"Nobody really understands gold prices, and I don't pretend to understand them either."
– Ben Bernanke
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1. A medium that can be exchanged for goods and services and is used as a measure of their values on the market, including a commodity such as gold, an officially issued coin or note, or a deposit in a checking account or other readily liquefiable account.
2. The official currency, coins, and negotiable paper notes issued by a government.
3. Assets and property considered in terms of monetary value; wealth.
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"There's fool's gold — pyrite — and then there's fool's gold — gold owned by idiots willing to trade it for worthless dollars."
– Jarod Kintz, This Book Has No Title
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"The desire of gold is not for gold. It is for the means of freedom and benefit."
– Ralph Waldo Emerson
by Grant Williams, Mauldin Economics,
The moment I landed in Charleston, South Carolina, on my way to a small barrier island 35 minutes away for a family vacation, I got that feeling in my stomach that this was a special place.
Eighteen years on, and my love affair with the Carolina Low Country has only deepened.
Now that I live in Singapore, my visits are far more infrequent than I would like, but whenever I get the chance to spend time amongst the marshes or at the beach, I fall in love all over again.
The city of Charleston is beautiful. Small enough to walk around, but filled with wonderful restaurants, gorgeous architecture, quaint shops, and the vibrancy of youth that comes with being home to several colleges (Go Cougars!).
It has twice been voted "America's friendliest city" by Condé Nast Traveler (a judgment I can second, having done my fair share of traveling around the United States over the years) and also "the most polite and hospitable city in America" — though in fairness, that particular award was bestowed upon the fair city of Charleston by Southern Living magazine, which may well have a dog in that particular hunt. No matter.
Above all, however, the city is filled with history; and this week I am going to share with you a story which illustrates beautifully why understanding history is perhaps more important today than ever before — certainly when you are considering what to do with your savings.
Charleston is the oldest city in the State of South Carolina, founded in 1670 as Charles Towne — a tribute to King Charles II of England. Seven short years after the War of Independence ended, that name, funnily enough, was changed to its present form.
But Charleston's greatest claim to historical fame is two events that occurred 83 days apart in early 1861.
On January 9, a group of cadets from The Citadel, a military college (Go Bulldogs!) that still sits just north of downtown Charleston, opened fire on the Union ship Star of the West as it entered Charleston Harbor on its way to resupply the troops stationed at Fort Sumter.
South Carolina had seceded from the Union in December 1860 after the election of Abraham Lincoln; and the Union commander, Major Robert Anderson, had subsequently moved his command post from Fort Moultrie on nearby Sullivan's Island to Fort Sumter, a far more substantial fortress that guarded the entrance to Charleston Harbor. But, as Anderson would discover, it was also something of a sitting duck (see map below).
Slowly but surely, Confederate troops began to lay siege to Fort Sumter, surrounding it with battery after battery — though no shots were fired.
At least, not until April 12, 1861.
As one look at this map makes clear, it was only a matter of time until the fort fell; and that time turned out to be just 34 hours, during which a savage bombardment rained down upon the beleaguered Union troops.
Anderson evacuated Fort Sumter (he didn't surrender) on April 14th with, remarkably, no loss of life on either side. Bizarrely, but perhaps unremarkably, the only casualty of the engagement occurred when a gun exploded during the surrender ceremonies (yeah, "ceremonies," apparently), killing one poor Union soldier who had made it safely through the barrage.
This engagement began the US Civil War, a conflict that would take the lives of almost 700,000 Americans and wound nearly half a million more.
It was during the siege of Fort Sumter that the story I want to share with you takes place. (Yes, I am afraid that everything so far is just background).
This story came to me from the pen of Jared Dillian, the very talented writer of an excellent publication called The Daily Dirtnap; and the moment I read it I knew I had to share it with my readers, because it illustrates perfectly something I have been talking to people about for years.
Readers can, and definitely should check out Jared's fantastic work HERE; and to give you a taste of Jared's enviable narrative prowess, I am going to let him tell you the story as he told it to me:
The Calhoun Mansion
Let me tell you again why I like gold and silver.
I was in Charleston two weekends ago for my mom's birthday. We did a horse and carriage ride, a historical tour, around the city. I always thought those things were cheesy, but as it turns out, the horse and carriage tours are very highly regulated, the tour guides have to pass a series of knowledge exams and then take continuing education. I kid you not! Ours had been doing it for six years, and was good.
