Whither Gold, That Barbarous Relic

From The Daily Capitalist
* See disclaimer, below.

I've been thinking a lot about gold lately. Especially now that Nouriel Roubini has come out and trashed the noble metal (see Tyler Durden's article). Anyone who tells you they know what's going to happen with gold is guessing. Roubini is guessing.

Roubini also makes some fundamental errors in his analysis, and his assumptions are flawed. Since he's my favorite playboy economist, I should point out that he did study at the Mises Institute, but he must have cut class. He is ½ Keynesian, ½ Monetarist, and ¼ Austrian (according to Keynesian econometrics).

My conclusion, an admitted guess, is that the trend for gold is up. But ... it depends on what the government and the Fed will do. The short term is a trader's nightmare, so I don't have a clue if it's going up or down tomorrow. The bubble seems to be subsiding. If I were to really go out on a limb, I would guess that the fiscal stimulus bump will continue through Q1 2010, but will wear off by Q2--Q3 2010. Good GDP numbers would have negative effect on gold.

Let me explain why I think the way I think. In part it is an answer to Roubini. I could go through his report point by point, but I would rather make my own case. I don't mean to sound pedantic, but reviewing the basics helps give perspective to the issue.

1. People want gold.

People flee to gold when they believe the future is uncertain. And you can't tell me people like gold jewelry just because it's pretty. It has always been that way. There is no secret to its value. People want it, it's in short supply, you can't make it, it's been used as money for millennia, and, well, people want it. Accept this fact.

If you thought your paper money was going to be devalued, or worse, worthless, you'd get into some hard asset. Gold works pretty well in these situations. It's value will be maintained while fiat money could be wallpaper. People will take anything to get rid of their paper: bread, cigarettes, candy, grenades. Whatever. Gresham's Law.

This underlies the value of gold.

2. Fear is driving gold.

The big fear out there is that the U.S. will eventually face high inflation, perhaps hyperinflation, and sovereigns and investors who hold dollars see gold as a hedge against that event. Stability in an unstable world.

If it were all trader-driven speculation, the bubble would pop and gold would be back to $*** (pick a number). But when you have China doubling its gold reserves, and India buying tons of gold, when guys like John Paulson, Paul Tudor Jones, and David Einhorn reveal they've been loading up on gold, you know something is going on.

There appears to be enough demand to create a floor which would limit a collapse of the price of gold.

3. Perspective.

According to the NBER, this is my 8^th cycle. My mother sold her stocks at the bottom of the 1962 cycle (down about 12%). She confided that fact to me later that year when I came home from college after starting Econ 101. She went through the Depression and was afraid. I told her we'd never have another depression: my professor told me so. That was my first cycle.

The point of the experience thing is that during almost every big cycle I've been through, the gold bugs came out in force and predicted dire things. Look at the ads on a lot of blogs. Check out the survivalist sites. Gold, guns, and food. Atlas Shrugged. It is not a new thing. The predictions you see today are the same as in the past. It has a big impact on (younger) people who haven't been through a major cycle before. Everything is new in their eyes.

Also, for the most part, gold bugs always like gold. They believe the world will come to an end, soon.

Because people say it, doesn't mean it's so.

4. Is this cycle different?

Yes, it's different. It's huge.

See Carmen Reinhart and Kenneth Rogoff, This Time is Different: A Panoramic View of Eight Centuries of Financial Crises who note that cycles all act pretty much the same. What is different is that we're going through the biggest financial-credit crisis the world has ever seen.

Fueled by cheap Fed money, rising home prices caused U.S. household debt to expand from $6 trillion in 2000 to about $14 trillion in 2007, a 233% increase. Estimates of capital losses on the balance sheets of private institutions range from $2.1 trillion (Goldman Sachs) to $3.6 trillion (Roubini). Worldwide declines in equities and real estate wiped out $28.8 trillion of global wealth in 2008 and the first half of 2009, down from a 2007 a peak of $194 trillion.

The whole world was plunged into recession because the housing boom spread world-wide, aided by central bank cheap money. The CDOs, MBSs, and CDS "insurance" were based on false risk models and spread (mainly) U.S. paper throughout the world.

This means the risks to investors are higher and grander in scope than they've ever been.

5. The solutions are worse than the cure.

This is the key to gold.

Fiscal stimulus:

In order to finance Keynesian fiscal stimulus, national debt is now $12.1 trillion and growing (85% of GDP). The Administration recently announced that the deficit over the next 10 years will double the national debt to about $25 trillion by 2019.

This deficit spending is a waste of money, has done nothing to revive the economy, the resulting debt is a tax on our great-great grandchildren (intergenerational theft), and the interest burden will be a substantial drag on our economy.

Money supply:

This is where folks get nervous. Money base has exploded:

Yet, money supply, M1 for example, has dropped:

And bank reserves are very, very high:

What this means is that credit has dried up. The FDIC reported that bank lending in Q3 contracted by 3%:

Banks aren't "hoarding" according to that popular Keynesian "liquidity trap" myth. They are properly responding to the risks on their balance sheets. They aren't going to take loan risks until their balance sheets are stable. Think not only of the bad residential mortgages and subprime paper, but the huge amount of commercial real estate held by small and regional banks--which banks are the lifeblood of most businesses.

Obama can jaw the "fat cats" all he wants, but he can't make them lend. If he can, watch out.

Exit strategy:

The reason gold is in demand is because gold buyers doubt the Fed's exit strategy. That is, when banks are healthy, they will lend. They will have access to all that money and credit the Fed has created, and, considering how much was created, it will lead to high inflation. Some people say hyperinflation.

