Gold is hotter than ever.  You can’t turn on the TV these days without seeing a gold commercial.   Several well known hedge fund managers have leveraged up positions in gold while John Paulson even went so far as to start his own gold hedge fund.  As an asset class gold has outperformed just about everything over the last 10 year period.  It’s been an impressive run.   But is it all justified?  Bear with me for a bit while I take a long-term macro look at gold as an asset class….

After having experienced deflation through much of 2008 and the beginning of 2009 the economy began to reflate as the government eased monetary and fiscal policy.  Asset prices began to stabilize and bank balance sheets were suddenly flush with cash as the government provided stimulus.  The inflationistas immediately began crying wolf.  All of this extra cash was certain to cause inflation.  And that meant one thing: buy gold and short dollars.  Right?

All was not what it seemed, however.  Underneath the surface, there was no real reflation – only continuing signs of deflation or at best, benign inflation.  Asset prices surged as money flowed out of low risk assets (for which investors were no longer rewarded) and into high risk assets.  But there was a continuing problem lurking beneath the surface – debt de-leveraging.  While asset prices have improved the liability side of the ledger remains in tatters in the U.S. economy and around the world.  De-leveraging continues and demand for more credit remains subdued.  Yet, the price of gold rallied.  I believe a large portion of the move is based on the misconception of gold as an asset class.

When analyzing the price of gold it’s important to understand that gold prices do not move like most other commodities.   It has certain built-in unquantifiable characteristics that drive price.  The price of gold is actually a function of four things: 1) its replacement potential for the U.S. dollar; 2) the future rate of inflation, 3) Sentiment – generally fear based and 4) true supply and demand.  Let’s take a look at each.

Nouriel Roubini recently quoted Keynes in describing the gold standard as a “barbarous relic”.   Ignoring the fact that the gold standard has failed repeatedly, there is still a hefty premium built into the price of gold because it is viewed as a currency – currently an alternative to the dollar.  It has served as a reliable currency for thousands of years and continues to be seen as an alternative to fiat currencies.  Going forward, I think this is a dying belief which has led to considerable confusion in the current economic environment.

The fact of the matter is, the fiat currency system is here to stay (or at least some form of it).  The odds of reverting back to a purely gold based system is next to zero in my opinion.  The truth is, the gold standard as a currency system is a barbarous relic.  It is a currency system that worked well in the old world economy, but simply does not have the flexibility to meet the demands of the growing global economy.   The global economy has become too complex and too intertwined to be constrained by the gold standard. The fiat currency system is a product of economic evolution and the growing demands and strains of international trade.  Famous examples of the break-down of the gold standard and its inflexibility to meet trade demands include the UK in 1931 and the U.S. government’s destruction of the gold linked currency system under the Bretton Woods agreement.

Gold investors generally make the false argument that the gold standard somehow stabilizes prices (as if the price of gold is stable) or will restrain governments from excess spending, but the truth is, under sound stewardship, the fiat currency system provides all the benefits of the gold standard and all the flexibility that the gold standard didn’t contribute.  In addition, the  gold standard had a tendency to cause severe strains on countries due to trade imbalances and the inability to provide flexibility to countries with trade deficits.  The argument that inflation, instability, corruption and mal-investment cannot occur under the gold standard is historically false.

If we were to alter our currency system it is most likely that we would move to a currency basket of some form, a global currency or move to a commodity basket – of which gold would likely be a component.  Realistically, however, the odds of moving back to the gold standard (or even a commodity basket) are next to nothing.  Nonetheless, gold investors remain hopeful of a currency collapse and a rewinding of our economic evolution.  Don’t count on it.  The current monetary system provides sovereign issuers of currency with enormous power over their currency and they are unlikely to relinquish this power into the hands of gold producers or an international currency (or bank) any time soon.

