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CMI Gold & Silver, Inc.

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When Gold is King

October 18, 2002

Fears of deflation seem to dominate the thinking of avant-garde economists. Here deflation means a period of slow or declining economic activity marked by falling prices. John Mauldin, president of Millennium Wave Advisors and editor of a brilliant weekly economic commentary, recently had this to say about deflation:

"Martin Barnes of BCAresearch.com, Stephen Roach of Morgan Stanley, Bill Gross of Pimco and other major economic luminaries are openly telling us that deflation in the near future is a real concern. Even Andrew Kashdan of Apogee Research seems to grudgingly admit that deflation might be a problem in the short term before inflation comes roaring back. They all seem to think (or hope) the Fed can keep us out of a destructive deflation. A common theme is that as long as the housing market holds up, we should be able to avoid serious problems or "disaster," as normally sanguine Martin Barnes so states. This may prove to be a thin thread holding us back from the abyss.

"Japan is at the epicenter of the deflationary forces that are sweeping the world. The Fed told (or suggested to) Japan at their Jackson Hole meeting that they could get out of their deflationary spiral by printing money and dramatically dropping the value of the yen. The Bank of Japan could care less what the Fed thinks. However, they have finally come to the end of their ability to do nothing, and being faced with a true crisis, will go about destroying their currency on the backs of the average consumer by reducing the overall standard of living for the little guy, all the while striving to save face. Given the massive incompetence demonstrated heretofore by Japanese banking authorities, there are those who question whether they can succeed in actually dropping the yen, but central banks can destroy value when they put their mind to it."

Mauldin further noted:

"The Federal Reserve recently published a paper noting that the US could avoid Japanese style deflation by, among other things, allowing the dollar to drop and providing a very easy money policy."

Nowadays--in a world of fiat currencies--the solution to the problem of deflation is the printing of still more paper money. One economist has said that Japan’s problems are so immense that the Bank of Japan needs to print yen until they trade 1,000 to the dollar. Presently, it takes about 125 yen to buy one dollar.

Richard Russell, editor of Dow Theory Letters, sees China as a major cause of deflation. He recently noted that 18 million Chinese, with typical wages of sixty cents an hour, enter the workforce annually. It has long been known that manufacturing seeks out low wages, and now even Mexico--which sucked manufacturing jobs out of the United States--is losing jobs to China.

During a period of deflation, the overall price level falls, and "cash becomes king." Unfortunately, debt becomes the great destroyer, and Americans are awash with debt--not just individuals, but also corporations, the federal government, most states, and many municipalities. If deflation becomes a reality, then wages will fall, making it harder for all debtors to payback borrowed monies. Bankruptcies will become commonplace. Truly, deflation would lay waste to the economy and the American dream.

Tuesday, Mineweb (www.theminingweb.com) reviewed major investment houses’ thoughts on how gold would do if deflation sets in. The article was aptly titled Golden During Deflation.

JP Morgan’s John Bridges said gold stocks and physical gold will probably survive the effects of deflation better than most asset classes. Merrill Lynch recently advised that as much as 5% of general investments should be in gold. (Frankly, CMI believes that only 5% in gold in these times would leave too many assets exposed to other calamities that could hit the world’s economic and financial markets.)

From the Mineweb article:

"The inference of JP Morgan’s recent gold market and gold equities research is that although gold is a hedge against inflation and a weak currency, it is also a reliable asset in the reverse (i.e., during periods of deflation.) The underlying principle is of gold’s safe-haven status which equally applies in periods of war. 'Cash is king during deflation but there’s generally a lack of confidence in other paper wealth which is where physical gold comes in,' another economist says.

"Bridges draws from the world’s last major deflationary period, the 1930s depression, in which listed gold producers easily outpaced the Dow Jones Industrial Average, notwithstanding the fact that the gold price was fixed. Bridges uses silver, which had a spot price and moved in greater volumes than it does today, as a proxy for monetary metal."

Most Americans also draw from the Great Depression when they think of deflation. Truly, then "cash was king," as many banks had collapsed, wiping out life’s savings and destroying businesses. But, there are aspects of those economic times that are often forgotten--or not known.

Until Roosevelt called in gold in May 1933, the dollar was gold. Twenty paper dollars were redeemable for one Double Eagle or two Eagles, or four Half-Eagles, or any combination of gold coins totaling $20. One paper dollar could be redeemed for a $1 gold coin, beautiful little coin, which today is a collector’s piece. So, when people say that "cash was king" during the Great Depression, they are saying that gold was king. As Bridges notes, when there is generally a lack of confidence in paper wealth, that’s where physical gold becomes king.

To battle deflation, the world’s central banks will follow standard operating procedures. They will inflate their currencies, and, as Mauldin noted, "will go about destroying their currencies on the backs of the average consumer by reducing the overall standard of living for the little guy." Physical gold and silver offer the best protection against central bank printing press policy.

In October 1999, when the prospects of deflation were only surfacing, I wrote an essay titled Debunking Deflation. The ideas offered in that piece are still relevant.

Call CMI at 1-800-528-1380 for answers to any questions or clarifications.  Our hours are 7:00 a.m. to 5:00 p.m. Mountain Standard Time, Mondays through Fridays.  Our offices are in the middle of the Phoenix, Arizona financial district.  CMI has had the same bank account since its inception in 1973.  References available on request.  http://www.certifiedmint.com

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