The Fed says they can sop up the funds by raising the Fed Funds rate and increasing banks' Tier 1 capital reserves. Let's say they do that and the recovery collapses because of tighter credit, higher interest rates, and the like. Mortgage rates will go up, credit is tight, and Congress screams. You think the Fed is independent? Don't bet on that.

What about the Fed paying interest on banks' reserves? The theory is that banks would rather get interest on a safe "loan" of their reserves to the Fed, than make a "risky" loan to the public. That won't work. Doing this will make it impossible for the Fed to maintain its target interest rate. Also, banks don't keep customers if they don't lend, so they will. Please see this article for a thorough explanation of this.

Higher interest rates will stop inflation. Will Bernanke do this? It worked for Volker. If he doesn't, we'll have inflation.

6. The dollar.

The decline of the dollar is an intentional yet unofficial policy of the Obama Administration to pull us out of the recession. I don't know why they believe this, because, while it will stimulate U.S. exports, it will kill businesses which are based on imports.

We've been running trade deficits for many years before this crisis, yet the economy expanded and jobs increased rather than decreased. One can clearly conclude from the data that when GDP expands, imports increase. Conversely they shrink during a contraction. It's been this way for at least 30 years.

Right now, the current account is more "balanced" in that exports have been rising. That has everything to do with the recession--people are buying less. In economic terms, letting the dollar fall in order to boost exports is just old fashioned mercantilism. It was proven wrong with the introduction of free trade.

The result: we all pay more for imported goods, which, these days, is just about everything. The offset in exports won't be enough to stimulate consumer spending. See, "Economic Megatrends That Will Drive Our Future."

Don't expect the Fed or the Treasury to halt the dollar's decline anytime soon. High inflation will be a big negative for the dollar and a positive for gold.

7. Why did gold go up?

I was hoping this wasn't as obvious a question as it seems.

The dollar is going down is a more accurate way to put it. That has the most to do with gold's rise. Here's a chart of the dollar (DXY):

You will notice from the chart that during the initial stages of the crisis, people flocked to the dollar which shows that it is still the world's reserve currency, especially during a crisis. But after that, it's been a slide.

Reason No. 1:

Check out this recent article from the Financial Times:

One factor supporting [gold] prices is the change in attitude by central banks, some of which see buying gold as a way to diversify from the dollar and their holdings of US Treasuries. For many years, central banks were net sellers of gold. Not any more – earlier this year it emerged that Chinese gold reserves had almost doubled. ...

There has been speculation this week that China could snap up the remaining 203 tonnes of IMF gold. Brazil has also been touted as a potential buyer.

Michael Lewis, commodities strategist at Deutsche Bank, notes that the majority of central banks banks in the developing world have less than 10 per cent of their reserves in gold.

Mr Lewis combines this list with large holders of US Treasuries who have a strong incentive to diversify into gold given the “non-negligible risk of a US debt and currency crisis”.

China, Japan, Russia, Taiwan, India, Singapore, Brazil and Korea are strong potential candidates to increase their bullion holdings, he says. “We expect central banks, in aggregate, to be net buyers of gold over the coming year for the first time since 1998.”

Reason No. 2:

Private buyers of gold or gold related assets such as GLD and gold futures are the second reason for gold going up. See above about Paulson, Jones, and Einhorn. Lots of buyers in China and Asia.

Reason No. 3:

Speculation. As I said, I have no idea what will happen tomorrow. Note that the dollar rose in December and gold declined.

8. Does the deficit matter?

Foreign buyers finance 30% of our debt. We sell our debt to China, Japan, and the U.K. China holds $1.521 trillion of our debt.

Big exporters like China and Japan can't do much about their holdings without cutting off an arm or two. They know they are stuck. They'll grab their ankles and keep buying our debt, perhaps demanding more TIPs. I think the Chinese really believe in the Fed's exit strategy. But ... they are still buying gold as a hedge.

U.S. banks have been investing their reserves in Treasuries. Also, because U.S. consumers are increasing their savings, private holding of Treasuries have also increased. And, it appears the Fed and Treasury have been monetizing some of the debt.

This is why T-rates have been low.

Deficits affect gold only in the long term. I don't think holders of dollars will not buy our paper. Assume China and Japan cut back on funding our deficit. What will happen? Investors will demand higher returns, interest rates will go up, paper will be sold, and the ultimate tax burden will slow down the economy.

It is printing money and easy credit which causes inflation, drives the dollar down, and causes gold's rise.

9. Gold will go higher--eventually.

It's all about inflation and world stability.

Black Swan:

By definition you can't see the next world-changing negative Black Swan event coming. I'm leaving an economic crash out of this part of the discussion. Volcano. Nuclear terrorism. Iran. Comet. Pakistan. Take your pick. These events create world instability and people run for safety.

These are the reasons you buy some gold anyway. Taleb is completely right on investment strategy: be conservative on 80% to 90% and bet the farm on the rest. Gold is safety.

Deflation:

It's not over. This is a controversial issue, but as long as real estate assets fall in value, we won't see much inflation. I didn't say "any" inflation, just not much as long as real estate keeps dragging banks down, causing credit to remain tight.

I've addressed the continuing problems with housing recently; if you need more on this see "Why The Housing Market Is In Trouble."

Commercial real estate is as bad. The Administration has adopted a policy of "extend and pretend" for banks with CRE debt. If you can show that you will eventually be able to amortize the loan at least to even when things get better, banks can extend the loan, reduce interest, or whatever it takes.