The popular idea of hyperinflation is one of the primary arguments in favor of gold. Of course, as we’ve already discussed, this is inherently flawed because the likelihood of reverting back to a gold based monetary system is virtually nil so anyone hiding gold bars under their bed is unlikely to find themselves trading them back and forth at the local Wal-Mart any time soon.   Regardless, speculation, corruption and mal-investment will occur in any currency system that allows such things to persist.  If these inefficiencies are allowed to persist they can lead to inflation and economic ruin.  The favorite arguments used by inflationistas are the Weimar Republic and Zimbabwe, however, any true historian understands that the United States is not even remotely comparable to these corrupt and inefficient economies.  The comparisons are completely illogical.  See here for more.  This is not to imply that inflation cannot occur in the modern currency system, but under sound stewardship the fiat currency system is no more potentially destructive than a gold standard (where sound stewardship remains a necessity).

Of course, there is nothing in a gold standard that keeps a country from becoming a poor steward of the currency. In fact, the restrictions of the gold standard have resulted in more government defaults than any flexible exchange rate fiat currency.  The argument that 99% of all fiat currencies have failed is simply an outright falsehood.   Fiat currencies restricted by the gold standard or pegged to another currency have failed repeatedly.  That is not the system in which we reside today.  It’s important to understand that the currency system in which we reside is vastly different from the pre-Nixon Shock currency system in which  currencies did not freely float and currencies were convertible.   As I described last week, a sovereign issuer of currency with no foreign denominated debt cannot go bankrupt in a floating exchange rate system unless it effectively decides to.   Inflation is another story altogether, but we’ll touch on this further.

The gold standard and single currency systems have all ended in demise for similar reasons. There are several flaws in single currency systems, however, two are most notable:

  • They are inflexible
  • They impose inherent constraints
  • They are susceptible to corruption

The inherent inflexibility and inherent weaknesses imposed on particular trade partners within the currency system is always apparent in single currency systems. As I’ve previously noted:

“the gold standard had a tendency to cause severe strains on countries due to trade imbalances and the inability to provide flexibility to countries with trade deficits.”

The move off the gold standard and convertible currency systems has generally been due to the inherent restraints imposed by such systems. For instance, trade deficit nations are at an inherent weakness when attempting to respond to recession because the trade imbalance results in rising unemployment and falling output and prices – an inherently deflationary environment. With your own currency this imbalance would naturally offset over time, but under a single currency system there is no opportunity for the floating exchange system to reach balance. This is just one very simple example of the types of inherent restrictions a single currency system imposes on a nation, but it’s particularly pertinent as we see this exact event unfolding in Greece – where the single currency system is destroying the country and handcuffing the government from properly defending their economy and thus providing for their citizens. Instead, they are risking default (a risk which does not exist within a sovereign issuing floating exchange system) and forcing their citizens into recession all so the surplus nation of Germany can enjoy price stability and continued high exports.  Such a system is wondrous during the boom, but it can be catastrophic during the bust.

The other critical flaw within the Euro system (and the gold standard) is a very human one and not necessarily unique to single currency systems.  In Europe, it is the unwillingness to accept political failure which ultimately results in a form of political corruption and manipulation in a misguided attempt to right previous wrongs.  In his “Money: Whence it came, where it went”, John K. Galbraith described this flaw:

“It had also a notable flaw. That was in asking, in an age of growing nationalism with a growing tendency to hold governments responsible for economic performance, that both nationalistic instinct and domestic economic management be subordinated to an impersonal, international mechanism, one capable of inflicting considerable hardship and distress. It was a flaw that supporters of gold did not accept. They saw any reluctance of governments as inhering in the lack of moral fibre of politicians – a lack that led them to try to ameliorate the strains that gold imposed. That the morality of politicians is difficult to alter in the short run was not recognized.”

When the world was constrained by the gold standard it very much resembled modern Europe.  It was a world of many countries with multiple governments, multiples, economies, differing needs and no monetary sovereignty.  What happens in such a world is that you experience severe trade strains.  With no floating exchange rate a government can do little to influence its trade balances.  What results is severe imbalances.  In the case of Europe, you have the periphery nations all suffering through high trade deficits.  The core nations are experiencing surpluses.  In order to offset the current account deficit the periphery nations were required to become high deficit spenders.  This is sustainable for so long. And the results are now clear.  The profligacy of the periphery has come back to haunt them as asset prices fall and economies contract.  With no floating exchange rate there is no way for these nations to combat this problem.  They must either suffer depression or hope that the core nations will bail them out.  That’s no way to live and any government that allows a nation to be involved in such a currency system should be truly ashamed of itself.  The same things used to occur under the gold standard.  But as the single currency imposed it natural strain on the world countries wised up and rejected it.

