"Gold Is A 6,000 Year Old Bubble" - Citi's Dutch Strategist Throws Up All Over Gold, Days After Dutch Gold Repatriation

Citigroup may have been unable to prevent the Netherlands from repatriating some 122 tons of "a fiat commodity currency with insignificant intrinsic value", or in the words of Ben Bernanke, "tradition", but it sure won't stop that erudite expert on the timing of Greece's exit from the Eurozone, Willem Buiter, from doing all in his power to throw up all over the "fiat currency" known as gold. So with Buiter no longer predicting with certainly just which month in 2010, 2011, 2012 Grexit will take place, here are his bullet points that make readers scratch their heads in wonder:

  • Gold is a fiat commodity currency (with insignificant intrinsic value).
  • Bitcoin is a fiat virtual peer-to-peer currency (without intrinsic value).
  • Gold and Bitcoin are costly to produce and store.
  • Gold as an asset is equivalent to shiny Bitcoin.
  • Central bank fiat paper currency and fiat electronic currency are socially superior to gold and Bitcoin as currencies and assets.
  • There is no economic or financial case for a central bank to hold any single commodity, even if this commodity had intrinsic value.
  • Forbidding a central bank from ever selling any gold it owns reduces the value of those gold holdings to zero

Scratching... because some may ask if gold is indeed such a worthless insignificant "fiat currency" (don't ask), then why just two months ago, did Citibank rush to be "reclassified as a spot Market Making Member of the London Bullion Market Association with effect from today, 25th September, 2014... In order to qualify as a LBMA Market Maker, a company must offer two-way quotations in both gold and silver to the other Market Makers throughout the London business day." Could it be that gold actually has some value to Citi, if nothing else than pocketing commissions from traders, now that the bank's rigging of everything from Libor, to FX to, drumroll, gold, is no longer possible?

Here are some of the more amusing punchlines from Citi in its blitz-propaganda campaign aimed at the undecideds in the Swiss gold referendum:

On November 30th, 2014, the Swiss will vote in a referendum on a popular initiative 'Save our Swiss gold' (henceforth the Gold Initiative). If the Gold Initiative passes three consequences follow: (1) the Swiss National Bank (the SNB) must hold 20% of its assets as gold, (2) the SNB has to repatriate the 30% of its official gold stock that is now held abroad by the Bank of England and Bank of Canada and has to physically hold all its gold in Switzerland, and (3) the SNB may never sell any gold again.


Figure 1 shows the total assets of the SNB, its gold reserves and its other foreign exchange reserves, the sum of foreign currency investments, the reserve position with the IMF and international payment instruments. There is a break in the series for the value of the gold holdings and for total assets: as of 2000, gold holdings have been priced at market value. Until 1999, they were valued at the official parity price of CHF 4,596 per kilogram.



As can be seen from Figure 1, the balance sheet of the SNB has exploded in size since it began to lean against the appreciation of the Swiss Franc by active foreign exchange interventions early in 2009. Its balance sheet at the end of September 2014 stood at 522 bn Swiss Francs, about 83% of annual GDP. On that same date, the value of its gold reserves was about 39 bn Swiss Francs, about 7.5% of the value of its total assets. That represented 1,040 metric tonnes of gold, almost 129 grams (4.5 oz.) per capita. In 2000, the SNB held 2,500 tonnes of gold and it has also been the biggest national seller since.


If the gold initiative passes, the SNB would have to purchase at least 1,733 metric tonnes of gold to meet the 20% threshold by 2019 (based on end-of September 2014 SNB balance sheet size and gold price). The world’s annual production of gold is around 2,500 metric tons.


