OZ on the Potomac

The monuments of Washington, DC are beautiful tonight, well lit reminders of what was once the last best hope of the planet. OZ is indeed visually impressive. Yet, OZ is rapidly becoming an empty facade where the streets are paved in worthless greenbacks. The wheels of America's government still turn smoothly, its entitlements, earmarks and various and sundry wars, humming like a fine tooled machine fueled by endless debt. And, the weather is delightful tonight, crisp, clear and cool. It's after midnight and we are safe for at least a few hours, Congress has adjourned for the evening and the Wizard sleeps.

However, the fate of the nation hangs in the balance. Financial markets are in turmoil. Tomorrow Congress will continue to debate the terms and conditions of the "Mother of all Bailouts."

OZ, this mythical bastion of Capitalism and free markets, has become something akin to a National Socialist State. Consider on the one hand the "Storm Troopers" of the Department of Homeland Security using fear to justify tyranny who are a matched pair with thousands of SWAT teams intent on imprisioning more people in both absolute and per capita terms than any other nation on earth in a futile effort to win a "War on Drugs." America has become a police state. Meanwhile, on the other hand, companies deemed "too big to fail" are being taken over by a government and thus insulated from the consequences of their mistakes and their corruption. The "Land of the free and the home of the brave" has become a phantom or a figmant of imaginative spin doctors.

Nobody knows how the masters of our universal debt, America's creditors, will react. If the Asians, Indians, Arabs and Europeans don't approve of the terms of the "Mother of all Bailouts," they could sell their multi trillion dollar currency stash and call their multi trillion dollars in government notes; dumping their assets like so much sand into the fine tuned gearbox of America's debt based Empire and dismantling the "shining city on the hill." Of course the resulting disorder might consume them as well. That consideration might yet preserve the status quo for a time. Where will it all end? Who can know?

Meanwhile those who contend to become the new Wizard stalk the countryside. What to they think? Not much. What do they really say? Even less. They would rather talk about something else; almost anything else. The current financial melt down is beyond their comprehension. One calls for "Change," yet represents the status quo of a generation of failed policies. The other is comitted to the maintainence of Empire and continuation of the never ending war, while confessing he doesn't understand economics. The focus of the race has devolved to identity politics revolving around the race of the Presidential nominee of one party and the sex of the Vice Presidential nominee of the other party. America's media, political elites and the vast majority of American voters really have no clue as to what really matters.

It is said that when Rome burned Nero played the fiddle. One doubts that any of the national candidates who would be the new Wizard have enough musical talent to emulate him. Yet make no mistake, OZ is engulfed in financial flames lit four score and fifteen years by the passage of the Federal Reserve Act in 1913; creating a fiat currency inspired insanity. The consequences of those decisions can't be avoided much longer.

The moral of this story is: Buy precious metals.

The Yellow Brick Road Part Three

While the price of crude oil has risen in terms of these national currencies, it remains relatively stable in terms of gold. Crude oil is not becoming intrinsically more expensive, rather, the purchasing power of these national currencies continues to diminish. In fact the price of crude oil has remained essentially unchanged for decades when measured in terms of gold. Measurements of other commodities against national currencies and other precious metals will resemble this chart.

When measured against gold, most western currencies saddled the the high cost of maintaining a social welfare safety net for their populations are losing purchasing power due to government's deficit spending. In the United States that trend is exacerbated by excessive military spending relative to other countries. If Asian currencies were charted the result would demonstrate a less extreme loss of purchasing power due to cheap labor, higher savings rates and relatively lower expenditures for military and social welfare segments of their economies.

When measured against other western currencies the U. S. dollar is losing its purchasing power at a faster rate. The Rainmaker believes that much of the discrepancy in relative purchasing power between the dollar, pound and euro is largely due to two factors. First is the incredibly bad PR associated with the current American Administration. Second is the fiscal policy of the United States that is incurring record deficits to simultaneously fund two wars, entitlements and the financial sector bail out of the week.

What's next?

