"The U.S. dollar is a 'faith-based currency' dependent on the credibility of a central bank"
-- Dallas Federal Reserve Bank President Richard Fisher
The price of gold hit a new all-time high yesterday of $910 an ounce, and is expected to reach $1,000 an ounce this year. The price is being driven by "growing investment interest, safe-haven demand and strong market fundamentals".
So a small investment class is going up. What does that mean to Mr. and Mrs. Joe Citizen?
It means everything.
Gold isn't just some commodity, like pork bellies or iron ore.
Gold is the canary in the coal mine. Gold is the wet finger in the wind. Gold is the measuring stick of the one thing that effects everyone - the purchasing power of the money in their pocket.
When gold speaks, you should listen. And right now it's screaming.
Inflation: A persistent increase in the level of consumer prices or a persistent decline in the purchasing power of money, caused by an increase in available currency and credit beyond the proportion of available goods and services.
In other words, more currency chasing fewer goods produces price inflation. Price inflation is a symptom of monetary inflation, in the same way that a high temperature in a person is caused by a virus infection.
Inflation is not caused by union wage demands, or greedy oil companies, or extraterrestrials. Only one entity can cause inflation, and that entity is the only one that can legally print money - the Federal Reserve.
"Give me control of a country's money and I care not who makes the laws".
- Meyer Rothchild
The financial media and Wall Street have gone to great lengths to keep you uninformed and misinformed. That's not paranoia talking - its common sense.
For instance, the current rising price of all commodities is blamed on speculators, "global tensions", and one-off events like terrorist attacks.
Nothing could be further from the truth.
The value of commodities aren't going up. The dollar is going down.
Food prices aren't going up because of "geopolitical tensions". Your dollar is worth less.
Oil prices aren't going up because of terrorist attacks. Your dollar is worth less.
Gold isn't going up because of speculators. Your dollar is worth less.
It's really very simple, and if the financial media existed to do something other than keep you misinformed and uninformed, you would already know this.
How did this happen and what does it mean?
"The central banks are flooding the market with paper. Does anybody now take the dollar, the euro or the pound seriously? People are turning to gold because it is the only hard store of value."
- Peter Hambro of Peter Hambro Mining
StreetTracks gold ETF (exchange traded fund) currently holds 641.81 tonnes of gold in their vaults for private investors. That makes them the 7th largest holder of gold in the world.
This fund didn't even exist until 2004.
StreetTracks vault
Private investors are turning to gold because countries have returned to the practice of "Beggar-thy-neighbor", last seen in America in the Great Depression. Because America still holds the world's reserve currency (for the moment), this practice is pushed out onto all of our trading partners. The resulting effect is rising worldwide inflation and loss of confidence in every single currency, thus savvy investors are turning to gold.
Joachim Fels, bond guru at Morgan Stanley, said that the central banks will tolerate an upward creep in the underlying level of inflation because the pain required to kick the habit at this late stage is deemed too high. "I strongly doubt that they will tighten the screws. I expect 2008 to mark the beginning of another global liquidity cycle."
Blame the return of 1970s stagflation. The China effect has turned malign, pushing up global prices. The easy trade-off between growth and inflation is over. All choices are now bad. Infecting everything is the looming end to US dollar hegemony. Mid-East and Asian states are importing America's bailout policies through their currency pegs (or dirty floats), stoking an inflationary fire. Prices are now rising 14 per cent in Qatar, 10 per cent in the UAE, 13 per cent in Vietnam and 6.9 per cent in China. The pegs are near snapping point. Bretton Woods II is dying.
It's important to understand what a dollar is - an IOU.
Every dollar is someone else's liability. It's been like this ever since 1971 when we went off the external gold standard. There is nothing backing our currency except the ability of other people to pay the money they owe.
Hence the problem with the subprime meltdown and resulting insolvency crunch.
People with capital are afraid that the money they loaned out isn't going to come back to them. Because financial institutions have gone to great lengths to keep their losses from subprime investments off the books, investors are fearful where to keep their savings. They know that there are more financial timebombs waiting to go off. The magnitude of losses are at least twice as large as Wall Street originally admitted to, and likely to go higher.
