Saturday, December 04, 2004


With the US Dollar dropping precipitously, it seems wise to review Gresham's law.

Gresham's law (gresh-uhmz)

An economic principle proposed by an English financier, Sir Thomas Gresham, that bad money will drive good money out of circulation. For example, if the US government minted silver dollars and then, at a later date, began to mint dollar coins out of cheaper metals, the public would hoard the silver dollars (possibly for later sale at higher prices) rather than use them as a medium of exchange: silver dollars would stop circulating. --COPIED FROM GURU.NE

When a currency appreciates in value, as is the recent case of the British Pound and the Euro, the public begins to hoard the currency, driving the value even higher still. This is one of the reasons that futures and cash markets often swing to extremes.

Some 40 years ago, there was a sugar shortage in America. The price of sugar went up and up. As a youth visiting my Grandfather, I was surprised when he showed off his stash of 5 pound bags of sugar. He showed me and my Dad the bags that he had purchased at 59 cents, 70 cents, 99 cents, $1.29 and so on. I made an insensitive comment basically asking why anyone would collect so much sugar. Dad let me know in no uncertain terms that the 5th commandment, Honor thy Father and Mother..., includes ones Grandparents.

For weeks afterward, Papaw Miller continued to enjoy using his 99 cent sugar as the price went up even more. He continued to hold onto his 59 and 70 cents bags so he could show them to visitors. I silently continued to think it was a silly game. It was. Sometimes our human nature causes us to do silly things. Besides, the older and wiser I become the wiser my grandfather turns out to have been.

Only a few years after the sugar shortage, the government started minting copper clad silver coins. During this time, I worked part-time as a grocery store clerk and I quickly amassed a large collection of silver coins that appreciated quickly in value. The Hunt brothers tried to corner the market and silver soared to ten times its prior value. Like Papaw Miller, I continued to buy all the way up and failed to sell my hoard when the market peaked. Papaw was at least able to eventually eat all his sugar. I, after 38 years, still have the silver coins. The ones purchased at the peak are worth about 12% of what I paid for them! (I still need to learn the lesson of the King's Ten Servants, Luke 19:11--27).

Although much has been made about the falling dollar, the real-trade weighted value of the dollar is still not at extreme lows. However, as the above examples show, it is impossible to guess just how far a speculative trend will go when the public gets greedy. The price of Gold and Silver have risen rapidly for the past couple of months and almost as rapidly for three years. Very large amounts of US Dollars are flowing into international mutual funds.

I hope you will avoid getting caught in this speculative spike. The greatest investor of our time, Warren Buffet, is famous for saying that the key to investing is to be fearful when others are greedy and greedy when others are fearful. Anyone who buys Gold at $450 per ounce, hoping that it will go to $500 per ounce is getting greedy. Anyone that over committs to foreign mutual funds, because they have done well for the past few years is a fool.

One should remember that markets are self correcting (remember the invisible hand of Adam Smith?). In effect, US Dollars have become "hot potato" dollars. As Gresham's law indicates, the Euro and other strong currencies are now being hoarded or taken out of circulation and replaced with hot US Dollars. Just last week, it was reported that the Chinese, who have been the recipients of billions of excess trade dollars, have started trading US dollars for Euro dollars.

If the foreign public does not want to hold US dollars what is their ultimate solution? The simple answer is that the pressure is mounting to purchase American goods and services. So far, the foreign public have resisted spending the dollars. Instead, they have purchased record nominal amounts of US Treasury securities. They have helped hold down US interest rates. After adjusting for inflation and for the decline in the dollar, they have been losing a lot of money on these Treasury investments.

Politicians on both sides of the pond have tried to use the situation for political gain. The good news is that the law of supply and demand alway trump the empty words of politicians. Even politicians, who know better, are apt to make statements supporting trade sanctions against the Chinese because they are suposedly committing unfair trade practices. The fact is that if the Chinese are willing to hold large amounts of dollars that are declining in value in order to continue to sell us more products at extra low prices we should be more than happy to let them! This process is almost like writing a lot of checks to buy goods only to find that the seller is not cashing the checks!

The recent purchase of Euro dollars by the Chinese is part of the reconciliation process. The Chinese have "exported" their excess dollar problem to the Euro community. Pretty soon much of the developed world will start buying American products with their hoards of US dollars.

Large companies such as IBM, Kellogs and Microsoft are likely to be among the beneficiaries. IBM has made news because of rumors that it will exit the business of selling personal computers. IBM is the third largest seller of personal computers and the rumored price of the business is $2 Billion. Why would IBM sell the business that it founded some 20 plus years ago? Because they want to deploy the capital in higher margin businesses! Besides, playing Dell is a bit like Davie County High playing the UNC Tar Heels! Go Heels beat KY!

IBM in partnership with Sony and Toshiba has invented the cell chip computer. Please use Google News to read about this exciting computer. Comparing this computer to the one you use now is like comparing a 2004 Corvette to an 1883 LaMancelle steam car.

These new computer chips will initially be expensive but put yourself in the shoes of the Chinese for a moment. You have hundreds of billions of dollars that are depreciating in value and IBM has a computer that beats anything you have ever seen. Do you hold the dollars or buy a machine that will transform your business? Yes it will be several years before IBM is "on fire". Buy the stock now and ride it all the way up!

Please note that I am an ameteur investor. I post my views for your intertainment. I receive no emuneration and readers should not invest in securities without doing thier own reserch. My views are not posted as investment recommendations.