 69.45. If between now and the end of December the NYSE index rises to 71.45, the two-point move is worth $1,000 per contract. If the opposite happens and the index falls two points to 67.45, you lose $1,000—unless, of course, you were short December.
Because the premiums on forward months are very small in all of the stock index futures, the market favors bulls. For longs, the smaller premiums mean greater profits and smaller losses for a given change in price. For shorts, the smaller premium means smaller profits and greater losses.
Spreads—buying or selling contracts in different months or different markets—are a less risky way of trading stock index futures. Because they tend to be less risky, they carry lower commissions and margins. The object is to gain from future changes in the differential between two contracts.
Most common are intramarket spreads. The general rule is: if the distant months seem to be rising faster than the nearby months, buy the distant months and sell the nearby. If the front months seem to be rising faster than the back months, you would do the opposite—buy the nearby and sell the distant months.
Another possibility is an intermarket spread. You might want to go long the VLA index, for instance, with its greater weighting of better-performing second-tier stocks, and short the NYSE index with its preponderance of heavily capitalized stocks. If and when indices based on industrials, utilities, transportation stocks, and so forth are approved, the possibilities widen. If you expect different trends in the stock and bond markets, you can already do a spread between one of the stock index contracts and a Treasury bond or Ginnie Mae contract.
Because no one knows where the stock market is going from day to day, or even month to month, it is best to follow a few rules. To begin with, get to know the market. Although there are as yet no charts available on these futures, it is easy enough to get charts of the actual indices. In addition, you can chart the different contract months yourself. Having done that, you can draw trend lines and trade within the channel that they form—selling at the top of the trading range and buying at the bottom. Using moving averages—watching the intersection of three different period averages to pinpoint trend changes—is more precise.
No system is perfect, so it is wise to use "stop" orders. Whether you are buying or selling, you can place a standing order with your broker to close out your position at some prudent level above (if you are short) or below (if you are long) your entry price. That limits the risk of an adverse price move.
A final word of warning: this market is not for the small investor with little financial cushion nor for the nervous. As with other "commodities," the risks of loss are as great as the profit potential. It should not be supposed that one can simply buy or sell the indices and cash in if the market moves your way. Short-term fluctuations en route to your predicted bull or bear market can wipe out your margin and more very quickly. If you can't stand large setbacks, you should look instead at stock options, where the risk is limited to a relatively small premium. Or wait for the next new wrinkle—options on stock index futures.
Steven Beckner is a free-lance financial writer, the assistant editor of World Money Analyst, and the author of The Hard Money Book.
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]]>Notwithstanding recession, high interest rates, and gold sales by OPEC countries, the Soviet Union, and others, there is and will continue to be enormous resistance at the $300 level. To say that $300 per ounce is an important psychological barrier admittedly sounds all too familiar. The same, after all, was said about the $600, $500, and $400 marks. Glen Kirsch, manager of Deak-Perera (Washington), predicts that the $300 barrier "will be pierced," but adds, "The question is whether it will stay down there."
Much will depend on the volume of trading on futures markets. Thin volume will make it easier for short-side speculators to drive gold down. Even if the bears do succeed in overcoming the $300 obstacle, however, it seems very unlikely that sub-$300 prices could be sustained for long. Gold in the $200–$300 range should call forth tremendous buying interest.
It's no little secret that the biggest reason for the yellow metal's current doldrums is high interest rates—or, more accurately, the confluence of high interest rates and much-diminished inflation. With the consumer price index rising at a 3.6 percent annual rate and wholesale prices actually falling in time to the recessionary music, three-month Eurodollars were earning around 15 percent—an incredible, albeit hypothetical, 11.4 percent real return. One has to have a stout heart to bet against the dollar and in favor of gold at those rates, no matter how dire your long-term expectations.
But that isn't all that's been buffeting bullion. For one thing, the very fact that gold became far overpriced in January 1980 has amplified and accelerated the inevitable downward reaction. The late 1979 surge that took gold to $875 per ounce, silver to $50 per ounce, and platinum to over $1,000 per ounce sucked a lot of naively ambitious investors into the market. This included not just small investors but big timers, including countries like Libya and Indonesia. As the price decline has gained steam, selling has snowballed, bringing much of the newly acquired metal stocks back onto the market.
One of the biggest dampers on the market in the first quarter was heavy sales and rumors of sales by certain OPEC nations, chiefly Iran and Iraq, which are thought to have dumped upwards of 60 tons, but also possibly Libya and Indonesia. In addition to actual sales, many central banks have sought to use their gold stocks as collateral for balance-of-payment related loans.
Probably the worst of the hangover from the 1979–80 binge is now over. One would hope so, with gold having fallen nearly 65 percent, silver 86 percent, and platinum 67 percent since their peaks. In Washington recently, Credit Suisse chief Rainer Gut told me that the overvaluation of gold two years ago "has been digested." He called $300–$325 a bottom, though he predicted that gold would still be below $400 by year end.
Much will depend on adjustments in supply and demand, said Gut. He noted that both the Soviet Union and South Africa have been forced to sell more gold than they might like at these prices in order to finance their imports. But he speculated that by April the worst of these sales would be over. "Once we get down to a level between $300 and $350," he added, "it could well be that central banks would pick up some gold." Possibilities might include Switzerland and Japan.
Interest rates and inflation rates aside, the law of supply and demand has not been repealed. Already, at the lower price levels two things are happening. Gold and silver production are falling. A number of important South African mines have costs-per-ounce exceeding the $325 level, ranging up to $417 per ounce. Mining wage costs have risen 245 percent over the last decade, and one mine, Witwatersrand Nigel, has already closed down.
Meanwhile, both industrial and investor demand should increase. So far, due to the recession, industrial demand has not improved greatly. But silver consumption was about 7 percent higher in 1981 than in 1980, which shows that lower prices do attract increased usage. "I can't believe people won't take advantage of these prices to replenish inventories," observes Deak's Kirsch.
The most encouraging source of new demand has been Japan, where primarily small investors have suddenly discovered gold. Japan imported five times more gold in 1981 than in the previous year, and more is expected.
Naturally, demand will continue to be dampened by interest rates, which affect both inventory costs and the relative appeal of alternative investments. But there is growing evidence that interest rates are falling—particularly abroad.
A key question is whether this reflects diminished inflationary expectations or easier credit policies. Undoubtedly, people have adjusted somewhat to lower rates of inflation for now, but at the same time it is apparent that monetary restraint has loosened. That doesn't mean that hyperinflation is around the corner, but given Congress's unwillingness to cut spending, it becomes increasingly likely that the Federal Reserve will be forced—by statute if necessary, as House Banking Chairman Henry Reuss recently threatened—to accommodate fiscal policy. When this becomes clear, gold will take on its old glitter again.
Silver should be pulled along in gold's wake, particularly as the economy recovers. So should platinum. The biggest thing holding back silver will be continued uncertainty over the fate of the Hunt brothers' hoard, which purportedly must be sold under the conditions of their rescheduled loan agreement. But this worry has probably been exaggerated. The Hunts may yet be able to pay off their debts and keep their silver. And anyway, the Texas billionaires are not the only ones who recognize the beauty of silver at $7.04 per ounce.
Steven Beckner is a free-lance financial writer, the assistant editor of World Money Analyst, and the author of The Hard Money Book.
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]]>Henry Kaufman, the sage of Salomon Brothers, thinks he knows, and everyone on Wall Street listens to him. He says interest rates are headed back up to their previous record levels or beyond, having fallen nearly 5 percent from their summer 1981 highs at one point in December.
Others, including this columnist, disagree. Kaufman's prognosis "just doesn't compute," asserts William Miller, vice-president of Crucible Securities in New York. "If the market is going to hell in a handbasket because we're going into a recession, how in hell can interest rates go up?"
So much depends on government economic policy—in particular, the interaction of fiscal and monetary policies. If fairly conservative projections of a $100-billion fiscal 1982 budget deficit and a $150-billion fiscal 1983 deficit come true, then seemingly almost any method of financing them will tend to put pressure on interest rates, other things being equal.
Strict reliance on the private capital markets by Treasury, which could drain off at least one-third of available private capital, would, in simple supply and demand terms, tend to drive up rates. But even resorting to the accommodative open-market facilities of the Federal Reserve would not guarantee lower rates. Indeed, the inflationary expectations that would result from Fed money creation might drive interest rates higher than otherwise.
It now appears that the Fed—which, despite a few lapses, has done an admirable job of reducing monetary growth and thereby laid the groundwork for both lower inflation and lower interest rates—will not fully accommodate the Treasury's financing needs. Naturally, it will come under increasing pressure to do so. If Paul Volcker and company do hold a steady course, and if other pieces fall into place, then it is likely that the upswing in rates early in '82 will prove temporary.
For one thing, because of the recession, private credit demand is off and should further decline. Then, too, there is every reason to expect that the private savings rate—now at a disappointing 4.9 percent—will increase throughout the year, although it is unlikely to approach the administration's goal of 8 percent. Finally, it is unlikely that the budget deficits will come in as high as projected. There will be more spending cuts and, unfortunately, new taxes.
By year-end, the beginnings of economic recovery should begin easing the deficit strains for fiscal 1983, although the revival of private credit demand at that point should give a fresh boost to interest rates. With this admittedly debatable forecast in mind, what is the outlook for various investments?
Stocks: For the better part of the year, general market conditions look bearish. This is particularly true of the Big Board—the "blue chips," The Dow Jones index could dip to 700. Shorting the shares of large, heavily institutionally held companies should prove profitable. But don't be greedy. Ride them down a few points and get out.
Use your profits to buy up some of the promising second-tier stocks, many of which are at attractively low prices. Look at up-and-coming companies involved in data transmission, laser technology, robotics, and the like. On foreign markets, even companies in rapidly growing areas, especially the Far East, have been hit by worldwide recession. Selective purchases of foreign securities—or foreign unit trusts—look good for long-term growth.
Bonds: Assuming an eventual decline in interest rates, bonds may soon be due for a long-awaited rally. Miller suggests buying 20-year, high-grade, deep-discount corporate bonds with open and active sinking funds. Bonds issued 10 years ago at 6 percent must now be sold at a 50-percent discount to compete with newer issues. Therefore, according to Miller, you can buy $1,000 worth of bonds at $500. You can hold until maturity for a long-term capital gain or sell out at the market when lower interest rates increase the value of the bonds.
Commodities: Commodities have been hit perhaps worse than any other investment by recession, disinflation, and to an extent, tax-law changes. It may be some time before we again see the kind of wild bull markets of the last decade—unless the Fed reverses course and revives inflation. But the coming economic recovery should give a profitable lift to all kinds of commodities; for example, lumber, copper, silver. Gold, for now, should be relegated to relatively small cash positions as the ultimate hedge. Since we don't know when the recovery will come, the best tack is to buy positions in distant delivery months, then watch and wait.
Currencies: Right now the dollar is the reigning king of the hard currencies, blessed by declining inflation and relatively high interest rates, giving it the highest real yield around. But as interest rates come down, the dollar's edge will dull, particularly if inflation begins to rise again. Although the European currencies and the Japanese yen made a recovery in the fall, they have since slipped back. They are all far below their 1978 highs and must be considered undervalued. As the Polish crisis recedes from memory and as the European economies gradually pick up steam later this year, the Euro-currencies should gain. The yen has better immediate prospects.
IRAs: Before signing off, a few obligatory comments on the latest rage—Individual Retirement Accounts. There are three prime considerations: How far are you from retirement? How much taxes will you really save? And what else could you be doing with the money?
IRAs probably make sense for a good many people, but beware of locking your earnings away over a long period of time in instruments that may or may not fare well in the uncertain financial environment of the future. The best route is a self-directed plan or a plan that will allow you to shift among mutual funds to get the best available return.
Steven Beckner is a free-lance financial writer, the assistant editor of World Money Analyst, and the author of The Hard Money Book.
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]]>The stock market drifts lower, while commodities continue to languish. Real estate, precious metals, diamonds—almost everywhere you look, investments are in a slump. And, as usual, the US shock waves have reverberated abroad, afflicting even the dynamic Asian stock and property markets.
The best investment continues to be high-yielding US-dollar money market instruments: Treasury bills, commercial paper, certificates of deposit, and money market funds. But now, even that haven is threatened, as the Federal Reserve's tight money policy at last begins to bear the fruit of lowered interest rates.
But therein may lie the clue to investment strategy for 1982. First a word of explanation, for some might not agree with the foregoing assessment. Tight money leading to lower interest rates? True, up until recently the hallmark of Fed Chairman Paul Volcker's tight money policy has been high interest rates. But those interest rates were as much an expression of inflationary expectations as of Fed tightness. Not that the Fed hasn't been relatively tight. It has kept well within its targets for moderate monetary growth.
The result has been a significant diminution in inflationary expectations. While the consumer price index was actually higher in the third quarter than in the previous ones, the wholesale price indices presage lower retail prices for 1982. So interest rates are coming off, and the bond market is showing a corresponding rally.
A bond rally traditionally presages a stock market rally. Whether that happens in 1982 depends on the depth of the recession, and that in turn depends on how the economy at last reacts to the first installment of the Reagan tax cuts. (With all the announcements of the failure of Reaganomics, you'd never know that the tax cuts, such as they are, don't begin to take effect until 1982.)
Whenever there is such a loud chorus of moans and groans it is good to take stock of the situation. It is doubtful whether the recession will be as severe as most seem to think. And if it's not, it may indeed be a very good time to "take stock."
The market is replete with bargains in many sectors. Generally speaking, smaller, well-capitalized, technology-oriented companies whose shares are underpriced relative to underlying net asset value should have the greatest potential. Such companies are most likely to profit from the liberalized depreciation rules by investing in productive new plant and equipment.
Since the next year, at least, will be one of great uncertainty—due to doubts about the inflationary impact of projected budget deficits—the US stock market is not the only place to be.
For one thing, give stronger consideration to selected foreign securities. Asia-Pacific stock markets, which have suffered bigger setbacks than the US market in the past six months, should be due for a major recovery later in 1982. When the time comes, the markets of Hong Kong, Singapore, and Japan have a record of exciting performance.
The barrier, again, is US recession, however. Those trade-oriented economies suffer from slackened US and Western European demand for their exports. Even so, awakening Western interest in those markets make them a good place to put a fraction of your portfolio.
Falling interest rates, mixed with continued long-term inflation fears, could finally pull precious metals and other commodities out of their doldrums. After two years of digesting the January 1980 binge, gold and silver should be ready to test new ground by mid-1982.
Other commodities could follow. Lumber, for instance, should benefit from renewed housing demand as interest rates fall. Long positions in future contracts with distant delivery months for such things as copper in anticipation of the eventual recovery in industrial and consumer demand also make sense. An alternative to commodity futures are resource-based stocks, including those of Australia. There can be little further downside price risk in this area.
A final area of interest is foreign currencies. As stated in this space last year, the US dollar is overvalued. That judgment has already proven correct with respect to the Swiss franc, which appreciated some 20 percent in a three-month period through early November. The dollar, at this writing, is still overvalued relative to the German mark, Japanese yen, and others, in view of our deteriorating balance of payments. Time deposits of securities denominated in these currencies are a good hedge against the US dollar and good speculations as well.
Steven Beckner is a free-lance financial writer, the assistant editor of World Money Analyst, and the author of The Hard Money Book.
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]]>Now, you may say that this doesn't sound like a very promising picture. Who wants to buy into a bear market? Not many, but who wouldn't buy in at the bottom of markets that have explosive long-term potential?
That is not to say that the bottom has been reached. It probably hasn't. But in the longer term, Singapore's booming property and financial sectors and Malaysia's rubber, tin, and other resources promise great things.
As for Hong Kong, the bloom appears to be off of the property speculation craze, which has always been the driving force behind the stock market. Real estate prices (and rents) continue to rise but at a much slower rate and, after discounting 15 percent inflation, are adjusting downward in real terms. Until lower US interest rates enable Hong Kong to follow suit, Hong Kong's four exchanges—soon to merge into one—are apt to remain weak.
But again, the longer-term picture is bright. The British colony's strong growth, high productivity, preeminence as a trading and financial center, and energetic development—all based on a laissez faire-oriented policy of low taxation and regulation—mean that Hong Kong shares have much higher to go.
Frank Heath, research director for Sun Hung Kai Securities, Hong Kong's largest broker, suggests looking at smaller property-based companies with good growth prospects and sound financial backing.
