Professor Elam

Thursday Feb 18 2010

I asked permission and it was granted from Richard Russell, author of the Dow Theory Letters, to reprint a recent column.   Mr. Russell has written his investment letter since the 1950s. He has authored numerous articles for Barrons and is well respected in investment circles. By the way, at age 85 he writes every day, and has more subscribers than ever. His remarks on gold deflation and the dollar appeared Feb 17 2010.

What does it mean when people say that the "dollar is strong?" At present, there is no definition for the dollar. The dollar is only defined in terms of other currencies. For instance, "The dollar is worth so much in terms of the British pound." The euro was created to be the chief competitor to the dollar. The euro, because of the Greek mess, has been weak. As the euro weakens, the dollar is listed as "strong." 

But there must be one solid reference point against which everything is gauged. That item is gold. When the dollar price of gold rises, it means that the dollar is truly strengthening. When the dollar, as now, is declining against gold, it means that the dollar is weakening. A "strong dollar" today is taken to mean a dollar that is strong against the euro. But at the same time the so-called strong dollar can be weakening against the standard — gold.

At this time, almost every item and sector class is declining against gold. This is a indication of deflation. If the price of houses, commodities and real estate were rising against gold, that would be a symptom of real price inflation. T hat is not what's happening. People do not understand deflation. They think deflation is a decline in the dollar price of items. Deflation is a decline in price of items against gold. As the value of the dollar declines against gold (or as gold rises in price in terms of dollars) we see deflation. 

As the price of gold rises in terms of dollars, the dollar is being devalued. In a matter of months or possibly years, this decline in the dollar vs. gold will transfer to other prices. The price of everything will decline in dollar terms. This is what the Fed is so afraid of. The Fed can control inflation simply by raising interest rates or cutting back on the money supply. But once deflation sets in, there's little the Fed can do about it except attempting to smother deflation with new oceans of money.

Deflation and unemployment tend to feed on each other. The real battle facing the nation today is chronic unemployment. Americans are both frightened and furious. They see that the Fed has bailed out Wall Street, but what has it done for the man on the street? The so-called "stimulus" packages have proved useless. 

The real employers of people are America's small businesses. The small business man is now confronted with higher taxes, uncertainty, debt and "too much government." The small business man must cut overhead in order to survive. The easiest way to do that is to fire every last employee he can live without. His second option is to move to lower rent quarters. Both of these are basically deflationary. The cost of the Obama health plan would be a further burden on the small businessman. 

The US economy is caught between a rock and a hard place. The little guy sees the government, not as his savior, but as his main problem. This has given rise to the "tea parties." Get the government and Wall Street out of my hair" is the cry. Soon the cry will be deflation.

The question – Why hold gold if deflation is our future?

The answer – The Bernanke Fed will fight tooth and nail against deflation. They will do it with zero interest rates and the creation of massive amounts of more dollars. This will have the effect of destroying the dollar over time. And it will direct "survival" traffic toward the one item that can not be devalued — gold. When all confidence in fiat paper disappears, the rush will be on for the one money that cannot be destroyed or devalued — gold.

Russell recommendation — Do not expect too much from gold now. Over time, gold will prove to be the ultimate reservoir of wealth. In the end, gold will be "the last man standing." Compute your gold position in ounces, not in its current value in dollars.