Most of the hyperinflationists or gold investors I know are worried that the Fed’s printing press (or button pressing if you will) will ultimately result in inflation.  This is not entirely correct.  As I have previously explained, when you pour an iced tea packet into a pitcher of water you don’t automatically get iced tea.  You have to stir it in.  Our banking system is much the same.  There is no demand for credit as of now and therefore there is no expansion in the amount of actual money in the system.   Because the private sector is busy repairing their balance sheets aggregate demand remains historically low.  Therefore, the hyperinflation argument remains bunk.  The latest readings on wage inflation, demand for credit, etc all point to continued de-leveraging and low demand for credit, and in our banking system that means inflation is not yet a concern.  For a more detailed explanation of the deflationary risks please see here.

In terms of sentiment there is an inherent premium built into gold because it is viewed as a safehaven currency.  This opinion is generally sold to the public by investors who genuinely believe the world is going to end or that the modern economic system will ultimately fail as the dollar crumbles.  These people genuinely believe that the entire global economy will collapse one day and we will all be sitting around trading our gold bars back and forth.  This is pure and simple fear mongering.  This is not to imply that the U.S. dollar can’t fail or that the fiat currency system will always exist in its current form, but the idea of reverting back to a time when we carry gold in our pockets in order to purchase goods is simply ludicrous.  “Barbarous” as some might call it.  The truth of the matter is that the fiat currency system is simply an evolutionary step in our economic progress.   Those who latch onto the days of the gold standard simply don’t understand how fiat currency works in the current floating exchange rate system.  If you want to believe the global economy will one day collapse that is just fine, but should that scenario actually pan out the last of your concerns will be which local market is accepting gold in exchange for food.  The man with the most lead will be the man with the most food in that scenario.

Where gold does contain real value is as an actual commodity.  I don’t believe that gold has no intrinsic value as many gold haters believe.  I believe it has intrinsic value in the same way that diamonds have intrinsic value.  I just don’t believe gold should have any intrinsic value as a currency.  None.  From a purely supply and demand perspective the gold market actually looks fairly constructive.  Nouriel Roubini pointed to several reasons why gold is not necessarily a bad investment:

“the global supply of gold—both existing and newly produced—is limited, and demand is rising faster than supply over the medium term. The recovery of the global economy has started a revival of retail gold demand especially in India. Central banks looking to diversify their portfolios account for further demand—see for instance, the recent increase in gold holdings by emerging market central banks. Most of the increase in demand comes from private investors using gold as a hedge against low probability tail risks of high inflation and another near depression caused by a double dip recession. Inflation risk and the risk of a double-dip are both low, suggesting lower gold prices, but increasingly investors want to hedge against such risks early on. And given the inelastic supply of gold, it only takes a small shift in the portfolios of central banks and private investors to boost increase the price of gold significantly.”

Passport Capital recently laid out the bull case as well:

  • Demand in India and China is surging and demographic and wealth trends should bolster prices.
  • Demand from central banks has undergone an important shift in recent years in response to the credit crisis.
  • Mined supply peaked in 2001.
  • The ability of above-ground gold stocks to satisfy demand is undergoing structural change, and markets may be overestimating their ability to satisfy an increase in demand at current prices.
The more destructive myth regarding gold is this idea that we should collect gold bars in bunkers as though they protect our wealth.  I should be clear that gold is most certainly money.  It is a viable and widely accepted medium of exchange, which, in my opinion, is enough to qualify it as “money”.  But while gold might be a form of money, it is not a superior form of wealth.  Real wealth is found in things that improve our living standards.  Productive assets, friendships, family, time, etc.  The man who collects $100,000 in gold bars in his basement is not better off than the man who invests that same $100,000 in a field of corn.  After 10 years, the man with gold bars might have $100,000 of metal in his basement (or he might have $0 worth of metal in his basement).  But the farmer will have produced a decade worth of food that will have fed his family and loved ones.  The idea that gold is an “investment” in its raw metal form is flawed.  It might serve as a hedge in the short-term and a good way to bet against political stupidity, but the long-term trends in human ingenuity are likely to prove gold an inferior bet when compared to productive assets.  This doesn’t mean it can’t protect against inflation due to perception, but I think it’s flawed to confuse this unproductive asset with a productive asset.