Australia is down under right now, but interest rate relief and a labor settlement should make it bounce right back up at some point. Australia is a virtual treasure house of resources, with reserves of coal,oil, gas, uranium, diamonds, and many other minerals that are only beginning to be tapped. Close to $10 billion in foreign capital is expected to flow into Australia in the coming year. Petroleum can only benefit from the resource development boom.
The important common denominator is that nearly every economy in the Asia-Pacific area, at least those with a free-market disposition, is enjoying fantastic economic growth, even in the face of current world financial and trade conditions. Hong Kong's economy has grown an average 11.3 percent over the past five years in real terms. This year, growth may end up only at 8-9 percent, but that's not too shabby. Singapore grew 10.2 percent and Malaysia 8 percent in 1980. The more mature economies of Japan and Australia are growing at a slower pace but still faster than those of Europe or North America.
The scary thing about markets in this part of the world is that they are incredibly volatile. This is due to the very fact that they are economic frontiers and are not dominated by institutional investors. The heavy degree of small, less- informed investor participation makes these markets more risky but at the same time more exciting. "Because the general level of knowledge is not as high as in a sophisticated market," notes Heath, "anyone that takes the trouble to do the research and do the work can gain an advantage, which is much harder to do in the States."
Another factor to consider is exchange rates. Right now and possibly for months to come, many Asian currencies are undervalued against the US dollar. This is certainly true of the Japanese yen and the Australian dollar. It is probably true to a lesser extent of the Singapore dollar. The Hong Kong dollar is more of a question mark. It could continue to drift lower, though not nearly enough to dent potential profits. In other words, in many cases, gains in shares or property could be compounded by currency gains.
How does one get involved? One way would be to open an account with a broker in the region. But unless you are prepared to leave trading decisions to his discretion, communication problems make that a bad choice for most people.
It is simple enough to trade through a US broker, though—preferably one with connections to a broker in the country you are interested in. Firms like Merrill Lynch and Bache have offices all over the world. Sun Hung Kai works with Bear-Stearns. Japanese brokers—Nomura, Yamaichi, Nikko, and Deiwa—operate their own US offices.
Then too, a number of Asian stocks are traded in ADR (American Depository Receipt) form in US dollars on the US market—for example, Broken Hill Proprietary of Australia, Japan's Hitachi, Toyota, and others.
Finally, and perhaps easiest, you can choose from among the unit trusts (mutual funds) that specialize in Asia- Pacific stocks. There are numerous ones managed and traded in Hong Kong, principally by Gartmore Fund Managers, G.T. Management, Jardine Fleming & Co., and Wardley. Examples are Jardine's JF Southeast Asia Trust, JF International Trust, and Jardine Eastern Trust; Wardley's Nikko Asia Fund and Japan Trust; Gartmore's Hong Kong and Pacific Unit Trust; and G.T. Management's G.T. Asia Fund.
These trusts are made up in different measure of Hong Kong, Singapore/ Malaysian, Philippine, Japanese, and Australian shares. Minimum investment is expressed in terms of units (shares), ranging from 200-500 units. The units trade on the Hong Kong (and sometimes London) stock markets and fluctuate up and down like any other shares. Sales and redemption fees and management fees are calculated into the bid-ask spread, which can go as high as 6 percent. However, the performance records of many funds can make the spread seem minuscule.
The US stock market may yet shake off its doubts about Reaganomics, get some interest-rate relief, and quit diddling with the Dow Jones 1000 mark. But in the meantime, to coin a cliche: Go East, young man.
Steven Beckner is a free-lance financial writer, the editor of Deaknews, and the author of The Hard Money Book.
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]]>By now the arguments for minor metals as a strategic investment are familiar enough to most. They center around the assertion that the United States and its allies are in a "resource war" with the Soviet Union at a time when Western stockpiles are low, foreign dependence is heavy, and demand is rising for military applications of various metals.
Indeed, the United States is dependent to varying degrees on foreign sources for 20 of 36 "strategic" minerals. America must import upward of 90 percent of 7 metals. The federal government's strategic stockpile is felt to be deficient by nearly 50 percent overall, and efforts are under way to bring the government hoard of things like cobalt up to snuff.
It is also true that military spending on the scale President Reagan has in mind is sure to boost demand, and hence prices, for a host of metals required in the manufacture of special steel alloys for the new weaponry. It is likely, too, that nonmilitary demand in areas like laser technology, fiber optics, and robotics will require increases in columbium, titanium, germanium, chromium, and so forth.
Fine, but the first thing that needs to be said is that the prices of metals, like anything else, do not operate in a vacuum. The law of supply and demand is notorious for foiling the bold predictions of investment propheteers. Just as silver fell from $50 per ounce in January 1980 to under $10 recently (despite the insistence of some that it was on its way to $100), so the price of cobalt returned to $18 per pound after being run up to $50 in the wake of the oft-cited 1978 invasion of Zaire's Shaba province.
Strategic metals brokers always use that allegedly Soviet-inspired escapade as an example of the West's vulnerability but neglect to tell the rest of the story—except to quote current prices as a glorious bargain-buying opportunity. The moral of the story is that—resource war or no resource war, cartel or no cartel—the market tends to adjust to the most severe shortages and price manipulations.
In the case of cobalt, just as with silver and oil, production increased and consumption fell as substitutes were found. Needless to say, if you had bought cobalt when it was at $4 per pound prior to the Shaba invasion and sold at $50, you would have done very well. Or take chromium. The engines of capitalism did not collapse when Zimbabwe went "Marxist," and the USSR halted its exports two years ago.
Other metals—titanium, for example—have had equally impressive price run ups. In fact, most of the "strategics" have had mighty gains, which gives rise to the question: How much more potential is there at a time of generally falling commodity prices and apparent disinflation? And if strategic metals are so hot, one wonders why brokers invariably urge clients to hold them for three to five years.
Among the dozens of different metals, there are sure to be some that will soar in the years ahead. How do you choose the best candidates? Chances are you'll have to rely on the expertise of a broker. But even the expertise of the most honest brokerage firms that have entered the strategic metals field in the last two years is very questionable.
The market for metals, barring the few (lead, zinc, palladium, platinum) that are traded on the London Metals Exchange and the New York Mercantile Exchange, is as disorganized and non-investor-oriented as it is complicated. Historically, the market in minor metals has been made by a score of old metals merchants, most of them in London and New York, each of them tending to specialize in a few metals. Their raison d'être has been to act as middlemen between primary producers and end users. Rarely have they wanted to bother with the "man-in-the-street."
That has begun to change somewhat. As investor interest has been whipped up, some of the more adventurous merchants have begun to do business with novice brokers (while continuing to keep their own hands clean of direct involvement with the public).
Firms like Sinclair & Co. and Bache have been doing their best to provide a new service to investors interested in strategic metals by attempting to construct a package of certification, storage, and insurance. But as Nick French, trader for the London merchant firm Wogen Resources Ltd., told me recently in reference to one leading broker, "If it takes us full time [to trade just a few metals], I don't see how they are going to be as sharp on the ball as us." French also complained that the upstart "investment dealers" are hopelessly "trying to force [minor metals] into the parameters of other investments" with their talk of spreads, commissions, unit trusts, and so on. "They are trying to impose outside laws on an industry that traditionally hasn't had them."
For their efforts, investment dealers exact a heavy price from those investors willing to entrust a conservative minimum of $50,000-$100,000 to their care for the recommended fallow period of three to five years. In addition to forgoing interest on his funds for that time and to storage and other costs of at least 2 percent per annum, investors must pay commissions that range as high as 10 percent at either end of the transaction. For the record, Sinclair & Co. works with a buy-sell spread of 5-8 percent, according to Paul Gleason of its new London office.
What's more, these costs assume that you can buy at a reasonable price in the first place. One Florida-based firm was recently quoting cobalt at $50 per pound, more than twice the going market price. Finally, even with the best of brokers or merchants, the metals investor is apt to wait a good while to get what he considers a "reasonable price" for his barrels or ingots or boxes of strategic goodies, simply because of the illiquidity of the market.
All that having been said, however, one should not overlook this alternative investment area. Just be careful, and educate yourself. Consider stock market plays related to strategic metals—not only the shares of producers like Oregon Metallurgical and US Antimony, but also the shares of end users. "What's important to remember is that you don't have to just be involved in brokering metals," says Robert Sylvester, a Washington-based strategic metals consultant. "You can get involved in mining stocks, mining equipment companies, pipeline companies, fabricators, and end users who push the material through the system. A diversified and total strategy is better than just buying cobalt."
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]]>For instance, at this writing, the Swiss franc is selling for 48 cents—20 cents below its all-time high of autumn 1978, nearly a 29 percent depreciation. The German mark, at a current price of 43.8 cents, stands nearly 14.5 cents below its October 1978 high, a 25 percent depreciation. The French franc, jolted by the leftward lurch of the last election, stands at a 10-year low. At the current rate of barely over 18 cents, the franc is off 28 percent from its all-time high of 25 cents.
Depressed as these exchange rates may seem, the way the dollar has been going, the foreign exchange markets could become bloodier yet. The mark and the two francs, as well as other currencies, could fall even further against the ultrabullish US dollar.
The primary reason for the strength of the dollar and the weakness of the traditional "hard currencies" is high US interest rates. Once again nearing record nominal levels, rates on US money market instruments are also achieving a very high real level in terms of diminishing inflation. For now, US inflation is back in single digits. The economy appears strong, with GNP and productivity growing and the trade deficit narrowing.
Even if the impressive US performance continues, however, there is little doubt that the dollar is now as overvalued as it was undervalued in 1978. As the economy moves out of the recession and credit demand increases, inflation is sure to creep back into double digits. Regardless of the long-term effects of Reagan's vaunted supply-side tax incentives (such as they are), the short-term effect is sure to be hard-to-finance budget deficits. In order to elicit the kind of economic boom that the administration has heralded for its program, the Federal Reserve will come under heavy pressure to bring its interest rates down in the midst of strong pressures for monetary expansion.
So, while the short-term outlook for key foreign currencies remains bearish, the longer term outlook is quite different. Clearly, the unit with the best potential (as always) is the Swiss franc. Ironically, although its currency has suffered most over the last two and a half years, Switzerland has the strongest economy.
Thanks to the franc's depreciation, which in real terms is more like 35 percent, Swiss exports are booming. The Swiss economy, which had been excessively stimulated by an expansive monetary policy, is now slowing down as the Swiss National Bank tightens credit and raises interest rates. As a result, inflation should begin to recede from its recent 6 percent level. With practically zero unemployment, reducing inflation and strengthening the franc should present none of the ticklish political tradeoffs facing Germany and others.
One of Europe's foremost economists told me that the Swiss franc (and to a lesser extent the German mark) are due for a major bullish correction later this year. Hans Mast, chief economist for Swiss Credit Bank, predicted a "noticeable firming" of the franc by year-end. He asked that his specific exchange rate forecast not be quoted because "it would shock everybody today." Indeed it would!
Not only is the Swiss central bank trying "to achieve a certain appreciation of the Swiss franc…to lower import costs and to dampen the export boom," but foreign investors and bankers are once again beginning to look on the franc with favor, according to Dr. Mast. As US interest rates begin to fall, while Swiss rates rise, said Mast, "there comes a point when investors say, 'Why should I stay in US dollars with practically no real rate of return, when at the same time I'm receiving in Switzerland a quite appreciable real rate of return?'"
Of course, Mast's prognostications assume not only a diminishing interest rate differential but also a widening inflation differential—quite the opposite of what is now occurring. Mast's views find surprising concurrence among other leading economists and bankers in Europe. But it would be a mistake to bet whole-heartedly against the dollar.
Positions in Swiss francs and other units should be regarded either as a fractional hedge against high-yielding dollar positions or as a long-term speculation. It's not a sure thing, but there is a strong probability that, without returning to its old high, the Swiss franc will rebound substantially from present lows. Therefore, placing perhaps 10 percent of a portfolio in that currency makes sense.
How do you do it? Well, don't go out and buy Swiss franc banknotes and sit on them. Your realistic alternatives, depending on your means and your risk-taking proclivities, are Swiss franc deposits (preferably three- or six-month certificates of deposit) or futures contracts.
Recently, three- and six-month Swiss franc CDs were yielding 7-1/8 percent at a typical Swiss bank for a minimum investment of $5,000. That rate may rise or fall, but the risk is low, and if you are willing to roll them over indefinitely, there is a good chance that over the next two years you will catch a wave of franc appreciating that will dwarf the interest you are earning.
Alternatively, take a long position in Swiss franc futures contracts on the International Monetary Market (IMM) in Chicago. The current minimum exchange margin on a Sfr 125,000 contract is $2,000. Each one-cent change earns (or loses) you $1,250.
No one knows when Paul Volcker will relent on interest rates or when US inflation will rise again, setting off the overdue correction. Therefore, probably the best strategy is to take positions in distant delivery months—as much as a year out. If you can afford it. Such a strategy requires having enough additional money in your account to ride out dips and resultant margin calls in expectation of a longer-term rise. If you can't afford such a strategy or if you think you're astute enough to trade shorter-term, then at least employ stop-loss orders 10-20 points below your entry point.
At this writing, there was evidence of a flight of French francs into Swiss francs in the wake of the Mitterrand election. And the Swiss National Bank has raised its Lombard rate a full point. A change in fundamentals on either side of the Atlantic in Switzerland's favor may be all that's needed to spark the next big move of the Swiss franc.
Steve Beckner is a free-lance financial writer, the editor of Deaknews, and the author of The Hard Money Book.
MONEY QUESTION Q: I have not as a rule invested in real estate, but I understand there could be some advantages in buying my parents' house. This could not only provide me with some investment property and tax deductions but, if they financed the loan, could provide them with some interest income in their retirement. Perhaps you would discuss this in your column or provide me with a source of information on the subject.
L.B., Great Falls, VA
A: What you are suggesting sounds sensible to me, but I don't know all the ramifications. I suggest you refer to Albert J. Lowery's books on the subject.
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]]>Hong Kong's reputation as an outpost of laissez-faire is no longer fully deserved, as the government insinuates itself more and more into the economy. But the markets here are still far freer than almost anywhere else in the world. What's more, its lack of trade restrictions and foreign exchange controls and its low personal taxes, taken together with its good communications, energetic outlook, and excellent harbor, make Hong Kong a natural magnet for commerce, finance, and investment.
As the world grows smaller and investing becomes, by necessity, less provincial, Hong Kong has a lot to offer the internationally oriented American investor. Whether you're interested in gold, agricultural commodity futures, foreign securities, gemstones, real estate, or just a high-yielding foreign bank account, Hong Kong can fill the bill. It has 115 banks, scores of "finance companies," four stock exchanges, two gold exchanges, futures contracts in three other commodities (cotton, sugar, and soybeans), and, starting soon, a diamond exchange.
Though gold is in the doldrums at the moment, it is in the precious metals that Hong Kong has most clearly made its mark, becoming the world's third most important gold-trading center. And for good reason. For one thing, the Chinese have always had a healthy respect for the yellow metal, as indicated by the fact that the Hong Kong Gold and Silver Exchange Society has been trading gold taels (gold wafers of 1.193 ounces) for 70 years.
More important is Hong Kong's fortuitous spot on the world's time clock. Aside from Sydney, Australia, whose market is strictly local, no market begins trading earlier than Hong Kong's. When it's 10:00 A.M. in Hong Kong, it's 3:00 A.M. in London and 10:00 P.M. in New York.
But that's not all. In addition to the traditional ethnic "society," where 5-tael bars are traded in terms of Hong Kong dollars, there are now the westernized gold futures contracts of the Hong Kong Commodity Exchange. In addition, Hong Kong's brokers have invented contracts based on both the New York Comex and the London Metal Exchange. These "loco-Comex" and "loco-London" contracts can be traded for a slight premium after those two foreign exchanges are closed or before they open.
None of these markets have limit price moves. If a trader gets locked in to a short or long position on New York because the price has moved up or down "the limit," he can almost always take an offsetting position in Hong Kong, where trading takes place virtually around the clock. Finally, taxes on profits hit a maximum of 15 percent, at least as far as the Hong Kong government is concerned.
Hong Kong's stock exchanges, which are soon to merge, under a government scheme, into one large exchange, have been a rollercoaster of excitement. Anyone who followed the market, picked out a half-dozen of the leading stocks, bought in at a low point, and then sold when they again reached the top of their trading range could have done very well in the past few months.
The Hang Seng Index (the Hong Kong equivalent of the Dow Jones) has soared over the past few years, reaching a peak of around 1600. Recently, in a matter of a few days, it rose 130 points and then fell back 85 points.
