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Zeus with a laurel crown. Gold stater from Lampsacus, Mysia (ca. 360–340 BCE), obvers
Remember when real estate was the only sure bet investment? It had real... estate value. You could pass it down to your children. You could live on it, or in it. It had physical size and was tangible. However, its value went up and up and up, far beyond its real affordability. Why? How? Because the banking game had changed and people who were not bankers were throwing money at unsophisticated ordinary citizens and telling them they could afford these homes and the extra demand pushed the price of houses up. When the houses became more expensive they just increased the amount of money they could loan people of a certain income. Prices went even higher and these non-traditional bankers started making loans to people without checking their credit worthiness or doing a check on anything. Volume was the watchword for these brokers. With every loan they made they collected a fee, and they experienced none of the consequences if the loan went bad after. Then they turned around and sold these mortgages in pieces of paper, telling the purchasers that the value of their paper was guaranteed because, even though these were risky investments, they were backed by something of real value, actual houses, which at the time was an unmistakably safe investment. Real estate had only gone down in value twice in the United State's history and that was during the Great Depression and again during the Reagan years associated with the savings and loan crisis. Even though the new bank/brokerage houses were doing the very same things that lead to the Great Depression, in their eyes, the United States was an endless ocean of prosperity, it was like the atmosphere or the seemingly limitless number of fish in the sea, their illegal activity couldn't possibly pollute it or diminish it, at least not to the extent that it would create any real damage to our economy. For them there wasn't any danger of the United States going into anything that remotely looked like a Great Depression; to the new bank/brokerage houses that was like talking about ancient history. Things were different now. We have smart phones and super fast computers; we drive sophisticated cars that run on gasoline. Besides, real estate is real estate and will not go down in value. Unfortunately, we know now that that type of thinking is ludicrous. So use that critical thinking to think about what people are telling you about our money and gold?

The true value of gold is what others are willing to give up or do to get it from you. Gold, just like real estate, only has value when conditions are right to support that value. The value of gold is relative to the value of its importance to what you buy given a particular set of circumstances. Let me give you an example. If I am starving and I will die soon if I don't get food and I have gold in my pocket, I will want to exchange that gold for food real fast. Gold has no value for me in comparison to food. However, if the food supply is limited and the person who has food also needs it to survive, my gold is worthless. It is worthless to both or us because you can't eat it and survive. The decision of whether you will get food at all for your gold depends on either the goodness of the food holder's charity or the timing when the food holder thinks there will be more food. Chances are the food holder will only give you at most a portion of his food for gold, and more likely then not, he or she will want all your gold for an amount of food that will most likely not sustain you. You can substitute anything that has a myth of value for the word gold here, such as jewels, platinum, stocks, bonds, money and even mansions. Let me explain. During the Bataan Death March wealthy people signed over mansions for food only to die anyway. Suddenly faced with dying their mansions weren't that valuable anymore. Back to my point, things only have value relative to their worth during a given circumstance. It is an illusion to thing otherwise. So I am going to ask you, why do you think gold is any different than paper money? When you ask your self this question I want you to remember how real estate was discussed at the beginning of this post?

Paper money is the truest form of exchange under trading goods themselves for goods, or at least it should be. It truly has no value on its own. The value of paper money is in the exchange of goods. For example, socks are worth a buck a pair, let's say, and shoes are worth 10 bucks. You can also say shoes are worth 10 pairs of socks. Money is just a medium of exchange. If you put gold into the equation things get more complicated. Let's say that you purchase wool and knitting needles with 2 bit of gold and you make ten socks. You go to buy shoes but the person isn't willing to sell you his shoes for your 10 socks. He wants gold. He says you have to have ten bits of gold first. So you have to go to someone who has gold to buy gold but the only gold in this economy is the gold you first used to purchase your wool and needles that you used to make socks. You go to him and he wants three pairs of socks for the one bit of gold, because he wants to rent shoes from the guy with the shoes when he goes outside and renting shoes only costs one bit of gold and he plans to go out twice. Now, think of this simple example on a Macro level.

Why is gold valuable? One reason is that it is not a common metal found in abundant quantity. It is scarce compared to the demand for it. Just imagine how valuable gold would be if it was the medium of exchange for the world's economy. Very few people would be capable of possessing it. All the gold in the world would not equal all of the active money being handed over for goods in a single day in the current size of our world's economy. It doesn't take a genius to realize that gold simply doesn't work in a modern economy as it didn't work in my example about the socks.

