Petro-Dollars (courtesy Google Images)
Every so often, I propose a theory that’s new (to me, at least). When I do, my initial presentation of that theory is often clumsy and incomplete. This isn’t surprising. If the theory offers a new insight, it takes time to learn how to explain it clearly. However, over time, if the theory comes to seem valid, my presentations of that theory become more refined and easily understood.
Today, I present another theory with language that’s at least clumsy (some might say, “half-baked”). I don’t like to present texts that seem clumsy even to me, but I have to do so to not only to try explain the theory to my readers, but also to explain it to myself. More, I must make the presentation because I know that some of my readers will make comments that will help me to better understand if the theory is probably true or probably false and thereby help me to make clearer presentations in the future.
In essence, I can’t seem to take this theory any further without help from my readers.
For today’s theory du jour, I propose that while the former global monetary system from A.D. 1971 to A.D. 2001 was based on the singular “Petro-Dollar,” in the past two years it’s been replaced by a new system based on several “petro-currencies”. The fiat dollar is no longer the only currency that can purchase petroleum, but with the reemergence of the US as an oil exporting nation, the fiat dollar has gained some value as one of several “petro-currencies”.
The emergence of the several “petro-currencies” might explain the last 20-month decline in the price of gold.
• “The trend is your friend” is an investment cliché that’s both absolutely true and generally confusing because, while we can easily say what the trend “was” at some distinct period in the past, we can never be absolutely sure what the “trend” is right now.
That’s because a general trend is a kind of vector that results from the combination several (or even innumerable) other, smaller, ever-changing vectors moving in different directions and with different degrees of force.
Imagine a ship at sea. The ship is heading due south at 15 knots, powered by its engine. But the wind is blowing due east at 10 knots, and the current is moving nor’west at 3 knots. The ship’s actual course and speed (the ship’s “trend”) will be the result of all combining the four “vectors” of ship’s engine speed, rudder direction, wind speed and direction, and the force of the current. By the time we compute all of those factors, the ship that’s headed due south at 15 knots may be actually moving sou-southwest at 12 knots.
The “trend” is the result of combining a number of underlying and often contradictory factors.
So long as we know the general trend, we can steer the ship appropriately to reach our destination. But if we don’t know the trend at any given moment, we may be in danger since we don’t know where we’re actually headed and we can’t reliably control our destination. I.e., we could steer our ship due south, and still wind up traveling south-southwest.
• The principle of “trend” applies to navigating investments as well as ships. If we can identify fundamental trends, we can invest our wealth in ways that minimize our expenditures and maximize our gains.
For example, when the trend for the stock market is down, if you invest in stocks you’ll probably lose some of your investment.
But not necessarily. Given that the “trend” of the Dow is composed of 30 smaller “vectors” (individual stocks) and some of those stocks are going up while others are going down, the Dow’s general “trend” could be down at the same time one of its component stocks is vectoring up. If you’re smart enough to invest in a stock that’s going up while the Dow’s trend is down, you can prosper.
The trend is your friend, alright—but which trend? The general trend for the market? Or the specific trend for a particular stock or commodity?
• When the trend in gold is dramatically up—as it was from A.D. 2001 when gold was priced at $280/ounce until September, 2011 when gold peaked at $1922—it seems easy to know how to invest our wealth. Gold was up 580% in 11 years, that upward trend seemed certain to carry gold to an ever-higher level over the next 5 years, so gold seemed a sure thing.
However, in the last 20 months (since gold peaked at $1,900), gold has moved significantly downward. Today, gold is $1,395—down 27% since its $1,922 peak.
So, we’re faced with some very fundamental questions:
Is the 27% decline in the price of gold merely a temporary “correction” in the up-trend (“bull market”) for gold that’s existed since A.D. 2,000 and is likely to continue for at least another five years? Or does the recent decline mark the end of the up-trend for gold and the beginning of a new down-trend (bear market) for gold?
These questions are vital because “the trend is your friend”. The trend is an implicit guarantee that, so long as you invest in way that’s consistent with the current trend and hold your investment long enough, you’ll prosper. On the other hand, if you fail to recognize the current trend and invest in a way that’s inconsistent with that trend, you’ll probably suffer significant losses.