Most of the major US brokers have offices in Hong Kong, as do most of the rest of the world's leading brokers. So taking a position is no problem.
You probably wouldn't want to do so through a US broker, but trading through a nominee is a common and accepted practice. The adventurous American can easily establish a company in Hong Kong or have someone act as his nominee and trade shares in Hong Kong anonymously through a broker, says Tom O'Donnel, partner in First Financial Services, a firm that helps foreigners place funds in Asia.
Doing that would probably entail having a bank account in Hong Kong to avoid problems with transferring funds. Even if you're not interested in that gambit, though, there are other advantages to having a bank account in Hong Kong. There are limitations, too. Basically, only accounts in US dollars and Hong Kong dollars (roughly five Hong Kong per one US dollar) are available. And banks are restricted, as in the United States, from performing brokerage services themselves—unlike, say, Swiss banks.
It is often possible, however, to earn higher rates of interest in Hong Kong. There are no Regulation Q interest ceilings or Fed reserve requirements. So even a simple "statement account," a kind of interest-paying checking account like the new NOW accounts, outstrips the allowable earnings on most US certificates of deposit.
And the Hong Kong certificates of deposit are even more competitive, fully in line with Eurodollar rates. The "finance companies," or "deposit-taking companies," which are barred from offering checking accounts, pay even more than the banks. To take a recent example, while the three-month Eurocurrency deposit rate was 16 15/16, the Hong Kong office of Chase Manhattan was paying, for much smaller deposits, 15.375 percent; Bancom International, Ltd., a finance company, was paying a full 17 percent; and another finance company, Asia Alliance, was paying 17.75 percent. But, advises O'Donnel, "You have to look at the strength of the company. Some companies pay extremely high rates and I wouldn't touch them with a 10-foot pole." He suggests using foreign banks' branches in Hong Kong, such as the Bank of Nova Scotia or Banc Nacional du Paris.
The Hong Kong government has a 15 percent withholding tax on interest, but it does not apply to US dollar accounts. Any US citizen's foreign bank account is supposed to be reported to the US Treasury, but "if you don't want to report the interest, the Hong Kong banks won't," notes O'Donnel.
In July, the Hong Kong Diamond Exchange will take its place alongside the colony's other markets and services. Already a major diamond-trading center, Hong Kong can be expected to grow in status with this new exchange.
Although the exchange will not be open to public participation, it will be simple enough for investors to broker their stones on the exchange via a diamond dealer. Diamond dealers and principals in the forthcoming exchange claim that Hong Kong is a much cheaper place to buy diamonds. Not only are there no import or export duties, they point out, but there is no sales tax and a lower rate of income taxes upon resale.
Furthermore, according to exchange president Warren Leung, Hong Kong dealers (typically stores that sell unset investment-grade stones along with jewelry) operate on smaller profit margins. Leung estimates that the typical dealer's profit margin would be "three percent, more or less. In other countries I don't think they trade on such narrow margins." Even after the retailer tacks on his profit, Leung estimates that the final buyer would pay "below 10 percent above the manufacturing (cutting) cost."
Such claims should be taken with a grain of salt, but they are worth further checking out, especially if you plan to make a trip to this fascinating, curiously beautiful city.
Steve Beckner is a free-lance financial writer, the editor of Deaknews, and the author of The Hard Money Book.
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]]>Unfortunately, the mixture of seeming ineptitude in the Reagan transition team and backsliding from those crucial tax-cut promises seem to have quelled market exuberance for the time being. The Dow could easily retrace to 800 temporarily.
At this writing, it's still too early to say for sure whether or not the Reagan administration will renege on its relatively radical fiscal policy strategy and embrace orthodox Republican budget balancing. There's still time to regain the initiative and restore investor enthusiasm by making the tax changes necessary to provide incentives to savings and investment.
It depends on who within the administration and in Congress wins the ideological debate and Reagan's ear. If the Stockmans and Andersons and Kemps prevail over the (Donald) Regans and Greenspans, then the recent slump in blue chip stock prices will prove to have been just a buying opportunity preparatory to a dramatic upturn in US shares—especially those of smaller companies traded on the American Stock Exchange and in the over-the-counter market.
If the GOP opts for the old medicine that has failed repeatedly to generate either noninflationary prosperity or balanced budgets, then investors must once again turn reluctantly to the alternative investments that have been the main thrust of this column.
If, as now seems likely, Reagan follows the course laid out in Senate testimony by his designated Treasury Secretary Don Regan and allows inflationary tax-bracket creep to continue unabated, then the recent depressed precious metals prices will prove to have been the real buying opportunity. Foreign securities could then prove to be more attractive than domestic. And traditionally strong foreign currencies like the mark and Swiss franc could be set for a long overdue bull move, mirroring what has been happening to the Japanese yen.
Because it's so difficult to be sure, it is wise, as always, to have a diversified portfolio. Be in the US stock market, for sure, particularly in second-tier stocks in the high-technology industries. But also, despite the inconveniences associated with buying them, you might consider having a few foreign stocks—for example, those of resource-rich Australia.
South African gold stocks could be another strong consideration, because whatever else the Reagan administration does, it seems likely to take a more congenial approach to that nation. Given the explosive world situation, hold on to, if not add to, your "core holdings" of gold, silver, and platinum, with emphasis on the latter two. You can protect yourself against continued quiescence or weakness in the precious metals by writing call options on your holdings. Gold bulls should keep in mind that even $570 gold (or $15 silver) is very high in historical terms, though considerably down from the highs of a year ago. A period of consolidation of the 1979-80 gains is to be expected.
Consider some speculative purchases of the undervalued "hard currencies." Only futures contracts make much sense there. But don't abandon the dollar. Short-term US interest rates are apt to remain fairly high, so it seems wise to at least have deposits in a money market fund reflecting those rates, if not to lock them in longer-term via Treasury bills or certificates of deposit. Trades in the longterm bond market, though certainly not long-term possession, appear attractive, but they assume falling interest rates—a risky proposition that may not be entirely fulfilled.
There is a growing consensus that the United States and the world are entering a disinflationary period. Few are predicting absolute deflation. But a lessening of the rate of price increase is commonly prophesied. The recent collapse of commodity prices, as well as renewed hope for long-term bonds, seems to confirm this view.
This is to be hoped and prayed for, of course. But if the Reagan administration "hits the ground" crawling and groveling instead of "running" and shies away from bold fiscal policy changes while pumping up military spending, it could soon find itself presiding over $100-billion budget deficits. Hardly disinflationary.
We don't know what will happen. That's why any investment strategy must incorporate a mixture of hope and fear, optimism and pessimism. A good mix of investment vehicles and a willingness to shift weight from one to another will be the most profitable course in what promises to be a very volatile decade in all markets.
MONEY QUESTIONS Q. What are the differences among ADRs, IDRs, South Africa-registered, and United Kingdom-registered when purchasing South African stocks?
A. An ADR, which stands for American Depository Receipt, is a receipt for a like number of shares of foreign stock issued by a custodial bank. An ADR allows an American investor to trade in foreign securities without having to go through foreign brokers and foreign exchange transactions to purchase or transfer them. The disadvantage is that, in the event of foreign exchange controls or hostile relations with South Africa, it might be more desirable to have in hand the actual foreign shares, even though it is not quite as easy to buy and sell or to get delivery of the stock certificate.
As for "IDRs," in all honesty (after checking several sources) I'm not aware that the beasts exist. I can only guess that they might be foreign banks' counterparts to our ADRs.
As for South African- and United Kingdom-registered "kaffirs," the difference seems obvious. There has always been an active market for South African mining stocks in London, and the shares of the same mines and mining finance houses are often traded there as well as in Johannesburg. The difference is that in London they would be priced in terms of pounds instead of South African rands. Investors might find it a little easier to trade through a British bank or broker than through a South African one. For that matter, an American broker should be able to trade on either market, assuming the stock wasn't available in ADR form in the United States.
Steve Beckner is a free-lance financial writer, the editor of Deaknews, and the author of The Hard Money Book.
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]]>It seems reasonable to assume that the long-term trend for the precious metals will continue to be up, but it is difficult to say when that will become evident. The Reagan election has fostered great hopes for the American economy that have overcome doubts about his potential impact on the level of world tensions. The new administration could reduce taxes and regulatory burdens, in the process stimulating productivity and lowering inflation. But this will be a tough row to hoe, especially since Reagan has set a stern course toward an expensive military buildup. In any case, structural inflation has a momentum of its own.
Things are bound to be better than if Carter had been reelected. But when it becomes apparent sometime next year that inflation will not be routed in landslide fashion, those ever-cynical bullion markets are sure to register that realization—other things like basic supply and demand for metals and world peace being equal (which they never are). With prices moving lower at this writing, however, and likely to at least remain quiet for awhile, what does one do with his precious metal holdings right now? Those who are disinclined to divest themselves and who may even want to add to their holdings at lower price levels do have some little-noticed alternatives—some options, to be precise.
Anyone who has ever considered buying "call" options on gold or silver knows that the premiums are quite high on these rights to buy metal at a certain price within a specified length of time. But, looking at it from the option seller's point of view, the very fact that premiums are so high presents an interesting investment strategy. Anyone with a minimum of 100 ounces of gold or 1,000 ounces of silver can "write" call options on his holdings, through a broker, with options dealers like Valeur White Weld and Dowdex (for gold) or Mocotta Metals (for silver). You thereby give the purchaser of the "call" the right to buy your gold or silver at an agreed-upon price with a certain period of time (usually three months). You risk losing your metal, but you also get respectable income, while limiting your own potential losses from a fall in price.
"We believe you should own precious metals, because they have proven to be the only true money to own," says Michael Boyd, Jr., vice-president of Crucible Securities Management of New York. "But the case for options is that, since precious metals are a nonearning asset, in a flat market they are an expensive asset to own." Not only does the owner forgo the returns available on other investments; he pays storage and insurance costs. Crucible, which manages investments for the Deak-Perera Group, seems to be the leading exponent and practitioner of gold options writing at the moment. William H. Miller, the firm's treasurer, says that premiums on gold and silver options are now so high that writing calls on one's gold is a low-risk way to "convert a nonproductive asset into an income-earning asset."
Annualized returns on options writing have sometimes approached 40 percent, according to Boyd. He recommends that "you write options against only half of your metal in order to generate enough income to make it attractive to hold your metal on an overall basis." As an example of how this intriguing play might work, assume that you had bought 100 ounces of gold at $600. (If you had bought it at $100, so much the better.) So your cost is $60,000. Let's say you write a three-month call option with a "striking price" of $660 for a premium of $30 per ounce. To start with you would receive an immediate premium check of $3,000. That, in effect, makes the cost of your gold $57,000. Should gold rise above $660 within the three-month life of the option and the purchaser of the option exercises his right to buy your gold at $660, you would sell your gold for $66,000.
In this example, your upside potential is $90 per ounce, and you are protected from loss up to $30 per ounce (this does not include brokerage fees). If, during the life of the option, gold did not move enough to put the option "in the money" for the buyer, you received good income on your gold and avoided delivery.
In order to play the options game it is necessary, first of all, to have at least 100 ounces of gold or 1,000 ounces of silver, for all options must be fully collateralized. You cannot "short" the market. It is also necessary to place your gold in a warehouse approved by the guarantor of the option's performance. Although the major gold options market is in Switzerland, it is ordinarily possible to arrange storage and even delivery in the United States.
Despite the income-earning potential of call options, some people might not be comfortable with the risk of losing their gold if the option is called. Dr. Wray A. Kunkle, who trades commodities for Wheat First Securities in Washington, suggests an alternative method of hedging a stagnant or falling gold market. "I'd rather buy 'puts' (rights to sell at a certain price) on Homestake Mining shares," says Kunkle. "It's much safer. If you're really bearish on gold, you can buy puts on Homestake, and you can sleep at night. Nobody is going to take your gold. It's the least expensive insurance policy around." In mid-November, Kunkle notes, with Homestake selling at $74, April puts with a striking price of $50 were selling at 15/16 ($93.75 per 100 shares).
Selling calls on actual metals is only plausible, contends Kunkle, if you are convinced that gold is either going straight down or sideways. In reality, he added, the gold market is extremely volatile, and wild price swings could unexpectedly activate a call option.
Boyd demurs from the Homestake "put" idea. "They're not the same—apples and oranges," he argues. "Homestake is a piece of paper. The vagaries it is subject to are not quite the same as the metal." Moreover, Boyd contends, since Crucible advises its clients not to write options on their entire gold holdings, their own scheme makes sense. "The income is so large in the short term that you could risk losing gold at a comfortable price," says Boyd. "And you would anticipate buying it back," he adds, at an attractive level.
Anyway, who says gold can't earn income?
Steve Beckner is a free-lance financial writer, the editor of Deaknews, and the author of The Hard Money Book.
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]]>A mixture of ignorance and fear have prevented all but a few Americans from using the freedom they have had since October 1977 to make contracts payable in or valued in terms of gold. A book telling how to make use of "the gold clause" is long overdue; Henry Mark Holzer's only begins to fill that need.
The book is of immense interest to students of American economic history. It traces back over 100 years the origins of the current monetary muddle. And conceivably, any attorney who already has an interest in writing inflation-proof contracts could make use of the detailed case law and legislative history contained in this book. Holzer technically is more editor than author of the work, seven out of nine of the chapters being written by other legal experts. Over half of the book consists of footnotes and an appendix of court cases involving gold clause contracts.
Unfortunately, however, the book has very limited practical value to the layman who wants to know how to go about implementing gold payment clauses in leases, loans, mortgages, and so forth. Only one brief chapter addresses the area, whereas ideally, a series of examples detailing how people in various circumstances can use gold clauses should be given.
Holzer may have avoided this because of a feeling that gold clauses are still in doubt, notwithstanding legalization. Aside from the obstacle of usury laws in some states, which have been interpreted to construe inflation-indexed increases in the principal as additional interest, Holzer worries, justifiably, about historical precedent.
Prior to 1933, according to the book, nearly all contracts specified payment in gold of "standard weight and fineness" prevailing at the time the contract was executed. The practice had become prevalent after the Civil War, when the federal government for the first time made paper—some $450 million in "greenbacks"—legal tender. Those fiat currency units reached a low point of 38 cents on the gold dollar.
Following the war, the courts ruled in the "Legal Tender Cases" that only those prewar contracts that had clearly specified payment in gold coin (or the value thereof) were enforceable. All other contract obligations were to be settled at the whim of the debtor in "greenbacks," even though the creditor may have originally assumed that he was contracting in terms of traditionally "hard" money. What's more, the Supreme Court made clear that the power of Congress "to regulate the value of money" took precedence over the sanctity of contracts.
Over 60 years later, when President Roosevelt and Congress seized privately owned gold, devalued the dollar, and abrogated hundreds of billions of dollars in gold clause contracts, the same precedent was cited. In the "Gold Clause Cases" it was determined that gold clauses were against the public interest as Congress, with its power to "regulate the value of money," defined it.
On this history, the book contains some very enlightening passages. A 1934 law journal article that makes up one chapter reveals that some legislators supported the resolution abrogating gold clauses in order to redistribute income. Decrying "those who own the bank deposits and fixed investment bonds and mortgages," Senator Thomas of Oklahoma urged passage in order to "transfer that $200,000,000,000 in the hands of persons who now have it, who did not buy it, who did not earn it, who do not deserve it, who must not retain it, back to…the debtor class of the Republic."
Another chapter, written for a 1937 law journal, justifies repeal of the gold clause on the grounds that devaluation of the dollar (taking the official gold price from $20.67 to $35.00 per ounce) was designed to bring about "a prompt and spontaneous rise of internal commodity prices." Wrote one Angus McClean in the North Carolina Law Journal: "Until a corresponding rise has occurred [in the general price level] the enforcement of the gold clause in private contracts would result, as in the case of public obligations, in the creditor's 'unjust enrichment.'" The book also contains a transcript of Supreme Court Justice James C. McReynolds's vigorous dissent in the Gold Clause Cases. Noting that right up until the moment of gold confiscation and suspension of dollar convertibility the government had been selling bonds containing gold clauses, McReynolds bitterly charged Congress with deliberately trying "to bring about confiscation of private rights and repudiation of national obligations."
"The Constitution," lamented McReynolds, "…is gone.…Shame and humiliation are upon us now. Moral and financial chaos may confidently be expected."
