When most “normal” non-economist people talk of inflation, they mean one thing: the rise in prices. Fuel prices are up double in one year; housing prices skyrocketed 100% to even 300% in some markets in 4 years. People call that inflation, even though it is an effect of inflation, or the creation of new money.

When people speak of this simple definition of inflation, they talk of figures: 5% a year, or 10% a year, or the government’s imaginary figure called CPI of 3.1% or so. Even free market economists look at the price rises and judge them based on a percentage year over year. They’re all wrong. Price increases, the effect of inflation, is even worse.

In a market with a fixed money supply, say gold (but it could be a fixed supply of dollars, or euros, or nails or dirt, too), there’s an interesting side effect in a productive market: prices tend to fall softly over time. This is called deflation, but in fact it is just prices dropping.

When you have a fixed amount of money in an economy, and an increasing supply of goods, more goods chasing the same fixed amount of money mean that prices will fall over time. Your money, over time, becomes more valuable. This is a good thing as it instills a desire to save money rather than spend it frivolously. It means that the poor can save money to become wealthier in the future, and the wealthy who spend it frivolously can lose their wealth quickly in an economy where the money becomes more valuable by just sitting in a bank or under the mattress.

In a fixed money economy, prices tend to fall over time. In an inflationary economy, prices tend to rise over time. We generally look at just the rise in prices year over year, but we ignore the reality that those prices would actually fall, so the true price of inflation is the percentage increase over a year minus the expected decrease of prices in a fixed economy.

Let’s say you have just $100 in an economy, and that doesn’t change. There are 10 apples for sale. People are willing to pay $4 per apple. Now, a new product, oranges is released, and there are 20 oranges. They’re good, maybe better than apples, but they’re in plentiful supply. Because the money supply is fixed at $100, the same money chases both apples and oranges. People are unwilling to pay $4 for apples since a new choice is on the scene: maybe apples fall in value to $3 a piece. That’s a 33% decrease over a period of time in prices.

Now let’s say that you have a central bank that increases the money supply. Maybe they’ll add $10 to the economy. With $110 in the same economy, it is possible that apples would rise in price to $4.40, or an “inflation” figure of 10%. So the experts will say “Look, inflation is 10%!” But they’re ignoring the growth of new products to compete with those apples. Once oranges are introduced, the amount of money being grown to $110, prices might rise, but in reality they’ll fall because of the new supply of goods. Apples might fall to $3.30, which is a larger fall than we’d see in a non-inflationary economy ($1.10) but leaves us with a price higher than in a non-inflationary economy ($3.00). In the end, the apple that would normally fall to $3.00 only fell to $3.30, from $4.00 nominal pricing, which means that the figure normally quoted for inflation can be quite a bit higher.

While it is impossible to gauge what items or markets will increase in price during a period of monetary inflation, we should realize that prices in a stable currency market generally softly fall, as long as there is no surge in demand or drop in supplies. When you factor this “soft deflation” of prices in a fixed-currency economy, you can realize that even the most aggressive inflation figure estimated by free market economists is still off.

And today, while still an avid goldbug advocating the many reasons to own gold, my new proclamation to these fine folks makes them frown: Gold is a terrible investment. No, not because I feel it will fall in relation to the dollar or other currencies; gold has always been a terrible investment, even when it has skyrocketed almost 400% in less than a decade.

Gold is not an investment, not now, not ever. Then again, most stocks aren’t investments either. For an investment to be true, it must offer two things: an asset of value, and a return on investment from the profits the asset makes. If you start your own company, that is an investment: you end up with assets (property, tools, software, etc) and if it generates a profit, you get a nice return. At any time, you can sell the company and its assets for money as well. This is a worthy investment.

In terms of the stock market, the only true investment is one where your shares purchased offer you an asset (property, tools, software, patents, etc) that would have value if sold, but the share also pays you a dividend, or a portion of the profit that company makes. Most stocks pay little to no dividend. If you buy a stock that does not issue a reasonable dividend (I believe in at least 10% annually, but my businesses can pay well over that), you’re not investing, you’re gambling. The main reason a stock price goes up is because people see new value in what the assets of that company would sell for. A company that issues no dividend is not a profitable company because the profits are spent elsewhere: capital growth, big big bonuses, advertising, etc. Would you start your own business if it paid zero profits? Of course not.

The worst investment, though, is hoarding. Be it dollars, euros or ounces of gold, hoarding has no long term gain in terms of profits paid. Even putting money in the bank is a better “investment” because you get an interest rate return, usually lower than the cost of living increases, though. Holding gold is akin to hoarding dollars. The only reason I do this is because gold tends to hold its value over time, versus all paper moneys which crash to worthlessness in usually less than one century. The U.S. dollar has lost almost 98% of its value in less than 100 years. $1 from 1910 is worth $0.02 today. Gold, on the other hand, has held up quite well, but its return is only in the gained value of its asset price.

For me, gold keeps up incredibly well to the theft of value that central bank inflation creates. An ounce of gold, to me, has stayed relatively stable versus life’s cost increases for as long as I’ve been holding gold. Even better, gold over decades has held its value, and gold over centuries has held its value. That’s all it is: a stable, consistent store of value. Yes, it fluctuates here and there due to industrial demand and investor demand, but overall, it tends to be more valuable over time (versus other currencies) because it is the only true money in existence. The first metal used by humans as money was gold. Gold has been the only money to exist as money after thousands of years of human history. Gold is the most liquid form of money imaginable: if you hold U.S. dollars and are in a foreign country, your gold ring would bring you a consistent return whereas you have no idea what the dollar will be worth depending on the market’s need for dollars.

I will never offer advice to people to buy gold as an investment. Will the price go up? Surely it will, over time, because our world’s currencies are constantly being destroyed through central banking inflation. Will it make you a profit? Maybe, maybe not, depending on how much speculation is built-in to the spot price. But it won’t become worthless, even if it falls in value over time.