So, is gold’s uptrend still intact—or is the downtrend here to stay?
Gold “bulls” say the past 20 months are a mere correction in the long-term uptrend.
Gold “bears” believe the past 20 months mark the beginning of a long-term downtrend.
• To understand today’s trend, let’s first consider a few highlights in gold’s previous “trend(s)”.
1934, government arbitrarily changed the price of gold from $20 to $35/ounce.
1975—President Nixon stopped redeeming foreign-held dollars for gold. The dollar became a pure fiat currency without any legally-fixed relation to the price of gold. By February, 1975, the average monthly price of gold jumped from $35 to $175/ounce—a 400% increase in less than four years. It’s important to note that his 400% increase was brought on by government degrading the dollar to a pure fiat currency.
1976—From February, 1975 to August, 1976, gold suffered a 37% “correction” as it fell from $175 to $110/ounce. (Coincidentally, this 18-month, 37% correction is not so dissimilar from to today’s 20-month, 27% “correction” in the price of gold.)
1980—From August, 1976 to July, 1980, gold rose from $110 per ounce to the monthly average price of $645—almost 600% in four years. (The similarity between the 1975-1976 “correction” and our recent 20-month decline in gold prices, is not proof that we can expect another 600% increase in the price of gold in the next few years. However, given that that sort increase has happened before, it could therefore happen again. If it did, and today’s gold jumped 600% over the next four years, it might top out over $8,000/ounce.)
1982—After the average monthly price of gold peaked at $645 in July of 1980, the price fell in a 51% “correction” until it hit a $315 bottom in June of 1982.
2001—During the 9 years between 1982 and 2001, gold ranged from $300 to $500 but moved mostly sideways and ended up at about $265/ounce in February, 2001—down another 11% from its 1982 bottom of $315.
And then the fun began.
2001 to 2011—From its $265 bottom in February, 2001, the price of gold rose steadily to $1922 in September, 2011. That’s a $1,657, 625% rise in ten years. Whew! What a ride! Left you “breathhhless!” and wanting more, didn’t it? (Note that the price rises between 1976 to 1980 and again between 2001 to 2011 both worked out to about 600%.)
The ten years between 2001 and 2011 created the up-trend that most “goldbugs” rely on when we talk about $3,000, $5,000 and even $10,000 gold.
If that trend is still intact, we’re golden.
If that trend is broken, we’re in trouble.
In a moment, we’ll reconsider this extraordinary 2001-2011 uptrend and ask “Why did it happen?” If we can discover a primary event that precipitated the 2001-2011 uptrend in gold, we might also be able to discover whether that uptrend is over or still ongoing.
But first, the fly in the trend ointment:
2011 to 2013—Aww, snap. In just 20 months, the price of gold fell 27% from its $1922 peak in 2011 to today’s $1395. I wouldn’t have thought it possible. I still don’t think it could’ve happened in a true free (unmanipulated) market.
Nevertheless, here we are. The price of gold is back to where it was in February, 2011.
Not much fun, is it? Ohh, it’s great for those who want to buy gold at a cheap price. But for those who’ve held gold for five or ten years, the past 20 months have been depressing and even disturbing because we don’t know if it’s merely a “correction” of the sort seen in 1975-1976 or if it marks the end of the magical 2001-2011 uptrend when gold was almost perfect.
Our ignorance makes us anxious. If we knew today’s trend for sure, we’d know what to do.
• Part of the problem with identifying trends is that they’re all time-sensitive. For example, did the current trend in gold start in the 1800s when gold was officially $20/ounce? In 1934, when gold was $35/ounce? 1975, when gold was $175? 1980, when it jumped to $645? 2001 when it was $265, or 2011 when it hit $1922?
The answer in every instance—except the period starting in 2011—is Yes.
We can choose to arbitrarily define any starting date to mark the beginning of today’s “trend”. If we claimed today’s trend started in the 1800s, gold is up. If we claimed today’s trend started in 1934, gold is up. If we started today trend in 1971, gold is up. If we started today’s trend in 2001, gold is up.
