Wednesday, June 06, 2007

If All the Gold's In Private Hands, Is a Gold-Backed Currency Possible?

Readers know from previously posted charts that gold has been a better investment than the stock market for the past seven years. Here is the "new record high" S&P 500 priced in gold, courtesy of frequent contributor U. Doran.

Please go to to view the charts.

Not so high as the mainstream and financial media makes out, eh?

Here is the issue in a nutshell. Forgive my brevity and all the complexity I have left out in trying to compress a deep and critical issue into a few lines.

Money supply (money created by "fiat" i.e. by government debt or printing presses) is exploding at 15%+ around the globe even as global growth is 4%. Massive expansion of money supply leads to inflation, which has been officially under-reported for years, though we intuitively know it is rising (and the bond market confirms this intuition). As a result, the cash in our wallets loses value every year.

In times of rapid growth of money supply, hard assets such as real estate and commodities skyrocket--exactly what we've witnessed over the past seven years.

Another result has been the declining value of the dollar in relation to other currencies--mostly the Euro, which is the only major currency which trades in a free market, i.e. "floats." (The yen is manipulated into a narrow trading range, and the yuan is pegged to the dollar.) If the dollar falls below the "line in the sand" of 80 on the Dollar Index, it could trigger a major decline of 30%-50%. Many observers consider this inevitable.

As the dollar weakens, investors and traders start backing away from their reliance on the dollar as a placeholder of value and as a currency used for trading. For instance, Kuwait split raises questions over longevity of the dollar (link courtesy of U. Doran).

Net result: owners of dollars (i.e. Americans and overseas owners of dollars or U.S.-denominated debt) find their purchasing power reduced/devastated. Many observers believe a pan-Asian currency will arise to replace the dollar: China, Japan, Korea on single currency unit. Many believe that any such currency will have to be backed by gold to have any "staying power."

For background on the issue of gold-backed currency, here are three links provided by U. Doran. I especially recommend the first one:

The Once and Future Money

The End Of National Currency

Gold and Economic Freedom (by Dr. Alan Greenspan, 1966)

So far so good. But as astute reader Don E. explains, there's a fly in the ointment for any gold-backed currency: most of the world's gold is in private hands:

"This idea presented itself as a problem last week when I read Anatal Fekete’s commentary on the preponderance of gold having moved from the hands of governments, central banks, to private holders. Gold Vanishing into Private Hoards.

This idea bothered me inasmuch as I began to wonder how on earth we will ever get back to a sane policy, a gold standard, where money really is money if the banks don’t have the gold to back it. Gradually I came to some understanding of the mechanics of this.

I read a lot of economic commentary, and if it is well-written and fairly simple I can follow along. You will find my own thoughts at least simple. Money is a store of value and a medium of exchange. Who determines the value of money? Those who hold whatever backs it. Presently we are in a state where money is not backed; it is all fiat currency - money by government decree only, having no intrinsic value. Who then sets its value?

Well, money, let’s just say ‘the dollar’ is not money, not any more. It is a commodity, a produced item, much like a farmer produces potatoes. As a commodity it is for sale on the open market and can be bought, at the very end of the line, with gold, with real money. Jim Sinclair likes to say that the value of gold does not change, only the value of the dollar does. I have read that many times without really grasping what it means - call me slow.

In my case it means that my pension from the State of California and the County of Alameda and the Social Security System comes to me not as real money, but as a commodity of ever decreasing value. Should those folk all send me potatoes I could eat them, and I could eat them as well in ten years as today. This is not the case with dollars. How many potatoes will my dollars buy in ten years? Not as many as today.

This brings me around to my small epiphany. It doesn’t matter if most of the gold is in private hands, because the market will always fix a value on the commodity-dollar. At least so long as this particular commodity is needed. It will be needed for quite some time as this commodity is what we pay rent, shop, buy services, and get taxed in. We will get squeezed as our personal stream of this commodity becomes worth less and less - what else is new?

But no matter who holds the gold the commodity-dollar will have some value, set by those who own the gold. Gold moving into private hands must simply be some part of the cycle of rebalancing. Do the governments finally get enough of it back to back a true-money currency? Probably sooner of later. Maybe countries where it is mined extensively, Canada?, will fill their coffers from domestic production and bring back real money.

This is most certainly not the way the various governments want it, but print and spend must have its consequence. The private holders of gold will do a much better job of keeping our money correctly valued than our governments have. Market price must trump lies. While this doesn’t bode will for those of us paid in commodity-dollars, or worse, on fixed incomes, it does have a tinge of justice to it that makes me smile. Actually, I can’t imagine why I am smiling as the burden of the printers’ deceit will fall on all our heads with traumatic force regardless of our complicity in the fraud. Down the garden path and into the weedy fields we go.

It is my family’s good fortune that we have accrued some gold in the meantime. Most have not. If I had fifty pounds of it hidden in the rafters I don’t think it would be enough at this point.

As an aside, what assets aren’t in gold are in Canada. We live in Maine and drove up to a border town a couple of years back and opened a Canadian account with some cash from the sale of a home. In the meantime we have rolled over our remaining IRA into a Canadian Broker and trade only in Canadian stocks and keep all the cash in Loonies. Our present vulnerability lies in our pensions. Our home is paid off and doesn’t really count as it is where we live and secure as such.

So, all this is pretty obvious and simplistic, but coming to grips with the idea of money as a manufactured commodity, and gold in private hands as the arbiter of this commodity’s value has somehow cleared my thinking a bit. Don E., who never promised a deep and probing analysis."

Governments can of course confiscate all privately held gold, as the U.S. government did in the 1930s. Yes, it was a crime to own coined gold or bullion in the U.S.A. It doesn't take much imagination to speculate that a nation, or perhaps many nations, could decide to create a gold-backed currency by confiscating their citizens' gold and paying them in paper for the privilege of giving their gold to the State.

Not a reassuring thought, to be sure.

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