Most people, including many knowledgeable commentators, are failing to grasp the real economic and political significance of these problematical times. These commentators, while emphasizing the preservation and increase of one's assets, have consistently overlooked the more all-encompassing consideration of survival per se. Increasing your ability to adapt to an ever changing world has usually been an important prerequisite to success, but we may very well be entering a time when adaptability will be an absolute prerequisite, perhaps even to personal survival. Hopefully the following comments will help the reader achieve a better perspective on some of the more important economic problems now facing the world, and will be an important adjunct to laying future personal and financial plans.
Two of the main causative factors for the growing number of problems we face are the ongoing inflationary debasement of currencies, and simultaneously, the erosion of the private sector by burgeoning bureaucracies throughout the Western World. An erosion, not only of an increasing portion of the free markets involved, but also of individuals and their capacity for self reliance.
Of course, when viewing this apparent Gordian knot of problems inflation surfaces as the most acute problem at this time—the oil crisis has shown us just how serious this inflationary path can be. The rise in the price of oil did not cause the inflation as many government officials and others would have you believe. No, the Arabs did not inflate our currencies, but rather the Central Banks and others in direct control of the world's money supply did, and coupled it with their lack of restraint and discipline in administering the same. The Arabs acted in self defense with their price increases for crude oil—a defense against eroding currencies.
There is no doubt that "democracies" as they are presently structured, and politics as presently practiced, are not going to be effective in fighting inflation. Inflation is now literally built into the system. Governments are obviously intent on placating their constituencies (i.e., maintaining their power structures) so it seems highly unlikely that the degree of governmentally imposed austerity that is necessary to systematically wring out the present, long-term inflationary bias will be found. The basic truism remains: inflation cannot be overcome without politically unpopular recessions and a basic, continuing change in the management of monetary policy.
It is also axiomatic that hard currency and freedom go hand in hand; soft money policies and the ensuing inflations have regularly opened the door to unwelcome political visitors. Communism had a field day in 1974—Italy, Portugal, and in all probability, Great Britain (via trade unionism) will also come under its influence. Economic upheaval is the greatest salesman of radicalism—remember that the Nazis came to power under such circumstances! In a way the Arab world is now demanding tribute of the Western industrialized nations as did France of Germany after the First World War, and that debt burden contributed heavily to that historic German inflation. The question that should be raised today is whether or not we will be attempting to pay off our international debts with increasingly inflated currencies!
Paper (fiat) currencies are failing in their attempt to function as money. A classic indicator of this is the fact that today's markets are moving in hyperactive spasms rather than in the more normalized bull and bear patterns of the past. Volatility is the order of the day as more and more seasoned traders "stand aside."
And so it is in this inflationary climate that today's investor must make his decisions—indeed, must survive.
In an overall sense, two of the more important concerns today are the growing accumulation of the world's free monetary reserves in the coffers of the OPEC nations, and what appears to be an ever-increasing role for gold in the world's monetary system. These concerns are intimately linked and warrant examination to help impart an important overall perspective to your investment decisions—a perspective that will help separate you from the crowd.
GOLD AND ITALY
Last year it became obvious to the world community that the government of Italy was in serious financial straits. Italy had debts of over $10.5 billion in the Eurocurrency market and a persistent payments deficit of an additional $500-$700 million a month. Italy had reached the point, through pernicious monetary mismanagement, where it could no longer sustain itself as a viable financial entity without major assistance.
In response to Italy's problem the "Group of 20" (the major industrialized nations) of the International Monetary Fund met in Washington and authorized Italy to use her gold reserves as collateral for a multi-billion dollar loan from Germany. The German-Italian agreement valued Italy's gold at approximately $150 an ounce, a figure which seems to have set a floor price in the free market as well.
Interestingly enough, it was Arthur Burns of the Federal Reserve Board who suggested that gold be used as collateral in the loan agreement. This was the first time since 1934 that the government of the United States clearly admitted to an increasing role for gold, if even on a supposedly interim basis.
There is a strong likelihood that this agreement will be the harbinger of a new monetary system that will use gold in a more complex and important fashion. The German-Italian loan agreement was the Rosetta stone of gold's recent history: with this agreement the metal's mystique was broken and its practical monetary uses demonstrated to the world once again.
With this trend toward the mobilization of official gold reserves, there has been some fear on the part of investors that part of these holdings would be sold on the free market to satisfy governmental needs for foreign exchange for deteriorating balance of payments. However, it seems most logical that official gold reserves will be collateralized or exchanged between Central Banks rather than sold to the free market. It would be illogical for governments to sell an asset that can be used as collateral while continuing to grow in value. Fears that gold will be sold into the free market in any significant quantities are unfounded.