The price of gold, like that of any asset price, is volatile. In nominal terms it has increased spectacularly over the more than 200-year period shown in Figure 2, and especially since the end of the gold peg of the US dollar in 1971. In real terms, the increase has been somewhat less spectacular, from $10.08 in 1971 (measured in 1913 dollars) to $59.89 in 2013. The real price of gold hit $73.60 in 1980 and $73.30 in 2012, underlining the volatility of the (real) gold price. Someone who invested in gold in 1971 and held onto it for 42 years, that is, till 2013, would have achieved an annual real rate of return of 4.3 percent - reasonable given the riskiness of the asset.



Item (2) on the Gold Initiative ballot makes little sense to us. Holding all one’s physical assets in one nation means ignoring the benefits of geographic diversification of ‘custodial risk’. Item (3) is quite extraordinary because it would make the SNB’s gold holdings worthless. Making it illegal to ever sell any of the gold the central bank has now or acquires in the future and enforcing this gold sale ban effectively would make the gold useless as an international reserve. The gold stock can never be used for foreign exchange market interventions and it cannot be used as collateral. The gold becomes useless as a store of value of any kind. The gold has no consumption value to the central bank. Its value is therefore zero.

Apparently the Russian, the Germans and the Dutch never got this particular memo. Ukraine however sure did...

Yet in an attempt to at least appear somewhat objective, Buiter devotes a few hundreds words to what he views is "The good news for gold bugs":

Since gold is a fiat commodity currency, its value will be determined largely by its attractiveness relative to other fiat currencies – the fiat paper currencies issued by central banks. Gold should not be analyzed as one of a set of intrinsically valuable commodities (silver, iron, lead, zinc, platinum, aluminum, titanium etc. etc.) but as part of a set of intrinsically useless and valueless fiat currencies – the US dollar, the yen, the Yuan, the euro, sterling, the rupee, the rouble, Bitcoin etc. etc.). It is therefore in times that market participants are nervous about the future value of most other fiat currencies that gold will be most attractive. 


Such a time is what we are going through now. Many systemically important central banks have expanded their base money stocks and balance sheets massively. The Fed has quadrupled the size of its balance sheet. The Bank of England has more than tripled the size of its balance sheet. Many central banks have bought vast amounts of public debt. In the UK, out of the initial £375 bn of quantitative easing, almost everything was spent on gilts. Over the past two years, the Fed added $1.7 trillion to its balance sheet (which is around $4.5 trillion as of end-October 2014) through large-scale asset purchases involving Treasuries and Agency MBS.


Although in most of the developed world low-flation or even deflation is the immediate threat, there is a medium and long-term threat of much higher inflation in all countries with enlarged central bank balance sheets and the prospect of large future fiscal deficits. The great advantage to investors of gold is that, although it is not intrinsically valuable, it is very costly to increase its stock. The tap can be opened at the drop of a hat for fiat paper and electronic currency. The tap produces never more than a trickle in the case of gold.


So when fiscal profligacy threatens price stability in some of the main industrial countries (especially the US and the UK) because the central banks in these countries may be forced to monetize both the stock and large new net flows of public debt, the one fiat money whose quantity cannot be varied at will by a monetary authority will do well. We see that with gold  today. We also see that, to a lesser degree, in the strength of the euro. The ECB is by far the most independent of the leading central banks. It also has a heavily asymmetric de-facto interpretation of price stability: inflation is unacceptable, deflation is OK.


So until the risk of serious inflation is removed from the medium-term outlook for the US, the UK and other fiat currencies, gold could be a relatively attractive store of value despite the cost of storing it.


This argument, however, assumes that if paper or electronic fiat money loses its value, gold will keep its value. That is an assumption and, as I shall argue in what follows, most likely an unwarranted assumption.

That's the good news to "gold bugs." And now comes the propaganda.

An economy with fiat money can have many different equilibria. To make the point as clearly and simply as possible, consider a stationary economy. Population, endowments, technology, government spending, taxes and preferences are all constant. The government budget is balanced. Prices are flexible. There is a constant stock of fiat money (which could be paper money, gold, Rai, pet rocks, or Bitcoin). This fiat money is perfectly durable and therefore can serve as a store of value. It pays no interest. Because this fiat money exists and is  durable, it can, in principle, be a store of value – an asset. It is may help, but is not necessary for the argument that follows to assume that, should this fiat money have positive value, society has (informally/spontaneously/collectively) decided to use it as a medium of exchange or as means of payment. It could even be legal tender.