It’s been a long while since my last update, mostly because life has become increasingly busy. My church printing co-op is growing leaps and bounds, my consulting business is still showing growth, and travel has taken a lot out of me. I’m putting about 70 hours a week into preparing for a fall in future income, and it is paying dividends today.

The gold market continues to shock me, but not because I feel it is in bubble mode. When the stock market was in bubble mode, everyone and their mother was talking stocks — including friends of mine who were not really able to invest. When the bubble moved to housing, those same people were talking houses. No one I know talks about gold, except those who have listened to me for the past 5 years or so. I know of many people who cashed in their gold holdings in 2007, selling with a 250-400% profit over a half decade. Good for them.

Today the old media announces that JPMorgan Chase is buying Bear Stearns, for $2 per share, a 93.3% discount. The Fed is guaranteeing the purchase, with your future income as security. The Fed also lowered the Fed rate, which to me means that a 2.25%-2.5% rate will be lock come this Tuesday.

I’ve been watching the liquidity that the Fed has created recently, and the hundred billion or so that they’ve created is even more ridiculous when you consider the options. The Fed created money for one reason — to pad the banks’ reserve ratios so they don’t go bankrupt. The banks make trillions in bad loans, and the Fed does the wrong thing — it gives the banks MORE money to back up their empty reserves.

I’ve thought another option would be available for the Fed. It isn’t an option that I would particularly like, but it is one that makes more sense. Instead of the Fed creating more money to back up the banks bad loans (which is what more reserves are doing), the Fed would be better off injecting that money into the banks of borrowers who have bad loans. The borrowers could pay down their mortgages to be equity neutral (instead of upside down), the money would flow back to the banks to zero out their over-extension, and the cash would virtually disappear in the process. Instead of the Fed dropping hundreds of billions to cancel the debts, the Fed instead is giving the banks more ammunition to continue the problems that too much liquidity initially created.

What the Fed did is doom those in trouble. The banks will be “safe,” but you and I will pay more for gas, food, oil, and housing still. The Fed made a huge mistake, as the Fed has always made huge mistakes. There is no turning back.

I look at gold as a reasonable place to hold my assets, but I also look at another option: cash. Not cash on a saving or checking account balance book, but cold hard cash. I call it a Saver Strike. Pull your cash out of checking, savings, CDs, 401Ks, stocks, bonds, and money markets. Put it under your mattress, or in a safe in the basement. For every dollar you withdraw from the villainous banks, they lose upwards of $8-9 in liquidity. It’s the ultimate way to protect against future inflation.

Gold is great, but the gold you buy means your old dollars cycle back to people who put it into the banks. The banks use the money multiplier effect to create more liquidity, which destroys the value of the dollars backing up the new liquidity as reserves. It’s ugly. By monetizing your dollars in cash form, you put tremendous pressure on the banks. The Fed won’t generally print more physical money, they’ll just shore up bank reserves in digital form. That new money can’t be withdrawn because there aren’t enough physical dollars to withdraw them. I believe the most recent M0 money supply figure was in the range of $1 trillion. By injecting hundreds of billions of liquidity onto bank’s books, the Fed is creating MORE virtual money that can’t be withdrawn and sockdrawered.

The future is ugly. Gold will likely see a 20% or so correction (I figure around the middle to the end of April), but then it will springboard again. I foresaw $1000 gold as hitting us just after New Year’s, but I was a bit early. Now $1000 gold seems normal. Just look at the news. Banks have no real money. People owe a ton on debt, but they don’t have real money. Many Americans have negative net worth. Cash is king, but only in paper or metal form. Digital cash is fraudulent, so why bother using it?

If you have cash in the bank, or stocks, or bonds, or whatever digital form you save in, cashing it out is giving the banks and the Fed the 1-2 punch: 1. the banks lose their reserves, and 2. the Fed has to make the decision to actually have the Treasury print money, or let the economy hit real deflation.

For me, the ultimate investment is a balance if real cash (physical) and real metals (physical). You’re protected against inflation and deflation.

By buying gold EFT shares or investing your physical cash in digital investments, you’re losing the ability to protect against rampant inflation or rampant deflation. Instead, consider removing yourself from the digital investment domain and become the ultimate wealthy investor: the hoarder.

Times Online (UK) has a reasonable article titled Dollar faces new sell-off if Gulf states end greenback pegs that discusses the concern of some Middle East oil-producing States in divesting themselves of the so-called dollar peg. Currently, the petrodollar is the primary currency used to purchase oil. This petrodollar is already on its way out as Iran and Venezuela are looking to more currencies to be used to purchase oil. This can have a big negative consequence on the value of the dollar as more foreign States start using other currencies to hoard and redeem for oil. The concern here in the States is that the dollar’s loss as the petro reserve currency would cause oil prices to skyrocket, meaning a weaker dollar here and abroad. This view is justified, but there are many caveats to supporting it fully.

The Times article also speaks about foreign currencies that are pegged to the dollar as a reserve. When a foreign currency has a dollar tie, it means that more dollars created through monetary inflation cause that foreign currency’s value to fall against other currency. This makes foreigners less trustworthy of their own governments, due to their purchasing power reduced. If a foreign currency has a dollar tie, newly created dollars don’t just devalue old dollars, they also devalue the other currency’s value as well. That’s bad news for those foreigners.

The problem with predicting a true dollar collapse verses other currencies is that some of the dollar’s fall in value is truly speculation in believing it is weaker than other currencies, such as the Euro, the Yen and the Ruble. In truth, these foreign currencies are just as weak as the dollar as most of the central banks of foreign currencies are also devaluing their currencies, but it is the speculation in the dollar’s weakness that causes it to fall more against gold. Combined with the previously mentioned de-hedging of gold, it is quite possible that the gold-dollar ratio could fall if those same speculators catch on that almost all fiat currencies are inflated constantly, at seemingly connected values.