While many analysts see this as a positive, it isn't. It is just another way to ignore reality like suspending mark-to-market. This will drag out the recovery as banks are still burdened with make believe debt on their books. More uncertainty for lenders will keep them tight fisted.

This could last several more years. But the government has other ideas about real estate that could shorten deflation: reignite the bubble.

Inflation:

Since I don't believe the Fed can save us from themselves, I don't know why we won't have inflation.

Because the economy will remain sluggish due to the continuing credit contraction noted above, the Fed will keep pumping new money to thwart a "relapse" of the economy. I think inflation will eventually take hold in 2011 because the Administration will reflate the real estate bubble. And that will repair a lot of bank balance sheets. Real estate can be reflated by means other than monetary policy (FNMA, FHMA. FHA, GNMA, and tax policy).

I think inflation will last for some time because it benefits debtors, including the federal government, and will allow them to pay down debt with cheap dollars. The perception of a recovering economy will carry the Democrats and President Obama to victory in 2012. So you will see inflation well into Obama's second term. Oh, yes, he'll be re-elected. FDR made the Depression worse yet he was re-elected, so why not Obama. The odds are heavily in favor of incumbents.

So Ben won't have to muster his courage to raise rates until 2013.

Inflation will drive down the dollar and gold will go up.

Hyperinflation:

Everyone, Austrian, Keynesian, Monetarist, and Marxist knows what causes hyperinflation and no one will let it happen.

Hyperinflation is a popular theme with gold bugs, but I don't buy it. Hyperinflation is far worse than a recession and Ben, Larry, and Timmy know that.

Let me give you another scenario. When inflation really gets high, say to Jimmy Carter levels (13±%) or higher, we will see a temporary implementation of price and wage controls, as in Carter and Nixon. Since everyone also knows these don't work, it will just be a smokescreen to allow Bernanke to raise interest rates until inflation comes under control.

10. Remember, this is a guess.

These are the guide posts we should keep watching in order to protect our investments. As I said at the beginning, it all depends on what the government and the Fed do. I'm not going to tell you what to do because I don't give investment advice. But my analysis points to an increase in gold over the long term because I think a continued dollar decline is inevitable. Gold is a favored hedge against this.

*Disclosure: I am not selling you anything. I don't want to manage your money. I'm not giving you investment advice. I am peripherally involved in the gold mining business, but if you run out and buy gold it won't affect me. So, I have nothing to gain by this article. Keep that in mind when you research those selling gold investments.

Comments

[jmc8888]

Actually your comments on FDR are quite wrong. 

There is a lot of revisionist history when it invovles FDR so we need to clear some of that up.  Only because it's critical that the facts are known about one of our most infoluential presidents during a key time in our history.  (plus it wasn't that long ago, and we have FILM).  This isn't as hard as it's been made out to be. 

Okay.  First off, what FDR did, wasn't to lengthen the depression, not to mention the metric is faulty.  The metric of ending a depression is where did FDR take you? 

Well, he took us from great depression to the biggest economic behemoth that this world has EVER known.  So before we talk about how 'he made the depression last longer', you realize the end game was nearly perfection, something that has not been achieved since.

Plus you omit that fact that he died, at the beginning of his 3rd term.  Remember he was elected to be president until 1948.  So his overall plan was never finished.  (what was his plan -to end imperialism, make france and britain give up it's colonies, free the people under that rule (See Ho Chi Minh -who was our ALLY in WWII), and use the behemoth of our manufacturing monopoly as a way to free people, including the vietnamese.  However sadly, when FDR died, truman, a puppet of the British, reversed course, and made Ho Chi Minh release the Japanese prisoners Ho Chi Minh had captured, and to let them retake control of Vietnam, Burma, etc. 

(so besides putting us on a track to avoid a vietnam war,. because he was with the vietnam war, truman came in, did the opposite, and we have the beginnings of the resistance that would become the vietnam war.  Great job truman.  (which of course was the war that was also unneccessary, and forced us off the gold standard)

Okay back to earlier FDR.  One thing you have to realize is that FDR wasn't in a vaccum.  You are tending to see the 'great depression' as oblivious to everythign else.  That is just not the case.  You see the people here at zero hedge and other places around the internet know something is coming, it's called crash, volitility, and great depression. We know it's coming.  Well in the 1930's, those of us that would have been alive, would have been the people who KNEW WWII was COMING.  Just like we can see gold at 5,000 and ounce, these people saw WWII coming.

So FDR not only brought us out of the great depression,he also geared us up for the biggest war this world has ever seen.  Not only did we meet the call, we dominated. WWII wasn't one of these pus*y wars.  It was a REAL war.  You couldn't busllshit like you do now, because people were dying by the tens of millions.  Not 3,000 soldiers, or 58,000.  You were lucky if that's how many were killed in a day not 12 years.

It's wishful thinking that tax cuts would have brought us out of the great depression faster.  It wouldn't of.  If we went that route, we would of lost WWII.  If we went that route we wouldn't of been able to help vietname (oh wait, we still screwed that up).

The great depression was a beast, it's wishful thinking that tax cuts would have pulled us out sooner.  It's also not a certain that if he hadn't raised taxes, that demand wouldn't of fallen off a cliff even faster. 

You also have to remember that monetarily he was an enemy of britain, france, etc.  They knew that.  He knew that.  Why everyone else forgets is beyond me. 

He wanted to crush the great depression (which was started by the British).  Just like WWwI after leaching onto the US via the federal reserve act to fund WWI.