With a bit of further work, it can be shown that such an economy will have an equilibrium with a positive, constant price of money (a constant general price level). Economists call this the fundamental equilibrium. This stationary economy will, however, also have many other (in fact infinitely many other) non-stationary equilibria, called (speculative) bubbles. They always have equilibria in which the value of money starts at a positive value but falls steadily towards zero – the general price level rises without bound even though the quantity of money is constant. The holders of money anticipate the future inflation and thereby reduce the real stock of money balances they want to hold. This further increases the actual and expected rate of inflation, and the real stock of money balances goes to zero: the general price level goes to infinity or the price of money goes to zero. In other words, the economy becomes Zimbabwe.


What is often ignored is that this economy has an equilibrium that is even more ‘fundamental’ than the ‘fundamental’ equilibrium with a constant positive value of money. That is the equilibrium in which the price of money is zero in every period, not just in the long run (as with the speculative inflationary bubble equilibria). Remember, fiat money, including gold or Bitcoin, is intrinsically useless. It has value only because people believe it to have value. If everyone expects that money will have no value in the next period, it will have no value this period, because no-one will be willing to take receipt of money to carry it into the next period where it will be valueless. So fiat money with a zero value is always an (unfortunate) fundamental equilibrium.


I would actually call it the only fundamental equilibrium. All other equilibria with a positive price of money – an asset with no intrinsic value – are benign (relatively speaking) bubbles. The constant price of money (constant general price level) equilibrium is also a bubble, based entirely on belief and trust – a beneficial bootstrap equilibrium, lifting itself by its hair, like the Baron von Münchhausen. In a world with multiple fiat moneys, the zero value of money equilibrium lurks for each of the fiat currencies, including gold and Bitcoin. In a classic paper, Kareken and Wallace (1984) have shown that even in the other (nice) fundamental equilibrium, in which each of these fiat currencies has a constant positive value, those constant  positive values can be anything – there is exchange rate indeterminacy between the various fiat currencies. This holds for paper or electronic fiat money, gold and Bitcoin.


So if gold has positive, albeit wildly fluctuating value, it is because we are in a benign bubble for gold. Likewise, Bitcoin’s positive value represents a benign Bitcoin bubble. The gold bubble is, of course, pretty impressive. Intrinsically useless gold has positive value. It has had positive value for nigh-on 6,000 years. That must make it the longest-lasting bubble in human history.

Yup, Citi just called gold a 6,000 year old bubble: just call it "tradition."

Is there a possibility that, out of the blue, the market could produce a zero value for central bank-issued fiat paper and electronic money (base money)? Yes, if the prices of goods and services in terms of base money are freely flexible. Fortunately they are not. The world is Keynesian. Nobody understands the mysteries of the unit of account or numéraire, but for some reason in most societies and most of the time, central-bank issued fiat money or base money has been the unit of account for most contracts, and prices of goods and services in terms of this numéraire, are sticky - empirically and for reasons we don’t understand, but they undoubtedly involve limited computational capacity and other manifestations of bounded rationality. Nominal wage and price rigidities therefore rule out the zero price of base money equilibrium (notwithstanding the fundamental equilibrium at the end of a hyperinflation).

He's right: the world is Keynesian. That explains why never in the history of mankind have all central banks had to coordinate all their efforts to inject trillions of liquidity in the system to keep it from collapsing on itself, and provide the required credit money for a world in which growth is only possible as long as inside or outside money is created de novo out of thin air. It also explains, why over the past decade, western finance has gone from bubble to burst to bigger buggle, to more explosive burst... until we now find ourselves in the ultimate bubble - one where all central banks have bet all in on inflating away a global debt load which guarantees the world a slow, miserable, deflationary collapse - in the words of Albert Edwards, an Ice Age - unless there is a dramatic surge in inflation (see: Japan). Perhaps as the only natural offset to this sheer Keynesian lunacy, gold's "6000 year old bubble" nature does not seem all that shocking after all...