One might conclude that I think gold is a terrible investment after reading this.  That couldn’t be farther from the truth.  I simply believe gold is a misunderstood asset (particularly as an alternative to the dollar).  I know that the overwhelming majority of investors see value in gold and therefore it is ignorant to ignore its potential as an asset.  The modern fiat currency system is still largely misunderstood and very young.  It will take time for investors to learn to trust it and fully understand its benefits.

Of course, these misconceptions are likely to persist for years if not decades and ignoring the beliefs of a huge amount of the investment world is no different than the fundamental analyst who ignores the millions of chartists in the world.  The belief is there therefore the price action is there.  I believe there are good reasons to hold gold in ones portfolio, but those reasons should be purely based on the underlying laws of supply and demand at work as they pertain to gold’s value as a commodity.   The idea that we will one day revert back to the gold standard is simply not pragmatic in my opinion.   If I were a betting man (and I am) and if I had to bet my lead on it I would bet that the idea of gold as a currency will be almost entirely extinct in 500 years.   But that doesn’t necessarily mean the price of gold won’t be much much higher.

In conclusion, I continue to fail to grasp the rationale for gold as an “investment”.  While fear rules the day today, human ingenuity is likely to outperform unproductive assets over the long-term.   Additionally, with little to no inflation the inflation hedge argument remains bunk.   As for sentiment and the collapse of the modern economy, well, I don’t think gold will be the thing you really want to own in that world.  It is not gold we will all be clamoring for, but lead and God save you if you don’t have something to load that lead into because those gold bricks are mighty hard to throw at someone….The main takeaway from this discussion is that we should not seek to collect bars of metal in our basements.  We should seek to become more innovative, more virtuous and generally better.  And if you cannot achieve that on your own you should seek to invest in human ingenuity through the genius of others.  Collecting bars of metal is not the best way to achieve this….


Got a comment or question about this post? Feel free to use the Ask Cullen section, leave a comment in the forum or send me a message on Twitter.

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  1. I have wondered why those like Peter Schiff who believe we are on the road to hyperinflation tell their clients to buy gold as a hedge when they could just buy TIPS instead. TIPS bonds protect the investor from the possibility of losing their money if we suffer from another 1970s period of high inflation. Since TIPS weren’t created until 1997, bond investors in the 1970s and early 1980s had poor returns because all they had were fixed income bonds.

    Now, gold bugs might counter that the CPI (which is TIPS-linked) understates inflation and the government actively skews the data so as to underpay those holding TIPS. However, if that were the case, then TIPS would decline in price and their yields go up to adjust for that “miscalculation.” But, TIPS have been pretty steady and have shown no signs of eminent inflation.

  2. As we all know, in early 1970s Nixon finally abandoned the Gold Standard and M2 went nuts over the next 40 years as credit could grow only unconstrained by measures like bank capital requirments which were flawed and easily manipulated.

    Since then though, Gold has only outperformed M2 growth in the US, by a measly 25%. And that is coming from a time when Gold was artificially kept at 35$ between Central Banks but at times traded 30% higher in the public market as everyone knew 35$ was an artificial number that could not be backed up…

    Look at the alternative…yes cash provides interest which compounds etc, but if the supply of that cash is growing just as fast its real intrincic value is going nowhere.
    Gold, on the other hand provides no income, but the supply is relatively constant.
    One offsets the other…

    Forexample, 1$ invested in Gold in 1971 is worth about the same as 1$ put in Government bonds and re-investing the interest (the reality is that Gold has done better as tax on interest is higher than tax on capital gains etc)

    I guess my point is that, until Gold has materially outperformed the value of the Money supply or credit, its hard for me to see how its overvalued

    Further, people thought the EUR was a safe alternative to the US$ and now realise that it has its issues. Other currencies can only go so far before a Central Bank will intervene. Gold on the other hand wont bother anyone if it doubles overnight.

