by | Sep 28, 2009 | Howard Katz | 1 comment

Do you LOVE America?


    All the scaredy-cats are trembling in their shoes this week as gold dipped below the $1,000 level. Foolish people. Can’t they see that the U.S. dollar is in free fall? We told subscribers this on August 3, when the U.S. dollar index broke 78.20, thus completing a double top. That double top is now working out its implications, and the dollar bulls are taking it on the chin. As the dollar goes down, gold will go up. All those people who took part in the flew to “safety” got things a little bit wrong. Instead of taking part in a flight to safety, they have taken part in a flight from their senses. I would like to say that they will wake up after this is over poorer but wiser. However, that is not what happened in the 1970s. In the ‘70s, those people who followed the establishment woke up at the end of the decade a lot poorer than they had been but every bit as stupid.


    At the worst, what is probably happening to gold short term is a pull back to the apex of its symmetrical triangle at $960 (shown above). Such pull backs are common although their exact timing is tricky. Such a pull back, if it occurs, would be a very good buying point.

    I sincerely hope that you do not wind up at the end of this upswing in the commodity pendulum poorer. But if you do, then I want to contribute my part to helping you to get wiser (so that, having made the mistake once you do not make it again). To do that, we need to do some real economics. Real economics is the type such that, when you use it to make a prediction, the prediction comes true.

    For example, George Bush, Jr.’s economic advisors said, “We are the top economists in the world” when they took office in 2001. But as they were leaving office in 2008, they said, “The country and the world are in a terrible economic crisis.”

    Now if I hired a man for a job in 2001 and by 2008 he had gotten into a terrible crisis, then I would know what to do. I would fire him and hire somebody else. I would hire someone who could make accurate predictions and whose policies worked.

    For example, the new President, Barack Obama, has enacted a cash for clunkers program to make the country richer. You turn in an old car. The Government destroys the engine and throws it away. And then the President declares the country to be richer. This seems to work well in France. In France, they have destroyed so many cars that everyone goes around riding on bicycles. This is called the Tour de France. (Correction, I don’t think that France has yet thought of the idea of destroying cars. It is just that the whole country goes on holiday at the drop of a hat, and so very few cars are built.)

    What real economics has to say to the average person is not very encouraging these days. Most everyone who takes an interest in investing does so with the idea of retirement in mind. So let us examine the concept of retirement and see what real economics has to say about it.

    The first thing to learn about retirement is that it is a fairly new idea in the scheme of things. Prior to 1785-86, there was no retirement. Everybody worked until they died (unless they were rich, in which case they did not work at all).

    Retirement was invented in 1785-86 by Noah Webster, who is best known for being the author of the first American dictionary. Webster, then a young man, took a trip through the 13 newly independent states in 1785-86. He talked to state legislators and other influential people, and he convinced them to legalize interest. (This was only done in the northern states; the South waited until after the Civil War.) The following year the British philosopher, Jeremy Bentham, wrote a paper entitled, “In Defense of Usury [Interest],” and interest was legalized in Britain shortly thereafter.

    Once receiving interest was legal, people began to save. A normal rate of interest from 1788 until 1933 was 5%. As people saved, they would put their money in the savings bank or purchase a corporate bond. Here is how it worked. Suppose a man whose average salary was 30 oz. of gold per year saved an average of 6 oz. each year. His first year’s savings receives interest for 49 years (age 16 to 65). His last year’s savings receives interest for 1 year. His average year’s savings receives interest for 25 years. This means that the money he saves multiplies by 3.4 times due to the working of compound interest. If you can save 6 oz. of gold each year, then over a 49 year working lifetime, he has saved 294 oz. of gold. Since compounding at 5% per year multiplies this by 3.4, he now as a total capital of 999 oz. of gold. At 5% interest, he would receive earnings of 50 oz. of gold per year, 1.7 times his annual salary. With this incentive, Americans (and British) began to save. They would quit work at age 65 and live off the interest on their accumulated savings. This had never before happened in world history.

    Notice that this system of retirement does not depend on the young supporting the old. Once the 65-year old has accumulated his capital, he can live off of the interest for the remainder of his life, even if the human lifespan is extended to 200.

    Now it may be asked from whence comes the wealth that the retired person consumes? After all, a person who is retired consumes wealth, but he does not produce it. He lives in a house or apartment. He drives a car. He wears clothes and eats food. And he indulges in some of the amenities.

    How can a large class of people consume all of this wealth without putting a terrible burden on society?

    The answer is that, under Noah Webster’s system, the businessman, whose corporate bonds paid the saver his interest, would use the borrowed money to build/buy machines. These new machines increased the amount of wealth a worker could produce in a given day. With the workers creating more wealth, there was more wealth in the world. It was this extra wealth which produced the goods consumed by the retirement community. No young person had to support any retired people. The retired supported themselves by the interest on their own capital. The system worked brilliantly for well over a century.

    Then along came John Maynard Keynes. He hated interest. He worked out an underhanded way to undo Webster’s brilliant achievement and abolish interest. You know that, at present, short term interest rates in the United States are virtually zero. However, you have probably not been aware that they have been zero for the past 76 years. This is because what is important is the real rate of interest. This is the rate of interest minus the rate at which the currency depreciates. THIS REAL RATE OF INTEREST HAS AVERAGED ZERO FOR THE PAST 76 YEARS. That is, Keynes (via F.D.R. and Nixon) set up a system of depreciating the currency, and the rate at which the currency has depreciated has almost exactly kept up with the nominal rate of interest. That is, if your savings in the bank were $100,000 and you were receiving 6% interest, you would get $6,000 per year. However, if average prices were rising by 6% per year, then the buying power of your bank account would decline by $6,000 each year. In real terms, you would be receiving zero interest.