But alas, we tend to see things a bit cloudy.  Is it important that there were ups and downs which are typical of a depression, yet we assume there was a strategy that would not have this be the case? That's naiive.  FDR was fighting an economic war against Britain, who was fighting back. (see great depression philosophically caused by), and gearing up for a real war.

There was no better plan.  FDR did it right.  He built up the infrastructure.  He closed the banks.  He destroyed the oligarchs and their casino.  Glass/stegall anyone? Minimum wage that equals 25.00 per hour.  I don't see anyone doing that though.

And again, it's not always the journey but the destination.  So again, he turned around the great depression, kicked the british's a** economically and told them where to shove it (he did), built up for war, dominated the war (we had a goal see....kill hitler not any insurgent we deem is one for whatever reason and for whatever goal), and was about to make britain, france, netherlends, etc to give up ALL their colonies.  That was the price to be freed from Hitler (who was a british puppet turned rouge).

So let's not quibble over one side of a single position that raising taxes caused the great depression to last longer.  As you can see, it was far, far, far, far, far, far more complex that that.  Again, in the end, we were the biggest economic and military might this world had EVER seen.  (we would not have been if we went the other route).  We didn't win WWII by accident, we won it because we prepared well, and it was FDR who developed, implemented, and pefected in practice that strategy. 

It's easy to sit here, forgetting all that we benefitted by him, and assume we would of ended up the same way, plus ending the depression faster, had he just not raised interest rates.  That's full baloney.  Full revisionist history.  If we allow ourselves to forget the truth of WWII the british financiers will have won. This time, will we have a new FDR be able to again flip the bird at the britihs, and do what neccessary.  Or will we follow them to ruin?  I guess it depends on how well the average person knows what FDR did, and right now it's not looking good.

Educate yourself. 

[Econophile]

jmc, I don't know where you get your history but you're dead wrong about FDR. I rarely take the time to criticize comments like this because most of the readers at ZH are pretty capable. But what you say makes no sense and is contrary to history. Mr. Crime's reference to Amity Shlaes book is a good place for you to start if you wish to be educated rather than be paranoid. In fact the economy didn't recover from the Depression until the very late '40s when they started unshackling us from FDR's economic controls and central planning. The Dow didn't reach pre-Crash levels until 1954. Here's an article on this very topic. 

[Crime of the Century]

Amity Shlaes' The Forgotten Man is an excellent place to start.

_{http://tinyurl.com/ylgu22a}

[Grand Supercycle]

There is a lot of gold talk in the MSM these days.

That could well be a contrarian indication of a top of some kind.

It's had a parabolic run recently too.

http://www.zerohedge.com/forum/market-outlook-0

[Anton LaVey]

Sorry to say that, Supercycle, but you are startingt to sound like a broken record.

[ConfederateH]

Supercycle, your bet on getting rich on a rising dollar is going to crash like evil knievel at ceasars palace.

http://www.youtube.com/watch?v=kYGGCVE2lKY

[A_MacLaren]

Disclosure: I'm Long Gold.

Physical (coins, bars and a historic mine on 20 acres a half hour from where I live...) and Electronic (GTU/CEF/Some Mining stocks) 

For another perspective on gold from the finges of the internet go read this man's work...

http://unqualified-reservations.blogspot.com/2009/12/gold-and-central-ba...

Gold and the central banks: the game theory

...my position on the gold price is the same as in 2006. If gold will eventually be remonetized, gold is insanely cheap. If gold will never be remonetized, gold is insanely expensive. It's one or the other. Therefore, if you guess right about this question, you will make huge profits, and if you guess wrong take huge losses.

Your guess is probably better than mine, so I will refrain from making one. I note, however, that in 2006 the remonetization of gold was a decidedly fringe perspective. Now it appears regularly in the headlines. It is still a long way from happening. So there is plenty of time to hop on this bandwagon before it either rolls to glory, or off a cliff.

...

(Go read the rest, IMHO, it'll be worth your time.)

[Anonymous]

"The hard dollar is starting the next deleveraging leg, which has been postponed since March by Bernanke's talking down (shitting all over) the dollar and pumping gold. That's right, the Fed has been boosting gold for its own reasons"

I agree. If that liquidity went to the oil market and the oil prices went up to $120 instead of gold going to $1200, there'd be riots in the streets.

[DoChenRollingBearing]

Great piece.  They guy who writes fofoa.blogspot.com I believe has the best current take on gold.  It is the best form of wealth preservation.  Also a form of insurance.  He notes in one of his pieces that gold's "price" has varied through history by up 2 orders of magnitude, depending on conditions.

It is not money, but the definition of money (as we know) can be very slippery.

[Econophile]

See: http://blog.mises.org/archives/002808.asp

[Anonymous]

jolly good show econophile. but why do you think obama's historical position & trajectory are more comparable to fdr's than to hoover's? or was this just a "contrarian" tangent

[Econophile]

Hoover could be "W" in this case. But, mostly a contrarian tangent.

[Anton LaVey]

When FDR arrived in power, the USA were still a creditor nation. When BHO arrived in power, the USA were a debitor nation (meaning they owed money to everyone else).

When FDR arrived in power, the USA were still producing enough oil for their own needs AND enough to export. When BHO arrived in power, the USA imported oil from all over the world.

When FDR arrived in power, the USA were still an industrial powerhouse - yes, even with the Great Depression - When BHO arrived in power, the most important industrial production had been long outsourced to China and other nations.

There are other parallels to be made, but I'll leave them as an exercice to the reader.