It is only realistic, given such precedent and given a current legislative and judicial climate that is even less morally scrupulous than in the past, to have doubts about the viability of new gold clause contracts. Still, for shorter-term contracts, the risks might be worth taking. Unfortunately, all Holzer offers to would-be users of the clause is a briefly stated suggestion to make contracts in kind, that is to lend or otherwise contract in actual gold—in order to avoid objections about congressional power over currency values.
Despite its many interesting academic aspects, more practical exposition is needed.
Steve Beckner is REASON's Money columnist and the author of "The Promise and Perils of Gold Clauses," in the June 1978 REASON.
The post Sifting for Gold appeared first on Reason.com.
]]>Fortunately, you need not restrict yourself to the vagaries of the US securities markets. A growing number of savvy investors, while they are not prepared to abandon the US markets with all their diversity and liquidity, are realizing that there are other markets around the world from which to choose.
Over the past decade, the US securities market has been among the world's worst in terms of both capital appreciation and dividends. Today's historically low price/earnings ratios are evidence of this dismal record. Of course, relatively low stock prices can be seen as great buy opportunities, but only if you are optimistic about the course of government policy and of the American economy.
Realistically, it makes sense to look for more action abroad. One of the most dramatic cases in point at the moment is the Japanese stock market. The Nikkei (the Japanese version of the Dow) stood at 6000 as recently as 1978, but was rapidly moving toward 7000 as this was written. And some observers foresee the index hitting 10,000 within a year.
The reason is that, despite its enormous dependence on foreign oil and resistance to its exports, Japan has experienced a resurgence in its trade performance, while keeping inflation under control. As a result, there has been a strong inflow of petrodollars into high-yielding Japanese investments. Simultaneously, holders of Japanese securities have experienced a new surge in the value of the yen in which they are denominated.
Hong Kong has been the scene of another hot market. Stocks there have risen nearly 650 percent over the past decade, versus less than 17 percent for US stocks. Other exciting performers this year include France—the Indicateur de Tendance index of the Paris Bourse has gone from 96 to 119 since January—Mexico, and Australia.
It is hard to generalize about why foreign markets have been outperforming those of the United States. The important thing to recognize is that foreign markets follow US markets less and less closely. So when US stocks are in a slump, chances are you'll be able to find a healthy market elsewhere.
Aside from the countercyclical element, there are other good reasons to consider foreign securities. For instance, while it is validly argued that many foreign markets are less liquid (that is, harder to buy and sell in), this also carries advantages for those who are prepared to exploit them. For one thing, the stock of a foreign company will often sell at a lower price than the stock of a comparable American company—because of lower demand. For another, as Brian Toohey of the Australian Financial Review notes, the thinness of foreign markets often means that "it doesn't take much foreign interest to make it really take off."
Still another reason to consider foreign securities is the need for diversifying a portfolio. In some industries, of course, there simply are no respectable American stocks to choose from—for instance, in diamonds. But even where American companies are well-represented, it seems imprudent to ignore foreign alternatives.
"A security analyst or portfolio manager…is not doing his homework if he ignores Siemens, Hitachi or Philips in the electrical industrial; Sony and Pioneer in consumer electronics; L'Oreal in cosmetics; Petrofina in petroleum; Michelin in tires and rubber; Carrefour in retailing; Carlsberg-Tuborg and Heineken among breweries; Swissair among airlines; and Unilever, Ciba-Geigy, and a host of others among multinationals," writes Rainer Esslen in his Complete Book of International Investing.
Then too, investing in foreign securities can be a good way to diversify into other currencies. Most people who buy foreign securities don't get involved in currency transactions directly. After all, most major foreign companies' shares are listed in the United States as American Depository Receipts (ADRs). Or you can buy shares in a foreign stock mutual fund traded here—for example, Scudder, or Templeton World, or Japan Funds. All these are traded in dollars.
If you decide to trade on the foreign market, using the international department of an American broker, chances are you'll be making the transaction in dollars here, with the actual currency conversion being made at the point of sale abroad. Even so, if you buy a Swiss stock and the Swiss franc rises against the dollar, when you sell the stock, the francs in which it is quoted abroad will exchange for more dollars.
Another approach is to trade directly through a foreign bank, drawing on foreign currency deposits to invest on overseas exchanges. Communications, however, become a problem for the active trader; a discretionary portfolio management program or, alternatively, shares in a foreign-based mutual fund or unit trust might make more sense.
The watchwords, in any event, are global flexibility for the '80s.
Steve Beckner is a free-lance financial writer, the editor of Deaknews, and the author of The Hard Money Book.
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]]>Taking another look at the Internal Revenue Service's notorious Operation Tradewinds, the high court overruled a court of appeals decision and decided that it's okay for government agencies to use illegally obtained financial information to convict a third party. You will recall the case of a few years ago. While a Bahamas bank officer was being wooed by a female IRS agent, two other agents rifled through his briefcase and made copies of a client list. The IRS then proceeded to audit those clients, obtaining tax judgments against a few. No violation of those bank customers' Fourth Amendment rights, our "strict constructionist" bench declaims.
About the same time, the Treasury Department was tightening its regulations of domestic currency transactions. And Congress obligingly moved toward expanding Customs authority over international currency movements.
The Treasury announced that henceforth those benighted misfortunates who hold savings bonds and notes must give their Social Security numbers when cashing them. Not to be outdone, the Commodity Futures Trading Commission proposed a rule requiring US brokers who trade on behalf of foreign banks or brokers either to supply the CFTC with information on the account or to close it. The agency sought to bar Banque Populaire Suisse from trading on US markets because it refused to reveal the identity of its clients.
Under such incessant pressure from US authorities, there is evidence that the vaunted Swiss secrecy is beginning to crack. The upper house of the Swiss Parliament has passed a bill broadening Swiss cooperation in cases of foreign tax evasion. And some Swiss banks now ask new customers to swear that they are not violating the laws of their country and to waive their secrecy rights in the event of governmental inquiry.
To gain a full appreciation of the scope of this broad federal assault on financial privacy, it is necessary to look at its legislative and judicial backdrop. It all started in earnest with the "Bank Secrecy Act" of 1970. That laughably titled statute required banks to make and retain copies of all checks and to report to the Treasury any transaction over $10,000. Further, it required citizens to report whether they held a foreign bank account or trust and to disclose any movement of international currency amounting to $5,000 or more.
The Supreme Court entrenched and embellished the legislation in 1976, when it ruled that the constitutional prohibition against unreasonable search and seizure does not protect the privacy of bank records. Warren Burger and company reasoned that bank records are not "private papers" but business records that banks must keep under the Bank Secrecy Act. More recent law has conceded the procedural right to be notified of a government subpoena of one's records and to resist their release. But there is ultimately no substantive right to prevent the government from seizing them.
Now the Treasury is working hand-in-hand with Congress to widen federal surveillance even more. New Treasury regulations sharply restrict "financial institutions" from exempting customers from transaction reporting requirements and provide for more complete identification and recordkeeping on people who make "large" transactions. (Of course, that sum's size dwindles in significance by the day.) The new regs would bring securities and foreign exchange dealers, as well as foreign banks and money order issuers, into the reporting net.
The monitoring of international transactions is also being beefed up with little regard to traditional conceptions of privacy and due process. The House Banking Committee has passed and other committees are studying Treasury-pushed legislation that would make it illegal merely to "attempt" to transport "monetary instruments" in excess of $10,000 in or out of the country without reporting them to Customs. The bill provides for warrantless searches on "reasonable" (not "probable") cause and authorizes an army of paid informers to finger suspects.
Predictably, the justification for all this snoopery is the need to control drug traffic. For most politicians, that's hard to vote against. One of the few dissenters has been Rep. Ron Paul (R.-Tex.) who suggests that "there may be other reasons behind the obvious one of drug trafficking for the Treasury Department's support of this bill." He warned that the bill really looks toward "establishing or strengthening the legal framework for the total control of international capital flows by the federal government." As if to confirm these ulterior motives, Treasury Assistant Secretary Richard J. Davis regaled a congressional committee with horror stories of "how foreign accounts are used in tax evasion, bribery, securities violations, black marketing and smuggling."
One need not be involved in any of these activities in order to be disturbed by the steady squelching of our financial privacy. America has admirably survived nearly 200 years with a minimum of government supervision, after all.
Books have been written on the "how tos" of protecting the confidentiality of one's financial affairs, most notably Mark Skousen's Complete Guide to Financial Privacy. But there is no foolproof way. Those who feel they must use extralegal means to protect their capital (a growing class) should take due note of the risks involved.
Steve Beckner is a free-lance financial writer, the editor of Deaknews, and the author of The Hard Money Book.
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]]>The dollar, until recently, has been uncharacteristically strong. It still stands well above its low point of fall 1978. And with recession here at last, one can imagine an end or at least an abatement of the great American inflationary trend. Recession may not feel very good, but the traditional ones have tended to strengthen the currency. Credit contraction and slow economic growth do mean less greenbacks in pursuit of goods and services. So the purchasing power of each unit should zoom.
Relative monetary restraint, high American interest rates, foreign perception of the United States as a safe investment haven, along with oil-related transaction demand for bucks, all seem to make a pretty good case for a return to super-star status for the dollar—and for the demise of "hard money." After all, what is a "hard currency" any more? The German mark, the Swiss franc, the Japanese yen? They've been outperformed over the last year by the British pound and French franc. The Germans and Swiss and Japanese seem to be afflicted with the inflationary disease like the rest of us. And what's worse, their balance of payments are shot to hell, courtesy of OPEC. Their interest rates, the touchstone of all hot money movers, are paltry. And they're in the shadow of an increasingly obnoxious USSR.
What about gold and silver? Having already exceeded the cost-of-living explosion by a factor of 8 in the case of gold and 11 in the case of silver (using the relatively "low" prices of $530 and $15), how much more can we reasonably expect from them?
Recession is supposed to bring a subsiding of inflation—isn't it? What's more, the precious metals markets have been discredited and the bulls routed, with a little help from regulators and short-side manipulators. And brave Paul Volcker is restoring dollar supremacy, right?
Let's take another look. First of all, to believe the recession is going to cure inflation and smite "hard money" is to swallow the discredited Phillips curve whole. Inflation may come down a bit as unemployment rises, but it won't come down that much and, in any event, only temporarily.
Moreover, look what's happening in fiscal and monetary policy. Only several months after Congress, the White House, and the Federal Reserve were beating their breasts in unison by pledging credit and budgetary restraint, we hear quite a different chorus. True, Volcker is continuing to moderate the growth of money, but to the growing chagrin of legislators and administration minions at the Treasury. While mobs chanted "loan shark" in demonstrations outside the Fed building, certain Treasury officials took to the telephones for some late-night rumor mongering against the Fed chief. In a call to one newsman, an official troubled himself to connect Volcker's name with a "scandal" in approving a $1 billion loan to the Hunt brothers to help them "restructure" their silver debts.
Volcker, of course, let himself in for that smear. While it seems highly unlikely he is involved in anything underhanded with the Hunts, Volcker revealed his own slipping monetary grip when he jumped to the silver suzerains' aid.
That action followed closely his opening of a special $3 billion discount window to aid farmers and small businesses. At the same time, Carter ran to the aid of the housing industry. Meanwhile, Congress busied itself with the Chrysler bailout. The bread line of corporate mendicants could lengthen further. For good measure, the House upped fiscal 1980 spending by $24 billion.
All of which does not auger well for triumph over inflation. Nor does it give cause to believe the outward flow of depreciating dollars will slow. In February, the red ink on trade set a monthly record of $5.6 billion. The entire world economy may slump, but there is no assurance that the dollar will somehow benefit.
Then there's the growing level of chaos in the world, not just in the Middle East, but in the Far East and even in our Caribbean back yard. Terrorism, Soviet imperialism, and a disinclination by the crumbling Western alliance to do much about it is bullish for "hard money," particularly for precious metals and stones, but quite possibly even for noninflated foreign currencies. At times, the dollar has benefitted from such crises. But increasingly the United States is being isolated.
As our allies go their own way in foreign policy, seek accommodations with OPEC and the Russians, and take an America-be-damned attitude in trade, as well, the dollar will be less in demand and less likely to be supported in time of need. Europe and other regions have already demonstrated, with the European Monetary System, for example, a desire to insulate themselves from the dollar as much as possible.
In the long run, the precious metals and precious stones are going to be the real assets worth holding, although the Swiss are making a game battle of it by reducing their inflation rate back to four percent. All currencies are apt to come to grief in the end, but the true "hard" assets should do well.
Even in a deflationary cycle, they should maintain more of their value than other things. They'll have recognized, barterable value. In times of exchange controls, confiscatory taxation, price controls, and other government ukases, they have the qualities of anonymity, portability, and concentration of wealth to keep them in demand. No matter what the level of inflation, the level of unpredictability will give them a rock of Gibraltar quality that should help their owners preserve capital.
Meanwhile, there is no reason why anyone should have all his assets in un-dollars. It's always smart to take advantage of investment targets of opportunity. Select stocks and real estate, for instance, can become good speculative buys to watch for as interest rates fall and these markets stagnate.
But, like it or not, "gloom and doom," gold coins, dehydrated food, and shotguns are very much alive. And it's probably wishful thinking to hope that a Reagan administration would make much of a difference.
Steve Beckner is a free-lance financial writer, the editor of Deaknews, and the author of The Hard Money Book.
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]]>The questions that are being asked in Washington, in New York, and, with fervid interest, in such competitive financial centers as London are: Did the silver-buying activities of big-time speculators like Nelson Bunker Hunt and family force the New York Commodity Exchange (Comex) to issue a "trading-for-liquidation-only" rule on January 21 in order to prevent "manipulation" of the market? Or, did other influential traders and companies with an interest in cheaper silver engage in manipulation of their own to drive the price of the white metal down?
The official justification for the suspension of all new position taking in silver futures contracts was that certain large silver speculators were threatening to create a "squeeze" on the supply of silver available for delivery. Many insiders, however, including sources at the Commodity Futures Trading Commission (CFTC) and Comex, believe the exchange's board of governors may have been motivated more by a financial squeeze on prominent members who had bet against rising silver prices by "shorting" the market—that is, selling silver for future delivery.
The Comex action had the effect of braking silver's rise and in fact causing it to fall from $49.00 to $33.50 an ounce within a few days. This allowed "shorts" to extricate themselves from their sell positions at lower prices, as it also accomplished the stated purpose of relieving the apparent shortage of deliverable silver. Further, it eased financial pressures on metals dealers, who had been getting huge margin calls on short hedge positions, which their banks became increasingly unwilling to finance. Gold traders with similar exposures may have benefited from a spillover effect.
A group of unidentified "longs" (those who had bought futures in anticipation of higher prices) are still considering a suit against the Comex for possible "conflict of interest," according to their counsel, Phillip Bloom. "A large number of people on that Board are known to have been short hedgers or sell hedgers," Bloom commented. "Many of them are such that they had inventories of metals that were not deliverable or in a deliverable state, who had been hedging them in the futures market and financing the cost of that inventory at major banks. And as the price of the metal continued to rise, the banks did not allow them to continue to borrow money for the purpose of paying variation margins [additional earnest money required to maintain a futures position].…So that may have precipitated the 'emergency'—not a squeeze."
Bloom has demanded all communications between the CFTC and Comex, as well as the proceedings of Comex meetings, the names of participants, and their positions in the market. The Chicago attorney, who says the Hunts are not among his clients, has not received a response to his Freedom of Information Request with the CFTC, and Comex has refused to release any information. Bloom vows that if Comex does not cooperate with his investigation he may "institute litigation and seek discovery." If he then determines there was "impropriety," his clients may sue for damages.
While this issue is being resolved, doubts about the integrity of American markets are rife. As a result, according to a number of traders and market analysts, US exchanges are losing business to foreign markets, and not only in silver. By reducing the liquidity of the futures markets, this drain of trading interest into foreign markets makes it more difficult for American producers and users of commodities to hedge their price risks via futures contracts.
Further, as prominent New York trader James Sinclair has noted, "if the interests who held those long positions in silver were bona fide international interests, specifically representing friendly OPEC nations, and we…reneged on their ability to take delivery, then we may have inadvertently seized their assets." That, he added, not only "takes interest away from our exchanges" but is "terribly negative for the dollar."
Sinclair says the "delivery squeeze," to the extent there was one, could have been handled through "negotiation" rather than through the drastic steps that were taken. "Longs" would have "acquiesced to taking reduced deliveries over deferred months." Bloom concurs, asserting, "My clients were willing to roll forward [their long positions].…Nobody asked them."
