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The Gold Price, the Dollar and the Specter of US Hyperinflation

"This is not a normal investment environment..."

IS THE WORLD nearing the end of the Dollar standard? If so, what will that do to the Dollar Gold Price – and the purchasing power of currency?

These are all questions pondered by ShadowStats.com editor John Williams in this interview with The Gold Report.

The Gold Report: When we talked in May, you predicted that hyperinflation could be a reality as soon as 2014. Have six months of Euro debt crises, Middle East revolts and US Treasuries' downgrading altered your outlook?

John Williams: Not a bit. We still seem to be moving down that road to a relatively near-term break toward hyperinflation. The most important thing that's happened since we last talked was the global response to the US legislators' negotiations over the debt-limit ceiling and the deficit reduction problems at that time. Clearly, no one controlling the White House or Congress was serious about addressing the nation's long-term solvency issues. That sparked a panic selloff on the Dollar against currencies such as the Swiss franc, and of course gold, which made the Gold Price rally sharply.

TGR: Did the politicos learn anything from those "negotiations," as you just described them?

John Williams: Not at all. In fact, I'll contend that everything that's happened since then has been just a playing out of what resulted in a complete collapse in global confidence in the Dollar. The ensuing rapid shift of market focus to crises in the Euro area was really more of a foil to distract the global markets from the Dollar. Following that horrendous performance by Congress and the White House, the global markets indicated a major loss of confidence in the Dollar that had been coming. I think that's now established and in place. The Dollar is doomed to lose its reserve status eventually, and any day now, we may see things heat up again over the deficit negotiations.

TGR: What steps would we see on the way to the Dollar losing its reserve status?

John Williams: Probably the biggest thing would be heavy selling pressure against the US Dollar, along with a spike in the stronger currencies such as the Swiss Franc. The more the pressure builds for selling of the Dollar, the more expensive and disruptive it will be for the Swiss National Bank to keep supporting the Euro so I don't think that intervention will last long.

As heavy selling of the Dollar develops against the Swiss Franc, the Canadian Dollar and the Australian Dollar, and the Gold Price rallies, we'll see a very strong effort by those who are dependent on the Dollar—such as the Organization of the Petroleum Exporting Countries (OPEC)—to have the Dollar removed from the pricing of oil. Along with that will come a movement to change the Dollar's reserve status.

TGR: If other countries start demanding payment in alternative currencies, how can investors protect themselves against a shift from the Dollar standard?

John Williams: I'm not a day-to-day timer in this. My outlook has been consistent that we're heading into US Dollar hyperinflation, and the effective purchasing power of the currency as we know it will disappear. If you're living in a US Dollar-denominated world, you don't want to be in Dollars — you want to move to protect the purchasing power of your assets, your wealth.

To do that, I look very specifically at physical gold, preferably Gold Coins and silver, and assets outside the US Dollar. The currencies I like the best are the Swiss Franc, the Australian Dollar and the Canadian Dollar. This is something you do for survival over the long haul because you're likely to see all sorts of volatility in the short term.

But once you ride through the storm, if you've been able to preserve your wealth and assets in terms of their purchasing power and to maintain liquidity — which the physical gold and the currencies will give you — you'll be in a position to take care of yourself and take advantage of some extraordinary investment opportunities that likely would flow out of the turmoil ahead.

In the interim, I wouldn't start betting that next week we're going to see the Dollar do this or that. This is a long-term hedge strategy, an insurance policy against the hyperinflation that I view as inevitable due to the long-range insolvency of the US

TGR: Is that long-range insolvency also inevitable?

John Williams: Severely slashing social programs such as Social Security and Medicare would be the only way it could be avoided. I don't have any problem per se with Social Security or Medicare, but you can't bring things into balance without addressing them. If you look at the US annual deficit on a GAAP basis—generally accepted accounting principles — with accounting for the year-to-year change and the net present value of unfunded liabilities in Social Security, Medicare and such, you're seeing a federal deficit in excess of $5 trillion per year.

Putting that in perspective, if you wanted to raise taxes, you could take 100% of people's salaries and the government would still be in deficit. You could cut every penny of government spending, except for Social Security and Medicare, and you'd still be in deficit.