There is another factor, perhaps an even more important one about how money works in our economy that makes using gold not beneficial to the ordinary citizen. The factor is how ordinary people and businesses create added value goods. Money is created in an economy by adding value. For example, clay has little value alone. You or I, if we know where to look for it, can probably get clay for free. However, you take that clay, shape it, glaze it and fire it and it becomes a useable bowl. This is something that has value to a lot of people. Let's say that those people specialize in making spoons, or soup or something else. Let's say you have made more bowls than you need and you want to explore the idea of not using your hands to eat soup out of your bowls. You are willing to exchange a bowl that you made to a person who has made spoons in excess of what they need. You come to an agreement that the bowl is worth four spoons. The value of the clay, plus your know-how and labor now has a measurable value in spoons. Spoons, in this example, become the de facto currency since compared to other goods spoons have a traded value when it comes to bowls. Bowls have an exchange value measured in spoons, thereby creating the "spoon" standard much like the so called "gold" standard. Substitute currency for spoons and now the bowl has an added value over clay of some figure of money. You, the lowly bowl maker has just created money in an economy over the value of nearly valueless clay. This happens almost every time goods or services are exchanged in our economy.

I know it is hard to believe, but you can replace the word "profit" quite comfortably with the words "value added" without messing up the meaning too badly. You purchase bowls in bulk that are priced at a value added over clay, and you sell the bowls in smaller quantities in a nice display at your retail establishment at an added value over bowls purchased in bulk. Every step of the way creates money. In order to deal with the ever-expanding value of raw materials being turned into value added goods you need something that will grow with it, and gold can't do that. In order for gold to keep up with this enormous engine of economies creating money, mining of gold would have to be on a level comparable to how we mine for coal or drill for oil. Gold, like oil and coal is a finite commodity. We probably in a year or two after switching to a gold standard would begin talking about peak gold.

Currency, however, doesn't have these problems. It is just a medium of exchange. The value of goods and services should not be based on the currency, but the value of your goods or services against all goods and services. What makes the value of money go up or down isn't a factor of the money itself, but its supply in the economy. In order for money to not go up or down in value is how close the government agency hits the mark of how much money was created during a particular period. In the United States the agency in charge with matching the production of money so as not to create inflation or deflation is the Federal Reserve.

Our reserve bank tries to keep the amount of money in our economy at the level of the economies creation of money. This is a bit of guesswork and is not an exact science. If they project too low then the value of currency will increase and you have deflation, if they put too much money into the economy the value of currency will decrease and you have inflation. The Federal Reserve adds or detracts money from the economy by printing money and lending it to the banks that circulate it into our economy in the form of loans. If interest rates are high, fewer people get loans and the money supply in the economy drops, if interest rates are low, loans are more affordable and many more people barrow money and increase the money supply.

The Federal Reserve is not a private institution; it is, however, an independent institution wholly owned by the Federal Government and the therefore owned by the citizens of this country. It is independent to free it from politics so that it may concentrate on its mandates. It has two mandates, the first is to keep inflation under control and the second is to keep unemployment low. It makes a profit over its expenses and hands its profits to the US Treasury. This is apposed to the Federal Reserve banks that distribute the money from the Federal Reserve. They own unsalable "shares" in the Federal Reserve, which entitles them to 6% of the Fed's earnings. The Fed and the Federal Reserve Banks make up the entirety of the Federal Reserve system. The Federal Reserve system is necessary because we industrious Americans keep taking things that are worth nothing or of little value and making them more valuable,  (i.e. making clay into bowls). We create money in our economy and so the money supply has to increase with that. The Federal Reserve controls interest rates at the bank level by the interest rates it is willing to lend to banks. (Oh, so that is why they report the Federal Reserves interest rates so much on the news.) The interest rates asked for by the Fed are directly linked to two things, the cost of borrowing and the rate of inflation; however, inflation has other factors affecting it as well. Remember that when interest rates are high people and businesses tend to barrow less. This dampens economic growth, but maybe necessary to slow down inflation. If it makes interest rates low then businesses and people tend to barrow more and grow their businesses and employ more people. However, more money flowing to people and businesses tends to increase demand and that causes inflation. Remember the example of the cost of real estate? Banks made credit to people wanting to buy houses really easy and it inflated the prices of homes? Low interest mortgage loans that were too easy to get by nearly everyone, caused housing prices to go up and up, in other words, caused there to be inflation in the housing market. This can happen with an entire economy such as one the size of the United States as well.  