Candidly, it's probably going to get worse before it gets better. It will take time to replenish all the money collected and misspent by a succession of administrations out of the Social Security and Medicare Trust Funds. These surpluses have been squandered over more than a generation. That bipartisan breach of fiduciary duty by our elected leadership can't be fixed over night. Given that not one of the major candidates for President throughout 2007 and so far in 2008 has been willing to admit there is a current problem is not cause for optimism. These problems will probably take as long to fix as they took to create. And, the repair work won't even begin until our elected leaders are willing to admit that there is a problem.

How can we protect ourselves, our families and our livlihoods?

The advice is deceptively simple. Work hard, reduce risk, get out of debt, save and put part of your estate into precious metals. Work with your financial advisor to design a personal strategy that maximizes revenue, reduces risk exposure, increases savings and diversifies a portion (how big a portion you should discuss with your financial advisor) of your estate into extractive industries as well as gold, silver and platinum. Follow the yellow brick road.

The Yellow Brick Road Part Two

Had the gold standard not been abandoned in 1971, nobody today would be talking about the rising price of crude oil or gas at the pump. Why? Simply because the price of crude oil would not be rising. The chart above relates to the price of crude oil compared in dollars versus gold. Charts for virtually any commodity, for example coal, corn or beef would relate similarly to any precious metal such as platinum or silver.

What has gone hay wire with America? Why do we feel we have run off the road into a ditch? Is it really all about fall out from the aftermath of Septemeber 11, 2001 and the wars that followed? Or could there be a deeper problem?

Perhaps there is another explanation that doesn't involve just the events since September 2001 but goes deeper into the basic structure of the American and world economies and how modern nation states structure their currencies. What does it all mean?

To understand what it means one must be clear about the question, or really to understand what is "it?"

The meaning isn't so difficult to decipher if one approaches the problem from the proper perspective. Is the intrinsic value of oil or an overnight stay in London that much higher than it was a decade or a year ago? In a word, NO! Or, is the intrinsic value of the dollar that much lower? In a word YES! So, what is the explanation?

This is what The Rainmaker believes "it" means.

Let's begin with what the journalists would call "deep background," which comes in two parts.

First, for more than four generations America's elected leaders, business leaders, our friends and neighbors as well as (perhaps especially) our bankers from the Federal Reserve on down to the community bank next door have busily squandered America's inheiratance. This represents a moral crises involving our leaders and ourselves. The cure starts at home with each of us living within our means, saving, accepting that there really isn't any such thing as a free lunch and building a better future one day at a time by making the right decision in the present. Then America's leadership must focus on the real problems and leave the side shows of lifestyle choice, culture wars and celebrity politics behind forevermore. Until these changes are made the decline begun back in 1913 with the passage of the Federal Reserve Act and the Federal Income Tax, will continue.

Second, the American dream has captured the imagination of people around the world. Chinese, Indians ane Brazilians--as well as the rest of the world--all want what we've got. Their economies are cranking up to deliver the goods. However, those countries, not to mention the Japanese, Koreans, Taiwanese and Chileans have a built in advantage in the sense their economies don't have to finance the American military industrial complex, supporting troops garrisoned in more than 100 countries around the world and spending more on the military than all the other countries in the world combined. Nor do those countries sustain a social welfare safety net for their workers. These aspiring Chinese, Indians and Brazilians--and all the rest--are driving demand for commodities, especially oil, creating shortages and posing a serious threat to the relative value of the dollar. In short, goods and services are going to continue to cost more in dollars and dollars are going to continue to be worth less and less against other currencies until and unless we get our act together.

The Rainmaker does not believe that this is a problem unique to the dollar. Why? Read on!

Well to really grasp this one must understand that while the dollar's slide is an American phenomena it is also the symptom of a more serious global problem. Why? Well the dollar, like most national currencies is backed not by real wealth but by debt created by national banks secured only by the full faith and credit of the nation. The Federal Reserve, a privately owned institution, loans currency into existence and the United States (actually the tax payers) guarantees those loans will be repaid. Taxes levied on the income of individuals and corproations pay the debt service. The dollar isn't backed by precious metals. The dollar is backed by our capacity to pay taxes.

One can make the argument that the dollar is not nearly as weak as it currently seems (June 2007) and the current valuation, especially against the Euro is really a function of the incredibly bad PR associated with the current Administration. In fact the fundamentals of the Euro are in many ways worse than the fundamental foundations underpining the dollar. European countries have much more significant entitlement problems, less productive work forces, lower savings rates and higher taxes than Americans. This should eventually enable the dollar to rebound against European currencies and make London hotel rooms a little more affordable.