Uncertainty and doubt in a world of "faith-based" currencies is not healthy for the financial system. And what good is a debt-based currency without a healthy financial system?
If the massive debts in the economy can't be paid then there are only two choices:
- defaults, which causes hard economic downturns and destroys money, or
- monetary inflation. This appears to be the strategy of the central banks of the world.
Monetary inflation is not without its drawbacks. For starters, inflation only benefits those that are close to the source of the money creation. Usually this means Wall Street, and the big investors who have their wealth invested there. Those far away from the source of money creation, like Mr. and Mrs. Joe Citizen working in Detroit or Houston, they are the losers. By the time the new money creation reaches Joe Citizen's paycheck prices had already increased months before.
Thus you see how monetary inflation shifts wealth from the working class to the rich.
What is seen as general asset inflation (i.e. "good inflation") in stocks and bonds is really just monetary inflation that hasn't turned into price inflation (i.e. "bad inflation") yet. Is that the only way that asset prices can increase? No. Wealth creation from technology innovations and actual labor also makes asset prices increase. But when debt and money supply are increasing far faster than the GDP then you have monetary inflation and the wealth transfer that goes with it, not wealth creation.
The metal of kings
First of all, what is Money?
Money is any marketable good or token used by a society as a store of value, a medium of exchange, and a unit of account. Since the needs arise naturally, societies organically create a money object when none exists. In other cases, a central authority creates a money object; this is more frequently the case in modern societies with paper money.
Anything can be used as money, but only certain things satisfy the three characteristics above: store of value, medium of exchange, and unit of account.
The first type of money in history that you didn't eat was precious metals, namely gold and silver. This happened shortly after the first written language was developed.
China tried using Cowrie shells for a time. This didn't work because it failed to meet the third characteristic of money. Massachusettes settlers imitated native Americans and used Wampum shells as currency until it stopped being legal tender in 1661. In England they tried using hazel sticks.
A piece of wood split down the middle will only match perfectly with its other half. So wooden sticks became a key component of English currency. The government's debt office took a nice looking hazel stick and notched across it various symbols which denoted monetary amounts borrowed and lent. The stick was then split down the middle, with each side showing one end of the notches. One side - which had a wooden handle known as a 'stock' - was held by the king's treasury, while the other was given to the goldsmith, who also got a piece of paper describing the date and circumstances of redemption.
It was used from the 12th Century until it was outlawed in 1826.
The first real coins were made in Lydia (western Asia Minor) circa 640 BC. They were an amalgam of gold and silver. A few decades later China began minting their own metal coins. Centuries later gold and silver had become accepted as money in Europe, Asia, Africa, and even in the Americas. Societies had decided it independently and without coercion.
But we have paper money now. It it worlwide and therefore superior, right? Well, not really.
The first thing to remember is that paper money has been tried before. Many times. And it has always failed.
China was the first to try it in the 10th Century but it ended early in the 11th Century because of hyperinflation.
It arose in China yet again in 1131 AD and the government outlawed all redemption rights into metal coins. The currency ended in hyperinflation in 1166. Mongol conquerers then issued their own fiat money, although like the previous attempts in China, it kept declining in value through multiple "re-issues". Gold, silver, and gems were forbidden from being sold except to the emperor.
But their fiat currency was over-issued. Credit was expanded too far and inflation went out of control. Eventually people lost faith in the currency. By 1350 the fiat currency ceased to exist and the empire crumbled into warfare and economic chaos.
After yet another try at paper money that ended in hyperinflation, China finally abandoned their 500 year experiment with fiat currencies in 1455 AD.
This pattern of inflating a paper currency until it was totally worthless was repeated over and over again throughout history. It was done during John Law's Royal Bank of France (circa 1720), during the American Revolutionary War by the Continental Congress (hence the term "Not worth a Continental"), and Germany's Weimar Republic (early 1920's).
It has been done over and over again - more times then I could list here and you would want to read.
Why is this history important? To demonstrate that the main competitor to the world's reserve currency (i.e. the dollar) isn't another fiat currency like the Euro, it's the previous world's reserve currency - gold.