You can't escape the eventual hyperinflation if those programs are not addressed. Originally, I was looking for hyperinflation by the end of this decade. I've advanced it to 2014, and it may well come before that. I think we're already in the early stages of going through what has to happen for this to break.

TGR: But would politicians touch those entitlement programs in an election year?

John Williams: No one wants this, but the federal government and the Federal Reserve have backed us into a corner and there's no other way of escaping. There's no political will to address the long-range insolvency, so they kick the proverbial can down the road. They did that in 2008. They did everything they could to prevent a systemic collapse by creating, spending and guaranteeing whatever money they had to.

We're coming to another point where we face risk of systemic collapse, and we're likely going to see another round of quantitative easing (QE) as a result. That also could pull the trigger for massive Dollar selling, moving us into much higher inflation. That will start the final process.

TGR: One of your recent newsletters showed that annual core inflation had risen for 12 straight months, ever since QE2. What would QE3 do to some of the indicators you watch — gold, silver, commodities?

John Williams: Gold tends to anticipate the inflation problems. All sorts of factors hitting gold create tremendous volatility, but generally it will continue to move higher as the broad crisis deepens. Then as we get into the high inflation, it will start soaring. People have to keep in mind that they're preserving the purchasing power of the Dollars that they put into gold. 

If gold gets up to $100,000/ounce (oz) as you start breaking into the hyperinflation, and they bought gold at $2,000/oz, it isn't that they made $98,000 per ounce. Instead, they've maintained the purchasing power of the Dollars they put into gold.

They've also lost the purchasing power of the Dollars that they didn't put into gold or some other hard asset. That's a different view than most people look at with investments, but this is not a normal investment environment. Again, this is one where you batten down the hatches and look to preserve wealth and assets, as opposed to trying to make money day to day in the markets. Once you have your basics covered, then you take gambling money and go play Wall Street's casino.

As to core inflation, the Fed likes to ignore energy and food prices, using the rationale that those prices are too volatile and don't hold over time. Yet, oil is probably the most important single commodity in terms of domestic inflation. Not only does it hit basic energy costs, but it also affects the cost of transportation of all goods. Beyond what is defined as basic energy costs, oil is also the basic raw material for many products, ranging from chemicals to fertilizers to pharmaceuticals and plastics.

As oil prices rise, the Fed just takes out the energy component in so-called core inflation. But the inflation still spreads to the broader economy. When they started to jawbone on QE2 in October of 2010, year-to-year inflation on a core basis was at 0.6%. In the consumer price index reporting of October 2011, despite a drop in the gasoline prices, core inflation was at 2.1%. In response to QE2, gold rose against the Dollar and the Dollar weakened against other currencies. The weaker Dollar, in turn, spiked oil prices. The higher oil prices spiked gasoline prices and broader inflation, which still is boosting consumer inflation in the US

With the next round of Fed easing, the Dollar problems will intensify again. That will put new upside pressure on oil and gasoline prices, further intensifying the spreading broad inflation pressures in consumer goods and services.

The Fed's mandate from the government is to try and sustain reasonable economic growth and contain inflation. From the Fed's standpoint, however, those are secondary to maintaining the solvency of the banking system. Nothing in the outlook for the system has changed meaningfully since the crisis in September 2008. The banking system still is in a solvency crisis, the economy continues to worsen and we've had no real recovery. The stopgap measures to prevent collapse of the system did nothing but kick the crisis a little further into the future, and now, we're coming to peak period of crisis again.

TGR: You've repeatedly said that the global economic crisis is not Europe's fault but part of a pending systemic collapse that started with the manipulation of the US financial markets — the moves you've been talking about. What countries or sectors will suffer the most if the crisis continues?

John Williams: The more closely they're tied to the Dollar, the greater the inflation impact will be in other areas, but the runaway inflation I'm talking about will be largely in the US and for people living in a US Dollar-denominated world.

That's from an inflation standpoint. Yet, it also will have an extremely negative impact on the US economy, and problems in the US economy indeed will have a global impact. The US economy is still the largest in the world, and you can't push it deeper into a depression without having negative economic consequences outside the US

But while the global economic problems will worsen, systems can ride out bad economies. We can't ride out a hyperinflation because the currency becomes worthless. That's an ultimate crisis that forces a resetting of the system.