Gold doesn't have the capacity to do anything that the Federal Reserve Bank can do to regulate inflation or deflation. Gold doesn't allow money supply to keep up with money creation, which is what happens in a sound economy. Gold is a limited supply commodity that is finite. All the mined gold in the world today would fill up a little over two Olympic sized swimming pools. It won't reach to cover the entirety of the United State's economy and there ain't a prayer that it will cover the worlds economy.

Moving to the gold standard would probably cause a supreme amount of deflation.

Deflation has economic problems that can be just as bad as inflation. If we tried to use gold as our currency, we would have massive deflation. Massive deflation leads to money hording rather than investing and banks can't lend because the value of things are going down. Deflation is mostly associated with depressions.

Just like what happened in the housing market and the supposed incorruptibility of the value of real estate, we have been manipulated in believing the value of certain things such as gold don't go down only to have them change in value dramatically.  If you can't remember back 14 or 15 years ago to the end of the 1990s let me remind you, gold had gone down in value to a 22 year low. That means that those who had purchased gold close to their retirement as a sure bet in the late 1970s, for the intervening 22 years of their life, they would have seen their savings drop by 69%. If someone had saved 100 thousand dollars and purchased gold with it in the late 1970s, at the end of the 22 years, provided that they hadn't touched it for living expenses, they would have had only gold worth $31,000 by the end of the 1990s. If they would have kept their money as cash in a bank, they would have been far ahead even while earning relatively low interest on their deposit.  I am sure with every drop in the price of gold during those 22 years; investors were told that gold had enduring value, that you can't beat gold as an investment, etc. etc.  But the reality was that gold went from a high of over $800 per ounce around 1980 to a low of somewhere around $250 in 1998 and stayed there until 2001. That drop in value would have given us an inflation rate of over 14% a year for 22 years on average. The truth of the matter is that most of that 69% drop occurred in the first 5 years. Most average citizens would have experienced an inflation rate of 50% or more per year. 50% inflation for half a decade would have been devastating to our economy. Given this historical reality anyone can understand why gold doesn't work as a currency anymore.

If we truly are thinking of social and economic justice then think of this. One percent of the wealth of the United States is controlled by 1% of the population. Murphy's golden rule: whoever has the gold makes the rules.

During deep recessions there isn't a lot of economic activity so interest rates come down to encourage companies to barrow and pump that money into the economy. That part of our economy is not working the way it should work. Businesses are holding huge amounts of cash on the sidelines. They don't even need to barrow to do what they may want to do. Growth has stopped and many businesses have gone out of business. Ordinary citizens have gone bankrupt or had their homes foreclosed on or are upside down on their mortgages. The housing market, which would normally be the leader out of a recession, is still in very bad shape with trillions of loaned dollars still at very high risk.

How did we get in this mess? We repealed a very important law called Glass-Steagall. Glass-Steagall prohibited investment houses from entering into the mainline banking business of lending to homeowners and small businesses traditional loans. Allowing investment houses, now often referred to as investment banks, into traditional banking is what created the mortgage crisis and destroyed our economy. It is Wall Street for the last decade and the Republican controlled congress of the Clinton era and not the Federal Reserve that screwed things up.

In conclusion gold simply isn't a good investment right now since it is at economic bubble values, gold won't hold its value over time because investors will abandon it so that they can use the cash from its sale to invest in something else that will be growing in value or is proclaimed to have the ability to retain its value over currency, also, gold won't be a good substitute for US currency because there just isn't enough of it around to make it a practical currency. In order for our economy to work we need a money supply that can grow with the creation of money that happens naturally in a healthy economy. Currency that has no real commodity value such as paper and coin money is an ideal medium of exchange as long as the supply is controlled in the economy the way the Federal Reserve controls the entrance of money into our economy. We as a nation could reduce the swings of inflation and deflation of our currency by instead of only backing the US currency with the full faith and credit of the US government, we instead index the value of the US dollar to the cost of goods commonly traded between countries. This would enhance the dollar as "the" exchange currency by having the US government promise to exchange the US currency with supplies of goods on the index. This would make the Federal Reserve's job a lot easier since heavy swings of inflation and deflation would largely be non-existent.  The Federal Reserve would only have to get close to what the money supply should be for that time period, but the index value would be the ultimate arbiter of the value of the currency. In other words sell your gold and invest in yourself and in things with which you have experience.