TOO MUCH MONEY
Meanwhile, the large build-up of the free world's monetary reserves in the Mideast creates many serious problems. The World Bank has publicly stated their opinion that by 1980 the OPEC nations' reserves will increase to $650 billion, and by 1985 to $1,200 billion. Hopes that the Arabs will use the Petrodollars to buy up assets in this country only place us, by historical perspective, at the crest of another great inflation. It was the French who purchased the German means of production during the German inflation of the 1920's, and the Americans and Germans who purchased the productive assets of Brazil during the 1960's. In addition, there is serious doubt as to whether or not most Western governments would allow the Arabs to buy up significant positions in our industries and other investment outlets, or indeed, if the Arabs trust the West sufficiently to consider it.
Recycling these funds back to the debtor nations via loans is in fact a restructuring. The funds leave the country in the form of a national asset and return as a liability. Increased liabilities do not lead to national solvency! Apparently neither the commercial banking systems of Europe nor those of the U.S. can cope with the recycling demands of Arab funds. In the words of Arthur Burns the flow of Petrodollars had become "unmanageable."
At present the Arabs are purchasing large quantities of U.S. Treasury Bills with their new-found liquidity, but this of course is a potentially volatile situation and not the solution. Many banks are taking these short term funds and making long term commitments—a sure prescription for insolvency.
When considering the disposal of these funds the question of gold arises, both as a means of paying for oil, and as an investment medium for Petrodollars. It does not seem likely that the Arabs will take gold in payment for oil at what they probably consider to be excessively high valuations for the metal at this time. Furthermore their lack of gold as a percentage of their total reserves tends to make them take a negative public position towards gold. However, they would undoubtedly like to begin accumulating the metal should the price begin to weaken noticeably from its present levels. We may very well someday see an Arab currency backed by gold.
Additional speculation about the Petrodollar problem includes the possibility that the OPEC nations may form their own banks to invest their new found wealth. There is also a feeling held by some that the price of oil will ultimately be linked to a composite price index of 20 world commodities, and rumors to this effect recently intensified. Of course this type of agreement would at least (in part) defeat attempts to purposefully depreciate currencies to obtain "cheap" oil from the OPEC nations.
To give you a better perspective, one might say that we are now passing through a "Clutch Period of Human History"—a period when the world is changing gears. At present we are feeling the effects of two important economic cycles: the 40 month and the 9½ year business cycles. Because of its shorter duration (from peak to trough) the 40 month cycle is the more noticeable of the two and is now headed toward its deflationary bottom. On the other hand, the 9½ year cycle is just beginning to peak, and this longer cycle is now reflecting the impact of capital expenditures made as many as five years ago. The discrepancy between these two cycles helps explain the current paradox of an economy where some industries are depressed while others remain at full capacity.
In mid-1975 the 40 month cycle is expected to turn bullish and its impact on the markets will make many investors forget fundamental, underlying instabilities. By 1977-78 an unusual occurrence will take place: both cycles will turn down simultaneously. Then and only then, in my opinion, will a true deflation occur. Expect the 1977-78 period to be the hangover after the party.
Explained differently, we are now in a period of "stagflation" with currently a heavier impact of the "stag" expected into the middle of 1975. Then we will begin seeing more of the "flation" aspect of the stagflation as the impact of various politically popular reflationary devices reaches economies here and abroad. Of course the ultimate consequence of this continued, politically motivated stimulation is worldwide depression.
As discussed earlier we are now witnessing the beginnings of some serious breakdowns in society as we know it. The situation makes it incumbent that one concentrate on personal survival as well as asset growth.
Don't expect that your gold holdings will take care of you entirely. When the crutches are finally pulled from under the complacent investor, the run to gold will be of a magnitude I dare not speculate on. In the interim you can expect wide swings in its price, especially when the public would seem to least expect it.
The spectre of serious food shortages also looms in the future, and the world food problem could very well be our most pressing problem in the 1980's. If it is, it will be a time when gold will buy a great many things, but also when food will buy a great deal of gold!
The extreme complexity of today's world demands that systems operate efficiently. Few can imagine what life will be like when the systems of distribution, transportation, and law fail to function. Clothes, food, fuel, lodging, and transportation all need to be considered. Better postpone the new Porsche in favor of a four-wheel-drive vehicle with a 42-gallon gas tank. A farm in the country may be good for more than just the kids!
James E. Sinclair is a General Partner of Vilas & Hickey, and head of Foreign Department, and President of Vilas & Hickey GMBH, Freiburg, West Germany. Mr. Sinclair was educated at the University of Notre Dame and Wharton School of the University of Pennsylvania. Mr. Sinclair has been a major speaker at Gold Forums and International Monetary Conferences and he and Dr. Harry Schultz have co-authored How the Experts Buy and Sell Gold, Currency, and Coin, forthcoming from Arlington House. He is past Vice Chairman of the International Monetary Seminar.