So as we went by the Calhoun Mansion on Meeting Street, the tour guide fella starts telling us about the house. It was built by a guy named George Walton Williams, who was the richest guy in town. This was back during the Civil War. It's a 24,000 square foot mansion with 14 foot ceilings. It's just monstrous. It cost $200,000 to build — back in the 1860s! So how did Mr. George Walton Williams make his money?
Well, as you probably know, Charleston is a port city, and during the War, the Union Navy blockaded the port and then bombarded the city for weeks and months, but during this time, there were these guys who were "blockade runners" who would sneak by the navy ships, bringing necessary supplies to the city, which was under siege. Blockade runners made a lot of money — five grand a trip sometimes — but you know who made even more money? George Walton Williams did.
He financed the blockade runners.
Williams was not the only one doing this, but he was the most successful, why? Because he insisted on being paid only in gold and silver. If you know your Civil War history you also know that there was a Confederate currency, and I don't know if Mr. Williams had a particular view on the Confederate dollar, but at the conclusion of the war, the Confederate dollar collapsed, and everyone was left holding the bag — except for George Walton Williams.
Williams became like a J.P. Morgan character in the city — Charleston was the center of Southern finance, and Williams singlehandedly bailed out the Broad Street banks. He also built a pretty cool house.
Sorry to interrupt; I know you were enjoying Jared's prose, but we're just about to get to the point of this story, so I want to make sure everybody is paying close attention.
This next paragraph contains the fundamental principle of investing in gold and silver, which so few people genuinely understand — despite the multitudes of commentators expending countless thousands of words.
Hit 'em between the eyes, Jared:
So these anti-gold idiots are just that, idiots, or else they have the memory of a goldfish, because currencies come and currencies go, as sure as night follows day. It is the natural order of things. And as you can see, it's not about trading gold to get rich or getting long gold or buying one by two call spreads or getting fancy, it literally is about protecting yourself in the end. It's not like Williams got rich. He just stayed rich. Everyone else got poor.
It's not like Williams got rich. He just stayed rich. Everyone else got poor.
That's it. Right there.
Thanks, Jared, I'll take it from here.
So ... five pages in and we've yet to see our first chart — that's another first, but at least it's a familiar chart:
That is a chart of the gold price from the beginning of the secular bull market in 2000 to today, and it lies at the root of the fundamental misunderstanding about gold that I want to address today, with the help of Jared's wonderful story.
The bull market in gold started for two very distinct reasons and amongst two very diverse groups of people.
The first group were those who saw a commodity of intrinsic value that had fallen so completely out of favour that it was trading at or below the cost of production, along with a group of companies producing that commodity whose stocks were so out of favour that they simply had to go higher over time.
This is what the chart of the gold price looked like heading into 2000:
As you can see, gold was beaten down — hard.
Between 1980 and 1999, gold fell from $850 to $250, and had there been an ETF for gold mining stocks as there is today, it's safe to assume that it too would have been battered almost beyond resuscitation. What we DID have was the Philadelphia Gold and Silver Index (XAU), a capitalization-weighted benchmark that includes the leading gold and silver mining stocks.
The index was formulated with a base value of 100 as of January 1979 — we'll get back to why THAT'S important shortly — and as you can see here, by 2000 it had taken what is known in the industry as "a pasting":
Shares in gold and silver mining stocks halved between 1979 and 2000 and fell fully 70% from their interim high of 1987, so it's safe to say they were as beaten down as the metal itself, if not more so. Once the market changed its opinion of the mining stocks, however, they took off, soaring almost 400% between 2001 and 2011. The reason for this massive rally? Why, the change in the metal's fortunes, of course; and that's what attracted this first group of people who contributed to the gold bull in the early 2000s — the traders.
These people saw an opportunity to make money by buying something low and selling it high — as they would a stock or a bond or a piece of real estate.
But gold is different, and to illustrate why that is, let's turn our attention to the second group of people attracted by gold around the turn of the century (sheesh — that makes it sound so long ago).
The second group of people were those who looked at the landscape around them, saw the massive amount of debt that had been created over the previous four decades, and began to fear for the future of fiat currencies in general and the US dollar in particular.