However these arguments don't hold against the Asian competition.

So, what is the real story? The bottom line is that most all national currencies are ultimately secured by the ability of the national government to collect taxes sufficient to carry the debt due the national bank issuing the currency. How can one judge the severity of our currenty problem? The answer is to look at commodity pricing and currency valuation compared to gold.

Please return to the chart at the top of this piece and look at it again with this analysis in mind.

Is this a problem unique to the United States? Or does it involve other national currencies as well? We'll explore that topic in Part Three of The Yellow Brick Road.

The Yellow Brick Road Part One

After the tornado deposited her in the wonderland of "OZ," Dorothy looked at her faithful dog and said, "Toto, we arent' in Kansas anymore!" When gold recently broke through the $900 per ounce barrier, flirted with $1,000 per ounce and then retreated back to the high $800 per ounce range, its price performance seemed to correlate positively with the dollar hitting new lows against the Euro. It's a strange new world made even more confusing by the advent of $4 a gallon gas at the pump. Americans everywhere seem to feel the same confusion as Dorothy as she realized she was in a strange new land.

This may be a strange ecnomic landscape and nothing we counted on seems safe anymore, but what does it really mean to us as we live our daily lives?

During the last half of the twentieth century, we Americans grew up believing in the inevitability of our day to day reality. What was before would always be. The dollar was the "go to" currency of choice in a world of change and uncertainty. America only fought just wars. American "know how" would always save the day.

However, during the first decade of the twenty first century Americans look around and nothing seems quite so safe any more. The September 2001 attacks were a shock. The failure to find "Weapons of Mass Destruction" in Iraq after the intelligence community assured the President the presence of WMDs was was a "Slam Dunk" and their discovery inevitable, was disheartening. The subsequent failure to "win the peace" in Iraq after such an easy and triumphant invasion was hard to believe.

The seeming financial fall out of the cost of the wars, such as the credit meltdown hammering the banks and mortgage companies, the stock market stagflation, sticker shock at the gas pump and the economic malaise all seem surreal. The fact that the dollar seems to be weaker against other currencies, notably the Euro, and that a decent London hotel now costs $800 per night is simply unbelievable.

What does it all mean? What will happen next? How do we protect our families and ourselves and our business investments in the clinches, which are apparently the fall out of September 11th? This is now what most of us believe to be the relevant question.

But perhaps there is another explanation that doesnt't rely just on the events of September 2001 and has to do with funny stuff like currency management, going deeper into the basic structure of the American and world economies and how modern nations structure thier economies.

Next, the Rainmaker will explore those alternative explanations or our current unfortunate reality.

The Times They Are a-Changin'

When Bob Dylan wrote the words "The times they are a-changin'," he was of course writing about the cultural mega shifts of the sixties. But these words are more applicable today than most of us realize. However, the application has shifted from the forty+ year culture war to the economy.

Why?

Because the United States' economy is about to undergo huge changes due to three overlapping factors:

• Rising inflation;
• The long term continued decline of the dollar; and,
• Entitlement reform.

What do these changes mean? How will they effect each of us? What personal decisions provide the most protection, the lowest risk and the greatest opportunity?

In ancient time inflation usually involved monarchs shaving coins or dilution the precious metals from which those coins were cast. Nowadays, it's much easier because the United States has delegated management of its money to the Federal Reserve (FED), a privately owned bank. The FED can issue money at will with a few computer key strokes.

What does this mean?

It means that the purchasing power of a dollar today is about the same (actually a bit less) than the purchasing power of a nickel back in 1914. 1914 is about the time the U.S. monetary system was privatized and turned over the FED. The same can be said for the Euro, the Yen, British Pounds and other paper currencies around the world. Interestingly the purchasing power of gold in the past 94 years is virtually unchanged. According to the World Gold Council, no paper currency (FIAT currency) has existed longer than a human lifespan and the Federal Reserve Dollar is already a Methuselah at 94 years. I guess we're lucky life expectancy has been climbing.

Why would the FED allow this to happen?