All of this is why people talking about a new "New Deal", FDR-style, make me laugh: they have no historical perspective and are still fighting the last war.

[Anonymous]

ZH has worried me somewhat with all the gold cheerleading. It's the only aspect of the site that I don't trust - everything else makes sense, and is cutting edge to boot. I might go so far to say that my Anon goldbear comments have been deleted by the moderator (Sorry but it's true).

I look forward to more open and honest debate.

[Anton LaVey]

Like 'Econophile' pointed out, gold is insurance.

In times of uncertainty, gold goes up. And we are certainly going through very uncertain times. As soon as the system becomes more or less stable again, people will sell gold, and invest their money elsewhere. But that time is still a long way out in our future.

This being said, if you want a "more open and honest debate", you should try to contribute more. I am very interested in hearing contrarian ideas. Grousing about having comments deleted is no way to contribute to a "debate", in my humble opinion.

[Anonymous]

Let's not put the cart in front of the donkey - saying "gold goes up" is a pretty vague statement. It has to go up relative to something, which in this case was the USD. As Roubini said, it didn't appreciate much versus the Euro.

Historically there have been many monetary systems where gold was the medium of exchange. In many ways they were susceptible to problems similar to the fiat paper systems we use now. Some could create money (mining), but most couldn't. People used fake gold, diluted gold dust, and others simply shaved bits off of coinage. Surely many a banker calibrated their scales a little low sometimes, and robber barons stole gold outright using their military might. I think those times are in many ways analogous to our current situation:

Some idiots can create the money, most have little access to it, some make "fake money" (derivatives), and some shave a little bit of it off every transaction (fees). Bankers have some severely miscalibrated "scales" (cooked books), and "corporate pirates" steal it outright (bailouts, fraud, offshore banking). When a huge gold vein was discovered, do you think they mined it all and dropped it on the market the next day? Would the Fed monetize beyond any imaginable level (eh, maybe...)? That is their "responsibility" - if I water down your milk 100% overnight you'll spit it out at breakfast. Slowly turn up the heat on those cooking frogs, that's the only chance you've got.

I don't think anybody is "going back to the gold standard", any more than I think the Fed will not inflate the dollar. However I don't see your ounce of gold really being worth 220 burritos, 75 steaks, 700 cups of coffee, or 2 good quality whores for an hour. When you go to trade it, you won't be the only one setting the price.

[Anton LaVey]

Gold coinage can be debased? No news here. Google: Gold, Tungsten, Bank of England for the most recent example of this.

I never said anyone was going to go back to the gold standard - you did. On the other hand, I agree with you that this would probably be awkward. Very awkward. But this is due, mostly, to the insane indebtness and speculation of the financial industry worldwide.

But here is the deal with gold: it retains its value very well in bad times. Admittedly, it retains, and will retain, its value relative to something else, as you point out. If that "something else" is a (fiat) currency, and the currency goes down in value and purchasing power (due to inflation, for instance), gold retains its value and its relative price, based on the debased currency, goes up. On the other hand, if said currency goes up in value (due to deflation), gold will lose value, or see small raises in value, simply because it is a good store of value and rather "liquid" (exchangeable for hard cash).

This, I believe, is the situation we are in: most markets have "priced" gold as the ultimate hedge against inflation. Therefore, it has been going up in value very rapidly. This rise has also been due to speculation by TBTF financial "institutions". Recently, some moderately positive stats have appeared and the (relative) price of gold has reacted accordingly, by going slightly down and sideways.

Only when confidence in your (fiat) currency goes up (due to a real economic recovery) will the "price" of gold go down for the long term. Again, its price will go down relative to the perceived value of the (fiat) currency, and (especially) the confidence of investors in the health of the economy propping said currency.

This can be easily verified based on historical data: 1970s inflation and political uncertainties (Nixon's Watergate, Inflation, Vietnam War, etc) gave a big boost to gold price, relative to the US$. Once these uncertainties were "removed", and inflation slowly brought under control, the price of gold went down. The same dynamic is at work right now.

In other words, as long as severe "uncertainties" remain about the US economy and US$ "quantitative easing" by the Fed, gold will go up in price, again relative to the US$, of course. I believe this is a long-term trend, and unlikely to change anytime soon: if the FED slows down quantitative easing too soon, the US economy will be plunged into another Great Depression. Conversely, if the Fed keeps on using QE, the price of gold will go up, since inflation (which can be very severe 'hyper'-inflation) is the only possible outcome. Therefore, the price of gold will go up.

As an aside, gold has also appreciated - a lot - versus the Euro, and I suspect Dr Roubini to be mistaken when he says the Euro has retained its value vs Gold. After all, the ECB has been printing an awful lot of electronic Euros lately... And most Eurozone countries are not doing so good (See: Greece, debt ratings).

Finally, I get your point about the price of an ounce of gold. On the other hand, this is what I would call a doomsday scenario: a complete collapse of the economy. In such a collapse, very few things would be left to trade with: food, weapons, fairly advanced skills - I bet competent doctors would make a "killing" so to speak in such an environment -  raw materials... and gold and silver... would be the only things left to trade with, if we ever return to the dark ages of barter. But that is still a long long way away, in my humble opinion.

I hope this makes sense to you.

[Econophile]

Anton, nice.

Anon, I don't know of a situation where gold caused inflation. Maybe when the Spanish stole all the New World gold, but not sure. Or when the "robber barons" stole it? (I assume you are talking about "our" barons.) When did that happen?