What is also forgotten is the strength of U.S. consumers in terms of acquiring foreign goods. U.S. consumers far outspend any other nation in terms of durable and disposable goods (clothes, paper products, food, fuel, etc). With a weak dollar, foreign goods become more expensive for United States Americans, which causes the foreign economies to destabilize as their inventories go up, and their labor demand down. Reduce spending in the U.S., and the Chinese and Indian companies don’t know who to sell to. To prevent this decline in sales, the foreign central banks like to inflate their money supply in lock-step with the United State Federal Reserve. This makes foreign goods not rise in price, but in the long run it harms the foreign manufacturers and laborers since the currencies they’re paid in fall in value against goods that country imports (usually fuel but also raw materials). The countries that have a strict central bank combined with a high demand export product (say, gasoline or steel) generally profit greatly as the cost of their goods go up, but they purchase little from outside their country, so they have no need to inflate their currencies to keep their export consumers happy. Currently, there are few countries that are truly not worried about foreign competition in terms of raw materials or energy, but that could change based on supply and demand.

I have little faith in the dollar, but not because it will fall in value versus any other fiat currency. My faith in the dollar is lost because I have no faith in any fiat currency. All fiat currencies, backed with non-full reserve banking (a.k.a. fractional reserve banking), fall in value versus raw materials as they’re inflated away. This shows up as price increases, when it is in fact buying power decreasing from dilution through monetary expansion. Because all fiat currencies are inflated, they all lose value versus real goods over time. It is how you price those real goods that shows the reality of each currency’s decline against other material goods. If you just judge the buying power of the dollar versus the buying power of the Euro, the dollar seems to fall in value versus the Euro. If you plot both versus real costs of goods, you see that both currencies are falling in value over time, but the dollar falls faster. If you had a decision: jump off a cliff holding a big rock, or jump off a cliff holding a small rock, you may chose the small rock versus the big one (yes, I know, you’ll fall at the same rate eventually, but not initially). I prefer to not jump at all. The analogy in currencies is: hold dollars (big rock), which are falling fast, or hold euros (small rock), which are falling slower, or hold gold (don’t jump at all), which is rising against all currencies over any plot of time in the past decade or two.

My recommendation is to plot your life expenses (food, fuel, insurance, clothing, housing, and income) versus other goods and versus gold. If you earn $5000 a month, compare what your income would be in gold and euros at the current exchange rate, and then compare what the price of your expenses are in dollars, euros and gold at the current exchange rate. Over time (years, months, even weeks) you’ll see that gold is particularly strong, whereas euros and dollars are particular weak and getting weaker (with the dollar the weakest currently, but that’s mostly speculative pressure).

It is very difficult for people to view “real costs” when it comes to gold ounce purchasing power, mostly because they are unable to understand that the rising cost of goods in dollars is really just a fall in value of those dollars. In a market economy, prices rise for two reasons: the supply of goods goes down, or the demand goes up. In a fiat-based economy, prices rise also if the value of the fiat currency falls. Since we have no idea how fast a fiat currency is being inflated through monetary expansion, it is almost impossible to truly know if prices are rising due to low supply, high demand, or too much new currency created. Even worse, some purchases that cause a low supply of goods or a high demand of goods is a malinvestment due to monetary expansion! If you feel wealthier, you may splurge on a nicer new car, or a new kitchen, or a new home, because you feel richer even if you’re poorer due to the value lost of your earnings through monetary expansion. This malinvestment causes the supply of that good to go down, the demand to go up, and makes that product even more expensive even if your purchase was wrong due to your not realizing your wages went up but their value went down.

One of the emails was added as a comment because I had asked her to. A regular reader, Lane Petersen, emailed me the following question:

this advice goes against everything ive ever read from ramsey and other financial gurus. id love to see you prove them wrong tho, because we are in big debt and following ramsey’s advice and each month we have nothing left over and it is depressing. i read it twice and it does sound like it makes more sense in a harder economy. can i email you my financials and have you tell me how to go over payments?

I emailed her back last night, and she emailed me her family’s financial situation, which is precarious but not over the cliff. From the few people I’ve emailed about my theory, which goes against every financial expert’s view, I think it will work, and it will lessen the burden of a possible recession.

To recap, I have always been a “Pay off debt before investing” financial advisor for friends and family. Why invest at 10% if you’re paying 20% on your debt? It generally makes more sense to knock out debt before saving for the future, because you’ll pay less in interest sooner, compounding your long term investment gains. In the past 3 months, I have changed from that view significantly. I believe that savings is more important than debt reduction, but with a few standard caveats thrown in. I’ll try to explain my advice by using Mrs. Petersen’s example below. As I said, and others confirmed, there are not a lot of financial advisors who recommend this system. I am not a professional, I have no financial degree, and I am just theorizing this based on what I consider common sense, coupled with what I have seen as a massive amount of questions from people I respect who are now in financial trouble.

Here is the information that Mrs. Petersen sent me about her financial situation. She has given me approval to post it:

Income
Husband - $53,000 per year
Wife - $48,000 per year

Expenses
Mortgage - $1100 per month ($13,200 per year)
Property Taxes - $2100 per year
Insurances - $3600 per year
Credit Card #1 - 17%, $13,000 balance (Min is $260/month)
Credit Card #2 - 12%, $18,000 balance (Min is $360/month)
Credit Card #3 - 6%, $5,000 balance (Min is $100/month)
Auto Loan - 4%, $11,000 balance (36 months remaining, $325/month)
Groceries Monthly, $960 (budgeted)
Utilities Monthly, $840 (Electricity, Gas, Cable, 2 Cell Phones)
Auto Gas, $180 per month (they rideshare to work with others)

I totalled everything up, and their annual budget is $55,000, making just minimum payments. Lane told me that after taxes and budgeted payments, they have approximately $18,000 left over, or about $1500 per month. They’re putting all of this toward retiring the credit card debt, but they have absolutely nothing saved except for a small 401K. She told me that even though their bills are paid every month, they are depressed with their financial outlook for the future. I figured that if they continued to put all their extras towards debt payments, they’d be debt free in 25 months. If they paid the minimum, they’d be paid off in approximately 86 months. The difference is huge: 2 years versus 7 years.