One Comex member, who did not wish to be named, has suggested that firms and traders with exposed "spread" positions had their "problems solved by the breakup of the silver market." (A spread, also called arbitrage, involves the simultaneous buying and selling of commodities in different months.) "You're either borrowing money on the physical and shorting the forward, or you're short the near [month contract] and long the far," he explained. Either way, the short side of the spread was creating painful financial pressures not offset by the long positions.
He said his firm had gotten a $90 million margin call on the short side of one of its spreads. "We're a moderate size arbitrageur," he noted. "If we're getting $90 million margin calls, my colleagues are getting $200 million, $400 million, and $800 million margin calls." Sooner or later, the banks "are going to shut you off," he declared. "And unless something comes along to turn around these markets, unless you work out of your spread positions, you could be in awful trouble."
Chris Feierabend, a New York commodity consultant, said he is "sure" the financial squeeze "had something to do with" the Comex action. He said those with "bull spreads" (long actuals or near months and short far months) were particularly strained by their banks. Asked if traders with such exposure may have used their influence to get silver trading shut down, one leading Manhattan bank officer with the knowledge of bank financing of arbitrage simply stated, "I assume that that's what happened."
What was the role of the CFTC? One silver trader asserted that the commission came under great pressure from big silver users and shorts, who succeeded in persuading the commodities watchdog that their interests coincided with the "public interest." As a result, he concluded, "the CFTC probably advised them to liquidate only, and by that time the Comex had so many wounded members that it was only too happy to oblige the CFTC."
One well-placed CFTC source confided that the commission discussed in advance the use of trading for liquidation only at a closed meeting in early January with representatives of Comex, as well as the Chicago Board of Trade and Mid-America Exchange. (Hunt came to the meeting uninvited and was refused entrance, the source said.) Asked if such a discussion had taken place, Commissioner Robert L. Martin replied, "I don't know if it was discussed. It was not raised by the commission, because I suppose that it is always a consideration.…We didn't pound on the table and tell them you've got to do this or you've got to do that." But Martin went on to say that the CFTC's main "concern was with the shorts in the market who were not going to be able to perform." Martin said he was prepared to grant an extension of the rule if the Comex requested it.
CFTC officials say the commission received considerable input from companies with an interest in lower silver prices. One recalled "three or four meetings" with the Silver Users Association. Another stated he had talked to "several" representatives of companies with an interest in lowering silver prices. In particular, he said a representative of GAF Corp. "was all upset that, through speculation only, the price was going up."
He added that Dr. Henry Jarecki, president of Mocotta Metals Corp., was "very vocal to the commission." He noted that this leading precious metals dealer "just had everything on the line with their banks.…I suspect they had something to say about it." Dr. Jarecki, a Comex board member, failed to return a reporter's calls, as did Comex president Lee Berendt. Silver Users vice-president Walter Frankland said that his input with the CFTC was "not anything more than we have always called for." He did say, however, that he had advocated "forced liquidation until speculators come under (contract) limits." Frankland added that Comex experienced only an "apparent shortage" based on the "formality of its delivery requirement."
The latter CFTC source felt the closing of the silver market (until February 13) was "basically done by Comex members who had large short accounts and not by public customers." He did not know to what extent the commission influenced the decision, or was influenced to approve the decision by short interests. But, recalling the earlier suspension of grain trading, he noted, "the major grain people flooded Washington," and it "became quite apparent that it was all because of their actions that the commission closed down wheat trading for two days. The CFTC came out and said, This is in the public interest. We have to let everybody digest the news, when in point of fact it was the grain companies that had this tremendous clout."
Steve Beckner is a free-lance financial writer, the editor of Deaknews, and the author of The Hard Money Book.
The post Money: The Silver Trading Caper appeared first on Reason.com.
]]>These are perennial questions and apply to all kinds of investments. A bimonthly column cannot hope to answer them for you. Fundamental analysis can provide some good notions for medium- to long-term investment decisions. But even close attention to the fundamentals cannot tell you with a high degree of dependability at what price to buy or to sell.
True, someone who closely follows the price action of a stock or commodity (with or without reference to charts) and who stays informed about shifting supply and demand factors can make some educated guesses. He can buy on retrenchments and sell at or near a previous peak. And if he acts consistently he can generally make money. But that approach would not have availed the average trader much in the recent gold and silver eruptions. There was simply no way to predict that untoward political events would carry gold above $800 and silver above $40. Most would have liquidated their positions at much lower levels or, worse, taken up open short positions at those lower levels—and gotten burnt.
There is no absolutely sure-fire way to make money and avoid losses. But there is one proven method by which to minimize losses while maximizing gains—a technique for actualizing the old axiom "Cut losses short and let profits run."
It's called the "moving average system," and it has brought its practitioners into the market at propitious moments, kept them in for near the duration of major movements, and then told them when to exit. It sounds too good to be true, especially to proud fundamentalists, who are wary of being wholly wedded to the austere mechanics of charting.
But let's be open-minded. First, what exactly is the moving average system? It is simply a scheme of plotting averages of closing prices for various periods and superimposing them over a standard bar chart (showing each day's high, low, and closing prices). Typically, 4-day, 9-day and 18-day averages are used in conjunction. What results is a set of three trend lines following (with a lag) the movement of the bar chart's daily price action. The theory is that when the shorter-term average intersects with the long-term averages, a buy or sell order is indicated (depending on whether the trend is up or down). The system is designed to signal trend changes far enough in advance for the investor to take advantage of most of a bull or bear move).
A leading exponent of the moving average system is Dr. Wray A. Kunkle, a vice-president with Wheat First Securities in Washington, who says that the theory worked effectively in making good profits for his clients in both gold and silver during their recent run-ups, while preventing them from being caught short. Kunkle said the beauty of the system is that, "through daily homework, a trend change can be spotted early enough to participate in a run. It is not necessary to monitor daily news events or to analyze statistics, political manipulations or other fundamental factors that actually affect the markets." Kunkle says that he does not totally eschew such fundamentals but emphasizes that the system's track record has proven it to be a more reliable approach to trading. "For gold, this system has been amazingly accurate," avers Kunkle.
When asked recently whether he foresaw an imminent surge in the Deutschmark and Swiss franc, Kunkle replied that it is inevitable at some point. He predicted that, at some point, central bankers will "run out of money to support the dollar with.…They can't hold back the tide of big money moving out of the dollar." Kunkle is not alone in that feeling; New York adviser James Sinclair recently predicted the Swiss franc would reach one-to-one parity with the dollar sometime in 1980 (it's now worth about 64 cents). Ah, but when? Asked if now is the time to buy marks and francs, or failing that, at what price one should buy, Kunkle issued a predictable, but uncannily reliable response. He uses it in answer to all such questions: "Just follow that system."
Without reference to charts it is difficult to give the reader a full grasp of how the moving average system works. Those who are interested should get access to the weekly Commodity Trend Service (100 E. Kimberly, Davenport, IA 52806; 319/386-2950). Any broker worth his salt probably subscribes. You may wish to subscribe yourself at $300 per year and update it daily. Or, if you like to chart and make your own trading decisions, plot your own.
It's a simple matter. Get the daily closes for your favorite commodities (or stocks) from any good daily newspaper and plot them religiously on graph paper. Then, begin computing the three averages mentioned above. For the 4-day average, just add the last four days' closing prices and divide by four. For the 9-day and 18-day averages, do likewise with the closings for those respective periods. This kind of procedure can easily be programmed on a home computer, to minimize the drudgery.
"When the 4-day moving average penetrates (intersects) the 9-day moving average," explains Kunkle, "this signals a change in the trend. More conservative traders may wish to wait for the 4- and 18-day averages to intersect. When looking for sell signals, the rules are often a bit different, he advises. Because volatile markets often fall faster than they rise, it is not always wise to wait for the 18-day average to cross the 4-day in order to confirm the previous 9-day intersection. Sometimes, he says, it may even be prudent to act when the 9-day average intersects the current price.
As much confidence as he has in the moving average system, Kunkle is careful to use stop loss orders. These are instructions to one's broker to buy/sell above/below specified price levels in order to liquidate short/long positions when a reversal is in the making. He says "the system" can help in determining where to place these stops. Thus, with a long position, the cautious trader would move his stop-sell orders upward at a safe level below the average trend lines. With a short position, one would move stop-buys downward at a safe distance above the averages.
No system is perfect, but in the heat of a mid-January rally in the precious metals, Kunkle exulted that this one "is dynamite—right on the button in fact!"
Steve Beckner is a free-lance financial writer, the editor of Deaknews, and the author of The Hard Money Book.
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]]>They ran the gamut—from slick to schlock. All were competing to put up a more impressive facade in the conference's huge display hall, alongside the gold dealers and food dehydrators. It was a battle for the best location, the most professional-looking booth, the glossiest literature. Some were hopelessly amateurish efforts. But most looked pretty convincing. Yet, it was certain that—behind the facades—some firms were less legitimate than others.
But how was one to tell? If you asked any of the dozen about the credentials of their competitors, you would invariably hear the most scurrilous attacks and innuendoes. Almost every firm had something bad to say about every other. And so, for the uninitiated would-be diamond investor, observing this mud-slinging carnival scene, the overall impression must have been, well, muddy.
So, how does the person who is interested in buying precious stones glean the gems from the rubble? Thankfully, the number of fraudulent and borderline-fraudulent firms seems to have diminished. As tends to happen in all markets, the more reputable firms survive, while the others fall by the wayside. But the problem of choosing a dealer persists.
It's not the only problem. Take, for instance, the dilemma of choosing among diamonds and the colored stones. What do you buy? How do you get the best price, now and at resale time? Considering past price performance, what has the greatest price potential?
It behooves every prudent investor to thoroughly check out the vendors of commodities like diamonds. Check the Better Business Bureau, both in your state and in the state where the firm is located. Check Dunn & Bradstreet. Ascertain whether the attorney general in the firm's home state has taken action against it. Demand a company's references—and check them.
Beyond those precautions, there is no substitute for valid certification of precious stones. "Valid" means not only that the certificate is from an independent, widely recognized laboratory but also that the certificate you are given in fact goes with your stone.
Diamonds of a carat or larger should be certified either by the Gemological Institute of America (GIA) or the Hoge Raad Voor Diamant (HRD). Stones smaller than a carat should be certified by the European Gemological Laboratory (EGL). The HRD is a Belgian lab, and its certificates, as yet, are not very common in the United States. The chief US graders are the GIA and EGL (both with offices in New York and Los Angeles). While both are qualified to grade all sizes, in practice there has tended to be a division of labor, so that a one-carat stone with a GIA certificate might sell for a slight premium over one with an EGL certificate. In no case settle for a certificate from an unknown lab or buy a diamond "graded according to GIA standards" or by "GIA-trained gemologists."
Colored stones are only now acquiring the blessings of certification. The American Gemological Laboratory (AGL) has been grading colored stones for over a year now. But its certificates are not widely accepted nor its grading standards recognized by the trade. The EGL is in the process of developing its own colored stone grading and certification program, but it is sure to face similar problems. For this reason, more than any other, colored stones have to be regarded as still on the investment frontier—fraught with risks but also filled with opportunities for those willing to take them.
Unfortunately, a certificate alone does not bridge the knowledge gap, even in diamonds. There have been cases where a firm has sent a high-quality diamond to a legitimate lab again and again, thus obtaining a quantity of high-grade certificates, which it then used to sell lower-grade stones. And since, to the naked, untrained eye, it is hard to tell the difference between diamonds, such switching has been successful—particularly when the firm seals the stone in plastic and warns the customer that if he breaks the seal all guarantees of authenticity are void.
There are two ways to avoid this switching problem. One method is for the company to offer an insurance policy guaranteeing that the stone in the cube matches its certificate. Of course, the program has the drawback that one cannot fully enjoy one's diamond, since it is sealed. The insurance policy lapses if the seal is broken, unless opened by an adjuster. (Otherwise, a client could switch stones and claim he'd been cheated.) Then too, the insurance premium, which must be continued by the investor to keep the policy in force, is an extra cost.
The other method is for the diamond dealer to arrange for the investor to receive a loose diamond directly from one of the labs, or to pick the stone up at the lab. The lab can either recertify the stone or, for a smaller fee, verify that the stone and its certificate match. The firm must either provide a money-back guarantee in case the lab does not find the stone to be of the stated quality, or hold the customer's funds in escrow until the lab attests to the quality. Stones must be shipped to the GIA in the name of the customer and not in the name of the firm. No firm has a privileged relationship with the labs in this regard.
The prime proponents of these two approaches are, respectively, Gemstone Trading Corporation of New York and Gemma Corporation of Beverly Hills, California. But that doesn't mean they are the only reputable firms in the industry. Others, including Kohinoor, North American, and Reliance, have longstanding reputations.
The best approach is to make thorough comparisons of a few companies—their records, their prices, and their total programs. Of particular importance is their ability to resell the stone for you when the time comes. Your alternatives are auction houses, jewelry stores, and the classified-ad pages. Buy the best quality stone you can afford. Don't sacrifice quality for size. A general rule is to buy 75-point (¾-carat) or larger diamonds in the D-H color range and the "flawless" to "VS1" clarity range.
Without widely accepted grading standards, it is very difficult for the average person to know what he is buying in colored stones. Even more than with diamonds, you must trust the integrity of the seller. By the same token, liquidation is more difficult. On the other hand, current prices for colored stones do not fully reflect their much greater scarcity—now being aggravated by Far Eastern political disruption. Comparing comparable qualities, colored stones are probably underpriced relative to diamonds per carat. For those with greater than average expertise or a greater than average willingness to take risks, genuine, top-quality rubies, emeralds, and sapphires could outpace diamonds, assuming the coming colored stone-grading revolution increases investor demand for them. And, with diamonds having risen an average 25 percent per year over the past decade (about 40 percent this year), that's saying a lot.
Steven Beckner is the editor of Deaknews, the financial newsletter of the currency trading firm Deak-Perrera.
The post Money: Precious Stones appeared first on Reason.com.
]]>While there are kinks to be worked out and legal refinements to be made, individuals can begin to take advantage of the inflation protection that gold-clause freedom can provide—so long as they act prudently. So, let's examine some of the potential pitfalls and see how to skirt them successfully.
The gold-clause legislation, which became effective the minute President Carter signed it on October 28, 1977, was greeted with a mixture of hope, doubt, fear—and some misinformation. Major publications like the New York Times and the Washington Post heralded the law as an effective reestablishment of the gold standard. Sen. Barry Goldwater, addressing the New Orleans "Gold, Monetary, and Economic Conference" in November, commended it as a "means for establishing a private gold standard." The US Treasury, on the other hand, in giving its endorsement, obviously felt it was merely contributing further to the "demonetization" of gold (and reducing it to the status of "just any commodity").
At least one gold-clause contract, involving a ship lease, went into effect immediately. According to the New York Times, it called for dollar payments to increase (or decrease) by the same percentage as the London gold price when the lease comes up for renewal in three years. (Other possible formulas will be reviewed below). A condominium owner was reportedly tying payments on his units to the gold price. Utility companies were openly talking about issuing gold-backed bonds in order to get lower interest rates. On the international scene, where gold-clause contracts have never really been illegal, there was speculation that the Arabs might now index oil prices to the gold market. And there were a number of actual inquiries about the law from various Japanese companies.
Meanwhile, there were others who raised legal questions about the tax treatment of gold-clause contracts and about various government regulations that could affect them adversely. New York Law School Dean Donald Shapiro discoursed at length in New Orleans on the proper writing of these novel contracts. His and others' recommendations will be examined later.
Even the bill's sponsor, Sen. Jesse Helms, had his concerns, vowing to the New Orleans gold bugs to "take every step I possibly can to prevent regulatory repeal of this legislation." After the conference he sent letters to then Federal Reserve Chairman Arthur Burns, the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Securities and Exchange Commission, and others to determine whether they planned any regulations governing such contracts.
Thus far, only the SEC has responded to Senator Helms, saying it "plans no regulations affecting gold clause instruments" but has "adopted a wait-and-see policy," according to Helms Legislative Assistant Howard Segermark. "If someone contacts them with a proposal to issue a gold clause security [the SEC] will review it and see if it conforms with basic standards," said Segermark.
While investors await the issuance of new gold-clause securities, some brokers have rushed to hawk gold-clause bonds of pre-1933 vintage as prime speculations. One such broker, Robert Ellison of Bache Inc., in Seattle, was cited in the November 30 issue of Inflation Survival Letter. In a mailing to investors, Ellison states, "the new law is neutral regarding the enforceability of these obligations" and goes on to call these old railroad and utility bonds—issued prior to the gold-ownership prohibition—"an ideal speculation" (emphasis added).