TGR: Can Europe or China do anything to counteract what's going on in the US?

John Williams: Dump the Dollar. China needs to delink from the Dollar, and it will be forced to do so. It's importing inflation. If China doesn't want that inflation problem, all it has to do is cut its link with the Dollar, and oil suddenly becomes a lot cheaper.

TGR: But how practical would it be for China to sell off all the US Dollars and US Treasuries it holds?

John Williams: In terms of insulating itself against US inflation, all China has to do is delink its currency from the US Dollar. That's true of other currencies as well. The Swiss franc is artificially linked to the Euro now, but because of the general weakness in the Dollar, it's ironically also intervening to support the Dollar against the Euro.

Whenever major holders of Dollar-denominated assets decide to sell those assets, that will determine how large a loss they will take on the US currency.

TGR: Will the Euro survive?

John Williams: I wouldn't bet on a long-term survival of the Euro, but I think it will survive the current crisis as long as its survival is needed to prevent a systemic collapse in the US The Fed will do whatever it has to do to keep Europe's problems from imploding the US banking system. It can create whatever money it wants to do that.

Long term, I would not look at the Euro as surviving in its current form. The loss of the Dollar eventually will force a reexamination of the global currency structure. That might be a time when other currency disorders get resolved and we may see the Euro break up. It was never practical to think that all the countries within the Euro would be able to align their economic and fiscal policies in a way that would enable them to operate together. The Euro was doomed from the beginning.

TGR: Let's go back to gold. According to your research, the September 2011 high of $1,895/oz gold was below the historic high of $850/oz in 1980, if the 1980 figure was adjusted for inflation. The $850/oz in 1980 would have equaled $2,479/oz in Consumer Price Index–all Urban consumers (CPIU)-adjusted Dollars, or $8,677/oz Shadow Government Statistics (SGS)-alternate-CPI-adjusted Gold Prices in 2011. Is gold underpriced if you put it into that context?

John Williams: On that basis, yes, it is. It also depends on when you measure it. My hyperinflation report looks at what has happened to the Dollar over a longer period. Since President Roosevelt took the US off the gold standard domestically in 1933, the Dollar has lost 98–99% of its purchasing power. People tend to forget that. But if you look at the Gold Price movement since 1933, it actually has moved a little more than the government-reported pace of inflation. My estimate of what inflation should be if we had consistent CPI reporting shows that the loss of the Dollar's purchasing power against gold is the same as it is measured by the CPI.

So over time—and this is true over millennia—gold tends to maintain purchasing power, which means it holds its value net of inflation. Not that you'd break a piece of gold down to a small enough unit to buy a loaf of bread, but if you did, it also would have bought a loaf of bread in ancient Rome.

TGR: For the same amount of gold.

John Williams: Same amount of gold. Gold has a long tradition as store of wealth. That's why—globally—gold generally has been viewed as such. It only got bad press in the US because private ownership of gold was outlawed after Roosevelt's action. It became legal for Americans to own gold again after Nixon abandoned the international gold standard. Yet, even today, some on Wall Street discourage investment in physical gold, largely because they cannot make a commission on it, as they do with stocks and bonds.

Given the gold ownership limitations after 1933, those in the US who wanted to Buy Gold turned to Buying Gold stocks. But because of what happened in the 1930s—that's now two generations or so ago—gold as an investment and as a hedge to protect wealth lost some of what had been its commonly recognized value in the US Outside the US, almost everyone views gold as a traditional hedge.

TGR: That's physical gold. What about exchange-traded funds and gold equities in the juniors? Will those investments also preserve wealth?

John Williams: I wouldn't count on the financial system working as it should. I look at physical gold, preferably sovereign coins, not only as a store of wealth, but also for purposes of liquidity. 

Gold stocks also should preserve wealth over time, but I would look at them as longer-term holdings. There could be periods of systemic failure with resulting interim liquidity issues. 

TGR: You talked about hyperinflation coming as early as 2014, or even before that. But 2012 is just weeks away. What can people expect next year in terms of the data you watch and maintain versus some of the government-issued statistics?

John Williams: I can tell you that the economy is weaker and will remain weaker than the government reports. We don't have an economic recovery in place. We'll tend to see higher inflation.

TGR: Something to watch out for. Thank you, John.

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