The problem with the situation is that they have NO emergency capacity, other than credit on their cards. This is very scary. If either should lose their job, they would immediately be underwater. Thankfully, they did NOT HELOC a lot recently, and have paid that off. Their equity in their home is reasonable enough even in this popping bubble market, but taking a HELOC to overcome a job loss is not a good idea.

I looked over various options based on my “save now, pay debt later” theory, and I came to the following conclusions:

1. They’re overpaying for insurance. Because they have at least $20,000 left in credit lines, are very healthy, and don’t use their insurance often, they should raise their deductibles immediately. Putting a yearly deductible payment in an emergency on a credit card is actually a reasonable option, until you’ve saved enough in cash to pay for the deductible. By raising their low deductible from $500 to the maximum allowed (by law or policy), they can shave almost 30% off their health insurance and car insurance bills. This savings alone adds $1200 a year more to their extra.

2. Their utility bills are too high for the area they live (relatively warm winters). Yes, energy costs are up, but there are many ways to save. Wear sweaters before turning the heat above 66. Dress lighter rather than run the A/C. Turn off the lights (of course), and unplug appliances that aren’t in use (especially the TV which isn’t turned off but put on standby). They can shave another $300 a year with some basic changes. I highly recommend a family gathering each week to note your electrical, gas and water usage at the meter. Write this down into a spreadsheet. Look at week-over-week and month-over-month uses. You can even calculate what your bill will be (within 10%) by using the information from your past bills. I guarantee you’ll see at least a $30 savings the first month when you see what minor changes can do. Some households can see a $100+ saving in 2 months by learning what effects each utility.

3. There is no reason why they can’t be “saving” around $2000 per month. Their monthly minimum payment for all expenses comes to $4190. To have 18 months of security, they’d need $75,000 in the bank. Because they are a two job household, I believe that having 9 months of security in savings makes good sense, since the chance of both workers losing their jobs (in two different non-related industries) is slim. It can happen, but it is unlikely. I told her that they should try to get to $36,000 in the bank as fast as possible. This would take 18 months. It would means that all their credit, other than mortgage, could be paid off in 4 years instead of 2.

We examined both of my analyses this morning: how long they can live safely if one person lost their job, but they were paying down debt fast versus house long they can live safely if they paid the minimum and saved the maximum. The difference was 3 months versus 26 months, based on the idea of cutting off all unnecessary items and living VERY frugally if one person lost their job. We then made the same analyses together based on if one person lost their job, but quickly went to work for a very low wage at a restaurant, retail store, or other “lower income” type work. The difference was 8 months versus 44 months.

Mrs. Petersen and her family will be trying this theory. I have guaranteed her 6 months of interest if she doesn’t like it (I will pay the difference in interest). Already she says her and her husband are relieved, because she remembers when they had money in the bank, and the comfort it gave her when she knew she would be OK if life through a rock at her. Yes, it is counter to almost every financial expert, but the experts sometimes forget the depression you can enter when you’re paying your bills, but your subconscious mind makes you concerned about life’s speedbumps.

Note that my theoretical idea is not for everyone. I told Mrs. Petersen that their spending MUST be kept at the current level: zero. They have NO budget for some typical needs (new clothes, travel, household goods, etc) beyond what is listed above. They have NO gas budget right now either, as they both rideshare with others. I mentioned the idea of selling one car, but they’re unable to do so currently. One of their cars is paid off, and has a KBB value of approximately $7500 wholesale. This would get them to the 9 month safety level 4 months earlier, at which point they could consider buying an older but in good shape used car.

While this is a typical family in some ways, I have a great deal of respect for them to look at future problems before they occur. Most of my friends who are concerned about finances are already over the edge, and I have a very difficult time in helping them without resorting to bankruptcy or other legal, but immoral, means. This theory is for others like the Petersen family: those who feel “comfortable,” but have a nagging sense of depression or fear in the background.

Paying debt off quickly makes sense, but not if you can’t weather the short term before you catch up with the long term. Even if the dollar falls in value, your debt is based on the previous dollar’s value. Eventually, money inflation can lead to wage increases (without value increases), which does help pay down your debt easier, but other expenses are costlier as a percentage of your income.

A year later, we now have top news regarding increased gold de-hedging, with the gold hedge book at its lowest level since 1992. In the third quarter of 2007 we saw a markable increase, one that is not expected to slow as the fourth quarter hits.

According to my information, the gold de-hedgers chopped almost 15% of their hedges in the second quarter alone. Some of the largest gold hedges are completely de-hedging all their positions by year’s end (I believe as much as 40% of hedges will be gone).

Why is this? Normally, gold producers hedge against gold in both directions: against a fall in prices, and against a huge rise in prices. Without these hedges in place, the producers seem to be thinking that there will be a large rise in the price of gold versus most or all currencies. This could be due to insider information detailing a future shortage of new gold, an increased demand in gold in the future, or a combination of both. I don’t believe specifically that this de-hedging comes because the producers believe that currencies will fall in relation to gold’s price. If that happened, the producers would be in trouble as they purchase their fuel, machinery and labor with fiat currency. When we look at gold’s price change, we always (always!) have to consider those three issues:

1. Is there more or less gold coming up out of the ground?
2. Is there more or less gold being consumed or bought in the market?
3. Is the currency base moving up (inflation)?

In case #3, gold’s price moves upwards only because the currency value has fallen. This means that a move from US$700 to US$800 per gold ounce doesn’t really return a reward, it just made all other prices higher due to the dollar’s fall in value. Yet if gold does move upward in demand, or downward in available supply, we’d also see prices move up, but not just due to currency values falling.