It’s only if we start today’s trend in 2011 (when gold peaked at $1922), that trend (if it’s a true “trend” rather than a mere “correction”) is down.
For me, that’s cause for some relief. The trend for gold is up, up, and up for most of two hundred years—except for the past 20 months. Yes, there were other instances (like 1975-1976) when the price of gold fell significantly, but those were only “corrections” since they interrupted, but did not terminate, the long-term uptrend in gold.
Only the past 20-month decline in the price of gold is still ambiguous in that it might merely be a correction in the long-term uptrend for gold—or it might mark the onset of a completely new downtrend in gold and the corresponding end of the previous, 2-century long, uptrend.
Looking at the recent price decline from any perspective over 2.5 years old, gold is up. So, it seems unlikely that the current price of gold is in a long-term downtrend. Such downtrend isn’t impossible, but it would defy the odds established by the past 10, 40, 80, and even 200 years of gold price changes.
Judging by any long-term trend (other than the last 20 months), the current 20-month price decline is merely a “correction” in the ongoing uptrend in gold. If so, the price of gold should go higher in the near future.
Next, let’s reconsider some fundamentals.
• National Debt. Although President Obama says that debt is $17 trillion, John Williams at Shadowstats.com says the debt is actually closer to $90 trillion; the Congressional Budget Office (CBO) says that, including unfunded liabilities, the national debt is over $200 trillion. I believe Williams and the CBO are right. If so, the national debt averages out to between $300,000 and $700,000 per living American.
There’s no way that even half of that debt can be repaid. I guesstimate that at least 80%—perhaps 90%—of the national debt must be repudiated by inflation and/or government admission of overt bankruptcy. If I’m right, at least 80% to 90% of all government bonds (and other paper debt instruments that memorialize the national debt) must be “vaporized”. I expect the repudiation of paper debt instruments to spread from bonds to stocks, mortgages, So-So Security, pension funds and even bank accounts. As paper debt instruments become worthless, people should abandon fiat dollars and start screaming for gold and silver. If so, the prices of precious metals should soar.
Has the national debt disappeared? Is it likely to disappear in the foreseeable future?
No.
Therefore, I believe the unpayable national debt implicitly guarantees inflation and therefore the uptrend in the price of gold.
• Global Inflation. The Federal Reserve’s Quantitative Easing (QE) is intended to be inflationary. But the Fed isn’t the only central bank bent on inflation. The central banks of the world are currently printing more and more fiat currencies in order to “stimulate” global economies with more inflation.
If central banks succeed in causing major, global inflation, the price of gold must go up at least enough to match inflation—and probably even more as demand for gold soars.
• Fiat dollars. In 1971, President Nixon stopped redeeming foreign-held dollars for gold and reduced the dollar to a pure fiat currency. As a result, the price of gold jumped from $35 to today’s $1395/ounce—a 3,800 % increase in 42 years. Now, that’s a trend. It’s important to note that his 3,800% increase was caused by government degrading the dollar to a pure fiat currency.
So long as the dollar remains fiat, the price of gold should continue to rise.
• Petro-Dollars. After the dollar became pure fiat in 1971, the Nixon administration cut deals with Saudi Arabia and OPEC whereby those oil-exporters guaranteed to sell their crude oil for only fiat dollars. As a result, any nation in the world that wanted to buy crude oil (and most nations did), had to first have fiat dollars to pay for the crude. This created a global demand for intrinsically-worthless fiat dollars. The demand gave the dollars an implicit value. Thus, the fiat dollar was implicitly backed by petroleum (rather than gold or silver) and became the world’s only “petro-dollar”.
The Nixon administration’s scheme worked brilliantly until about 2001 when Saddam Hussein started selling Iraqi crude for currencies other than the fiat dollar. By selling Iraqi crude for euros, Saddam launched a mortal attack on the “petro-dollar”. If the world could purchase crude oil with currencies other than fiat dollars, the global demand for fiat dollars would fall, and the apparent value of “petro-dollars” would fall and might even die in a burst of hyperinflation.