[Anton LaVey]

Econophile: actually, the Spanish galleons, bringing gold from the New World, is the reason why inflation was defined in the first place. This was noted by a French economist at the time (his name escape me at the moment, I think it was Jean Bodin) who demonstrated that, all things being equal, a rise in the money circulating in the economy will always result in a rise in prices, since producers could not - at the time - ramp up production enough to respond to the accrued demand.

But this was due to gold being used as legal tender at the time. Our time is different, since (a) gold is not legal tender anymore, (b) money is largely electronic these days and can be created and destroyed at will and (c) most producers have a lot more options available to them to ramp up production. You can also add that the means to combat inflation (especially raising the interest rate) are now fairly well known.

[Econophile]

It goes far back, and was a well known phenomenon in Ancient Rome. Some argue it is what caused the fall of the Empire.

[Anonymous]

That's an interesting factoid about the galleons bringing too much gold back. I believe this thread would qualify as informed debate that Anon referred to a few posts back. Thank you. On that note...

What we are talking about here is exchange value. Point (b) in your post brings up an interesting aspect. Today you can trade gold for more paper currency than you could last year at the same time. However, one major caveat - there isn't enough paper currency. Yep, you got it, right now there isn't enough paper currency in circulation to cover even a fraction of the so-called wealth in the world. It's mostly electronic.

Think about it, when the Fed does some QE they just click the 1 trillion checkbox in their little Microsoft Windows Federal Reserve software interface! If they had to print the real money, even if they printed it in $10,000 bills, it would take YEARS to print a trillion dollars (100,000,000 $10,000 bills), and the bills would fill a huge warehouse. I don't have decisive proof, but I believe we are at the moment where printing a $1 bill costs more than a dollar. Soon, printing a $5 bill will cost more than $5. The key is that even the dummies have to do all their transactions electronically (also the single biggest reason why the elite hate the black market).

If there's a run on anything it will be "physical currency". Just like COMEX is out of physical gold, the Treasury is out of physical paper. Citi's vaults are filled with mostly air. Your "wealth" is just a number you keep in your head, which you check on a website or a monthly statement (I'm assuming you're a little richer than a typical WalMart worker, who has no balance anyway). If the economy were to suffer any (further) major trauma, we would revert to using paper currency.

Did you ever wonder what the best way to prevent US hyperinflation is? The banksters/Fed could put a hold on electronic transactions! This would immediately decrease the velocity of money dramatically, making the huge supply of "money" irrelevant. Everyone would line up outside the vaults, and the first 1000 would get some bills, everybody else would be stealing and scraping from their neighbors. Nobody ever says it, but the banksters control not only the supply of money, but its velocity also! Granted, they've mostly used that power to freeze transactions with Hamas, etc., nonetheless it is an option to them.

If they want the velocity of money to increase, just give the minions more 0% zero down mortgages, they'll happily lap them up like the lapdogs they are. I'm afraid that this hoarding gold concept might be a bit "pre-modern".

Welcome to the Matrix.

[delacroix]

deflation does not make the dollar more valuable, and gold is more than a commodity. why do seemingly smart people continue to wear blinders, that keep them from seeing the big picture? when in uncharted territory, you want a gun, AND a knife.

[Anonymous]

don't be alarmed it's all part of the image, infinitygold is the numerator over zerohedge

[Anonymous]

Gold is just a proxy. It is a proxy of exchange for all the other life-sustaining necessities and luxuries which make a bountiful experience. It is merely the most easily recognizable, quantifiable, and exchangeable commodity short currency (stable currency that holds confidence). Since currency is dead due to central bank malfeasance, gold is the natural go-to medium of exchange.

In a world papered over with IOUs of different denominations, terms, expirations, creditworthiness--all which CANNOT be honored when the natural constraints on growth are realized, there must be DEFAULT. It will not be a minority of issue either. MORE than 50% of extant issue of the world IOUs MUST default over time. Therefore choose wisely the container in which you chose to house a lifetime's stored labour. Only gold is an equity instrument of proven scarcity and immune to easy counterfeit.

All else is sand in a whirlwind. The value a man creates in his life endeavors is REAL. This man is ever surrounded by the most conniving and cunning jackals seeking to deprive him of his substance. Short of physical theft, only precious metals will preserve him from the depredations of conspiring and evil men who will NOT earn their living by the sweat of their brow.

[Anonymous]

Why all the smoke when the facts are oh so clear. The USA is as bankrupt as a country has ever been and there will be no restructuring. Rome is burning. Dollar will be out as world reserve currency. New world currency backed by 10%-20% gold and other key commodities. New curency will have value unlike the US dollar which is a dead man walking. We are coming to the end of a long term credit cycle and are in the midst of deleveraging process the likes of which this planet has never seen. The other strong economies know this and are preparing for the unavoidable. Traditional economic theory and analysis are now non-starters which is why decision makers are and will continue to get it wrong. Big name intellectual analysts like Roubini and Krugman are nothing but dogs barking in the night. Roubini may be partially correct however in that within the US spam may be more valuble than gold. However throughout the the rest of the world gold will be the rudder. This time the Revolution WILL BE TELEVISED.

[Anonymous]

good analysis. 2 criticisms:

1) *Disclosure: I am peripherally involved in the gold mining business, but if you run out and buy gold it won't affect me. So, I have nothing to gain by this article.

you might as well leave that out b/c the bloody statement is contradictory...just sayin...

2) intergenerational theft:

I feel like zerohedge may need some non-economists occasionally.