I still am not certain as to why we saw the massive de-hedging this year. The gold news sites (Kitco, GATA, etc) issue absolutely impossible to read reports written by people who don’t want to explain why this is happening, other than to confuse the situation. With the de-hedging likely coming to an end (at least in speed) this year, it could have two opposite pressures on gold’s price in all currencies:

1. End-of-year gold profit taking would send the price down in currencies.
2. End-of-year gold supply reductions could send the price up in currencies.

Will they balance each other out? Will one overpower the other?

Through 2006, I increased my silver hold and actually liquidated some gold. In early 2007 I increased my gold positions early on, and slowed down my silver holds. In the third quarter of 2007 I increased both in equal measures. Now I am bearing on gold for year’s end, for a variety of reasons.

First, the credit crunch is hurting wealthy people I know. I know of at least 3 business owners who manage $100m+ businesses who rely on the commercial paper market to protect cash flow. They use factoring organizations, short term loans, and lines of credit to overcome their slow payments from clients. I’ve noticed my own income has slowed from an average collection of 45 days to 70 days. This is not just in consulting, but also in working with not-for-profits. I don’t use lines of credit to keep cash flow smooth, I deal with the peaks and valleys. From an income perspective, I am paper poor for the fourth quarter due to delinquent payments over 45 days. When the wealthy are cash poor, they’ll sell commodities to make up the difference. Almost every wealthy person I know with gold holdings over US$100,000 is talking about selling at year’s end.

Second, the de-hedging puts a lot of confusion into what really will happen. If the producers expected gold’s price to fall regardless of currency inflation, I’d think they would be VERY concerned and hedge stronger. If gold’s price fell due to monetary deflation (the act of destroying credit and liquidity), I think they would have little concern as that act can also put downward pressure on machinery and energy costs. If they believe that there will be a shortage of gold and an increased demand, I would think they would want to be exited from all hedges (which cost money) since they feel secure in real profits from gold sales, not just paper profits from the fall of currency values.

Third, my focus on gold has always been to protect myself only in massive societal emergencies, coupled with the fact that gold is illiquid to me for short term useless purchases. Gold’s liquidity is great if I am in real trouble, but I won’t go out and buy a $3000 TV or a $30,000 car by selling my gold without thinking. When I sell gold (rarely), it is always to cover real short term or long term concerns (such as if my collections go over 80 days and I have no available cash to live). I feel comfortable with my income positions in 2008, especially with my deliquencies settling at the 50-55 day mark. When someone owes you money for 2 months, but still uses your services, it is usually a sign that they know they need you. If they escalate to 70+ days late, it is usually a sign of severe problems with their business or market. I can weather the 50-55 day delinquency just fine, and it gives me a sense of job security since I feel my business income will maintain a mild growth or minor loss in 2008. We’re prepared for a 25% fall in revenue, but are expecting a 7% increase in 2008. My real concern comes in 2009, especially if the credit crises get more severe worldwide.

My gold for 2008 is not to necessarily increase my gold or silver positions significantly, but to work harder to decrease our expenditures even more. We’re a six-figure household, but this winter we’re doing the blankets and sweatshirt “energy conservation” routine. Set the thermostat at 65 and deal with cold mornings. We’re also working harder at reducing our driving, cutting back to using 1 car 90% of the time. Also, we’re correlating our long distance visits with customers, family and friends to coincide with each other. If I have to work sometime in the next week 25 miles from here, and it’s close to a friend or family, we’ll set up both visits together. We’re currently trying to see if we can live on 1/4th our income without dipping into our hard money or credit lines. We’re working heavily on new income streams that should turn profitable in 18-24 months, albeit at 1/10th my hourly rate.

I am fairly scared for the status quo United States resident. I have many friends with significant debt on their books (at least 4X annual income, including mortgage), and they aren’t considering market declines in their industries. I think that the next 18 months should be a time to shore up savings (whether in dollars or hard money) rather than just debt reduction.

I am a big fan of paying off your debts fast, as fast as possible, even if it means that your life isn’t so fun for a year or two. I’ve changed my position completely. Now, I believe it is more important to bolster your savings over paying down debts more than the minimum. Why is this?

Consider this: If you use every cent you have to pay for your minimum overhead and maximum debt reduction, you end up with zero savings. If you should lose your job, you will have NO ability to pay anything, including your minimum overhead and minimum debt payment. Even if you’re paying 18% on your credit cards (or more), it makes sense to try to fulfill a savings account that can continue to make the minimum payment through a job loss or market change. Yes, you’re paying more in interest by not accelerating debt reduction, but you’re also giving yourself a bit of protection in the short term. It may add 4 years of debt payments just to get 12 months of savings security, but it will help you weather those 12 months. It’s a hedge against short term calamity.

I am extremely aggressive in telling my heavily in-debt friends to buy gold and silver over debt reduction for the next 18 months. Hard money is hard to spend easily and stupidly. It gives you a position of comfort and reduces the depression of “what am I going to do to pay the bills next month?” But my hard money protection advice comes ONLY with the advice that you must live at the bare minimum, and I do mean the bare minimum. With Christmas ahead, now is a perfect time to eBay literally everything that you own and don’t touch once every 3-4 months. That great book collection? Get rid of it. Toys the kids don’t play with? Sell them. Extra clothes? Even $1 a piece is something, and it reduces clutter and maintenance needs. Tape up the windows to keep energy costs low, wear a lot of layers in the cold winter, skip eating out (even $5 McDonalds runs), and cut back on expenditures as much as possible. Work with another family to oversee each other’s expenses: mutual accountability here is key.

Every other expert, include the honorable Dave Ramsey, will disagree with my “slow down debt payoff” ideas, but they’re also thinking that the market will stay solid for all. I am not so sure. As I said, at worst you may end up with 4 more years of debt and only 1 year of savings — but if there is a decline in your specific industry, you’ll thank me.

