Monday, April 10, 2006

Gold Price Has 'Em Talkin'

We're beginning to see all kinds of punditry around gold's performance. I'll take this one from Reuters and give an improvisational spin.

"So far, major inflation indexes appear sufficiently contained to suggest the U.S. central bank is edging closer to a pause in its monetary-tightening cycle. Yet the surge in the price of gold and other precious metals is prompting some to question that conventional wisdom, fueling worries the Fed may be behind the curve in its fight against inflation." Not only is the Fed behind the curve, it is the cause of the curve. Contrary to conventional wisdom, it is the earlier Fed loosening of money that has caused this bubble mentality around the world and that will soon rob the little guy of even more of his purchasing power unless he's got gold. Furthermore, I will wager that it doesn't matter what the Fed decides to do, the dollar must pay the Piper sooner or later, and gold will be the eventual winner. Gold's value may be "making a come-back," but it's role as Piper-To-Be-Paid is as old as Herod. We can of course expect the gold price to over-blow and then settle back down -- i.e. perform like a bubble -- although I'm betting this time it'll keep a lot of its "newfound" value, i.e. the dollar will finally reveal its "not-so-newfound" loss of integrity.

"For a long time, a direct correlation existed between yields on longer Treasury debt maturities and gold -- both are safe havens when times get turbulent, both are good places to hide when the economy heads south." I guess I'm too young (58) to have learned that direct correlation. Bonds would be the last thing I would buy in times like these.

" 'The problem with the logic of using the price of gold as a leading indicator of inflation is that it is subject to a variety of influences that have at best a tenuous relationship with U.S. inflation,' warns Lakshman Achuthan, Managing Director at the Economic Cycle Research Institute, an independent research group. 'This includes the policies of the world's central banks with regard to the sales of their gold holdings, the hedging policies of gold producers, and the demand for gold jewelry around the world.' " I guess Mr. Achuthan is right about the speculative nature of today's price of good and the difficulty of trying to use that price as a standard regarding monetary policy...

[Click on image for a larger view.]

[Thanks to Peter Nicholson for this cartoon.]

It's true that, as a Federal Reserve statistical tool, today's gold is a pretty poor rung on which to step -- unless of course you actually reinstate the gold standard... Ahem... which, you respond, will happen when hell freezes over and it's not about to, what with Global Warming and all; to which I answer, "Or is it? If the statisticians are so wrong about GW, maybe they're wrong about the gold standard as well..."

As I keep repeating, you can take the gold out of the standard, but you can't take the standard out of gold.

Read the whole Reuters article.


Anonymous Nelson said...

What's so special about gold anyway? Why should I care more about gold than a piece of paper? If I take a gold bar to McDonnald's, they won't give me a burger for it. But if I take a dollar or two, mere pieces of paper, they will give me a burger in exchange.

12:55 PM  
Blogger Katy said...

Nelson, I'm glad you asked.

You are correct, gold will probably not buy you anything at McDonald's, at least not at the moment. However, gold has played an important role in history because, in the past, paper money has always lost all of its value over time if it was not standardized in relation to a certain weight of gold. That's just a historical fact. And unfortunately, since the last century, paper money no longer is standardized in this way. As a result, your hamburger dollars are buying less and less meat and bread and everything else at the rate of about 3-5% annually, even though you don't notice it because it's so gradual. You can read more about this in my earliest posts from last year, if you are interested. Also, Nelson, you should know that gold has been the only money (yes, coins used to be made of gold) that has preserved its value over time.

Good reading,

2:18 PM  
Anonymous Nelson said...

I still don't understand the obsession with gold. It is no less logical to put one's faith in paper than it is to put it in a mineral. What's important about money is what it represents, not the substance of its currency.

If you're worried about inflation, and you think gold is the answer, there is nothing stopping you from converting your dollars into gold on the open market.

Maybe you know something the rest of us don't. That is one advantage of a free market capitalist society. If you are correct when others aren't, you can profit from it.

7:39 AM  
Blogger Katy said...


I have no argument with anything you say, but if you're interested, I'll just offer a few clarifications.

1. I wouldn't call it an obsession with gold so much as a judgment call on my part that our paper dollars have not been worth what the printer says and what the national and international public believes.

2. It is indeed logical to put one's faith in paper (i.e. in a promise to pay), but only under the condition that the promise is upheld. The faith we have in our paper money's purchasing power is all we have to go by, because there is no more gold-backing clause behind it. (There used to be one.) I believe that, up until a few months ago and perhaps into the future (I don't have a crystal ball), our paper dollars have been overvalued relative to gold. Only the market tells us what people believe the dollar's gold value truly should be. We shall see what we shall see.

3. As to those like myself who are worried about inflation and who believe gold is "the answer," not only is there nothing stopping us "from converting our dollars into gold on the open market" but I would guess from recent events that millions of ordinary savers and professional investors have done just that, because within the last five years, gold has risen from around $260 to $600 today. In other words, the dollar price of gold has increased about 20% a year.

4. I don't know anything more than the rest of you. I'm just like everyone else. For example, I don't know where gold will go from here. There are many factors that determine the day-to-day price. I try to concentrate on the long-term trend.

4:17 PM  
Anonymous Nelson said...

Thanks for your response!

As for gold, I have always wondered why it had so much value historically. It just seems weird that a simple mineral could hold so much power over so many people.

And as for the stability of our money, I think the problem of inflation stems more from congressional spending than any other source. It's just insane how much our government borrows and spends. Even if our dollars were backed by gold in theory, Congress could (unwise as it may be) sever that link arbitrarily, so even that is not a guarantee.

6:44 PM  
Blogger Katy said...


I like your open enthusiasm.

Gold is very unusual. It has value because of many factors. Here are a few:

- beauty, as in jewelry or adornment
- chemical stability
- uniqueness, i.e. you can't cook it up in a laboratory
- inoxidibility, it doesn't rust or alter
- maleability, you can pound it, cut it, shape it, even into very fine leaves thinner than paper
- portability
- rarity, you can't just pick it up off the street

In other words, it's just the perfect object for the historical roles it has played in human history. I believe you cannot erase thousands of years of market experience by the stroke of a politician's pen. You'll find a lot about all of this in my earliest posts, especially the ones I labeled as Economics Lessons (a little pompous of me, I know.)

As to congressional spending, aside from it being disgraceful, it does contribute to inflation, and they have an accomplice, the Federal Reserve Board. The Fed, as it's called, buys treasury bonds in a way that pumps dollars into the system, side-stepping the tried-and-true banking procedures of the past. However, the Fed is not the only entity buying those bonds. Many foreign governments, individuals and other investors buy them as well, which has the effect of saying to Congress, "Okay, we trust you, here's some money, go ahead and spend more than you have on hand. And you don't even have to pay us anything in interest." (They were not even getting the inflation rate up until a year or so ago.)

You say that if dollars were backed by gold, Congress could still sever that link. That is exactly what they did back in 1974, before which there was a link. I believe we are now seeing the results of that folly. Of course, only time will tell who is right: they or I.

7:12 PM  

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