What do you think the world will be like in 2050 or 2060? The "leverage rate" will definitely increase over the next 50 years as technology grows exponentially.

Look at the money supply graph and superimpose a graph of processing power - see any correlation?

The most important economic question of the future and making super LONG term predictions is: how much can we "make" out of all of the given "resources" out there and at what rate is this process increasing?

Despite being a semi-gold bug (10-15% allocation is my attitude), I don't understand why everyone always thinks that the lessons of the Great Depression entirely apply to today. Technology is the driving force of society and is drastically changing

[Molon Labe]

Gold, snitches.

[Cursive]

steve from virginia posted this on the original ZH/Roubini Barbarous Relic thread last weekend.  BTW, thanks to all who answered the questions I posed.  I think he's really onto something here:

/////////////////////////////////////////////////////////////////////////////////////////

The traditional hedge against inflation in the US has been real estate. It can be had anywhere and everywhere and has 'always gone up'. Okay, we'll forget about that last part ...

Real estate is NOT a hedge anymore ... now what? No inflation, except in some asset markets where central bank liquidity and market manipulations are pushing up prices.

Gold ownership presumes that current economic difficulties are transitory and that the gold can be resold for currency sometime in the future at a profit. There is no other value- acquiring strategy to support gold ownership. The 'gold/can of baked beans' trade is not a good one.

Nobody alive today is old enough to recall the corrosive speculation in gold by banks and others during the early 1930's. Sovereign gold holders defaulted and abandoned gold. A large percentage of US banks failed. Gold speculation and  arbitrage emerges during crises where gold currencies have always failed. I can explain further, but the details are time consuming. You can certainly figure most of these out for yourselves.

Some consider gold to be an alternative form of currency against 'other, fiat' currencies. Willem Buiter points out in a fiat universe, all things including gold's putative value are fiat. Gold is not a currency. No citizen buys gold today to elevate the condition of his neighbors by circulating his gold to facilitate commerce in his town or city. Rather, he clutches his gold in his basement with one hand and a belt- fed weapon with the other with the intent of murdering his neighbors.

People become confused about credit and money creation. Finance creates credit denominated in currency. Central banks and treasuries create actual currency; the Fed creates dollars in open- market operations. Mr Bernanke is facilitating the laundering of illiquid dollar- denominated credit instruments into cash for his friends in finance. He and his partner- in- crime Mr Geithner are creating currency as fast as possible. Finance has many illiquid credit instruments; hundreds of trillion$ more of them than the Fed has available currency. Most credit instruments will never be converted; those 'in queue' are hoping against hope the current dollar slump lasts long enough so that they too ... can trade their worthless trash 'securities' for cash.

As a consequence of Bernanke's currency/securities trade, currency has vanished from circulation in large areas of the country. This is why the US is in a depression with millions of unemployed. In the real world, the effects of Bernanke's 'money printing' are negligible. See Steve Keen or another monetary economist for more nuggets of useful currency creation info.

There is physical gold and derivative gold or 'paper' gold which is the form most retail gold takes. There are numerous sites on the Internet pitching 'you buy and we hold' schemes. Since there are many more paper claims on gold than there is physical gold, the settlement of these claims will be done in currency. This is ironic; the gold basis has enjoyed an increase in value. The the paper claim against the metal may appreciate in value even more!

If your timing is good and you bought gold early enough, a paper gold trade might be a very good trade, indeed!

If the economy truly collapses, the paper claims will be repudiated. Gold purchasers will have neither gold metal nor currency. Suckers!

In the futures market there are also more long positions than physical gold for delivery. This implies a large short position held by the exchange itself and its banker(s) including Goldman Sachs. Uh oh ... If contract holders want to settle rather than roll over into new contracts, 'delivery' will be in currency not physical. This dollar/gold derivative trade is part of Bernanke's money laundering racket. The gold itself is meaningless, what matters is margin being converted to cash. It's a big reason gold prices have risen against the dollar, ditto stocks and bonds against the dollar. Don't fight the (crooked) Fed!

When the market turns and holders want to or have to sell to meet margin, there will only be one buyer ... Goldman- Sachs! Sorry 'bout your gold trade, bud! See Hunt brothers' silver corner for more info.

It is likely the Saudis and other Middle Eastern purchasers are behind the recent strong rise in gold prices. The Saudis have long bought physical gold. Since the Saudis have indicated they will hold crude oil prices below $85 they may be buying gold as they sell oil, transferring increases in the oil price above $80 to the metal. In other words, the dollar- debasement trade is shifted from dollar/oil to dollar/gold by arbitrage.

The outcome of this trade is to make the dollar a very hard 'petro- dollar'. Welcome to an extremely deflationary macro currency regime, gold bugs! You are getting right now all that you wish for! I hope you like the outcome, which will leave solid middle- class citizens and their families begging and camping out in cardboard boxes.

The Saudis flip Bernanke the bird; Saudia, not China, has the US economy by the balls.

I suspect this dollar hardening against oil is behind the rise in its value against other currencies. Keep in mind, a hard dollar still allows for a very high real price for oil; there is no escape from that! The hard dollar is starting the next deleveraging leg, which has been postponed since March by Bernanke's talking down (shitting all over) the dollar and pumping gold. That's right, the Fed has been boosting gold for its own reasons.

Saudi oil minister Ali al Naimi's intent to prevent a crash caused by oil prices rising to $100/barrel is instead causing a crash resulting from a very hard dollar. Welcome to the ironic universe, where all possible policy approaches have the same outcome.