    Gold is still the purest currency of all and its value is not much different relative to the value of fiat money 40 years ago. Considering its advantages who would dare bet that it doesnt outperform materially like it did in the late 70s.
    $$, EUR, GBP…Gold has taken them all out…JPY, CHF, AUD are likely next as overvalued currencies will cause problems alot faster than overvalued Gold!

  3. I like your attempt to deconstruct the interest in gold.

    I happened to be looking yesterday at some old postings, and found one about parabolic dreams. There are a lot of those going around with gold these days, even though the parabolic phase, at least in the short term, appeared to peak late last year.

    As with your look at gold, the point of the posting is to that we need to dissect the components that contribute to price moves and to think about how real and lasting they might be. You’ve done a nice job of doing that.

  4. thanks for the article; I never posted here before, so here I am for the first time :)

    I’ll make 2 comments here

    1. the price of gold is based on many factors (more than the 4 you have there probably) but on this particular one : “the future rate of inflation”. I think is wrong: gold does poorly during mild inflation; gold does well when there is stress (credit problems building in the system since Greenspan started the bailout to stop the system correcting); stress is depression or hyperinflation. The fundamentals today behind gold IS deflation; because central bankers try to fight it by printing; if inflation shows up, gold might do poorly, because central bankers will try to reduce the amount of money out there.

    2. The biggest problem actually with the paper currency system is of a different nature than those you list: malinvestement, recessions, imbalances, etc. The problem with a fiat regime is a moral one: the flow of money; think about it…


  5. You assert. But you don’t show. When you find yourself writing lines like “the fact of the matter is” (when you should be explaining) and also when you assert alot of sweeping claims like “for many years to come” that should be a sign you are expressing beliefs and not really explaining.

    I’m sympathetic to a desire to unpack gold’s allure. But you have not really done that.

  6. “If I were a betting man (and I am) and if I had to bet my lead on it I would bet that the idea of gold as a currency will be almost entirely extinct in 500 years. But that doesn’t necessarily mean the price of gold won’t be much much higher.”

    TPC, those lines pretty much sum it up for me. I truly don’t give a damn whether it’s ever used again as actual money. Like you said, that doesn’t mean the price won’t be much higher. I view it as a “prosperity trade”. The world is getting richer all around us, and a lot of people like, enjoy, and want gold.

    And, it actually does provide massive protection against an, admittedly highly unlikely, hyperinflationary event. For that type of event you must be early. Once it is upon you it would be too late. You will already have to own what you want, because at that point, gold, like many things, would simply become “unbuyable”. Sometimes it’s just a “peace of mind” trade; sort of an insurance policy against political malfeasance and calamity.

  7. The US government doesn’t “fund” itself via the bond market. You’re thinking in a gold standard world. This is a HUGE misconception that is ENTIRELY false. China is not our banker. There has been a lot written about this lately. I am not sure how this misconception has persisted for so long….

  8. The truth is, in a floating exchange rate world, gold has no value as a currency. I am not making a claim. This is a fact.

  9. I’m all for peace of mind. I am not trying to trash gold. I am simply trying to explain some of the misconceptions regarding gold’s potential uses.

    In today’s world, it is not a currency and should not be viewed as a currency any moreso than the shirt on my back is a currency. That’s all I am trying to portray. The world changed a great deal with the Nixon Shock, but for some reason, the economic textbooks didn’t portray this. We continue to think we live in a gold standard monetary world. I hate it break this news, but that system ain’t coming back. Ever.