These people didn't so much care about the price performance of gold (though most realized that the balance of probability suggested the path of least resistance was higher), as they cared about protecting a portion of their wealth from confiscation, which might come either through the inflation that was clearly going to be required to dissolve the debts, or through a dramatic loss of confidence in the mighty US dollar.
The price of gold wasn't their chief concern. Not even remotely. In fact, for the second group of people a falling gold price was a good thing because it enabled them to swap more of their dollars for the precious metal.
When you acquire gold, if your concern is the price you pay for it, then you belong in the first group — the traders — and should calibrate your expectations accordingly. If the gold price jumps from $1,000 to $1,500 and you sell your gold, locking in a nice profit, then you are happy and can either move on to your next investment or wait for a pullback in the price to be able to reload and try to repeat your success.
The danger with this approach is that it's also really rather easy to buy gold at $1,900 and find it languishing some $600 dollars lower a couple of years later. Ask "that guy." You know "that guy," right? We all do. He's the one who, when gold hit $1,900 in August 2011, told you it was definitely going to $2,500 and bought a bunch of it — through the ETF, of course. No point going to all the trouble of buying the metal itself.
Ask him. He'll tell you how much gold SUCKS.
"That guy" has been the one selling to crystallize his loss — or perhaps doubling up and going short to try to recoup his loss because the one-way guaranteed trade is back on, he claims — only this time it's headed in a more southerly direction. He's been the guy calling for gold to go to $1,000 or maybe even back to $600.
He often works in the research department of an investment bank.
Want to know what the second group of people have been doing as gold has fallen from its 2011 highs?
Accumulating more. Exchanging more of their fiat currency for physical metal.
Not futures contracts. No. Physical metal.
And no, not "buying more." Accumulating more.
I choose my words very carefully.
This group of people are the investors.
It has never ceased to amaze me that, whenever and wherever I discuss gold with folks, the first question
I am asked is invariably this one:
"Where does the gold price go this year? $2,500? $3,000? Higher? What's your 'number'?"
My answer is always the same:
"It doesn't matter."
At least, it doesn't if you are in the second group of people.
The story of George Walton Williams demonstrates this perfectly.
Williams wasn't refusing to accept anything but gold and silver as payment because he thought the price of gold was going to rise and he'd make a profit. There were no futures contracts, ETFs, or options on gold trading back then. No. Williams wanted gold and silver because they were money and would remain money no matter what happened after the Civil War had run its course.
Williams' alternative was to accept Confederate dollars in payment for his services to society:
(Wikipedia): The Confederate States of America dollar was first issued just before the outbreak of the American Civil War by the newly formed Confederacy. It was not backed by hard assets but simply by a promise to pay the bearer after the war, on the prospect of Southern victory and independence.
What would YOU rather have been handed as payment? A piece of paper that represented the promise of a group of individuals to pay you back — based, no doubt, upon their ability to tax those who had just won their "independence" from the Union after their inevitable victory — or a lump of metal that history had proven would be accepted by either side, no matter the victor in this little fraternal scrap?
Yeah, you're right; when I put it THAT way, it's hard to make a case for one of those alternatives.
What happened? Well:
(Wikipedia): As the war began to tilt against the Confederates, confidence in the currency diminished, and inflation followed. By the end of 1864, the currency was practically worthless.
Want to venture into the weeds a bit further to see how the mechanics of the devaluation played out? OK:
At first, Confederate currency was accepted throughout the South as a medium of exchange with high purchasing power. As the war progressed, however, confidence in the ultimate success waned, the amount of paper money increased, and their dates of redemption were extended further into the future. Most Confederate currency carried the phrase across the top of the bill: "SIX MONTHS AFTER THE RATIFICATION OF A TREATY OF PEACE BETWEEN THE CONFEDERATE STATES AND THE UNITED STATES" then across the middle, the "CONFEDERATE STATES OF AMERICA WILL PAY [amount of bill] TO BEARER" (or "...WILL PAY TO BEARER [amount of bill]" or "...WILL PAY TO BEARER ON DEMAND [amount of bill]").
As the war progressed, the currency underwent the depreciation and soaring prices characteristic of inflation.