(Except for one approach, which would work, guaranteed, but I won't go into it here ... :)

When the short- dollar trade unwind gains momentum it will be very hard for traders to exit their positions. I suspect the smart money is already on the sidelines. It would be smart to close short- dollar trades now. Consider that a market call. That includes gold.

Remember, there is no hedge against deflation ... zero hedge! Good luck!

[Anonymous]

Hi,

I will give only one criticism. I am not worried about margin call. I buy gold for cash without any leverage. I do not think I am alone. I do not buy to make quick bucks, I buy to protect my wealth from property tax, inflation tax, ... .

What if they are running out of physical gold/silver to cover the future contracts? GoldMan Sachs will have super squeeze on gold, like hedge funds on VW. I will only sell when I see the price of gold going nuts which is far away from it yet. I just keep buying, more every time it fells. I guess I have my own put slightly above the Chinese put ;). I prefer gold/silver based currency so at least by buying gold/silver I can vote with my money for this type of currency solution.

We will see who is right in less than few years.

best,
Radek

[Crime of the Century]

So sit in cash with Steve from Virginia and Karl from Florida. Not that it wasn't a well articulated piece, but I disagree. He couldn't help but throw a couple strawmen in there, tinder should the paper ignite on him. Remember, Exter's Pyramid says much for cash - until it doesn't.

[Rusty_Shackleford]

A store of value that can be infinitely expanded at no cost, is a contradiction in terms.

[Instant Karma]

Exactly. Price of a loaf of bread in 1909? About 25 cents. Price of loaf of bread in 2009? About $2.50. Loss of buying power? About 90%. Price of gold in 1909? About $20 per ounce. Price of gold in 2009? About $1000 per ounce.

Number of stocks from 1909 that exist today? Not many.

Price of picture of Obama getting into a limo in Copenhagen during a blizzard to pontificate about global warming? Priceless.

[gookempucky]

Funny stuff 901

Nice piece Econo really nice.

[Anonymous]

Balanced, we need more of this type of writing here on ZH

[Instant Karma]

Pardon my bluntness, but I own gold for the first time in my life for 2 reasons. First, I now have some money. Two, although I believe that the financial markets can be manipulated and are, I have no faith in the paper these governments print to facilitate commerce.

I'll take commodities, gold among them.

[delacroix]

not all paper assets will go down in value. toilet paper, will be a sought after commodity

[Anton LaVey]

In other words, you are long toilet paper? Interesting.

If the worst happens, and the USA and other countries go into hyperinflation, Zimbabwe-style, your currency will be your toilet paper. No need to buy rolls of Lotus triple-ply... <grin>

[Anonymous]

Writing that is a treat to read. Thank you.

[Al Gorerhythm]

Roubini needs to look up the definition of the term "intrinsic" before using it to beat up on gold. Nouriel, it is defined as: belong to a thing by its very nature. In gold's instance, its properties of durability, fungibility, rarity, purity, and malleability, speak volumes compared to your diatribe about the shit paper you store for safekeeping.

[Anonymous]

Four economists are sitting outside a brothel in a foreign land, discussing next steps.

The first economist, a student of the Great Depression, says "I have only six hundred US dollars, enough to buy the required condom, but I really don't need a balloon."

The second economist, a Nobel peace prize winner says he's not sure if his coinage is money and since the services offered inside may not contribute to the GDP, he will just have to go home and sleep on it.

The third, a goldman economist, peeks inside and sees ten working professionals. He thinks to himself, if I going to do God's work, I'll need a loan from the government.

The last, a playboy economist says I have twelve gold eagles, guess I am screwed and can't go inside. He mumbles to himself, "I shouldn't have ate the spam."

[Anonymous]

"Everyone, Austrian, Keynesian, Monetarist, and Marxist knows what causes hyperinflation and no one will let it happen."

Wahahhahahaha. As if they can exert control to stop it from happening. Like a drunk, dissipate, spendthrift run through an inheritance and has IOUed and check-kited himself into REAL debt.

Hyperinflation is the weak way out. It is now the only way out.

T. Sec. Mellon said liquidate them all. We will live through this, we will mend, free market rules apply. Tomorrow will be another day.

T. Sec. Bernanke says by his actions. We must suspend free market rules. WE cannot liquidate. We must extend, pretend, countenance fraud. IF we open a true accounting, we will die an ignominious death and never see another day.

Print we will. Print we must. We have no other device to resuscitate our strength other than the falsehood of a printing press. We have outspent and exhausted our strength with metaphorical whores.

We can no longer join the company of gentlemen or even good men. We are beggars and incontinents, from the sins of our fathers and greater sins of our own.

[BRAVO 7]

 CORRECT, LIQUIDATE EM ALL, LET GOD SORT EM OUT. THE HAND WRITING IS ON THE WALL, THE PARTY IS  OVER.

[Econophile]

LOL.

[celticgold]

well thought out, well put and well .. great!

[Anonymous]

Great post! I personally think Obama is do a single term and live a long, happy, unproductive life, far from Washington. Just like Carter.

[Anonymous]

The "noble metal" is actually Platinum.

[Econophile]

Actually, it is "a" noble metal. http://en.wikipedia.org/wiki/Noble_metals

[DoChenRollingBearing]

I'll buy all of the below, already have and will continue to:

Au

Ag

Pt

I am looking for a way to get into the "hot" rare-earth metals sector (the miners maybe, or even the metals themselves).  The rare-earths are used in magnets, color phosphors (computer screens), batteries, military applications, etc.  Very interesting sector but may be "too hot" as those mining stocks have run up a LOT.