  10. Mans tendency to assume his very finite experience (ie a 30 to 50 year period) can be extrapolated to mean that his experience is a constant throughout time never ceases to amaze me.
    For several thousand years GOLD has been the standard that all peoples on the planet have accepted. ALL PEOPLES. This dynamic is very powerful.
    The experiment with Fiat currency has really only been going on for about 100 years.
    Gold is the norm, not paper money. Paper money was invented at first to make it easier to trade a “store of Value” so you wouldnt have to lug your gold all over the place. Humans only accepted paper as a store of value because it was backed by GOLD. I submit that paper never would have been accepted if it was not backed by GOLD.
    Currency is only accepted if we believe it is a STORE of VALUE. Inlfation only ocurrs to a geat degree if monetary powers go beyond their mandates and add more currency to the supply. Inflation is PROOF that paper currency has no real value.
    GOLD did not cause inflation in the past, it was the over expenditures of government breaking the standard that caused inflation.
    Many sheisters of the Universe have used the claim that things are “Way too complex” for something else to work. Thats what sellers of derivatives have said, sellers of CDS, CDO’s, mortage backed, portfolio insurance, hedging strategies, Madoff etc etc “Oh my system is way to complex for you to regulate me or even understand it.” That is always a defense that is used by arrogant, self important fools that dont truly understand that complicated is not necessarily better or even effective. The argument does not hold water because buying and selling goods is just not that complicated. You trade one store of value for another, period.

    Exponetial money growth is certainly not the solution. Gold has always been a realistic check and balance on Politicians and given the pople confidence that they were not going to get screwed. Even now Central baks of the world are printing money while they are trying to increase their Gold supplies. Why would they be doing this? Why hold Gold at all? Because in time of stress if there is no reserve currency to hold then Gold is as good a solution as any and history backs that up. Not 50 to 100 years of history, but 10 thousand years of history.

    And just for the record Bernanke and Co are indeed being poor stewards by forcing people to chase risk because their currency is being debased.

  11. This stability you refer to throughout history is not in the history books. Even on the gold standard economies were highly volatile, at risk of hyperinflation and highly corrupt. Your wish to revert back to these times would not change that. As you said:

    “GOLD did not cause inflation in the past, it was the over expenditures of government breaking the standard that caused inflation.”

    EXACTLY. It is the principles of men that drive monetary & fiscal policy. As I said, the problem with the current monetary system is not that it doesn’t work (it has worked beautifully for 39 years with relatively low inflation and a standard of living that is thru the roof around the globe. The problem with the last 20 years is that we allow bankers to rape their customers while speculating and providing little to no utility to the real economy.

    We have become a society that ships its brightest minds to companies that do little more than shuffle money. What needs to take place (what the free market attempted to do on our behalf) is downsize & regulate this corrupt banking system before they drive us to ruin.

    Any monetary system that goes unregulated is subject to such corruption and malfeasance.

  12. Thanks for this. It helped me connect the dots on a few things I have been pondering.

    I recently saw a powerful presentation on the future of gaming and how gaming is leaking out from video games to real life.
    In the last 10 min an amazing argument is made for a future world immersed in “points”

    For anyone who knows anything about video games, “points” or “coins” are the currency of the realm, from the simple games taking over (such as Farmville and Club Penguin) to the immersive massive multiplayer worlds.

    So here is the connection. I’ve never seen fiat currency as something that is here to stay. I have unwittingly believed in the fall of fiat currency and a return to things more “solid” like gold. Well, TPC, you have convinced me the other way and I will take it one step further.

    I suspect there is a good chance that the next step in the evolution of currency is a break in the sovereign state monopoly of fiat currency. More and more we shall see others (I imagine large corporations and networks) issuing their own forms of currency. Of course this is nothing new, we all already hold some of this new currency already: airline miles, or points. We see this movement in the growth of the number of plastic cards in our wallets: credit card rebates, grocery store loyalty cards, etc. The growth of gift cards is another movement in this direction. Right now most gift cards are paid for with cash, but increasingly they are “won” by a variety of means (referrals, loyalty, spending a certain amount, and outright gifts)

    There was a recent video TPC posted with Warren Buffet. When asked about guarding against inflation, Buffett answered in stating this is why he buys stock in companies with strong long term growth, the “currency” of stock in a company is more valuable than the dollars the stock is denominated in.