Near the end of the war, the currency became practically worthless as a medium of exchange. This was because Confederate currency were bills of credit, as in the Revolutionary War, not secured or backed by any assets. Just as the currency issued by the Continental Congress was deemed worthless because they were not backed by any hard assets, so, too, this became the case with Confederate currency.
Even though both gold and silver may have been scarce, some economic historians have suggested that the currency would have retained a relatively material degree of value, and for a longer period of time, had it been backed by hard goods the Confederacy did have, perhaps such as cotton, or tobacco. When the Confederacy ceased to exist as a political entity at the end of the war, the money lost all value as fiat currency.
"Poof! It's gone." That's how these things happen. Always.
Of course, the ultimate irony is that today a crisp, uncirculated Confederate $100 bill will auction for upwards of $5,000...
But I digress.
The point of owning gold is NOT to get rich but to stay rich, and sometimes, simply by staying rich, you can become very wealthy indeed — just as Williams did.
Owning gold isn't about the price. Trading it is. Owning gold is all about possession.
For the last couple of years, the traders have been in control of the price and have driven it down because it stopped going up. That sounds simplistic, but it's true. During that time, however, the investors have taken advantage of the leverage applied on top of the physical gold market to acquire more.
A lot more.
One of the big reasons this isn't readily apparent to Western investors is the fixation in that part of the world with trading gold. Here in the East, it's all about ownership.
If you talk to most people in the West about gold, they have no idea about the price or its recent direction. Narrow your sample audience down to those with a passing interest in finance, and they will likely know that gold is an awful investment whose price only goes down. (Had we conducted this little survey in 2011, the results would have been different, but that only illustrates the point.)
Ask a random group of people in the East about gold, however, and the conversation is completely different.
In this part of the world, people talk about how much gold they (or their parents or their grandparents) own. They will tell you stories of the first time they handled a gold coin (usually as a child), and they will know the price but not have much of an opinion on how good or bad gold's performance has been — it will be far less relevant to them. They just know that you don't trade gold; you own it.
To further illustrate this point, let's talk about our old friends the world's central banks.
The chart showing the 25 largest central bank holders of the world's gold looks like this
If we take a look at the changes in those holdings between 2008 and 2013, an interesting phenomenon emerges: central banks in the East, as their reserves have grown, have been accumulating gold:
Since 2008, the central banks of China, Russia, India, Turkey, Saudi Arabia, Thailand, and the Philippines have increased their gold holdings on average by 119.67%. This number is derived from the available data published by central banks, which, let's face it, can be a little sketchy in some jurisdictions.
Like the data disseminated by China, for example.
In 2009, the PBoC announced that its gold reserves had leapt from 600 tonnes to 1,054 tonnes — an increase of 75% — and there those reserves have stayed. Officially.
That's the Party line. However, there is overwhelming evidence that suggests China's gold reserves have increased by significantly more than 75% since March of 2008:
(Shanghai Daily): China's gold consumption and production both notched new records last year as bullion prices plummeted, spurring feverish sales of jewelry and bars in the world's biggest gold market.
China's gold demand jumped 41.4 percent annually to 1,176 tons in 2013, led by strong growth in jewelry and bars, the China Gold Association said in a statement on its website today. The national industry association is comprised of exploration, mining, processing, manufacturing and other gold-related industries.
China's yearly consumption has topped India's 1,000 tons, making it the world's biggest gold market in 2013, according to data from the domestic association and the World Gold Council.
The World Gold Council said in November that India's combined demand for bullion in the first three quarters was 715 tons, while China's was 821 tons.
So I think it's safe to describe the demand for gold in China as "pretty healthy," don't you? No surprise to the investors in the physical metal, sure, but perhaps news to the traders of paper?
In addition to experiencing a huge surge in demand for gold, China has managed to keep a streak going on the other side of the supply/demand dynamic:
Mouthpiece Daily): On the supply side, China has been the top bullion producer for seven straight years. Gold production increased 6.2 percent from a year earlier to 428 tons in 2013, the China Gold Association said.
Koos Jansen did a little digging of his own:
(Koos Jansen): Friday the numbers were released on total Chinese gold demand for 2013. Total demand can be measured by the amount of physical gold that is withdrawn from the vaults of the Shanghai Gold Exchange. In the last full trading week (#52, December 23 – 27) of 2013 there were 53 tons of physical gold withdrawn, which brings the yearly total to 2181 tons.