The Powers That Be didn’t want a dead dollar and therefore determined to punish Iraq for daring to sell crude for currencies other than dollars. Under the pretext of seeking Weapons of Mass Destruction, we invaded Iraq in 2003; gave ‘em a dose of “Shock and Awe” (to terrify all other oil-producing country out of any intention to sell their own crude for anything other than “petro-dollars”); imposed US dollars as Iraq’s primary currency; hanged Saddam; killed several hundred thousand Iraqis; and generally devastated Iraq.
Saddam had only sold Iraqi crude for euros for about 2 years. But, our invasion was still too late to save the world’s only “petro-dollar”. The underlying fundamentals (i.e., the dollar is fiat and intrinsically worthless; the national debt is unpayable, etc.) were still too strong to be completely overcome by a mere dose of “Shock and Awe”.
Result? The dollar’s value (as measure by the US Dollar Index) began to fall from 120 in 2001 to a low of 72 circa 2011. And the price of gold jumped over 600%.
• The previous “fundamentals” have remained largely unchanged for the past several years. When each of those “fundamental vectors” are combined, the result is an economic “ship” that’s still “sailing” (trending) in virtually same direction as it was from 2001 to 2011. Insofar as fundamentals remain unchanged, I infer that the direction (trend) of our economic “ship” is also unchanged. The recent 20-month decline in the price of gold should be a mere correction in an ongoing uptrend rather than the onset of a new, long-term downtrend.
But even if we agree that the uptrend is intact, the fact remains that gold is down 27% for the past 20 months. More, we can’t use “fundamentals” as an excuse to completely ignore reality. On average, gold has fallen over 1% per month for 20 months—and no one seems to know why.
The mysterious cause for that “correction” (or for that fundamental change in the “trend”) is both bewildering and scary because it hasn’t yet been identified. A number of possible explanations have been suggested. But, so far, no explanation has been convincing.
Not wanting to be left behind in the “explanation derby,” I also have a theory as to what might’ve caused gold to fall for the past 20 months which I call,
• “Petro-Currencies” are the national currencies of those nations which export crude oil.
We know that in 1971, the Nixon administration stopped redeeming foreign-held US dollars with gold. We know that Nixon thereby reduced the dollar to a pure, intrinsically-worthless, fiat currency. We know that Nixon cut deals with the Saudis and OPEC wherein the world’s oil-exporting nations agreed to sell their crude oil for only fiat dollars. We know that the resulting global demand for fiat dollars caused the dollar to be implicitly backed by petroleum and thereby created an illusion of value for intrinsically-worthless fiat dollars. We know that the world, needing petroleum, therefore needed and valued fiat dollars. We know that Saddam Hussein threatened the fiat dollar’s illusory value when he started selling Iraqi crude for euros in A.D. 2001. We know that since Saddam’s threat in A.D. 2001, that the value of the dollar (as measured on the US Dollar Index; USDX) has fallen from 120 to 84 (about 30%).
All of this knowledge is evidence that, since A.D. 1971, the fiat dollar’s perceived value has been primarily based on its intimate relationship to crude oil.
Given the intimate relationship between fiat dollars and crude oil over the past 42 years, it’s not unreasonable to wonder if something dramatic has happened in the last two years that might’ve reinvigorated that relationship.
I.e., the relationship between the dollar and petroleum was partially torn by Saddam Hussein in 2001. The dollar lost value and the price of gold increased for ten years.
Could it therefore follow that, if the torn relationship between the fiat dollar and crude oil were recently mended (at least in part), that repair might explain the dollar’s rising value on the USDX and the falling price of gold over the past 20 months?
Seems so.
Did something significant happen in the oil industry since A.D. 2010 to strengthen the dollar’s relationship to petroleum?
Seems so.
In the past two years, America has increased domestic oil production and has once again become an oil-exporting nation. That means that foreigners holding fiat dollars can use them to purchase crude oil directly from the US.