What is bad for the dollar may or may not be good for the Euro. But what is bad for the dollar is always good for gold. The same is true for other currencies. Hence, gold has been going up by huge multiples against every single currency in the world over the last five years.
Why Gold?
A little over 2 years ago, when the price of gold was about $500 an ounce I tried to convince people at DKos to invest in it. I got mixed responses. Since I've often seen the same misinformed claims over and over again, I would like to respond to them now to avoid repeating myself later.
#1) "You can't eat gold."
Response: So? You can't eat paper money either. Gold isn't in competition with food. It is in competition with paper money.
#2) "You can't put gold into your car's gas tank."
Response: You can't put gasoline in your pocket either. See previous response.
#3) "Gold is only worth what someone is willing to trade for it."
Response: That is true. It is also true of paper money. The difference is that to get gold you have to find it, dig it up, smelt it, and coin it. The stock of gold usually only grows at about 2% a year.
Paper money, OTOH, can grow by infinite amounts because all you have to do to create it is punch some keys on a keyboard. This is why gold retains its value and paper money always becomes worthless in the end.
For example, in 1899 London an ounce of gold would buy you a nice men's suit. In today's London an ounce of gold would buy you a nice men's suit.
Now compare that to the purchasing power of a U.S. dollar.
#4) "Gold isn't money."
Response: Then why do Central Banks around the world have 13,000 tons of it in their vaults? Why would a bank put something into their money vault if it isn't money?
"But they are selling it," you say. Well, they are buying it to.
#5) "There's not enough gold around to be a currency today."
Response: Not at today's gold prices there isn't. But then there is no reason for gold to remain at today's prices.
#6) "When currencies collapse you want a gun, not gold."
Response: First of all, when whole societies collapse only precious metals are money. Nothing else is (for example, Roman coins were used as money for centuries in Europe after Rome had fallen). Precious metals became money without government coercion, and when the government becomes powerless, precious metals will return as common currency. Because unlike paper, precious metals aren't built on debt.
Secondly, every idiot in the country has a gun. Your gun isn't going to impress them.
Thirdly, society rarely collapses when its currency does. A good example is Weimar Germany. History is filled with examples of paper money becoming worthless, impoverishing whole sectors of a nation, and then the nation moves on and learns from the mess for a couple generations before they make the same mistakes all over again.
#7) "Gold is a bad investment based of its track record since 1980."
Response: The argument sounds good on face value, but not if you look closely.
First of all, gold spent all of two trading days above $800 in 1980. So extremely few people bought gold at the top of the 1980 mania, thus very few people lost the kind of money that gold-haters like to portray.
Secondly, the same people who criticize gold as an investment probably won't tell you to never buy tech stocks, despite the fact that a lot more people bought NASDAQ stocks near 5,000 (and lost quite a bit more) than ever bought gold near $800. The lesson here is: don't buy into a mania.
Finally, and most importantly, people didn't start buying gold in 1980. People have been buying and selling gold for 5,000 years. It has a track record that almost no other investment class can beat. It neither gains value or loses it. It just sits there...retaining value.
#8) "Gold is a risky investment."
Response: Gold is probably the safest investment you can make. Looking at the chart above, there is really only one instance in history that caused gold to make a dramatic fall - Spain dumping stolen Incan and Aztec gold onto the market. Barring a half-mile wide asteroid made of solid gold hitting the Earth, that is unlikely to ever happen again. The huge gold strikes in California and South Africa barely even made a dent in the price of gold.
All the other fluctuations made in the price of gold were caused by government and central bank manipulations. After decades of central bank gold sales totaling thousands of tonnes, the effectiveness and willingness of central banks gold sales is diminished.
Even more importantly, it appears that like Peak Oil, Peak Gold has arrived.
A little advice
So is now a good time to buy gold? Probably not. The seasonal low for gold prices is usually around mid-summer. That doesn't mean that will happen this time, only that recent history shows this.
Is gold mining environmentally destructive? Very much so. But then so is fiat currency that saddles future generations with debt and transfers wealth from the poor to the rich.
Can I promise that gold prices won't fall from here? No. I can only say that the market fundamentals of supply and demand which have caused the price of gold to more than triple in price have not changed, and don't appear to be ready to change.