Yes, total Chinese demand for 2013 was 2181 tons, excluding PBOC purchases....
So, for China, being the largest producer of gold in the world — again — was not enough. They needed more, for some reason. (Nota bene, Koos's numbers for mine supply in the chart below include all the gold produced by both China and Russia. Why do I mention that? Read on).
Total Chinese demand for gold was 2,181 tons, EXCLUDING PBoC purchases (the PBoC apparently do not buy any gold through the Shanghai exchange), which is a pretty staggering number for a country whose official reserves total less than half that sum ... but it gets better.
In an open letter to the World Gold Council in late 2013, Eric Sprott (a man who embodies the essence of a gold investor as opposed to a trader) broke down global supply and demand (insofar as the data opacity allows). His results are presented here:
See that number there? The one in red? Well, the amount of gold physically delivered through the Shanghai exchange in 2013 was 38 tons MORE than the year's entire available global mine production. (I say "available" because neither China nor Russia allows the export or sale of a single ounce of gold mined within their borders.)
Think that doesn't matter?
China has stayed silent on the levels of its gold reserves since 1999; but rather curiously, there recently began a wave of speculation that the Chinese were about to clue us in with a more current number. It started with a story in the Shanghai Mouthpiece Daily:
Mouthpiece Daily): China may soon announce an increase in its official gold reserve from 1,054 tons to 2,710 tons, Jeffrey Nichols, managing director of American Precious Metals Advisors, said.
The People's Bank of China has not reported any increase in official gold holdings since 2009, when the central bank said the official reserve was at 1,054 tons, which accounted for only about 1 percent of its multi-trillion foreign exchange reserves.
The PBOC has been "surreptitiously" adding to its official gold reserves. It has bought a total of 654 tons in 2009 through 2011, another 388 tons in 2012, and more than 622 tons last year, mostly from domestic mine production and secondary supplies, Nichols said in a commentary posted on NicholsOnGold.com yesterday.
Suddenly, the math was being done in even the most unlikely of places:
(FT): A 500-tonne gap in China's gold consumption data is fueling talk that the central bank took advantage of weak prices last year to bulk up its holdings of the precious metal.
The last time the Chinese central bank said it increased its gold holdings was nearly five years ago, in early 2009. Officials have since then repeatedly insisted that they do not view gold as a useful asset for diversifying the country's $3.8tn mountain of foreign currency reserves.
But the latest official figures show that China imported and produced far more gold in 2013 than its citizens bought. This chasm suggests that the central bank was a buyer in the gold market last year in spite of its protestations to the contrary, say analysts....
Adding up the reported and estimated figures, Na Liu, of CNC Asset Management, calculated that China's "apparent gold consumption" exceeded 1,700 tonnes in 2013, more than 500 tonnes higher than reported.
"We would not be surprised to hear the People's Bank of China announce a new, significantly higher figure, if it chooses to do so," Mr Na said. The PBOC has said that its gold reserves have been steady at 1,054 tonnes since April 2009.
Right in the middle of that article lies the key point:
Officials have since then repeatedly insisted that they do not view gold as a useful asset for diversifying the country's $3.8tn mountain of foreign currency reserves.
Gold is NOT a useful asset for diversifi.... look!! Over there!!! A squirrel wearing a raincoat!
Central banks continually rubbish gold as a worthless asset class because it constricts their ability to produce money at the push of a button. Not only that, but it offers their citizens the means to reduce their reliance upon a nation's fiat currency — one has only to look at the goings-on in India last year to see what THAT looks like.
Deep down, though, central bankers know what gold is for and why you hold it. They know.
In 1999, a group of central banks came together through the Washington Agreement on Gold to jointly manage sales of the precious metal. That agreement worked fairly well for a period of time (it was renewed twice, in 2004 and 2009, and will be up for renewal again this year), BUT there are a couple of things worth pointing out about that little agreement.
Firstly, take a look at the central bank signatories:
Österreichische Nationalbank — Austria
Banque Nationale de Belgique — Belgium
Suomen Pankki — Finland
Banca d'Italia — Italy
Banque de France — France
Banco de Portugal — Portugal
Schweizerische Nationalbank — Switzerland
Banque Centrale du Luxembourg — Luxembourg
Banco de España — Spain
Bank of England — United Kingdom
Deutsche Bundesbank — Germany
De Nederlandsche Bank — The Netherlands
Central Bank of Ireland — Ireland
Sveriges Riksbank — Sweden
See any Eastern central banks in that list? No.