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Comment Preferences

  •  Tip Jar (4+ / 0-)
    Recommended by:
    Bush Bites, Brian A, Crider, Sun Tzu

    Please consider the environment - do you really need to print this comment?

    by joelado on Tue Apr 30, 2013 at 04:09:56 AM PDT

  •  Moving back to the gold standard is idiotic (1+ / 0-)
    Recommended by:

    if only for the simple reason that EVERY country would have to do it.  If only we did it, as many want, then the rest of the world could easily manipulate our currency by f-ing around with the price of gold (easy to do, as shown 2 weeks ago).  I dont know why this issue never comes up.

    On the other hand, I don't think gold is a bad investment, if treated the right way.  I am invested in some, and have done quite well with it, even with the recent drops.  I think they key thing is to treat it like a LONG-TERM investment, and not get too freaked out over short term fluctuations.  If you try to speculate on gold, you're probably going to lose and lose big.  And lets face it, the right-wing gold industry really hawks speculation hard.

    BTW, many gold ETFs do not have the gold they say they do, and investors will get burned when this comes out.  GLD is an especially notorious example.  Some of the safe ones are GTU (the Canadian Central Gold Trust), and PHYS (Sprott Asset Management Gold fund), which both have highly transparent auditing processes.  Full disclosure, I have invesments in both of these.

    "Believe nothing, no matter where you read it, or who said it... unless it agrees with your own reason and your own common sense." -The Buddha

    by Brian A on Tue Apr 30, 2013 at 05:21:32 AM PDT

  •  Gold is NOT in a bubble (2+ / 0-)
    Recommended by:
    Brian A, jbob

    I wrote this diary sometime back destroying that assertion.

    “Wall Street had been doing business with pieces of paper; and now someone asked for a dollar, and it was discovered that the dollar had been mislaid.” ― Upton Sinclair

    by gjohnsit on Tue Apr 30, 2013 at 05:40:49 AM PDT

    •  Your diary is cherry picked nonsense. You only (0+ / 0-)

      show in your graphs the run up of gold when it was going up. You don't show the 22 year period prior when gold dropped by 69%. Your arguments seem to contradict what you are stating yet you then flip the obvious lessen that you present and claim that it proves the opposite. Absurd. Gold has wild ups and wild drops over time just like anything where too much money in the hands of unsophisticated greedy people create a craze for it. Right now it is the right wing absent brain trust that has made people believe that the collapse of the US currency is imminent, and gold is the only refuge. Yahoos that chase the weasel around the mulberry bush, whatever the weasel turns out to be, whether it be houses, gold, beanie babies or tulips, it always ends the same. Pop goes the weasel.

       photo 04-30-20139-40-35AM_zps6d067f57.jpg

      Please consider the environment - do you really need to print this comment?

      by joelado on Tue Apr 30, 2013 at 07:26:07 AM PDT

      [ Parent ]

      •  Speaking of cherry picking (0+ / 0-)
        You don't show the 22 year period prior when gold dropped by 69%.
        Gold haters always point to this without ever bothering mentioning the 8 year period directly before that when gold went up 2,200%.
           You know what the difference between that 8 year period and the last 10 years? The first 8 year period WAS a bubble. That's why it burst. You know how you can tell? Because people were panic buying, the opposite of what is happening now.
           You would think that after the Dot-Com bubble and the housing bubble that people would be able to spot a bubble now. You are proof that that assumption is wrong.

        “Wall Street had been doing business with pieces of paper; and now someone asked for a dollar, and it was discovered that the dollar had been mislaid.” ― Upton Sinclair

        by gjohnsit on Tue Apr 30, 2013 at 08:37:23 AM PDT

        [ Parent ]

  •  Gold has been valued throughout human history (0+ / 0-)

    and always will be. While the price will fluctuate in response to global currency activities, people all over the world will always value the precious metal.

    Whether as ornamental jewelry or as a compact store of value, there will always be a heavy demand for gold. I recommend purchasing small gold coins from a local coin store, and avoiding Goldline or any of the many scams advertised on radio or in newspapers.

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