The day doesn’t end without at least 3 emails from family, friends and customers who are now starting to listen to me. For 3 years, I’ve been the contrarian “sky is falling” housing bubble (and stock bubble, and commodity bubble) advocate, with few if any listening. Now the news is admitting the market’s problems, and some old media organizations are backtracking to the start of it all.

I was the sole Greenspan-detractor in 2002 of anyone I knew. Now everyone is bashing the man that was king.

The most common email I get is “So what do we do???” I’ve been preparing a Flash-based applet that lets people enter all their facts (income, expenses, mortgage, credit, leases, etc, etc), and tries to come up with an answer. Of course there is no one-size fits all solution, but there are generalities for all income and expense levels that should give you a foot in the door to escape the credit crunch.

Many people I know are not YET affected by the credit crunch, because their income exceeds their expenses, if even slightly. Yet with the price of oil, energy, insurance, and taxes moving upwards, more may find themselves upside down sooner rather than later.

If you are concerned about your overall situation, and future, I’d love to get your information so I can navigate some recommendations for each. All I need is weekly income, mortgage/rent payment, property taxes, average monthly utilities, family size, car lease/loan, and total credit card balances. With that info, I can start keying some solutions to the predicament that many of us will face.

My #1 answer to most, which should work for most, is to find a way — immediately — to have 18-24 months of minimum payments in the bank. Yes, cash is devaluing quick, but most of your debt is fixed in payment. By having a 2 year padding, you can still survive up to 4 years just by getting 1 or 2 low paying jobs, and living even tighter. I have one friend, a previous 6-figure earning mortgage broker, who did just that, and he’s stressed but surviving. I know him and his wife (no kids) wear sweatshirts and blankets at home to keep their heating bills low, and I also know that they sold many assets in order to pad their savings more (rather than pay down debt first). More important than having no debt is having your nest egg, your safety cushion, which keeps depression at bay and the bills paid. They’re not doing as well as they were 2 years ago, but they’re surviving, and that’s a key element in keeping your head above water.

For MOST families, I still see spending in excess of 30-40% over the survival minimum. Some families are spending 60-100% over that minimum. With the retail shopping season ahead, it is time to swallow your pride and get a part time job if you can’t save 18 months of payments in the next 6-8 months. I know of one family that started with a $62,000 household income (and $11,000 annual take-home savings after all minimum payments and taxes) with $26,000 annual minimum payments. In 9 months, they will have $30,000 in savings — all because they each added a second job, and cut their expenses close to zero. They’re each making an additional $150 per week, and saving an additional $260 per week by cutting back. After selling assets, adding in their previous savings, and cutting a few huge expenses out, they’re already at $21,000. In 6 months, they’ll be at close to $40,000 saved. Once they pass the $50,000 mark, they’ll be set for at least 2 years — and both will hopefully still have their main job and their backup job. Is life tough? YES. But it is easier than the fellow I know who complains to me every day that he can’t pay his bills, but he spends 10 hours a day online doing nothing. I wish he would jump in, drop the ego, and get a job at the local mall or restaurant.

The worst situation I can see, right now, is the retiree with only social security. I’m not sure how they can survive the pending destruction in the value of their dollar.

This article is followed up here: Save Now, Pay Off Debt Later: A Theoretical Analysis

Ron Paul, Presidential candidate for the Republican party, wants to do away with the Federal Reserve, fiat currency (meaning money that is backed by nothing), and return to a currency backed by something.

GC, a reader, posted the following reply to a recent article I posted:

I read these comments all the time about the federal reserve system with its extended tentacles worldwide, but NO ONE even the worlds leading economists have come up with an alternate solution
that could be implimented without causing a worldwide collapse of the financial markets.

Maby that is what it is going to take- to make people stand up and be counted to vote for a more equitable sustem, free from autocratic control and mass worldwide manipulation.

Come on you outstanding economists, I challenge you to bring forward a new system or even starty a debate on a new system- Everything evolves- but the FRS has evolved causing the world to a point of
absolute collapse. Its 5 minutes to midnight- you havn’t much time left. good luck

It’s a great response, and one that MOST Austrian economists have no real answer to. He’s right, an end to fiat currency would have horrific repercussions immediately. Even Dr. Paul himself says that we’d have great poverty initially under his system, but long term success would be quick. It’s a concern for many, though, because few of us actually think long term, and would rather have short term success even if it meant long term failure. We believe we can weather any downturn, as long as the short term seems safe.

I don’t have a “quick” solution to the problem, but I do have a reasonable one. My answer gels well with Dr. Paul’s 30-year history of providing solutions. It is also an area where Paul detractors ignore his words, and instead base their opinions on what they THINK he says. Dr. Paul will NOT return us to a gold standard, nor has he even promoted such an idea. Instead, Paul has recommended introducing competing currencies, and letting the market decide.

Based on the Constitution, only the States are required to pay their debts in gold and silver. The U.S. government doesn’t really have a preferred, Constitutional process to paying their debts. In this case, I see no reason why the U.S. government can’t pay their debts in fiat currency — the Constitutional problem comes up when that same government also RESTRICTS what the market can provide in terms of competing currencies. For now, only fiat Federal Reserve Notes are legal tender, and nothing else can be. As we saw in the recent Liberty Dollar theft by the Treasury and the FBI, even bartering currencies may be considered illegal if they compete with the fiat standard.

If I was President, the first thing I would do is work with Congress, through the bully pulpit, to overturn any laws that restrict what the market can use as currency. Immediately. This would be a key aspect of my Presidency — not war, not civil liberties, not taxes, not education nor abortion nor health care.

By providing the market with a chance to offer its own currencies, maybe dozens or hundreds, the system would be in place to see what demand there would be for alternative means of barter. I believe we’d see an immediate market open up to gauge the value of currencies against each other: basically a Forex for all the new currencies out there. This would be the system used to see if a currency was worthless, or worth something. Because we’re talking about a truly unregulated, competitive market, no business would have to accept any currency that they wouldn’t want to. This would give the U.S. dollar the prime position, since almost every system is open to the dollar. It would also allow the U.S. government to pay in U.S. dollars, and also collect taxes and debts based on U.S. dollar transactions.