Why? Well, for two reasons: one, they didn't have any "surplus" gold, and two, THEY'RE NOT SELLERS.
Secondly, take a look at the text of the Washington Agreement:
In the interest of clarifying their intentions with respect to their gold holdings, the above institutions make the following statement:
Gold will remain an important element of global monetary reserves.
The above institutions will not enter the market as sellers, with the exception of already decided sales.
The gold sales already decided will be achieved through a concerted programme of sales over the next five years. Annual sales will not exceed approximately 400 tonnes and total sales over this period will not exceed 2,000 tonnes.
The signatories to this agreement have agreed not to expand their gold leasings and their use of gold futures and options over this period.
This agreement will be reviewed after five years.
The first statement in that agreement? "Gold will remain an important element of global monetary reserves."
Penultimate statement of the agreement? "The signatories to this agreement have agreed not to expand their gold leasings and their use of gold futures and options over this period."
But, wait? You mean they lease their gold out? But I thought ... oh, never mind.
Interestingly, when the agreement was resigned in 2004, that text had changed:
"... the signatories to this agreement have agreed that the total amount of their gold leasings and the total amount of their use of gold futures and options will not exceed the amounts prevailing at the date of the signature of the previous agreement."
And ... by the time the third Washington Agreement was signed in 2009 (during which time the price had risen three-fold) that section of text had disappeared altogether.
The Washington Agreement worked when central banks were selling their gold because there were always buyers, at lower and lower prices — those were the investors soaking up the bullion.
NOW we have a bunch of central banks aggressively trying to BUY gold; and what they're finding (unsurprisingly) is that the investors aren't sellers, so the only people left from whom to acquire gold are the traders — and they have a very limited supply of actual metal:
That's a chart I've used before, and I use this previous version again here rather than redraw it, because the two vertical dotted lines are important.
Venezuela broke ranks first, demanding repatriation of its gold in early 2011 — a move which, counterintuitively, stopped the rising gold price in its tracks. A similar request from the Bundesbank in January of 2012 for a far larger amount saw the beginning of a strange but massive outpouring of physical gold from the major trading repositories — the COMEX warehouses and the ETF vaults.
Meanwhile, as the earlier charts and the recent data out of China show, Eastern central banks are buying — AND TAKING PHYSICAL POSSESSION OF — as much gold as they can, as fast as they can, because they KNOW what it represents.
Now let me ask you this:
If the very people who have the ability to basically create all the paper money they want out of thin air, whenever they need it, are exchanging that paper for gold at a record pace, what conclusions could you draw?
Would you think for a second that they are accumulating gold because they think the price is going to go up and they can make a quick profit?
Of course they're not.
Do you think they'll sell all their gold when the price reaches $2,000? How about $2,500?
When Western central bankers rubbish gold as a "barbarous relic" or, as in the case of Ben Bernanke shortly before he
started his job at The Brookings Institution left office in January, admit to a complete lack of understanding of it, does it not strike you as strange that, having accumulated significant stockpiles of gold over the years, they aren't in a hurry to swap any of it for paper money (well, with the notable exception perhaps of the United Kingdom, thanks to the antics of Gordon Brown, King of the Idiot Chancellors)?
Gold is held by Western central banks for exactly the same reason individuals ought to hold it: protection.
Central banks are accumulating gold because it cannot go BANG! like fiat currencies do.
Individuals should be doing the same — not being sidetracked by the distractions.
It's not about price. The story Jared shared with us demonstrates that beyond any doubt.
If you own gold, it will do all the heavy lifting for you when the time comes, just as it did for George Walton Williams.
It seems only fair to leave the final word this week to Jared, who, in a postscript to the story of the Calhoun Mansion added this:
If Calhoun had been paid in quarters, he would be just as rich today. But not because 800,000 quarters as CURRENCY held their value. It is because the silver content in those 800,000 quarters is worth about $4,000,000 today.
Hopefully that clears a few things up.
This article reprinted with the kind permission of Mauldin Economics and Grant Williams.
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