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Saturday, August 20, 2011

Out of the Bretton Woods?

I’m not a gold bug, and do not own gold or gold shares of any kind (maybe I should). August 15 marked the fortieth anniversary of Richard Nixon’s closing of the gold window in 1971; and I was reminded of this by an article in the August 13 issue of “The Economist.” The last sentence was a shocker. It read: “In terms of the old gold measure, the dollar has devalued by 98% since the end of the Bretton Woods era.” Wow!

I thought this couldn’t be true; however, it is. Checking values, gold in 1971 was a few cents less than $41 per ounce, 40 years later this August 15, $1,766. Today’s one US dollar will only buy 2.3% of the gold it could buy in 1971; so roughly 98% less.
With the collapse of the convertibility of money to gold, world reserve currencies became Fiat Currencies. This doesn’t mean they became based upon the solvency of an Italian second-tier automobile manufacturer; rather currency is now backed by the full faith of the country issuing it.

I’m not arguing here that gold was the investment of a lifetime (its return against the dollar was just under ten percent per year); in fact the S&P 500 for the same period returned almost 12%.
Looking at the long term; however, the depressing fact is the erosive power of inflation. Trying to manage wealth for future generations is a demanding project; the “real return” for the S&P 500 for this period was only 7.2%, rises in real prices consumed 4.6%. If things held constant, and you placed $1,000,000 today in a safe deposit box and left it there for the next forty years, you would withdraw only $165,000 in purchasing power in 2050. It turns out the biggest investment “expense” is actually inflation, and the math is depressing. If one spends say 3% of retirement assets per year, one would need an 8% or 9% gross annual return on the portfolio to cover spending, taxes and the effects of inflation in order to keep wealth from declining in real terms. This is a very tough goal to achieve with, say, a lower risk, balanced portfolio.

“Fiat” is actually a Latin word, roughly translated as “to be done” or “let it be done.” I guess the question becomes “let it be done” to whom?

George Bernard Shaw has a wonderful quote with which I will end: “If the governments devalue the currency in order to betray all creditors, you politely call this procedure “inflation.””

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