Yet by providing the entry to alternative currencies, you can believe that we WOULD see some competitive ventures. Some people may be defrauded by alternative currencies that say they are backed by something of value, but really aren’t, but the long term would show us competitive currencies that are backed, audited, and redeemable by something of value. Maybe we’d see McBucks that are only good for redemption at McDonalds, maybe we’d see Wal*Backs which are only good for Wal*Mart. Who knows?

It sounds terrible complicated, but in reality it would be a fairly simple navigating in terms of redeeming currencies for products or services. Just like the Forex (which shows you a real-time trade value for any currency) aids in international travel, we’d have a real-time assistant for seeing what 10 Wal*Backs might buy you at McDonalds. On a given day, we may see that 10 Wal*Backs is equa to 100 McBucks. While that number may fluctuate, over time we’d see the strongest currencies rise to the top in popularity. Since people would only pay taxes based on their income in U.S. dollars, we’d likely see the U.S. dollar quickly lose favor as a top currency.

This could have an immediate effect on war, welfare, and other government-subsidized “services.” Would you accept your paycheck in U.S. dollars, knowing you’d have to pay 20-50% taxes on that income? Would you stick to government welfare if they only paid you in U.S. dollars, which were quickly becoming worthless in the market? The system would be fine for those who believe in the U.S. dollar and government taxes, welfare, and warfare. They’d still be part of the program, and the rest of us would be able to withdraw from supporting, and being supported by, fiat currency. It is fiat currency that brings us warfare, welfare, and excessive taxation and regulation.

You may see people who accept paychecks in their employer’s currency, or the currency of their employer’s bank, but utilize a “Direct Deposit Conversion” bank that takes in the money digitally and converts it to the currency of their choice. Maybe you’d accept CitiCash from your employer, since that is where your employer banks, but have it digitally transfered to your bank who would immediately convert it to gold certificates and deposit it into your account. Or it could be vice versa: your employer would pay you in gold certificates, but your bank (say, CitiBank) would offer you a commission if you deposited them into CitiBucks. You’ have the freedom to save your money, and spend it, in the form you’d desire.

Some people may save their money in dollars backed by energy, or green manufacturing, or even diamonds. It’s a choice of freedom, not force.

What about buying things
People often tell me my idea won’t work because there’d be too many currencies to navigate. This is totally untrue, since the current form of buying things at a store almost always includes a third party processor to handling collecting, converting, and depositing of funds. When you use a check, credit card or debit card, the merchant account processor of the store handles putting the money in the form they need, usually cash in the bank. The same would be true of an open currency system. You may go to Target to buy a lamp with your TreePlantingMoney card. Before going, you notice that 100 TreePlantingMoney credits is equal to 10 U.S. dollars, which Target prefers. You have 5000 TreePlantingMoney credits in your account, which is equivalent to about 500 U.S. dollars. You go to Target, get your US$20 lamp, and use your TreePlantingMoney card to make the purchase. 200 TPM credits are withdrawn from your account. Target’s merchant collects 2% (as it typical) and converts the TPM credits to US dollars instantly, depositing US dollars in Target’s account. It’s a simple transaction, no different than using your US dollar-denominated credit card in Europe. Your bank may also charge you a small transaction fee.

The positive aspect here is that you can also shop at your preferred retailers, who may accept your TPM credits instead of US dollars or gold certificates, etc — at a discount or without overhead. Some web retailers may be your preferred outlets to buy from since they’d save you around 3% per transaction.

The secondary benefit of an open currency system is the chance to pick the banking system you want. All banks today based on the U.S. dollar are fractional reserve banks. This means that they must keep only a fraction of deposits available for redemption. If you deposit $100 into your checking account, you end up with a $100 credit to redeem. Yet if the Federal Reserve only requires a 10% fractional reserve, the bank can take up to $90 of your dollars and loan them out to others. This means that you have a $100 credit with the bank, but the person borrowing the $90 has a $90 credit with the bank, too. This means the bank has basically promised $190 out for $100 actually deposited. It is a fraudulent system that I believe would quickly end based on an open currency market.

You may pick a bank that guarantees 100% of your deposit is in reserves. The downside would be that your immediately-withdrawable deposits would have a fee attached, for the bank’s profit. They may charge you 5% a year to have your money withdrawable on demand. Yet you could also provide time-deposits, where you accept that your money is NOT instantly withdrawable, but will return interest based on what the bank can loan it out for. You may get a 10 ounce of gold paycheck from your employer, put 2 ounces of gold into your “always available” account (and pay around 0.1 ounces a year fee), and put 8 ounces of gold into your “can’t be touched for 6 months” account. The bank will loan out the 8 ounces of gold, and share the interest collected with you. If you had an emergency and needed your 8 ounces, you could get a loan against the future value of the account, and access the money immediately. Upon redemption of the 6 months deposit, the bank would withhold the loaned amount from you, and transfer the difference into your “always available” account (or roll it back into another 6 month deposit).

By getting rid of the fractional banking system (for everything but the U.S. dollar), we’d see asset and investment bubbles all but disappear. Banks with full reserves would be preferred over banks with fractional reserves, since those currencies would not be as prone to inflation (through fractional reserve lending) that U.S. dollars do.

All these open and competitive market provisions would quickly end the U.S. dollar hegemony. Taxes would only be paid by those who stick with the government’s fiat currency. Government spending would be curtailed based on what they collected by those who utilize U.S. dollar transactions. State taxes, and payments, would be paid for in gold or silver certificates, providing a Constitutional structure to keep the States in check. Alternative currencies would give added pressure on fiat currency, but also be redeemable for products or services so inflation would be in check, as well.