Unfortunately for would-be purchasers, however, the law specifically states that gold-clause enforceability applies only "to obligations issued on or after the date of enactment of this section"—not exactly "neutral" phrasing. In fairness to Ellison, he conceded in a recent interview that he is aware of this provision but said he is "very hopeful" that ongoing litigation to require gold payment on these bonds will be successful on constitutional grounds. "I'm certain it's going to be appealed all the way to the Supreme Court," he stated, adding, "There is that outside chance that the Supreme Court will see the light."
And anyway, Ellison asserted, even if suits seeking gold payment are overruled, the purchasers of these bonds will not have lost, because they bear "no significant premium when compared to other bonds of similar rating and maturity." If one is really determined to buy antique corporate bonds, which may or may not be a good investment, Ellison's point that it can't hurt to buy one with a contested gold clause seems ostensibly sound. But realistically, the chances of these bonds ever paying off in windfall gold profits are extremely remote. Asked if there was a chance the old obligations would be enforced, Segermark asserted, "Not at all."
Ellison did make one good point, however, in which he is not alone. That is that, so long as the abrogation of pre-1933 contracts goes unvindicated, many people will be reluctant to enter into new ones for fear the precedent will be repeated. It might be observed that the circumstances were different in the 1930's, when the Supreme Court narrowly killed gold clauses. (The United States was still on the gold standard, and the government had a more plausible reason for intervening to "regulate the value" of money.) But doubts will remain. In the event of hyperinflation and a skyrocketing gold price, who's to say the government wouldn't once again side with debtors and suspend their obligations to pay in gold or gold-valued dollars? As First National Bank of Chicago's Eugene A. Birnbaum put it in a letter to Senator Helms, "Questions would probably arise regarding the credibility of its enforcement in the event of a similar circumstance occurring in the future."
A related question—however the courts rule—concerns the ability of a debtor to pay if gold goes through the roof. A gold clause won't do a lender much good if the borrower simply declares bankruptcy. This issue is dealt with by Howard Ruff in the December 1, 1977, Ruff Times. Ruff urges that a loan contract require the borrower to hedge his obligation in the futures market, so that if gold rises to unexpected levels, the profits on his futures contract will allow him to pay it. Of course, this assumes the prospective borrower is willing to enter into such an unorthodox loan contract. But if he's unwilling, he might better be avoided.
Ruff is adamant as he explains how the hedge would work: "The contract must require that he buy gold futures contracts, at the commencement of the agreement, equal to at least the number of ounces of gold stated in your loan agreement—in this agreement one 100 ounce contract, and he must maintain that futures position for the length of the loan agreement. If the price of gold rises, his contractual obligation to you increases, but he has a corresponding profit from his 'hedge' position in the futures market, so he breaks even. If the price of gold goes below $160 an ounce, he immediately sells out his position (using a stop loss order). He's not speculating, because his profits are equaled by his obligation to you. By insisting on this, you have protected his ability to repay you." (Ruff suggests the contract specify that the lender get monthly statements from the borrower's broker to insure that he is not speculating.)
Ruff notes that the hedge is no substitute for good collateral and ability to pay. Naturally, there will be commissions for the hedging borrower to pay, and it may be necessary for the lender to take these into consideration in fixing the interest rate.
Ruff offers to solve another problem: how borrowers and lenders interested in using gold clauses can get together. He offered to serve as an intermediary between those of his subscribers who are willing to enter into gold-clause transactions.
What are the other ingredients of a well-drafted gold-clause contract? First of all, as Shapiro and other legal minds have recommended, the "points of reference" should be clearly stated. In other words, no matter which of the possible indexation formulas are used, you should specify the starting and ending points that will determine the amount of payment. Thus, if payment is to reflect a percentage change in the market price of gold from the time the contract is made to the time payment falls due, the contract should state the time and date of a specific gold market.
Shapiro recommended that the starting date be placed at least a week prior to the actual contract-signing date. So, if you were signing a lease or loan agreement, for instance, on July 9, 1978, the contract might take as its "reference point" the London afternoon gold fixing on June 30, and so specify in the contract. Likewise, future payment should be made contingent on the market price in a specified gold market at a specified date and time one or two or three years hence—whatever the term of the contract happens to be. An alternative method, if you're worried about unfavorable market fluctuations, is to base payment on an average price from the month preceding the payment date.
Further, the type of payment should also be specified—whether it be bullion or coins or dollars measured by them. If bullion is used, specify the fineness. Shapiro counseled against using numismatic coins because of the difficulty of separating intrinsic value and rarity value. He suggested specifying a certain type of bullion coin (for example, Krugerrands, Austrian 100-koronas, Mexican 50-pesos).
Another caveat is to be aware of the usury laws in your state and in the state of the other contracting party. Usury laws, which impose an interest rate ceiling, generally do not protect corporations, but if you are dealing with a private individual, as in a personal loan, you must take proper precautions. In their August 1974 article in the Americal Bar Association Journal, Rene A. Wormser and Donald L. Kemmerer suggest a corporation could even be "created for the purpose," and a "personal endorsement of the loan by an individual concerned could be demanded to guarantee payment." But if that is not possible or worthwhile, the problem can still be obviated in most cases by simply leaving interest payments out of the gold-clause arrangement.
If only the principal, and not the interest, were specified payable in gold or in dollars measured by gold, "I don't think that would be usurious," Shapiro stated. Wormser and Kemmerer elaborate further in their 1974 tract: If it were one of long-term capital gain, any accretion in dollar value should be treated merely as an addition to capital gain. If there is an interest factor, however, then the possibility of a defense of usury may be present. If a legal interest rate were always applied to the value of the initial obligation, usury could not result. If, however, the interest rate were to be applied to a figure resulting from an upward adjustment through a gold clause, the debtor might claim that the result was usurious." (emphasis added)
Even if the gold clause were applied to the interest as well as to the principal, Wormser and Kemmerer held that the contract "ought" to be upheld. The key question, they say, is one of "usurious intent." And since "the contract does not assure a usurious interest rate, inasmuch as the contract may operate, if the price of gold declined, to produce less than the initially stipulated interest rate," the lawyer-economist team contended no "usurious intent" could be inferred—except in cases where "the effective rate of interest could not be less but might be more than the initially stipulated rate." They went on to suggest that "declaratory judgments" on the issue could be sought from state courts. To be on the safe side, Shapiro's advice that interest not be made adjustable to the gold price seems like the best bet.
In choosing the type of contract one wishes to enter into, a major consideration is tax treatment. The question of whether dollar gains resulting from gold clauses are to be taxed at ordinary income rates or at capital gains rates has not yet been decided. Different observers have varying views on what the most likely treatment will be.
By all rights, gains should not be taxed at all, since the purported purpose of the gold clause is not to make actual gains but to hold constant the value of one's capital invested in the contract. But the IRS is no more likely to adhere to this principle in the case of gold clauses than it does in the case of consumer price index or any other type of escalator clauses—unless one specifies payment in kind, that is, in actual gold (or foreign currency), not in gold-indexed dollars. If one lends gold, assuming one can find an interested borrower, and receives gold in repayment, Shapiro stated, "I think you can get away without any gain." The only tax resulting from such a gold-in—gold-out (or Swiss franc-in—Swiss franc-out) contract, certainly, would be on any interest charged on the value of the gold loan. (It does seem likely, however, that capital gains would be charged in the event that the lender sold the gold he received in repayment.)
This type of deal, therefore, is attractive from a tax standpoint but is probably unrealistic for the great majority of potential gold-clause contracts, at least at the present time. For until gold becomes more widely recognized and accepted as a monetary medium in this country, it will be difficult enough to find a party willing to enter any kind of gold-clause agreement—unless one is in a strong enough bargaining position to demand it—much less one specifying actual bullion or coin transactions.
It then becomes a question of getting the lowest possible tax rate—capital gains, assuming that Congress does not eliminate the present favorable treatment altogether, as threatened. "If you phrase your contract properly you should get capital gains," Shapiro maintained. He wasn't terribly specific on the point, but until the IRS rules otherwise, there is no reason why a taxpayer should report anything but capital gains on such a transaction. Wormser and Kemmerer recommend it is "advisable to attempt to secure rulings from the Internal Revenue Service." The writers' own opinion was that "it would seem worthwhile to use a gold clause, despite the tax risk. If an alleged, although false, 'profit' were taxed as a long-term capital gain, a substantial net protection against inflation would still remain. If the false 'profit' were taxed as ordinary income, there would even then be a small net benefit from the use of a gold clause."
Interest would certainly be taxed at ordinary rates, say Wormser and Kemmerer, who add that the IRS might even contend that "any accretion in dollar value would constitute the equivalent of ordinary interest and be taxable as such." That type of argument "should be rejected by the courts," they write. But the higher tax rate could still be imposed, they continue: "The nature of the tax would depend on the nature of the underlying transaction. If it were one normally taxed as a long-term capital gain, any dollar accretion should be taxed, if at all, as an additional long-term capital gain. On the other hand, if the transaction were one normally taxed as a short-term capital gain or as an ordinary income transaction, the accretion could be taxed, if at all, as ordinary income."
A less sanguine view on the tax issue was taken by a New York law firm that sent a memorandum on the subject to Senator Helms. Looking at the question in the light of both a "currency revaluation" and as a "commodities contract," this particular legal opinion concluded on the basis of case law: "The likely result under the present Internal Revenue Code would be to look upon gains…as ordinary [rather than capital] gains, taxable at the rate that the individual is then presently at." Cases cited were Bates v. United States, 103 F. 2d 407 (7th Cir. 1939) cert. denied, 309 U.S. 666 (1940); and Corn Products Refining Co. v. Commissioner of Internal Revenue, 350 U.S. 461 (1955).
There is yet another ticklish area of which would-be gold-clause users should be aware. The Uniform Commercial Code maintains a restrictive definition of "negotiable instruments": writings signed by the maker or drawer containing an unconditional promise or order to pay a sum certain of money to the bearer on demand or to order. The key words are "a sum certain." Obviously, a gold-indexed (or currency-indexed) payment cannot be a "certain" amount, although a fixed amount of actual gold could. For that reason, the law firm quoted above also expressed the opinion that "the use of a gold clause in an otherwise negotiable instrument…[requiring payment] in money based on gold equivalent…would be rendered non-negotiable under the Uniform Commercial Code."
This is a pretty dim view, but it is not insurmountable. After all, gold clauses were successfully used for years before 1933, and similar uncertain indexation or escalator clauses are successfully used today in everything from mortgage loans to pension plans to employment contracts, without apparent infringement of the code.
Gerald T. Dunne, a professor of commercial law at St. Louis University, who has given some thought to this seeming dilemma, did not dismiss the problem in a recent interview, but he stated, "I think it's okay. I think the difficulty is far more imagined than real. Because, as you say, if this were fatal, every escalator clause would be likewise fatal." This belief is seconded in Robert S. Getman's article on gold clauses in the Winter 1976 Brooklyn Law Review, where he writes, "If the gold legislation were intended to make gold a commodity 'like everything else,' enforcement of escalator clauses based upon the value of gold should encounter no greater legal obstacles than would enforcement of other commodity indexing devices."
Of course, not all gold-clause contracts would fall under the definition of "negotiable instruments." As Dunne noted, "if it's not a bill of exchange or a note, then the problem doesn't even exist." Still, there may be cases where, ordinarily, a negotiable instrument might be desirable, and a gold clause could then present legal difficulties. In view of the code, Wormser and Kemmerer advise, "Either a non-negotiable note should be used, or reliance should be placed wholly on the contract of loan or sale itself."
The best advice of all is Dunne's injunction that "you should consult counsel and let him guide you. The person shouldn't be his own draftsman." That advice could just as easily apply to all of the foregoing areas. As Segermark said after passage of the law, gold-clause contracts need to be "written very gingerly," and the best way to insure that is to seek competent legal help. You may even be pleasantly surprised to find that the opportunities are not nearly so limited as some of the foregoing discussion might make it appear.
For those who are willing to try gold clauses, what are the mechanics? Keeping in mind the rules and caveats discussed above, which also apply generally to "multicurrency" contracts, there are several different types of clauses. Let us assume for purpose of discussion that we're talking about a personal loan contract, since at the moment that seems to be the most accessible type.
The old type of gold clause, which developed in the late 19th century amid "greenback" depreciation and uncertainty over whether the United States would stay on the gold standard, merely specified payment in US gold coins "of or equal to the present standard of weight and fineness." That was when US gold coins were recognized, circulating, legal tender. Now, however, with the growing numismatic value of even common-date coins, they might not make good standards of value for purposes of a gold clause. Better to specify bullion or bullion coins—or the dollar equivalent. But, if two contracting parties really want to deal in US gold coins and agree to specify payment in, say, 10 Double Eagles, it doesn't seem likely that a court would declare it unenforceable in most cases.
The most obvious and simple formula would involve a loan of a certain amount and type of gold—either bars of bullion or specified bullion coins—and repayment in kind, plus a fee or "interest" for the use of the gold over the course of the contract, which might best be imposed on the initial value of the gold. This avenue has legal and tax advantages. In addition, as the Gold Standard Corporation mentioned in its October 1977 newsletter, they would be "far more prudent" than "dollar denominated gold agreements" in the event of price controls on gold.
Nevertheless, most contracts will probably provide for gold indexation (or "measure of value" or "maintenance of value") clauses, which seem safe enough and are probably infinitely more marketable. One method has already been mentioned: simply require that principal (and/or interest) payments be tied to the percentage increase (or decrease) in the (properly designated) gold price. Thus, if you lend $10,000 for a year, and the price of gold increases 10 percent, you are repaid $11,000, plus interest.
Another method would be to state the contract in terms of a certain number of ounces based on the current market equivalent of the dollar amount you wish to lend. Ruff gives the example of a $16,000 loan initiated at a market price of $160 per ounce. This yields a gold equivalent of 100 ounces. When the loan comes due, the borrower is then obliged to pay back the then-prevailing market value of 100 ounces of gold (plus interest).
Ruff adds a somewhat troublesome twist, however. He suggests a contract with three payment options: (1) actual payment of the 100 ounces in gold, (2) payment in the dollar equivalent of the 100 ounces, or (3) payment in the original cash value. The lender would then be able to cash in on the appreciation of gold in event of inflation but would also be able to "demand payment of the face value in dollars" in the event of a fall in the price of gold. If you can get such a deal, fine, but it sounds a bit too much like "heads I win, tails you lose." A good many borrowers might insist that the lender hitch his wagon to gold either entirely or not at all—and accept the downside risk. Ruff would argue that a hedged borrower would have no objection to the cash-value provision, since he will have insured himself against all risks.
This may present no problem; it may be quite possible to arrange such terms, particularly with more aggressive, that is, more risky, borrowers. Obviously the more desperate a person is to borrow money, the more he will be willing to "sweeten" the deal for the lender. From the high-risk borrower's point of view, the gold clause may be just what he needs to get credit. At the same time, the lender must realize that to get a really creditworthy borrower and make a sound loan, he is not always going to be able to arrange the kind of made-in-heaven contract Ruff envisages—with enforced forward hedging, the original cash-value option, etc.
It's worth noting that European multiple-currency ("Lombard") bonds, which allow the investor to receive payment in a choice of currencies, have similar low-risk features. But precisely because of that, multicurrency bonds have become almost extinct in today's world of sharply fluctuating currency values. For a complete list of such bonds still on the market, see David Smyth's You Can Survive Any Financial Disaster (Regnery, 1976). The newer European Unit of Account ("Eurco") bonds also have multiple-currency features but are far less advantageous for the purchaser, since the exchange rate for each currency, on which redemption value is calculated, is fixed at the time of issue.
Even more elaborate formulas could be devised. For example, according to a Library of Congress study, two 1973 French bond issues-subsequent to the "Pinay bonds"—contain quite complex gold clauses. In one 4½, 34-year bond, floated to retire a similar 1958 issue, the redemption value, which is determined twice a year for redemptions taking place after June 1 and after December 1, "is equal to the nominal value multiplied by a coefficient which equals the average price of the 20-franc gold piece (Napole'on d'or) on the Paris free gold market during the 100 business days immediately preceding, respectively, May 15 and November 15, divided by 36 francs" (presumably the value—in "new francs" of 1960—of the Napole'on d'or at the time of issue of the 1948 series). The study observed that the redemption price of this bond "is not lower than 250 francs for each 100 francs nominal value, the apparent redemption value of the 1958 bonds at the time of the October 1973 conversion."