But other asset prices are not sticky in terms of the numéraire. There exists therefore an equilibrium in which the price of all other fiat moneys (including Bitcoin and gold) in terms of base money is zero. We are obviously not in an equilibrium in which the prices of gold and Bitcoin at zero. Does that mean that in the future also the value of gold and of Bitcoin will be (relatively stable) even if the central bank were to start running the printing presses at full speed, producing a hyperinflation in terms of base money prices? Not necessarily. Assume the initial prices of both gold and Bitcoin in terms of base money are positive and that the value of base money in terms of goods and services is positive. Once gold and Bitcoin have positive value in terms of base money today, their future value is determined by no-arbitrage relationships between these three fiat moneys – all of which don’t have any intrinsic value as consumer goods, intermediate goods or capital goods. No arbitrage means the absence of risk-free pure profits from buying and selling these three stores of value against each other. Since neither currency nor gold nor Bitcoin is interest-bearing, the exchange rate between currency, gold and Bitcoin should be expected to be constant over time. Any change in the currency price of Bitcoin and gold is therefore unanticipated. There must have been a lot of major  surprises! The fact that the stocks of Gold and Bitcoin are finite does therefore not suffice to keep them safe from hyperinflationary base money issuance by the central bank.

In other words, even if, and Buiter is quite close to suggesting that is the endgame here, there is hyperinflation at the end, even then gold may well be worthless. So... can we just use LBMA market maker Citigroup to sell it to Citigroup's prop desk?

And now, the punchline. Here is Buiter's conclusion:

I don’t want to argue with a 6,000-year old bubble. There have been hyperinflations with the value of central bank base money going to zero, but the price of gold has not followed that of paper money. Perhaps that was because, at the time, gold still  had some intrinsic value as a productive input, even today retains intrinsic value as a consumer good. Even if we view gold as an intrinsically valued commodity, it would still be unsound to invest 20% of the central bank’s balance sheet in a single commodity. If the central bank is to invest in commodities, better to have abalanced portfolio of commodities or, more conveniently, a balanced portfolio of commodity ETFs or other derivatives.


Requiring a central bank to put 20 percent of its balance sheet in any single commodity, even if that commodity had meaningful intrinsic value, represents a highly unorthodox and risky investment strategy, in our view, regardless of whether one judges it by its likely future profitability or by its wider social benefits. We conjecture that the SNB is most concerned that the Gold Initiative might pass.


Even though I view gold as a pure bubble, that bubble may well be good for another 6,000 years. Its value may go from $1,200 per fine ounce to $1,500 or $5,000 for all I know. Investing a vast amount of money in something whose value is based on nothing more than a set of self-confirming beliefs will make for an exciting ride. Whether that is enough to impose it as a requirement on one’s central bank is another matter.

Dear Willem, thank you for that valiant effort.After reading a few thousands words of empty propaganda we understand your "confusion": our advice, if you want to understand what gold really is, read the following from Kyle Bass:

"Buying gold is just buying a put against the idiocy of the political cycle. It's That Simple"

Because if there is a bubble that is even bigger and longer than the "6000-year-old gold bubble" it is that of human corruption, greed, and idiocy. And that doesn't even include the stupidity of those who don't grasp this simple truth.

As for gold being a nearly worthless fiat currency, if you can perhaps first convince your homeland to return those 122 tons of gold it just repatriated in secret from the NY Fed in direct refuation of, well, everything you just said before you go ahead advising foreign nations what they should do, well that would be just swell.

Finally, we are confident that upon reading the above JPMorgan will promptly recant and admit that what he really meant was "gold is a 6,000 year old bubble and nothing else"...