The current situation is not the same as the former “petro-dollar” scheme where foreigners were forced to acquire dollars—and only dollars—as a prerequisite for purchasing crude oil. Today, foreign nations can use almost any currency to purchase petroleum on the global markets. Nevertheless, if any foreign nation has voluntarily acquired any fiat dollars, those fiat dollars can now be easily used to purchase crude oil from the US.
The world still wants petroleum. Insofar as the world can now purchase crude oil from the US, the fiat dollar is, once again, implicitly backed by petroleum. Where, from 1971 through 2001, the fiat dollar was backed (primarily) by the world’s petroleum, today it’s backed by US petroleum.
Under the “petro-dollar” system, the US did not export much petroleum. Generally speaking, the world could use “petro-dollars” to purchase petroleum from foreign countries, but not from the US. The US did not back “petro-dollars” with US petroleum.
However, over the past two years, the fiat dollar (which was losing its perceived value as the world’s only petro-dollar) has, by virtue of rising US oil exports, become one of several “petro-currencies” and thereby regained some value.
Thus, a new monetary system of several “Petro-Currencies” has replaced the former system based on the singular “Petro-Dollar”.
Clearly, the fiat dollar is not as strong as it was when it was the only “petro-currency”. Even so, it has recently strengthened by becoming one of several “petro currencies” that are each implicitly backed by their country’s export of petroleum.
Once again, the fiat dollar is implicitly-backed by at least some of the world’s crude oil. Once again, the fiat dollar has regained an illusion of “intrinsic” value.
Result? Dollar up; gold down.
• Let’s consider this hypothesis in light of the following observations:
1) While we relied on the singular “petro-dollar,” the US was a net importer of crude oil. As a result, any war or instability in the Middle East that threatened the global supply of crude oil would cause the fiat dollar to lose value and the price of gold to rise. But,
2) If the US becomes a net exporter of crude oil, Middle East instability and war should not cause the value of the US dollar to fall, but should instead cause increased demand for US petroleum. I.e., an increased demand for US petroleum will increase the demand for fiat dollars. If so, increased global demand for fiat dollars should thereby cause the perceived value of fiat dollars to rise and the price of gold to fall.
Thus, this “Petro-Currencies” hypothesis (that the dollar is no longer the only “petro-currency” but has at least become one of the several “petro-currencies”) seems consistent with current events. I.e., over the past two years Middle East instability has increased but the price of gold has declined.
Is this proof that my theory of “Petro-Currencies” is valid? No. But it’s evidence that it might be.
If the theory is roughly correct, it raises an interesting implication: If government wants the fiat dollar to inflate, it should restrict the production and exportation of US crude oil and foster peace in the Middle East. Doing so should reduce the demand for fiat dollars and thereby reduce their perceived value.
On the other hand, if our government and/or the New World Order wants a stronger (deflated) dollar, it would be in their interest to foment more war and political instability in the Middle East in order to increase global demand for US petroleum and raise the perceived value of fiat dollars.
• A big question is, assuming my theory is roughly correct, how important or predominant might this theory be?
To go back to the ship analogy, the ship’s ultimate destination is the result of combining the several “vectors” of ocean current, wind speed and direction, and engine speed into a single vector or “trend” that will determine where the ship is actually heading and when it will arrive.
The “SS Ship of Gold” has been heading in a particular direction towards, say, $5,000+ gold since A.D. 2001. The fundamental “vectors” (fiat currency, inflation, national debt) are basically unchanged. But a new “vector” (US oil exports) has been added. As a result, we’ll need a “course correction” just as if we’d had a sudden growth of barnacles on our ship’s hull. The magnitude of that course correction remains to be seen.
I believe that the “fundamentals” tell us that we’re still headed for the same destination ($5,000+ gold). But so long as the US exports oil, the dollar will be somewhat strengthened and it may take a little longer to reach gold’s destination.
I’m not suggesting that this “petro-currencies” theory is the sole explanation for gold’s decline over the past 20 months. Overt price manipulation has played at least as great a role. But I am suggesting that the reemergence of the fiat dollar as one of today’s several “petro-currencies” may explain some of gold’s recent fall. If this explanation is roughly correct, it may also help to alleviate some of the mystery and fear concerning that fall.