By Dr. Murray Sabrin
May 26 2009 3:58PM

In November 2003, a month before the 90th anniversary of the creation of the Federal Reserve, I spoke to a group of money managers and

bond traders in south Florida about the Federal Reserve’s nine decade legacy. At that time the price of gold was approximately $380 per ounce. I informed the attendees that gold was the most undervalued asset on the planet. Nearly six years later, gold has nearly tripled in price and may have been the best performing asset class in the world since then, and one of the best investments in this decade.
Hopefully, the money managers who heard my remarks about the evolution of our monetary system took my advice for their clients’ sake and added gold to their personal portfolios as well. But then again, gold was so out of favor as an asset class by Wall Street a few years ago, it would not be surprising that the attendees ignored my advice and did not add the yellow metal to their portfolios.
With gold currently trading at $950 per ounce, where will the price of gold be six years from now? Conceivably, much higher than any current forecast. How high? Later in this essay, I will explain how returning to a “hard money” dollar and a sound banking system will require a gold price of at least $6,000 per ounce and possibly much higher
Before we hypothesize a future price of gold, it is imperative we understand the current financial crisis and the need to abolish fractional reserve banking, paper money and central banking. In other words, for the American economy—and the global economy-- to enjoy sustainable prosperity we need to inject a heavy dose of free enterprise in our money and banking systems.
This is easier said than done. The political and financial elites of America want to maintain the status quo, namely, the creation of money out-of-thin air, artificially low interest rates, and massive bailouts engineered by the FED and the U.S. Treasury.
Nevertheless, the financial meltdown of the 21st century has been well documented in two outstanding books of the past year, William Fleckenstein’s Greenspan Bubbles and Thomas Woods’ Meltdown. If you have not read them both, they should be on the top on your summer reading list. Both authors place the blame for the back-to-back bubbles, the dotcom bust and the housing collapse, squarely on the Federal Reserve’s easy money polices under Fed chairman Alan Greenspan.
In a nutshell, easy money drives down interest rates, which in turn set into motion feverish activity and speculation in sector or sectors of the economy that benefit from the flow of new money from the FED. The excess credit propels prices higher for common stocks, real estate, commodities, etc. When the FED “tightens” credit to rein in the overheated economy, the inevitable correction sets in. Bankruptcies soar, unemployment rises, stock prices drop precipitously, and state and local governments face huge revenue shortfalls as income and sales tax revenues drop. In other words, the unsustainable boom appears to create a perpetual “party” in the economy, only to be exposed as a period of “false” prosperity.
The booms and busts of the past two decades are textbook examples of the financial and economic crises caused by central banking. Of all the schools of thought, only the Austrian School of Economics explains how waves of boom and bust are inevitable if central bankers try to substitute credit created out-of-thin air for genuine savings. Working in the same tradition, economist Jesus Huerta de Soto in his monumental survey of world economic history (Money, Bank Credit and Economic Cycles), explains how economic fluctuations are the result of bank credit expansion prior to the establishment of central banking and how business cycles have unfolded since the creation of the first central bank in England (1692).

To prevent further boom-bust cycles, the following changes in the U.S. monetary/banking system should be implemented ASAP. These would require banks to restructure along the following guidelines.
  • All demand deposits would be backed by 100% reserves. In other words, fractional reserve banking would be prohibited as a violation of property rights. This would eliminate the bank run, because banks would have all the money in reserves to meet depositors’ requests for cash. This reform would be potentially deflationary since the banking system would have to contract the amount of money and credit in the current inflationary system to restore 100% reserve banking.
  • Banks would offer time deposits from one day to 30 years or more. This would provide a pool of real savings for banks so they could perform their role as financial intermediaries without government protection and intervention.
  • FDIC insurance would be eliminated. Banks and depositors would operate in a free market. Savers would determine how much risk they want to incur and lend their funds to banks based on their time horizons.
  • Permanent bank capital—preferred and common stockholders—would be the foundation of a free enterprise banking system. Risk of default would be allocated among shareholders and savers.
  • The Federal Reserve would be abolished and would no longer manipulate short-term interest rates and be the lender of last resort. The FED’s track record of the past century should convince any objective observer and analyst that it has been a failure. The dollar’s purchasing power has fallen by more than 95% since the FED was created and the business cycle is still with us.
  • The dollar will once again be defined as a weight of gold. What should the ratio be between the supply of dollars and the 260,000,000 ounces of gold held by the Federal Reserve?
There are several ways to revalue the dollar in terms of gold and make the U.S. dollar a hard money once again. This would create a 100% gold dollar. Americans as well as foreigners are used to conducting their exchanges dollars so the goal is to regain the confidence of dollar holders by ending the devaluation of the dollar.
  1. All currency and demand deposits and other forms of money would be convertible into gold. That would mean all forms of money that people are familiar with would “backed” by gold. Inasmuch as there about $1.6 trillion of this form of money outstanding that would be backed by about 260,000,000 million ounces of gold held by the Federal Reserve, the price of gold or more accurately the value of the dollar would be 1/6,153 of an ounce of gold. In other words, the price of gold would be $6,153 per ounce.
  2. According the Rothbard/Salerno definition of the “True Money Supply,” the current amount of dollars in the economy that functions as the general medium of exchange is about $5.5 trillion. Based on this approach, the FED’s 260,000,000 ounces of gold would have a dollar/ratio of 1/21,153, or the price of gold would be $21,153 per ounce. Before you mortgage the house and sell the kids to make more than twenty times your money, another economist challenges the Rothbard/Salerno definition of the true money supply.
  3. Economist Frank Shostak in his essay on the money supply, argues that savings deposits should be removed from the definition of money because they are a credit deposit rather than a demand deposit. Based on the Shostak approach, investment manager Mike Shedlock calculates M’, (M Prime), as approximately $2.2 trillion. The gold/dollar ratio would be 1/8.461 or a gold price of $8,461 per ounce under this definition of the money supply.
Clearly, no matter what definition of money is used to restore a gold backed dollar, the price of gold will have to be adjusted upward by a factor of at least six or more from today to reflect the enormous deprecation of the dollar since the FED was created nearly a hundred years ago.
The revaluation of the dollar will not happen because Ben Bernanke, chairman of the Federal Reserve and Timothy Geithner, U.S. Treasury Secretary embrace hard money principles and realize 100% reserves are necessary for the banking system to function as a reliable financial intermediary. The restoration of a gold backed dollar will occur when dollar holders lose confidence in the purchasing power of the greenback. The sooner the next great money and banking reforms are implemented, the less chance there will be for a global monetary debacle, given the trillions of dollars the FED and other central banks have created in the past six months. In the meantime, load up on the yellow metal. It is your best insurance policy against Obama, Congress, Bernanke, and Geithner.
Dr. Murray Sabrin