    Thus, instead of shrink, it suspect the number of “currencies” in the world will explode. The only thing holding back the dam is a set of efficient technologies to record our actions, transactions, and some sort of wallet to hold/organize all of our ‘money’. These technologies are already being developed by gaming companies. Smart phones will most likely be our future wallets. In the future we will most likely have the ability to buy our lunchtime hamburgers with dollars or McDonald’s loyalty points, or points from some fast food loyalty point network, beamed wirelessly from our phone. We will find ourselves paying for more and more things with points as points become commonly “earned” in a variety of ways: by shopping at McDonald’s, your child reading 10 books in a summer reading program at your local library, donating 2 hours of time picking up trash at the local park, watching a sponsored video on youtube, participating in a political rally, the list can go on and on.

    To me this sort of future seems entirely plausible. Sure, it will take decades to transition to. For the longest time there will be a Babel of currencies to sort through. But it represents the clearest picture of how companies are going to not only remain profitable but grow into the future. It also means stormy waters up ahead for the “old” economy, and the governments who are used to their currency monopolies and income via taxation denominated in those currencies.

  13. great post on a difficult subject. i have two comments.

    i think you have to distinguish between real asset inflation and financial asset inflation. we have cycled between these, with financial asset inflation (stocks) hitting its peak around 2000, and real asset inflation (real estate) hitting its peak around 2006. gold is a hybrid bearing qualities both as a real and financial asset. at times, so has oil and real estate (in the sense that they have been bought not just as a store of intrinsic value but also as a vehicle of speculative value).

    as a hybrid, you are never going to be able to analyze its value solely in terms of real asset inflation (its value as a hybrid won’t seemlessly track commodity asset values generally), or solely in terms of financial asset inflation (its value as a hybrid won’t seemlessly track financial asset values). because of this duality (think the movie, chinatown, “she’s my sister, she’s my daughter”), it will confound anyone who wants to “understand” it, which leads gold investors to become more faith-based than anything else…but in this regard is gold really that different from many other asset classes. i think you can develop a feel for it, but i haven’t and so i have stayed away from it.

    you will note that gld had a high in 2006 (i am a real asset), but then continued to new highs in 2008 (i am a financial asset), only to continue to new highs thereafter (i am a life preserver). too much going on there for me to get a handle on.

    the real interesting development on the next ten year horizon which you do not mention is whether the IMF actually proceeds with its announced plan to consider the creation of special drawing rights as an alternative reserve currency. the chinese seem to interested. if SDRs as a basket of currencies, and perhaps commodities and whatever else they put in there, on reserve at the IMF can serve the basis for the creation of a new reserve currency (really an index of currencies and whatever else goes in the basket), then the value of gold in my opinion as an alternative to fiat currencies is weakened.

  14. Chris, great great comment.

    You make an important point which I did not elaborate on thoroughly enough.

    1) The gold standard does nothing to stop hyperinflation. Only sound stewardship can do that and history has proven that corruption and malfeasance can exist as much in a gold standard world as in a fiat monetary world.

    2) I would argue that the bubble era of the last 20 years is not due to unsound monetary policy, but rather an unregulated and unproductive banking sector. These men produce little, take much and spend the majority of their time shuffling money from one pocket to the next. All the while, they do so with free reign in a largely unregulated world.

    This all ties in together. The common strain here is not a broken currency system (gold or fiat), but a broken regulatory world that allows a banking sector to malinvest and allocate capital inefficiently.

    This has resulted in pockets of malinvestment.

    The IMF will never be the governing body of the global reserve currency. That would effectively make them everyone’s banker. It would solve nothing. The Chinese are flat out wrong. What China needs is a more diverse economy that is not dependent on the kindness (or ignorance) of strangers (of the US consumer) via global trade.

    Greece is a great example of what happens when you relinquish your rights as producer of the sovereign currency. They are a mess. All of Europe is a mess and the Euro is largely to blame.

  15. Aye, Ill give you that TPC
    Opened up a can of worms ye did with this one
    Keep up the good work

  16. It’s a touchy subject. I know. Gold is religion to many people. Just trying to provoke thoughts and debates….It appears as though I’ve succeeded!

