Thursday, January 03, 2008

Gold: Not Such a Barbarous Relic After All

Anyone who has read my posts for a while knows what I think about gold, for example here, here, and here for the three most recent examples.

[Thanks to for the snapshot of gold's rise to $868 today. Click on the image for a larger version.]

I guess I'll once again give you my mantra, because it always bears repeating:

You can take the gold out of the standard, but you can't take the standard out of gold.

For the uninitiated, let me explain. For several centuries, your money was closely linked to gold, and governments helped to maintain its exchange value. Today, this is no longer the case, and your dollars and your pounds and your euros, yen, or whatever, are floating on an international exchange market with nothing to tie them to anything of value except market competition.

As an aside, economic theory states that markets should be free to determine the value of things; but economists make a huge mistake when they proclaim that money is such a thing, a commodity that will be controlled by a market.

Money is not a thing of relative value. It is an intangible, a kind of contract, a promise to pay; and a promise to pay is no longer a promise if its value is allowed to fluctuate or fade away. It's the equivalent of saying that the length of an inch is determined by the market. This is nonsense. But I digress; I will discuss this idea in some other post.

Today, I'm watching the Kitco gold price reach, maintain and beat its last all-time nominal record of $850. As I do so, I can't help but remember Keynes's famous quip about the gold standard being a "barbarous relic." I looked up the exact phrase in a search engine, and I fell upon this great piece by James Turk. It's about the role of gold, the "relic" quip, and the future of the dollar.

Turk makes one of the best cases I've ever seen for allowing gold back into some role as currency, if only as a parallel means of exchange to the fiat ones we have at our disposal presently.

He worries me, however.

His ideas are right on. He points out that it was the gold standard, and not gold itself, that was the true object of Keynes's scorn; and he correctly blames the central banks of the world for our current financial turmoil, because of their --most hypocritical-- intervention in the money markets in a futile effort to control prices and the economy.

The fact that they cannot succeed at this mission, for reasons I have mentioned here, seems not to concern them; nor does their role in assuring that the dollar will follow all its fiat predecessors down the drain of monetary history. Perhaps they console themselves with the idea that the dollar will not be alone.

But Turk worries me not because I think he's wrong; he worries me because I think he's right, and because his wonderful idea of using gold as a means of exchange and as currency (i.e. as legal tender, although he seems to be carefully avoiding that expression), could get him into trouble. Why? Because he is striking too close to home: He is jeopardizing the very existence of the central banks.

Merely reinstating gold as legal tender (see his website) would go a very long way to solve many of the monetary problems we have run into of late--things like the current account deficit, the government's own budget deficit, and the waste and damages incurred by currency and asset price speculation of the kind that got us into the housing and credit market messes.

Personally I think simply allowing gold use as payment of debts public and private would demonstrate to an important minority of the world's population (i.e. the balance-of-power minority) that gold works better than paper money, and after an initial adjustment period, it might even displace our fiat currencies.

But it would also make clear to everyone just how much governments and speculators profit from the fiat currency machine, and governments don't like to be caught doing that. Look what happened to Bernard von NotHaus and his Liberty Dollar?

Mr. Turk, keep your eyes and ears open for the guys and gals in those somber jackets with the lettering on the back. The central establishment is not going to like you if it turns out your predictions about the dollar are correct.

As to where gold is headed, we must look at the inflation-adjusted charts for the real gold price over the years. In 1980, gold hit $850. In today's dollars that is something like $2,100. (See the chart here, and another one here.)

We are nowhere near the 1980 gold peak (or the dollar trough, if you prefer), because back then the 1970s inflationary crisis and abandonment of the gold standard had an explosive effect on the speculative price of the metal (and/or on the speculative loss of value of the then dollar).

What we might call the "real price of gold" (i.e. the real gold value of the dollar), once all is said and done, will probably be, grosso modo, (1) something between $600 and $1,000, assuming the dollar retains its reserve currency status. This, however, is becoming less and less of a sure thing.

If the dollar loses that status, then (2) the real value of the dollar will likely be somewhere between $1,500 and $3,000 an ounce of gold, at present gold supplies. (For an explanation of these figures, see the fascinating booklet entitled "Prospects for a Resumption of the Gold Standard," a collection of essays from a conference at the American Institute for Economic Research in 2004.)

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