Brother, Can You Spare a Dime?

I was having dinner with some friends recently and made the comment that gasoline is cheaper now than it was half a century ago.  There was some polite laughter at our table. One’s friends are supposed to be kinder than strangers, but the strangers at the next table looked at me as if I were sipping gasoline instead of iced tea.   I will make the statement again now for the long suffering readers of this column:   Gas is cheaper now than it was in 1960, and no I have not been overcome by fumes. Of course I am speaking in terms of real wealth, not the monopoly money from Washington which now passes for legal tender. Allow me to explain.

 In 1960 dimes were made out of silver and three of them would buy a gallon of gasoline.  Those same three dimes today would be worth about $7.44, melted, and gasoline is averaging close to $4 per gallon for regular. Gas is cheap, priced in silver. Two hundred years ago an ounce of gold would buy a top quality rifle. The same is true for 100 years ago, and at $1700 per ounce you can still buy that rifle today and some ammunition to boot.  In the 1930’s, 30 ounces of gold would buy a top-of-the-line automobile. The same is true today. Since 1961 an ounce of gold on average would buy about 15 barrels of oil. As of the writing of this article on this blustery March morning, an ounce of gold will buy over 16 barrels of oil. Oil is cheap this morning, priced in gold. Precious metals like gold and silver are remarkably consistent indicators of real value.

One of the (few) interesting aspects of the ongoing republican “smack down” has been an opportunity to hear some of the contrarian views of Congressman Ron Paul, who has consistently advocated for a return to the gold standard and the dismantling of the Federal Reserve. This is not an endorsement of Congressman Paul or a suggestion that we unilaterally adopt the gold standard again. If you want to dismantle a house of cards without making a gigantic mess, you don’t start with the cards on the bottom of the stack. However, the contrarian view does make some excellent points. Since President Nixon took the nation off of the gold standard in 1972, the dollar has lost, on average, about 10% of its value in relation to gold every year.  The dollar buys less today than in its entire history. That’s bad enough, but the situation is about to get much worse.

Nixon released the hounds in 1972 when the dollar became a fiat currency tied to nothing more substantial than sentiment and sustained by American military might. Government unbound has created more debt almost every year since. Debt and the loss of purchasing power have remained as the naked truth behind the emperor’s new clothes. Debt and the loss of purchasing power have transcended every promise made by every democrat and every republican we have sent to Washington. That debt is unsustainable, and something has to give.

Government, for the vast majority of human history, has not been an institution of “giving.” Government takes. Government coerces. Government redistributes. We are the ones who give. The question today is how we are going to give and how much. I’m willing to venture a guess as to how our financial future might unfold. It involves our good friends, the Chinese government.

The Chinese government in some ways has been the kind of friend who buys you a drink while you are in rehab, but our addiction is spending. The United States currently has about $14.2 trillion of national debt and another $113 trillion in unfunded liabilities of Social Security, Medicare and prescription drug benefits. China has lent us, so far, about $3.2 trillion. About half of every dollar the government now spends is borrowed, and much of that is borrowed from China. China has a tremendous investment in this country, and they do not want to lose it.

If the US government defaults on its debt, the whole house of cards comes tumbling down and everyone loses. Only significant action will prevent that catastrophe, and this is how I believe it will unfold (but only after the elections.) First of all, look for more taxes, and look for them in all the ways government has of coercing more money from its citizens. Look for rates to change, credits to expire and loopholes to close. Look for more “sin taxes” and VATs or Value Added Taxes. Look for more taxes at the state and local level as these governments are left to their own devices as federal funding disappears. The next sign of imminent change calls for a little background information.

There has been longstanding political theater between Washington and Beijing about the value of the Chinese Yuan. Washington has demanded that the Chinese government allow the value of the Yuan to rise in order to make American goods more competitive. In reality, with a workforce of 810 million people and the ability to produce goods for pennies that would cost multiple dollars to produce here, the Yuan could quadruple in value and our goods would still not be competitive. I believe that the real reason Washington wants the Yuan to gain value is so that the dollar will lose more value – significantly more value.

Washington wants to be able to pay their debts with cheaper dollars, but what about the Chinese? If the US defaults, they lose their current investment. On the other hand, if they help us devalue our currency, their US paper is worth less, but they will find it much easier to buy up our hard assets – things of real value like real estate, mines and mineral rights and American companies. Look for the Chinese government, sometime after the November elections, to “grudgingly” allow the Yuan to appreciate in value. If and when that happens, watch the dollar and the price of everything we buy with it, and hold on to your hats.