Because the crushing pressure of debt service on the $40 trillion to $60 trillion in unfunded liabilities of Social Security, Medicare, Pensions, the "on budget" National debt, business debt, consumer debt and other costs such as the Iraq war makes it easier to repay that debt with cheaper inflated dollars. Our national policies and spendthrift politicians are debasing the dollar.

However, that's not the whole story. The dollar is also under inflationary pressure because of rising commodity costs. The people of China, India and Brazil all aspire to the "American lifestyle." Energy, metals, food and transportation are becoming scarcer and therefore more expensive.

The situation is unsustainable, eventually forcing whoever serves as President and in Congress to act. What can they do? There are only four alternatives: raise taxes, cut benefits, borrow more or inflate the currency in cooperation with the FED. At the rate the United States economy is deteriorating borrowing may not be an option much longer. Raising taxes is never a popular alternative. And cutting Medicare and/or Social Security benefits is rightfully called the "third rail" of American politics. It's not good for the proverbial political career to take expected benefits away from the electorate.

Regardless of how bad the situation may become, the questions remain about how best to deal with it personally. Obviously it is impossible to offer specific management or investment advice that means anything to you in this post. But in general three observations can be made and a couple of questions can be suggested for you to consider during your next meeting with your investment advisor.

The initial observation is: Although it's clear that something has got to give in the United States when it comes to entitlement reform, don't bet that reform will solve issues confronting successful people. Generally it's easier for politicians to adopt the "Robin Hood" approach and take from the deep pockets to give to the poor and middle class. If you work in a profession (law, medicine, architecture, investment banking), own your own business, or make more than $150,000 a year your pockets are perceived to be deep. You might plan accordingly to protect your assets, your income stream. Remember the old truism: "There is no limit to the good that do-goodees will do with other people's money.

The second observation is: Inflation in the United States is likely to become worse as time goes on. It is simply irresistible for politicians and bankers to avoid paying the price for their past sins as long as possible by using cheaper dollars to pay off old debt. Additionally, every time the FED encounters a financial crises its knee jerk reaction is to soften the blow by injection huge amounts of money into circulation to maintain liquidity. The broadsest measure of money is known as M3 and it's been growing at an annual rate of about 14%. That number is harder to pin down because in March of 2006 the FED decided to stop reporting M3. I suppose it became something of an embarrassment. In 2008 the FED has continued its practice of bailing out the economy by injecting vast amounts of cash for such worthy efforts as the Bear Stearns, Fanny Mae and Freddie Mac "bailouts." In a couple of years Medicare will begin to experience a huge cash flow crunch and one must wonder at whether even the FED can bail out that entitlement. Then in 2018 Social Security will experience its own cash crises.

The final observation is: The dollar is probably about to stabilize at least in the short term. The dollar will probably reach equilibrium at least relative to the Euro because the the Euro is beset by generally unrecognized structural problems such as unsustainable entitlement and tax policies that are actually worse than those facing the dollar. Asian countries artificially maintain cheap currencies relative to real dollar exchange values to facilitate exports to the United States. If those policies change due to the perceived credit risk of American debt and/or the increased ability of Indians, Brazilians and Chinese to consume their output, then all bets are off and the dollar could go into free fall.

Here are a couple of starter questions that you might want to consider asking when you next meet your investment advisor:

• First, with Medicare set to go cash flow negative in 2011 according to the Trustees Report issued last spring, does it make sense to pour a lot of capital into your business? Since medical care is such a huge part of our economy this applies across the board, but especially if you are in the medical professions?
• Second, with the upward pressure on commodities and downward pressure on the dollar does it make sense to increase the percentage of retirement portfolio invested in commodities, precious metals and companies that provide those, while seeking instruments in other currencies?

One final word of caution: However tempting it might be to give up the day job and invest in commodities, currency or anything else full time, it is strongly advised not to attempt this at home. Investment advisers who do this for a living may cost some management fees, but that is a small price to pay for avoiding undue and unknown risks in areas about which you have too little knowledge to even identify those risks.

Although the situation appears critical, a well prepared and fully informed investor can prosper even in the worst of times. It's time to do your homework, consult with your investment advisor and devise a prudent strategy to preserve your capital! "The times they are a-changin'!"