    But if the real interest rate is back to zero, then we are in the age prior to Noah Webster In this case, it is firstly impossible to retire because our capital is not increasing via compound interest. And it is secondly impossible to retire because our capital cannot earn interest.

    Now I am exaggerating a bit here. It is not completely impossible to receive real interest on one’s savings. Keynes’ system eliminated real interest for fixed income investments: T-bills, savings accounts, bonds. However, there are two kinds of investments which still yield (the equivalent of) real interest. These are stocks and (income producing) real estate. In each case, the real value of the investment protects you against the depreciation of the currency. Thus, the yield that you receive from your investment genuinely adds to your wealth, much as the typical American’s savings account genuinely added to his wealth in the 19 th century.

    “OK, Katz, if this is what you believe, then why are you a gold bug? Why don’t you recommend that we go into the stock (or real estate) market? The answer is two-fold. First, the stock market is notoriously difficult for the average person to play. Time and again the public rushes in to buy stocks right at the top. March 2000 was the last example of this. In 2½ years, NASDAQ investors had lost 80% of their money. The 19 th century American did not have to worry about this problem. Also, real estate is a business in itself. You have to learn it and deal with a host of problems. It can be done, and if you have an interest in it and a knack for it, then go ahead. But it is not for everyone.

    Second, the stock market bulls of today are completely ignorant of the commodity pendulum. When the Fed starts creating money, consumer prices respond rapidly (in about 2 years). But commodity prices do not respond for a long time (10-20 years). Finally, commodities are so undervalued in real terms that they make up for lost time. Thus there are giant swings in commodity prices (up in the 1970s, down from 1980-99, and up again since 2001). We saw the commodity pendulum work in the 1970s. Commodities rose. This fed through into consumer prices. And this forced the Federal Reserve to tighten credit. This made both bonds and stocks go down.

    So the rule is, while the commodity pendulum is on the downswing, it is a good idea to be in stocks or real estate. While the commodity pendulum is on the up swing, it is a good idea to be in commodities. And of course the most user-friendly commodity is gold.

    Since these swings can take decades, it is foolish to try to ride them out. I am not a gold bug in the sense that I am always bullish on gold. I play the commodity pendulum. I was a bull on gold from 1970 to 1980. I turned bullish on stocks and real estate in 1982. I turned bullish on gold again in 2002.

    Within the commodity pendulum, there is some overlap between the bottom in commodities and the top in stocks. At the present time, that overlap was probably the period 2001-2007. You can see how understanding all of this is extremely important. Since commodities have been racing for the moon over most of the past decade, sooner or later this has to catch up with the stock market. Therefore, the naïve stock bulls are on extremely dangerous ground. The longer they hold their bullish positions the more danger they are in. But these, of course, are the great majority of investors. Do you remember what the same type of people did over the course of the 1970s?

    In 1967-68, they went wild on a technology stock bubble just like the internet bubble of 1999-2000. Then they switched to the mantra, “Buy and hold good sound stocks for the long pull.” This is what they are saying now. Finally, at the very bottom in 1982 they turned bearish. Do you hear the stock bulls of today swearing that they will never, under any circumstances, sell their stocks? That is what they said for most of the 1970s. It is déjà vu.

    In short, getting a real yield on your capital (which is necessary to accumulate money for retirement) is possible only to a few. You must be able to play the stock market like a violin. That is not likely to happen. What I recommend instead is playing the swings of the commodity pendulum. When commodities are on the rise, be long commodities, and remember that gold is the easiest commodity to play. The current stock bull market will probably give a sell signal sometime next year. (Right now, 12,200 is my best guess.) All the establishment traders will follow it down. They are skating on thin ice. What happens next will not be very pretty.

    This is the time for commodities. Gold is leading the way. Buying gold now is like buying stocks in 1988. You have the long term trend on your side. The theory of the commodity pendulum is on your side. Understand this theory and trade in accordance with it, and you will come through this market period as a winner.

    Then you can reach your goal of having enough capital for retirement. To help people like yourself understand real economics and reach the goal of being able to retire, I publish a financial letter called the One-handed Economist ($300 per year). You can learn more about this letter by visiting my web site, You might also enjoy visiting my blog at This week I blog about Newsweek’s recent article, “The Case for Killing Granny.” (I don’t think you have seen me this mad in a long time.)

    Thank you for your interest.

    # # #


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      1 Comment

      1. I generally agree with this article. Jim Rogers points out huge pendulum swings in commodities and predicts that the current bull market we are in will last for at least 5 more years. And I think he was DEAD on with his zero interest theory (once again a theory echoed by another great economist - Marc Faber). However, there are some things which confuse me about this article – the gold chart in particular. Example, depending on where I started, I could draw a triangle on that chart that would indicate that gold would go down to 700. So why are we to believe that his lines are the ones to follow? Is it because he began them at the time of the most recent bottom in March? What if we get this double dip that people have been talking about and the dollar rallies? Then will we have to start over from scratch? The point being that the ‘short term’ future is WAY harder to predict than the long term. I don’t pay much heed to his call on 960 for a short term gold bottom. It may either do nothing but go up from here, or it could go down to 700 before beginning its major climb. Who knows?

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