The downside of an open market currency system is the changes that would need to be made by the average consumer. The banks and merchant processors and stores would instantly be ready, because they already handle hundreds of currencies from international travelers. The consumer, though, would need to be able to value their currency in alternative currencies, but we already have cell phones that can access Google Mobile, which tells you in seconds what your currency converts to. Try it: Go go google.com and type in 10 dollars in euros. It’ll tell you immediately what the current Euro-value of US$10 is. If we had TreePlantingMoney credits, you’d be able to look up your conversion value from your cell phone, or from a handy kiosk at the store you’re shopping at. Complexity may go up, slightly, but stability in currency would also happen. Gresham’s Law would work in reverse here (Gresham’s Law states that bad money drives out good money), as people would “hoard and use” good money and decline to accept bad money. Maybe in the long run the U.S. government would have few people who wanted their fiat, worthless currency, and people would quickly learn the lesson that believing in unbacked currency gives you long term poverty.

For those worried about saving in one currency, the banks may give you an account that saves in a barrel of goods, say 10% in gold, 10% in silver, 10% in U.S. dollars, 10% in Euros, 10% in oil, 10% in water, etc. The bank would allow for redemption, as possible, so you’d have the ability to “check” the bank in preventing illegal fractional reserve lending or malinvesting as the banks have done for decades.

Is it an easy solution? No, definitely not. But it is not a “gold standard” advocation either. Yes, I’d quickly convert to gold-backed, 100% reserved currency, immediately. But you’d be free to select the currency, and system, that you’d agree with most of all. You pro-government advocates can continue to use dollars, which would be in my best interest since I could hire you for cheaper and cheaper personal funds each year. I’d be free of government taxes, and you’d be free to pay what you want for the services you believe government should do.

It has been a LONG time since I updated my gold versus everything charts or graphs. It is a lot of work. I really love looking at them, though, so I am ready to resurrect it — with your help.

Instead of using my own Excel spreadsheet to keep track of information, I created a Google Docs Spreadsheet that everyone can browse, copy from, and utilize. I am asking for your help to provide information for this chart. If you’re ready to help, I will add you as an editor to the spreadsheet, which is 100% online.

What do you need to do? Here are the tasks I need help with:

1. Updating historical information on any of the commodity prices.
2. Updating weekly any single item (or more) based on the actual price you’d pay, including any taxes.
3. Helping produce graphs that are useful.

If you’d like to help with any of these items, please drop me an e-mail or post a comment. I’m looking for no more than 10 minutes a week, and if you hit the grocery store once a week, it is a simple task.

You can view this data a this link: Gold versus Goods. Please feel free to be a part of this experiment.

Reasons why I picked Google Docs Spreadsheet for this experiment:

1. Anyone can become a contributor.
2. Most sites have their historical data published as an image, impossible to copy and paste.
3. You can publish real-time charts like this:

4. Anyone can download the data and save it.

Gold’s recent price-rise has been connected to the fall of value in the US dollar due to the recent federal rate drop by the Fed in September, which is a price-rise that I concur with, but I believe is limiting in being the only reason. Some analysts are also connecting the rise in the currency-price of gold as connecting with the Indian marriage season, where families buy a significant amount of gold jewelry that is used in the wedding ceremony and as a form of early-savings for the newlyweds, but this too is not enough to try to understand the reason for gold’s current boom, and what may lay ahead in the future.

On area that most analysts are forgetting, and many goldbugs are ignoring, is the production of new gold from mining companies. Historically, gold has been produced in about the same amount as is used in industrial processes. This means that we’ve been fairly consistent over recent decades than when 1 ton of gold is “used up” for industrial needs, another 1 ton of gold was mined. While it isn’t a 1:1 ratio, the ratio is consistent enough that the industrial demand for gold is well balanced with the mining supply of gold produced — leaving gold’s price moving sideways due to the close connect between new supply and demand.

Yet one area where mining companies have been a cause of keeping the price from rising is the fact that most mining companies have been operating using cheap commercial paper loans to extend their capacity to mine more gold than they would be able to based on their available cash alone. Buying shares of a gold mining company gives the company no new cash to operate — you’re just buying from a previous owner of the shares. In some cases, a gold mining company will issue brand new shares to sell, but these new shares dilute the ownership value of previous shares, so it isn’t done often for the larger producers.

In the past, commercial paper-backed loans are loans that are created from commercial deposits, which are generally paid a low interest rate to the depositors. Commercial paper loans have also been used significantly by the recent mortgage loan industry, part of the reason for the massive bubble in housing price (easy and cheap loans backed by short term commercial paper led to easy credit led to overfinancing led to too much money aimed at buying houses led to prices skyrocketing until the commercial paper market crashed).

Just as the commercial paper market has crashed in terms of providing easy money for buying homes, it is also crashing in terms of easy loans for gold producers. The effect, though, is quite the opposite. When there is easy money to build and buy homes, prices in home skyrocketed because people were sending a huge influx of new cash into an existing market. In the gold mining industry, that easy credit led to prices to FALL for gold because of the influx of cash into the development of mines (heavy equipment, labor, processing and excavating). With the reduction in available loans for mines big and small, their ability to find new veins of gold, hire the labor to mine it, buy the equipment to support the labor, and process the ores mined is reduced. A reduction in production supply for gold should bring with it a reduction in the new supply of gold. If demand stays high (which may not happen as the price continues to rise), and supply drops due to mining companies having to produce on budget rather than with easy credit, the price of gold could continue to rocket upwards.

It is important to understand the limited supply of gold in the world today, and the intricacies of bringing in a new supply. The process of producing new gold is not as simple as finding a vein and bringing it up. It is very expensive industrially and chemically, as well as a very time-consuming process. Many mining companies fail because they misread how much gold they think they have access to, or they misread the costs of converting the mined ores to pure gold. With a reduced loan capacity to continue their operations, I believe we’ll see a reduced supply of new gold in the coming months and possibly as long as 2 years. This would definitely put upward pressure on gold until such time that a new source of credit can be found for the gold producers.