It is explained in the same study: "Another 7% issue contains a 'maintenance of value' guarantee that: is not tied directly to gold but instead to the ratio between the official gold content of the franc and that of the unit of account (U.A.) of the European Economic Community, the latter equal to the pre-1971 devaluation gold content of the US dollar (0.88867088 grams fine). The guarantee becomes effective when this ratio as it exists on January 1 of the year in which the transaction involving a bond takes place has lower value than the same ratio as it existed on the day of issue (January 16, 1973). The adjustment coefficient, applicable to both the redemption value and interest payments, equals the result obtained by dividing the day-of-issue ratio with the latest January 1 ratio. In effect, if the gold content of the franc decreases…the adjustment coefficient is greater than 1 and the redemption value in current francs is greater than the nominal value."
Only a government could come up with such Byzantine formulas! For the average person, the simpler the better.
One device, frequently mentioned as a gold-clause payment vehicle, is the gold deposit certificate, which is simply a warehouse receipt for gold. The most well known (and least-expensive) certificate is the Deak Gold Deposit Certificate, offered by Deak & Co. (Washington, DC). At this time it is not negotiable, however. Ownership of the certificate can only be transferred on the company's "Certificate Register" by surrendering it at Deak's Washington office and requesting the issuance of a new certificate to a designated person or persons.
In his letter to Arthur Burns, Senator Helms specifically asked, "Do you foresee any restraints or regulatory prohibitions against banks issuing negotiable gold certificates?" He urged that any regulations be issued "with a view toward modifying them should it appear that they are unduly restricting opportunities of individuals and organizations to utilize the advantages these devices may offer." However the banking authorities rule, it is probable that any company attempting to issue fully "negotiable" certificates would find itself subject to onerous securities regulation by the SEC, even though their use in gold clauses would seem to be perfectly legal now.
The Gold Standard Corporation offers gold "transfers," similar to gold checking accounts, which could conceivably be specified as payment media in contracts. While these "transfers" are apparently gaining customers, they are far from being widely accepted. (Bank of America has recently come forward with a proposal to offer accounts and credit in foreign currencies. Senator Helms is shepherding this proposal through the regulatory corridors, having sent a letter on its behalf to the chairman of the Federal Reserve Board.)
Gold Standard has also been in the vanguard, along with certain other interests, of those investigating possibilities of gold insurance. This, of course, is an area that comes under the bailiwick of the individual state's insurance regulatory bodies. Gold Standard's Marcus Braun said his company contacted the Missouri Insurance Commission and got some good news and some bad news from its general counsel. The good news is that "insurance policies may be issued with the premiums and benefits in terms of gold." But the bad news is that "the reserves must be held in dollar-denominated assets." That, as Braun noted in a recent interview, "would destroy the whole thing. No insurance company in their right mind could afford to issue something like that." And, since insurance regulations tend to be uniform throughout the states, the same policy probably holds true in all 50 states, although there could be exceptions.
There is another interesting possibility. Braun said he and other individuals are working on an annuity-type program that would get around these objections. It would involve storing gold and paying out a certain amount in installments up to a certain age. Here is how such a plan might work: A person would put, say, $100,000 in gold into the program at age 40. Then two to five percent of that gold would be released to the investor each year until age 95, at the then-prevailing market price—either in terms of dollars or gold or gold "transfers." In the meantime, the gold deposits would be held in safekeeping. Conceivably, gold loans or gold collateral loans might be made, adding to the earnings of the investors' deposits. As Braun conceives it, "We would take 10% only when a person gets out of the program—10% of the residue. And then the rest of it would be divided equally between the estate of the depositor and the remaining depositors. That way, if you live long enough you could get substantially more than what you put into it." Shortly before press time, however, the Missouri Insurance Commission ruled that this plan would constitute an insurance program, and hence, gold could not be held as a reserve. But Braun has now persuaded a legislator to introduce a bill legalizing gold insurance reserves. While this action is pending, Sen. Helms has made inquiries about the feasibility of gold-clause pension plans with the Employee Plans Division of the IRS.
And so, for now the application of the gold-clause law is in a state of flux. But this new freedom has too much potential to be wasted. Whether you be an employer, a valued employee, a landlord, or a provider of venture capital or a seeker of same, you can begin to use gold clauses to start living easier with dollar depreciation. Just keep in mind some of the rules and precautions noted above. You should be all right if you consult your lawyer (and/or relevant authorities) and deal with persons you know and trust.
Mr. Beckner is the editor of Deaknews, Washington, DC.
The post The Promise and Perils of Gold Clauses appeared first on Reason.com.
]]>In 1963, Victor Lasky intruded upon the waning idylls of the Kennedy Administration with his caustic bestseller, JFK: The Man and the Myth. Now Lasky is back with another blockbuster.
If its tone weren't a bit too apologetic for Republican misdeeds, It Didn't Start with Watergate would be more palatable and, indeed, more credible. Even so, it makes revealing, intriguing and—for those who retched at the craven hypocrisy of the Nixon witch-hunt days—very satisfying reading.
Much of what Lasky has to say in his unabashedly strident fashion will be familiar to most. He strives to construct from many sources a single, encyclopedic account of all the political deceit, corruption, and skullduggery of the last 40 years. It is this, and not any claim to reportorial originality, that is the book's main virtue.
The more one reads, the more one comes to the author's conclusion that the sins of Nixon were greatly overshadowed by those of his predecessors. There is no lack of examples. For instance, Lasky tells of how Kennedy used the Internal Revenue Service against Nixon and his campaign manager, Robert Finch, after his 1960 election victory. More vicious was the Kennedy use of the Federal Communications Commission, as well as the IRS, to silence right-wing organizations and spokesmen in preparation for the 1964 election—all in a surreptitious manner that would have made latter-day "plumbers" and money launderers proud. "The irony," Lasky writes, "is that the IRS witch-hunt, particularly as it was concentrated against right-wing dissenters, was applauded by the very same people who later were to raise unshirted hell when the Nixon administration sought to use the same techniques to 'contain'…the Black Panthers, the Weathermen and other violence prone New Left groups."
And Kennedy did not limit himself to abusing only right-wing radio commentators. Anyone who dared criticize Camelot found himself on the White House "enemies list" of that day. Even Washington Post Editor and sometime-Kennedy confidant Benjamin Bradlee was wiretapped, according to Lasky, who was himself a victim of Kennedy harassment.
For cover-ups it is hard to beat the Johnson-era whitewashing of the Bobby Baker scandal, when some of the same Democrats who later sat on the Senate Watergate Committee blocked attempts to make Johnson aide Walter Jenkins testify.
Campaign espionage? How about "Landslide Lyndon's" electronic surveillance of Barry Goldwater in 1964? Of course, Johnson didn't limit himself to spying on his Republican opponents, having earlier used the FBI against Democratic rivals.
Then there were even more unsavory FBI exploits against Martin Luther King, Jr., and others, under the specific direction and approval of "liberal" saints like Attorneys General Robert Kennedy, Nicholas Katzenbach, and Ramsay Clark.
Right up until the break of the Watergate scandal, the bitterest critics of Republican mischief engaged in equally culpable activity. While denouncing the school-boy antics of Donald Segretti, George McGovern was using legendary dirty trickster Dick Tuck to undermine the hopes of his intraparty foes. And where was illicit campaign financing more rife than in the milk-fund largesse of big-name Democrats?
The list goes on and on, but alas, Lasky grows more and more partisan. And when he attempts to show that Nixon was innocent of real involvement and was merely betrayed by subordinates, he falters. When he goes so far as to defend the Huston Plan for the use of mail covers, electronic surveillance, and illegal break-ins against "the left," then the book degenerates into pure right-wing dogma at its worst, which puts the author in the same class as many of the White House lackeys he claims to disdain. Nevertheless, surely one pro-Nixon book can be tolerated among the raft of less-than-honest diatribes that has glutted the market in the aftermath of Watergate.
Moreover, despite its shortcomings, the Lasky book is more than mere sour grapes offered up by a vengeful Republican of the right. In fact, it can be read as a relevant commentary on contemporary events. For after Nixon was driven from office, after all the putrefying gore of governmental abuse of power had been unearthed, too many people naively relaxed and gave in to the hope that, as Gerald Ford put it, "our long national nightmare is over."
What this particular Watergate account does, at its best, is to use historical perspective to show that for some time—since it abandoned the Constitution and adopted imperial hubris—America has been living in one continual nightmare. Even today, so soon after the devil had supposedly been exorcised from Washington, that nightmare continues:
• The old atmosphere of fawning, uncritical acceptance, which fostered so much presidential hoodwinking of the public in the past—has returned to White House press conferences.
• Congress engages in wrist slapping against Budget Director Bert Lance, whose flagrant financial misdealings should have disqualified him immediately from his crucial position of public trust. And it has been revealed that the Comptroller of the Currency knew about Lance's underhanded use of correspondent bank connections but curtailed its investigation after Jimmy Carter was elected.
• The Korean influence scandal "investigation"—dominated by the same Democrats who sanctioned the bribes-taking for years—meanders lethargically with scarcely a hint of the hue and cry that greeted GOP transgressions.
• And the trampling of civil liberties proceeds in earnest, the latest example being the massive raids (since declared unconstitutional in part) on the Church of Scientology. The raids were done openly and publicly, but that doesn't make them any less scary. In fact, former Washington ACLU Director Charles Morgan recently told a group of libertarians in the nation's capital that, "post-Watergate morality" or not, "people who stand against the government—left or right—can expect the government to fight back." Because of its libertarian stands, particularly on the international intelligence agency Interpol, Morgan said that "there are people in the IRS and FBI who would like nothing better than to get the Church of Scientology."
By documenting all the disgusting debauchery of authority emanating from Washington over the past 40 years, Lasky should have laid to rest the notion that Watergate was some kind of isolated, freak incident attributable to the vague, vicious personality of one man. While probably not intending to do so, Lasky shows that corruption, assaults on personal liberties, political sabotage, and so on are constant, inevitable phenomena in a society that is proceeding down the road to government omnipotence. The activities described in It Didn't Start with Watergate are nothing more than the acting out of Garret Garet's thesis in The People's Pottage. Writing some 30 years ago, Garet feared that, having sold out their own heritage of freedom and independence for the beguiling security and largesse of the "warfare-welfare state," Americans would soon have to pay the price of this Faustian bargain in terms of ubiquitous governmental dishonesty.
Lasky leaves us little hope. Indeed, he implies that the American people have not seen the last, that Nixon will prove to have been one of our milder "nightmares." And Nixon, as Lasky points out, faced a hostile Congress, press, and international establishment. Which leaves us with the haunting question: What havoc might future, more popular presidents—unshackled by journalistic or legislative vigilance—wreak upon an unsuspecting public?
Mr. Beckner has a background in history and economics and is the editor of Deaknews, a financial newsletter.
The post It Didn't Start with Watergate appeared first on Reason.com.
]]>This early lesson in the ambitious Hungarian's life was the germ of an idea that grew into what is today one of the world's foremost foreign exchange organizations—and the largest in the Western hemisphere. With over 50 member firms scattered from New York to London to Zurich to Hong Kong and back to Los Angeles, the Deak-Perera Group combines a broad and exciting range of foreign exchange services with dealings in precious metals and both international and domestic banking.
Following World War II, when millions of Americans wished to send money to relatives in ravaged Europe, it was Deak & Co. that handled many of those remittances abroad. When Vietnamese refugees left their fallen country by the tens of thousands only a few years ago, it was again Deak & Co. that rushed in to set up shop in refugee receiving centers on Guam and in this country to buy their thin, gold "Tael" wafers and provide them with the currency they needed to start life anew.
And over the years, wherever tyrannical governments have attempted to enslave their citizens by preventing them from removing their wealth, Deak & Co. and its affiliates have taken the lead in helping people surmount those exchange controls by often ingenious "blocked funds" transfers.
The unique character and personality of the Deak-Perera Group is imparted by its founder-president, a man whose story rivals that of Midas Mulligan or any other character ever conceived of by Ayn Rand. Born in 1905, Nicholas Deak remains the dynamic head of his international aggregation. A vegetarian, at age 72 he still runs in the New York marathon and finds time to ski cross-country, swim, and play squash and tennis.
Deak lived through runaway inflation in his native Hungary. He can recall the rush to spend increasingly worthless paper and the times his family had to barter their jewelry and clothing to farmers in exchange for food. Not surprisingly, then, Deak is a sworn enemy of inflation. And he is not optimistic for America's chances of avoiding that fate: "I feel that inflation will continue as long as the budget of the Federal Government cannot be gotten under control. With the budgetary deficit we continue to have inflation. Since budgetary deficits, in my opinion, cannot be cured, inflation will continue, and as time goes by will develop into accelerated inflation and lead to the collapse of our monetary system as we know it today. Subsequently, these developments will lead into a deflation and depression. The timing is uncertain. It will continue to depend on the magnitude of the budgetary deficits and other economic uncertainties."
Whether because of harsh experience or because of the financial traditions of his native land, Deak determined early to enter international finance. As he told the Newcomen Society at a 1975 dinner in his honor, his life and his business have been a response to the challenge of "creative entrepreneurship, dramatizing what men can accomplish in our free world."
After spending five years at the Royal Hungarian Trade Institute learning the basics of international trade and finance, he went on to earn a doctorate in international finance from the Swiss University of Neuchatel. Dr. Deak moved rapidly upward from there, going from the Hungary-Rumania branch of Overseas Bank to a post in the Economics Department of the League of Nations in Geneva.
But his was not to be the life of an academician. In 1939 he came to America and quickly launched a foreign exchange business. But with the outbreak of war, he joined the U.S. Army, where he soon came to the attention of the infant Office of Strategic Services (OSS). For four years he used his linguistic and paratrooper abilities in the service of "Wild Bill" Donovan on dangerous assignments in the eastern Mediterranean and in the Far East. In one exploit he likes to recall, Deak masterminded and personally carried out the wholesale smuggling of some 1,000 railroad freight cars out of Russian-occupied Hungary to the West at the end of the war. Later, such tactics were to be used in the service of Deak customers who wished to remove their money from economically or politically inhospitable countries.
In 1946 Nicholas Deak restructured the firm he had started before the war and incorporated as Deak & Co., now the holding company for the Deak-Perera Group. The Perera Company, Deak's major competitor, was acquired in 1953. The company flourished, opening offices throughout the United States and around the world-Washington, Miami, San Francisco, Vancouver, San Juan, Honolulu, Macao…Ever on the watch for innovative services, Deak pioneered in the opening of foreign currency vending machines at New York's John F. Kennedy (then Idlewild) Airport. These airport outlets have continued to spread throughout the country.
In 1958 the Deak-Perera Group broke more new ground, entering the preserve of the "Swiss gnomes" to open its own bank in Zurich in order to avoid paying commissions to Swiss banks. Today the Deak-controlled Foreign Commerce Bank is in the top 10 percent of Swiss banks and, with one of the highest liquidity ratios in the country, is among the fastest growing. In 1967 Deak acquired the respected Bankhaus Mayer-Loos in Vienna, Austria, changing the name to Bankhaus Deak, now the third largest private bank in that city.
Not one to restrict himself to international horizons, Deak had previously acquired a small-town bank in upstate New York. Since 1957, when he bought it, Deak National Bank of Fleischmanns, New York, has kept its small-town image while doing such unorthodox things as: offering checking accounts denominated in gold or silver; making gold and silver collateralized loans; effectively offering free, interest-bearing checking accounts through a combined checking-savings scheme, in which overdrafts are debited to savings; and offering OMNI checking accounts, by which checks can be written in any currency. These are not the kind of services Federal bank regulators and most of their clients have in mind—though perfectly legal—but their popularity can be measured by the fact that this little bank's deposits have grown 15 times over the past 20 years and include accounts from 30 states and 35 foreign countries. Unfortunately Deak was rejected when he attempted to bring his fresh perspectives on customer service and sound money to the entire banking community by running for a seat on the Federal Reserve Board of Governors last year.
A major role of the Deak-Perera Group has been in serving other banks in need of specialized foreign exchange services for their customers. Deak said many bankers told him there was "no market for our services" when he started, but he was undaunted. "They found…as time went on," Deak recalled, that "individuals and firms engaged in international business were demanding more varied services, including greater knowledge in exporting. Banks soon saw that their often conservative and old-fashioned 'foreign departments' could not fill the bill. They were faced with a new vocabulary and the fact that special skills definitely were needed to deal with such transactions as multilateral currencies; triangular deals; swaps of currencies; hedges and straddles; arbitrage; restricted, blocked, non-transferable, resident and non-resident accounts; multiple rate currencies; banknotes, and inland and hand payments. It didn't take long for the Deak-Perera Group to be ushered on to center stage to practice its fine art."
