May 20, 2003

Fleckenstein talks gold, dollar and such

We are active readers of William Fleckenstein’s Daily column. We are posting today’s excellent article as it is quite useful for our investing discipline. I have enjoyed Bill’s works for years.

Posted with permission.

Market Rap
Drinking the Dollar Pretty
By Bill Fleckenstein
Special to

05/20/2003 05:42 PM EDT

“Overnight, the equity market action was pretty subdued, and that about describes our opening and early going here. The market flopped and chopped around until midday, when we saw a selloff to the day’s lows. But the last 45 minutes saw a spirited rally that trimmed those losses, and we finished roughly midway in the day’s range. There’s little to point out about the day’s action.
Impediment to the Marriage of Two Gold Mines: Away from stocks, the dollar was on the slightly quiet side for a change, trading on both sides of unchanged vs. the euro and the yen, before closing down 0.5% against both. Fixed income screamed again, with the 30-year future up 1.5 points. Silver closed down 1%. Last night, gold was on a rip, up over $5 at one point, before closing up $2.10. Rumor has it that Ashanti Goldfields (ASL:NYSE – news – commentary) is closing down its gold hedges. AngloGold (AU:NYSE – news – commentary) , with whom it’s in talks, could have made this a condition to perhaps acquiring the company. That’s speculation on my part, but it all seems to make sense.

Turning to the news, I must reprise a story in today’s Wall Street Journal titled “The Dollar’s Stumble: Winners and Losers.” It underscores a point I have been making frequently, which is that potential problems in the dollar would be dismissed by folks lobbying on behalf of its decline. In that spirit, the story begins: “Unless you run a German factory, hope to buy a Canadian sports team or plan a vacation to Italy this summer, you probably should consider a declining dollar a good thing that likely will boost the prospects of U.S. companies.” Yes, if you were planning on doing those things, you would be affected, and if you’re not, you won’t be affected immediately, that being the operative word.

Indebted to Imperiousness: The big question is, will foreigners sit patiently by while we slowly cheat them? As my good friend Jim Grant says, “It’s an astonishing act of hubris from the world’s greatest debtor.” In essence, we are saying to foreign holders of our debt, we are going to pay you back less money than you lent us, because we’re going to depreciate our currency. If you were one of them, would you feel good about that? It’s a major point that seems to be overlooked in all this discussion, and you’ll look in vain to see it discussed in the Journal article. (The New York Times carried a more balanced discussion on this topic today, but it took them three full days to realize the snowman’s comments were news.) As I noted yesterday, the yields are so skimpy on our fixed-income instruments right now that they can be eradicated by a day’s move in the foreign exchange markets. Index Close Change
Dow 8491.36 -2.03
S&P 500 919.73 -1.04
Nasdaq Composite 1491.09 -1.68
Nasdaq 100 1112.85 +0.36
Russell 2000 408.85 +0.53
Semiconductor Index (SOX) 337.63 +0.87
Bank Index 794.15 +0.90
Amex Gold Bugs Index 140.79 +0.17
Dow Transports 2365.28 +4.34
Dow Utilities 233.09 +1.62
NYSE advance-decline +418 +1,793
Nikkei 225 8059.48 +20.35
10-year Treasury Bond 3.37% -0.078

Of course, it’s not just foreigners who will be affected. A declining dollar hurts us here in many ways. It is de facto inflationary, raising the price of anything we want to buy that comes from outside the country. Yes, some companies may not increase prices immediately, but over time they will. Also, anyone in America who competes with anyone from abroad will be able to raise prices in lockstep with foreign prices. In essence, this lowers our standard of living, pure and simple. So, here is another negative consequence that the Journal fails to identify.

Putting a Theory Through Its Pesos: Continuing on, the story makes an absolutely staggering statement: “To many investors, a weakening dollar is all well and good unless the slide turns into a rout. But even then, the stock market and the economy could do well.” Think about this for a minute. Not only are we to believe that a weak dollar is good, but even a really weak dollar is good. If that were the case, then nirvana would exist in countries like Argentina and Mexico, where currencies routinely vaporize. By this “logic,” every country with a weak currency ought to be doing spectacularly, which is obviously not the case.

Taking a step back to a period of dollar decline, the mid-1980s, the article gives the following quick, glib synopsis (which doesn’t jibe with my recollection, and I remember the period very well): “Economic growth in the U.S. was moderate over the next two years. Helped by a collapse in the price of crude oil, bond yields fell, inflation slowed, but most importantly, the stock market nearly doubled over the next two years. The rally ended with the 1987 stock market crash, so it is hard to say whether that story really does have a happy ending.” Are you kidding me? I mean, we had a stock market crash, helped by portfolio insurance but precipitated by what happened to our currency. The article’s description only applied to 1985 and 1986. In 1987, the bond market was slaughtered right up to the crash. The currency took a beating, and inflation kicked up to 5% or so. Then the market crashed. That’s a quick and dirty of what really happened.

Gold Refuge From the Race to Debase: In any case, the story does make a worthwhile point near the end: “One big difference between now and then: In the 1980s, the U.S.’s trading partners were happy to keep their currencies strong. Now, if a decline in the dollar hurts already-struggling foreign economies, it could lead to a round of can-you-top-this devaluations [what used to be called “beggar thy neighbor,” a strategy that’s been around for centuries] , with countries pushing their currencies down in an effort to boost their economies. In the worst-case scenario, that leads to trade feuds that could crush global economic growth.” Because all these currencies are made out of paper, we could in fact see that outcome.
This, ladies and gentlemen, is one of the reasons why folks need to own gold. Gold is a currency that has stood the test of time. Gold has intrinsic value, which is why it’s an insurance policy. Paper can be printed at the whim of the Fed. There is no printing press for gold. Its supply is finite, and taking it from the ground costs money. Gold has preserved its purchasing power, while during the great inflation of the last 90 years since the Fed came into existence, our currency has lost about 90% to 95% of its purchasing power.

Of course, the Journal does not bring up the issue of gold as an insurance policy, since it’s rather sanguine about the debasement of our currency and what that portends. This article is riddled with inaccuracies that can lead folks to the wrong conclusion. Given its stature as the business paper of record in America, I am amazed at the number of bad policies that The Wall Street Journal appears to advocate. ”