What if the US Had to Pay its Debt in Gold?

Bill Bonner - Wed 08 Jul, 2009

America Reneges on its Promise to Pay its Bills in Gold

The stock market seems to be rolling over. Investors read the news. It’s probably becoming clear to them that the economy is not going back to normal any time soon.

Yesterday, the Dow lost another 131 points. Another big day down and it will be in the 7,000-range.

Oil sank too – down to $62. The dollar, bonds, and gold stayed about where they were.

Economists are still talking about an “exit strategy.” But in view of what is actually going on in the economy, they’ll probably want to stay on this highway a lot longer. This is the long road to ruin, of course. It may be fatal, but it is not – yet – unpopular.

Broadly, what is happening is exactly what should be happening.

The stock market rally is getting old... and may have already peaked out.

The consumer is running out of time, money and credit. He has no choice but to cut back. Savings rates are rising fast – from zero to about 5% of disposable income. Naturally, businesses are finding it hard to make sales. Earnings are collapsing... stock dividends are down sharply...

... and of course, businesses try to cut expenses by lightening up on their payroll.

When the correction began, it was led by losses in the financial sector. Those loses led to cutbacks throughout the economy. Now, it’s the cutbacks that are leading to financial losses. The economy followed the markets; now the markets follow the economy. Investors are realizing that their favorite companies will find it hard to prosper in this new economic environment.

“US consumers fall behind on loans at record pace,” says a Reuters headline. Delinquencies are going up on a wide range of household debt. Debtors have never had such a hard time keeping up with payments. Credit card delinquencies, for example, are running at 6.6%.

Well... duh.

And no wonder “banks get stingy on credit,” as reported in the USA Today. “Despite massive government efforts to bolster the credit market, banks are pulling back severely on card lending,” begins the front page article.

Once again, we see the feds’ plans failing. They give trillions to the bankers; the bankers cut back on consumer credit. And why shouldn’t they? They can see what the rest of us see – the consumer can’t keep up with the debt he’s got already.

At least, the consumer has wised up. He’s sick of debt. He’s seen where that road leads. What he wants is to get out of debt... to be free... to be safe.

It’s the government that remains stuck in deep illusion... The feds know that it was too much credit that got consumers into trouble. Their solution? Give them more credit!

The banks are issuing fewer credit cards than they did last year – 38% fewer. They’re pushing credit limits down too – the average limit on a new card is down 3% so far this year.

Instead of passing money on to customers, the banks are using the feds’ free cash to build up their own reserves... raise their salaries... and pass out bonuses. Makes sense. What else could they do with it?

More news from Tom Bulford on a powerful trend in new media.

“The world-wide web has given us all access to a limitless amount of information and all available for free. Commentary on events need no longer be left to salaried editorial writers.

“We can all twitter and text and e-mail and get our views out there. ‘E-books’ are threatening to deliver the death blow to the printed word, meaning that we need not buy all eight sections of the Sunday newspaper but simply the bit that is of interest. With young viewers more likely to go on-line than turn on the telly and machines that enable us to skip the commercials, advertisers are deserting commercial television in droves.

“Media moguls are desperate to respond, but how? Out of the rubble of the old business model some new structures are emerging. Rather than fight the new on-line community, the newspapers, magazines and broadcasters are making their content available on-line and trying to grab their share of this audience.

“The media scene is changing very fast, and as always there are winners and losers. While independent television stations and local newspapers are fighting a desperate battle for survival, new media concepts such as interactive game shows and You Tube are in the ascendancy.

“Our habits are changing. We are no longer prepared to accept news and entertainment as it is delivered to us. We know what we want, and we know where and when we want it. There are threats and there are opportunities and the prizes will be won by those who are far-sighted and bold.”

Editor’s note: Tom Bulford writes a twice weekly free e-letter called Penny Sleuth, where he first wrote about this trend. He’s found small-cap companies that are looking to get ahead of the trend in ‘new media’. Click here to read the latest issue of Penny Sleuth.

And more thoughts...

*** “Uighurs are beasts” shout crowds of Han Chinese in the remote northwest of the country. Uighurs are the Moslem minority. Han Chinese are the majority. And, judging from the photos, the Han want to kill the Uighurs.

One thing smart people always do is to underestimate the power of foolishness. It is wild and reckless to stir up a race war. But that doesn’t stop people from doing it. Any kind of war is a blow to reason and civilization. But that hasn’t made war unpopular, even among the most reasonable and civilized people on the planet.

It was within the lifetimes of many people reading this Daily Reckoning that the most advanced countries on earth began a war of annihilation. At the beginning of the 20th century, high culture and science were dominated by Germans. German musicians and composers... German poets and writers... German mathematicians, physicists, painters, philosophers – even the German economy was a world leader, second in output only to the United States of America.

Then, the Germans went off their heads – along with the Italians, the Russians, the Japanese... and many others.

But the Han have it right. The Uighurs are beasts from time to time. So are the Han... the Teutons... the Anglo-Saxons... and all the tribes on earth. Occasionally, for no apparent reason, the masks and restraints of civilization give way to mobs... and the old beast starts howling at the moon.

It happens in markets too. What is a bubble, if not a wild and reckless thing? A kind of madness? A mass illusion... a foolishness, in which people leave reason and civilization behind?

*** What if the US had to pay its debt in gold?

In the old days, before the monetary reforms of the 20th century... notably, Richard Nixon’s unilateral decision to renege on America’s promise to pay its bills in gold... countries had to settle up with each other in the yellow metal. The system worked well; it was reliable; it prevented bubbles. Edward Chancellor explains:

“A country had to pay for its imports or foreign investments with money gained from a surplus on trade. If more money was sent abroad than had been earned through exports, then gold would be packed onto ships to discharge foreign creditors. A declining stock of bullion would induce the central bank to raise interest rates in order to attract gold from abroad. Rising rates would produce a credit contraction, unemployment and general economic misery. The typical nineteenth century was severe, but short-lived.”

Then came the improvements. And the Great Depression. And now we are faced with another one.

Governments are fighting this one... just as they did the last one... but with much more money. The cost is in the trillions – most of it in the form of public debt. How will these debts be paid? We all expect that they will ultimately be eased by inflation – in full or in part. But suppose the feds had to pay up in real money?

Colleague Simone Wapler compared government debt to government gold. The US has gold worth about $241 billion, she reports. Its official national debt is $11.5 trillion. That gives it a debt/gold ratio of 48 – meaning, the feds have 48 times as much debt as gold.

Britain is even worse. Prime Minister, then Chancellor, Gordon Brown sold much of England’s gold at the worse possible moment – about 10 years ago. This leaves the island with only $9 billion worth of gold compared to $1,274 billion of government debt – a ratio of 1 to 139. But Japan is the worst of all. It has $23 billion worth of gold and $7.3 trillion of government debt, for a ratio of 1 to 323. (Of course, Japan has vast holdings of dollars too!)

What nation has the best gold/debt ratio? Switzerland. It has only twice as much in government debt as it has in gold.