The ‘falling dollar/rising gold’ phenomenon

By WND Staff

Editor’s note: The following is a guest commentary from one of WND’s sponsors, Kevin DeMeritt, president of Lear Financial. If you would like to learn more about investing in precious metals, take advantage of the free information Lear Financial is making available to WND readers.

Between 1970 and 1980, the flawed economic policies of the Nixon/Ford/Carter years led to our dollar depreciating a stunning 70 percent against a basket of world currencies. During this depreciation, gold rose from $50 to $850 per ounce.

The next precipitous decline in the U.S. dollar occurred between June of 1982 and February of 1983 during the “Reagan Recession.” Concurrently, the price of gold jumped 75 percent.

Then, between February 1985 and November 1987, the dollar fell again as a result of the Plaza Accords, an agreement established among the central banks of the United States, the United Kingdom, France, Japan and Germany to devalue the greenback in a controlled fashion.

Gold increased in value by 78 percent over those same 29 months.

Now, to date in 2002, the dollar has fallen 14 percent and is at a two-year low against the euro. Accordingly, gold is up 19 percent over the same time span, outperforming the Dow and other investments.

Can we draw any conclusions here?

Gold and the dollar have an inverse relationship

When the dollar is up, gold tends to be down. And when the dollar is down, gold tends to be up. For every 1 percent decline in the dollar, in fact, the value of gold generally increases by about 2 percent. There are some powerful reasons for this.

The obvious one has to do with the fact that gold is priced in dollars, so as the dollar declines in value, the price of gold naturally increases.

The less obvious reason has to do with the consequences of the U.S. running twin deficits – near-record trade and federal budget deficits. As the dollar continues to decline in value as a result of these staggering deficits (and other factors as well), foreign investors are prompted to take a safer, more secure approach. That approach involves trimming commitments to troubled investments, like U.S. stocks and bonds, and adding more safety and profitability in the form of gold.

Twin deficits fuel the dollar’s decline

This inverse relationship between the dollar and gold is especially significant in light of the dollar’s dire outlook. Both the International Monetary Fund and the Organization for Economic Cooperation and Development, for instance, recently warned that the near-record trade gap could cause the dollar to fall sharply.

Specifically, the IMF warned in July that the gradual departure from the dollar by foreign investors could turn into a full-blown retreat because of America’s twin deficits: a record $409 billion trade deficit and a $160 billion federal budget deficit (an especially startling statistic since, just 24 months ago, a $313 billion dollar federal surplus was projected by the government).

Goldman Sachs has shared the same concern over the consequences of these deficits. With our “current account” deficit (another name for the U.S. trade deficit) presently in the $400 billion a year range, Goldman recently estimated that the dollar would have to fall an “astonishing” 43 percent against world currencies to cut the deficit in half.

“There are a lot of reasons why the market is pushing down the value of the dollar at this time. But only one is foremost. Current world economic and political conditions lead to less trust in the dollar’s value. Since it is the reserve currency of the world, a sharply dropping dollar can play havoc with the entire world economy,” said U.S. Rep. Ron Paul, R-Texas, in a June congressional speech. He added, “History and economic law are on the side of gold.”

Joining the chorus of other institutions, Morgan Stanley predicted in July (in a report on its
,) that the dollar could drop by 20 percent or more inside of a year. If, indeed, gold does tend to increase by about 2 percent for every 1 percent decline in the dollar, a $450 to $500 per ounce target would be entirely reasonable for 2003. At the very least, the prospect of a falling dollar and rising gold should merit your serious consideration. Allocating more gold to your portfolio not only can serve as an insurance policy against the unforeseen consequences of a weak dollar, but it can also position you for unexpected profits. After all, as Ron Paul put it, “History and economic law are on the side of gold.”

Special for WND readers, Lear Financial is making available free information on investing in precious metals.

With more than 20 years of industry experience, Kevin DeMeritt is president of Lear Financial, one of today’s fastest growing and most successful precious metals investment firms.