Today, in a world where exchange rates are more volatile than ever and at a time when people are increasingly concerned with the threat of inflation, the services that Deak & Co. offers are in greater demand than ever before. And its network of banks, foreign exchange houses, and precious metals departments—linked as they are by constant intracompany communication on market conditions and opportunities around the world—enables it to provide traders and investors nearly every conceivable service they might need. Whether it be a currency futures contract to hedge against an unfavorable exchange rate movement affecting foreign assets or liabilities, a Swiss Franc account in or out of Switzerland, a portfolio of foreign bonds, a bullion safekeeping account abroad, or collecting on a foreign draft, one or another of the Deak-Perera members can provide these (and many other) services. And for those with gypsy blood, Deak & Co. deals in 120 foreign currencies and even sells prepackaged currency complete with travel tips.
Deak obviously puts his trust in hard money. "The best way for a businessman or an individual to protect himself against inflation is to stay active, engage in imaginative business, swim with the tide and stay atop," he advised recently. "A sizeable part of the available capital should be invested in precious metals, and another sizeable part should be invested in highest yield, short term, readily convertible securities…"
Amid the dispute between investment counselors and economists over whether we face inflation or deflation, Deak counseled that gold and silver have always "fared well" during all types of "economic upheavals." "They were always readily convertible into cash, if cash was needed, or they could be bartered for other products, if we reach that stage."
And he is confident that, no matter what comes, the Deak-Perera Group will survive and prosper. "In our type of business, monetary and economic upheavals create additional activities," he observed. "We will not fare badly in an inflationary world, because we are active in business and we are aware of the dangers of inflation. We maintain a liquid situation in currencies, in ready funds, and we avoid speculations."
Asked about investing in foreign currencies, Deak replied that "of the so-called 'hard' currencies,…the Swiss Franc is the hardest and the soundest. The Austrian Schilling is aligned to the Deutschemark (and to some lesser degree to the Swiss Franc). The Austrian economy depends greatly on the German economy."
He added that "inflation in the United States will affect the currencies of the entire world. If there is inflation in the United States, there will be inflation in the rest of the world." Still, Deak said hopefully, "Switzerland might be an exception and, I should say, will probably be an exception. Accordingly, the Swiss Franc, in my opinion, is the strongest currency and will be the strongest one. Switzerland can withstand to a great extent inflationary pressure, but she cannot isolate herself completely from the outside world."
What concern does Deak have for government intrusion into his activities? Deak said he is "fully aware" that the company "would be greatly affected by U.S. exchange controls" and said he would have no alternative but to cooperate. But he noted that while exchange controls "might reduce the scope of our business considerably,…we might place more emphasis on our activities in the offices outside the United States." In any event, he said he does not believe "that dealing in restricted or blocked funds in foreign countries can be and will be prohibited by the U.S. government "
Deak said that another "gold confiscation, as it happened in 1933, is within the realm of possibilities," but he does "not believe that our customers will be exposed to harassment by the U.S. Government or will be subjected to more investigation or inquiries than in the past." The company "will always comply with the laws and regulations of the United States" but will only open its records for government inspection "if the laws require us to open the books to them for legitimate purposes" (emphasis added).
What does the future hold for the Deak-Perera Group? "We do not intend to enter into new types of services," Deak said, "but just expand the services which we are providing now to the public, and we endeavor to become more efficient and geographically more widespread." Thus the company just opened a new office in Chicago, to take advantage of a growing interest in foreign commerce and travel in the Midwest. But Deak said the company will expand only as fast as it finds more "competent managers," persons who "have to go through very lengthy training" and acquire "years of experience before they become managers." Many high-level Deak personnel are Swiss, including, most prominently, the company's executive vice-president and vice-chairman of Foreign Commerce Bank Otto E. Roethenmund.
Nicholas Deak will continue to stand by hard money. He is one businessman who is not bamboozled by the dreams, schemes, and promises of governments, and perhaps this is the secret of his success in good times and bad.
Steven Beckner graduated from Duke University and is the editor of Deaknews.
The post Making Money from Sound Money: The Nicholas Deak Story appeared first on Reason.com.
]]>The present system of our legislation seems founded on the total incapacity of mankind to take care of themselves or to exist without legislative enactment. Individual property must be maintained by invasions of personal rights and the "general welfare" secured by monopolies and exclusive privileges.
A campaign remark by Roger MacBride? A pungent commentary on Congress by Murray Rothbard? Or the frustrated indignation of a small businessman beset by OSHA and a dozen other government agencies?
None of the above. The observation was made March 11, 1835, by William Leggett in one of the innumerable editorials this 19th-century journalist wrote during an all too short career.
Some 140 years before the current crop of libertarians burst on the scene, Leggett was giving strident voice to a thorough-going belief in the principles we've come to associate with moderns such as Rand and Rothbard. It would be difficult to find a more consistent, cogent, or energetic advocate of liberty in American history. He attacked every conceivable type of government intervention in economic and social life. And contrary to popular opinion of the pre-Civil War era, there are few interventions today that were not already being practiced in some form back then.
Leggett was calling for laissez-faire in an age when government was being used in favor of business more often than against it. Though he was meticulously even-handed in his application of free-market principles, he was regarded by contemporaries, as he is now by most historians, to be in the labor camp. And in fact Leggett was the guru and spokesman for the New York-based Equal Rights or Locofoco party—a radical working-class spinoff from the Democratic Party. Created in 1835 as the earliest significant American labor movement, the Locofocos were probably more free-market oriented than the business community of that era.
Born in New York City in 1801, a son of Abraham Leggett—an officer during the Revolution—Leggett lived as a pioneer in Illinois for a time before taking a commission in the Navy in 1822. His naval career was cut short in 1825, when he was court-martialed for dueling with a fellow midshipman. As explained in the entry for Leggett in the Dictionary of American Biography, "His faults were chiefly hot temper and a witty, unruly tongue." For example, one of the charges against Leggett at his court martial was that the erstwhile young poet had quoted passages of Shakespeare "of highly inflammatory, rancorous and threatening import" against his captain.
But such faults were to serve Leggett well in his chosen profession. His came to be known as one of the most venomously articulate pens in the infant American newspaper world. Mencken and Pegler—and occasionally von Hoffman—are his only modern rivals at the art of ruthless, cynical commentary. After his military discharge, Leggett took up residence in New York City, where he devoted the remaining years before his untimely death in 1839 to intrepid political economic writing that enthralled some, scandalized others. He had no sacred cows. He attacked the Bank of the United States, and when Andrew Jackson destroyed that he attacked state banks. In analytical exposés that would make any Austrian economist proud, he called for an end to fractional-reserve banking and a return to gold and silver. He railed against government grants of monopoly, against tariffs, against government censorship, and against slavery.
The quotes used in this article are taken from The Collected Works of William Leggett, published in 1840, edited by his friend Theodore Sedgewick. It is regarded as the first American effort to honor the writings of a journalist.
After modest success as a poet, Leggett began writing for the New York Mirror and for his own short-lived weekly, The Critic. But his real fame and influence began when he became assistant editor and part owner with William Cullen Bryant of the New York Evening Post. During one period, June 1834 to October 1835, Leggett served as chief editor of the Evening Post while Bryant was in Europe. In Bryant's biography it is noted that when the great poet and editor returned from Europe he found "the journal without an editor, its business manager just dead, and its circulation, advertising revenue and influence disastrously injured by the ill-temper and lack of judgment with which Leggett has asserted a Locofoco Democracy, attacked monopoly and inflation and harried the Whigs." Leggett, whose ill health had prompted Bryant's return to America, was severed from the Evening Post. Even though Bryant made that paper one of the nation's strongest voices of Democratic, antimonopoly, sound-money, free-trade opinion, Leggett apparently found it too tame.
He now became editor of the Plaindealer, where he poured forth his increasingly anarchistic and abolitionist sentiment until that publication folded in September 1837. Simultaneously he found time to edit another daily, the Examiner. "How he finds time to write so much, I know not," Bryant is said to have remarked.
The 1830's were stormy years. America had developed its own peculiar form of aristocracy, the focal point of which was the small banking community. President Jackson succeeded in destroying the second incarnation of Federal central banking, and he distributed the government's deposits among some 80 "pet banks." In that day bank charters, like all corporate charters, were grants of privilege from state legislatures. These charters, conveying the right to print money to a selected few politically powerful institutions, were paid for in hard cash: "that peculiar species of argument with legislators…which, with very many men, constitutes the main ground of their desire to get into the legislature."
In an attack on the use of special legislation for special interests, published in the November 21, 1834, Evening Post, Leggett summarized the libertarian philosophy very aptly.
Governments have no right to interfere with the pursuits of individuals…by offering encouragements and granting privileges to any particular class of industry, or any select bodies of men, inasmuch as all classes of industry and all men are equally important to the general welfare, and equally entitled to protection.…Whenever a Government assumes the power of discriminating between the different classes of the community, it becomes, in effect, the arbiter of their prosperity.…It then becomes the great regulator of the profits of every species of industry, and reduces men from a dependence on their own exertions, to a dependence on the caprices of their Government.
For Leggett, the bottom line in judging the actions of government was the effect they would have on labor—a considerably broader category in early 19th-century parlance. The disenfranchised worker of that day, who was forbidden to organize to bargain collectively, was hit heavily by tariff walls that drove up prices and by fraudulent or exclusionary banking practices. And more ambitious citizens were preempted from many fields of entrepreneurship through the systematic denial of the benefits of incorporation to all but a few with political pull. Leggett, during the brief period of his writing, saw through the sophistry of arguments against free trade and sound money, and he gave the general citizenry the big picture on how the nascent U.S. corporate state was harming them.
Leggett's favorite targets were bank corporations, which he attacked as particularly evil cases of the legislative special-charter racket. While advocating the passage of a general law for joint-stock partnerships, he withheld his endorsement of general incorporation of banks until the advent of sound banking principles. In this respect, Leggett was a real precursor of the Austrian, Rothbardian position on money and banking—namely, that fractional reserve banking is both inflationary and fraudulent.
Beginning at least as early as 1814, states had allowed banks to break confidence with their depositors and default on their obligations by "suspending specie payments"—that is, refusing to redeem their banknotes in gold or silver. This enabled banks to create deposits at will by issuing more notes ("warehouse receipts" for specie) than they had gold or silver to back, thus creating windfall earnings on fictitious paper.
Leggett wrote prodigiously and contemptuously about this "fractional reserve banking," as it would come to be called. In a December 1834 editorial titled "The Monopoly Banking System," he identified the true nature and motive of this practice.
No set of men would desire a bank charter merely to authorize them to lend their money capital at the common rate of interest; for they would have no difficulty doing that without a charter, and without incurring the heavy expense incident to banking business. The object of a bank charter is to enable those holding it to lend their credit at interest, and to lend their credit too, to twice and sometimes three times the amount of their actual capital.
In the state of New York, as elsewhere, the banking system had become particularly enmeshed with the political authorities because of the state's need of a liberal credit machine to finance ambitious internal improvements like the Erie Canal. A state-sponsored cartel of banks had been created by the Democratic political machine (the Albany Regency). It was bolstered by a mutual insurance scheme known as the Safety Fund, which sought to protect all banks from the consequences of their own inflationary deposit and note creation. Commenting on this tightly held bank cartel, Leggett wrote in the December 1834 Evening Post:
The people of this state fondly imagine that they govern themselves; but they do not! They are led about by the unseen but strong bands of chartered companies. They are fastened down by the minute but effectual fetters of banking institutions. They are governed by bank directors, bank stockholders, and bank minions. They are under the influence of bank monopolies, with a host of associate and subordinate agents, the other incorporated companies depending on bank assistance for their means of operation. These evil influences are scattered throughout our community in every quarter of the state. They give the tone to our meetings; they name our candidates for the legislature; they secure their reelection; they control them when elected.
While longing for the abolition of restricted banking, Leggett qualified his support of "free banking." Writing on behalf of his libertarian labor constituency, he explained:
We would not have banking thrown open to the whole community until the legislature had first taken measures to withdraw our paper circulation. As soon as society should be entirely freed, by these measures, from the habit of taking bank notes as money, we would urge the repeal of the restraining law, and place banking on as broad a basis as any other business whatever.
Critics of free banking in the 19th century have charged that general incorporation, lack of regulation, and lack of central bank direction between 1832 and 1865 led to the chaos of "wildcat banking." The truth is that the "wildcat" or so-called free banking of that period was as much a mockery of the free market as was monopoly banking. The wildcat banks prospered by issuing large quantities of worthless banknotes and making it very difficult for the unlucky recipients to redeem them. Such fraud flourished under the benign neglect and often outright support of state and local governments, which sometimes used these fly-by-night institutions as convenient sources of support for their internal improvement bonds. Leggett inveighed against both abuses.
If anyone thinks that inflation is strictly a modern problem in America, consider that in the period of Leggett's greatest journalistic output (1834-37), money supply per capita (including only coins and banknotes in circulation) rose from $8.64 to $13.87 (according to the Annual Report of the Comptroller of the Currency, Dec. 4, 1916, vol. 2, p. 44). Most of the increase in banknotes was unbacked by real capital, and much of the capital was mere bonded debt of government. Many of the internal-improvements securities on which the pyramid of credit was founded would eventually be defaulted on by state and local governments.
On May 10, 1837, shortly after the Federal government had actually begun distributing a $37 million surplus among the states in a 19th-century form of revenue sharing, the inflationary bubble burst. All the banks in New York suspended specie payments, an action validated by the state for one year. Other states followed suit. Leggett, capsulizing the laissez faire philosophy of the radical Democrats and explaining cause and effect, had this to say in a Plaindealer editorial:
Banking is a good thing enough in its intrinsic nature; but government should have no connection with it, and should recognize nothing as money but silver and gold.…We are not an enemy to a paper representative of money, any more than we are to confidence between man and man in any other shape it may naturally assume, for mutual convenience in the transaction of necessary dealings.…We are not an enemy to banking.…We are an enemy only to a mixture of politics with banking; to the vain attempts to regulate the channels in which trade shall run; to that legislative intermeddling which withdraws credit from the harmonious operation of its own laws, disturbs its equal flow, and leaves the community to be at one time deluged with a cataclysm of paper money and at another exposed to all the horrors of financial drought.
To Leggett, the Panic of 1837 was caused "by the inevitable operation of monopoly legislation…the wretched charlatanry, which seeks to prop up an artificial system of credit with special statutes, and hedge it round with penalties and prohibitions." It also demonstrated "the consequences of that folly which would substitute the laws of man for those of nature, and wholly change the irreversible order of causes and effects." But would the public or the politicians learn any lessons from this latest denouement of the boom-bust cycle? "What can legislation do?" demanded Leggett. "Insult the community, by confirming the special privileges of money changers, after their own acts have declared their utter worthlessness? Enable a band of paper money depredators to prey more voraciously than before on the vitals of the people? Authorize them to pour out a fresh torrent of their promises? Will the community tolerate such an enormous fraud?"
"Let the banks perish," said Leggett. "Now is the time for the complete emancipation of trade from legislative thraldom. If this propitious moment is suffered to pass by unimproved, the fetter, now riven almost asunder, will be riveted anew, and hold us in slavery forever."
As anyone who now endures the vicissitudes of the Federal Reserve's monetary "targets" and the threats of the IRS and the FBI to the privacy of bank accounts knows, history has not taken Leggett's advice.
William Leggett—a creature, a phenomenon, of the 1830's—did not live beyond the end of that colorful decade. In 1838, he nearly succeeded in winning a Democratic nomination to Congress but was rejected as too radical on the basis of his antislavery convictions. In 1839, President Van Buren appointed him diplomatic agent to Guatemala, his friends hoping the climate would save his health. He died before sailing. He was buried in a New Rochelle cemetery, where, ironically, the Tammany Young Men's General Committee erected a monument over his grave. The fact that Leggett had had running battles with the Tammany Hall administration throughout his career is testament to the esteem in which this libertarian man of principle and integrity was held.
Steve Beckner is editor of Deaknews, a financial newsletter published by Deak & Co. He is a graduate of Duke University, where he majored in history and economics. His articles have appeared in such publications as Human Events, Boardroom Reports, and the Congressional Record.
The post Leggett appeared first on Reason.com.
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