  17. “I would argue that the bubble era of the last 20 years is not due to unsound monetary policy, but rather an unregulated and unproductive banking sector.”

    “The common strain here is not a broken currency system (gold or fiat), but a broken regulatory world that allows a banking sector to malinvest and allocate capital inefficiently.”

    actually, i think there are severe limits to the efficacy of regulation. regulation addresses a problem as an institutional failure. to the extent that there is any one thing that i can point to that causes boom/busts, malinvestment etc, it is more of a joseph conrad thing, heart of darkness.

    a case in point. practitioners in the legal and accounting professions in the period 1975-2000, as i encountered them, typically did not consider themselves undercompensated…they found great satisfaction in the recognition (not unlike the points referred to in the other chris’s post above) they received within their professions which when added to their cash compensation left them more than satisfied.

    but then something happended. lawyers and accountants started looking around and found that society increasingly allocated benefits almost exclusively with money and less with professional esteem; in response, accountants started to establish consultancies on the side, and these side gigs started to become more valuable than the core profession, which led the core profession to be cheapened and deemphasized. the legal profession went through its own deprofessionalization phase at about this time where firms started to reward rainmakers, which destabilized many firms and tended to make firms exalt the business side of their firm over the professional.

    no worries, except then we saw how arthur andersen completely whored itself to enron. that malinvestment can be directly tied to the decline of professionalism and the exaltation of profitability (at both AA and enron). regulation could not have prevented this because this was caused by problems within the AA accountants’ and enron executives’ hearts of darkness.

    ask your son who the best baseball player is. in our day, we would argue between the flair of willie mays and the grit of mickey mantle. today the argument is over, it is arod, because he has the biggest contract.

    so again, a theme i revert to perhaps too much, keep your eyes and ears open and try to make money (and love life, friends and family), don’t try to change the system (thinking that new regulation will do the trick), because first, change is very hard to accomplish in any event, and second the change needed is not so much in our social institutions as in our own cultural values.

  18. “The man with the most lead will be the man with the most food in that scenario.”

    Truer words were never spoken. There’s plenty of guns around but not that much ammo.

    And the richest nation on Earth will be the Mongols, since they’re the only ones that still keep lots of horses.

  19. TPC
    I love your rants about the banksters and all power to your bow in getting this recognised. And while I agree on most points of your gold article, I think you miss an important one from an international perspective. I live in a country with an overvalued currency at present so perhaps I should be hedging. But into what? Was in Jim Rogers that said picking a favourite currency at the moment is like picking a favourite dental procedure? So gold is the perfect hedge. It goes up and down in any one currency reflecting only the strength of that currency. Also, it is international. I can go to a bank in Geneva or Beijing and change my gold into the local currency. Try doing that with lead.

  20. Thanks Gordon and VERY good points. I guess I would counter your hedging argument by saying that the same thing can be done by owning other currencies. You don’t have to buy gold. It is not the only asset with negative correlation to your currency.

    As for exchanging gold anywhere – this is true, but largely due to misconception. China and India have been piling into gold, but why? Do their bankers really believe we will revert back to the gold standard one day? Meanwhile, the US (the effective creator of the current monetary system) has been dumping gold or at least not purchasing gold, since WW2. The US understands that there is no need to hoard gold any longer. It is 100% pointless as long as we remain a strong viable economy which can tax its citizenry (I dont see that ending any time soon). The fact that you can take a gold coin into the bank in Geneva and exchange it for Franks is a function of the old gold standard days. Nothing more. Of course, I realize and understand that these misconceptions regarding gold as a currency are prevalent which is why I would never discount it as a valuable asset.

  21. A few comments.

    TPC said, “because those gold bricks are mighty hard to throw at someone….”

    But, throwing a gold brick would be more effective in stopping someone than throwing a dollar bill. And you could exchange your gold for lead, whereas your paper money may not even buy you enough lead for a single bullet.

    Gold is a store of value and paper money is not. If you held a dollar from 1913, today its worth about 5 cents.

    TPC said, “Fiat currencies restricted by the gold standard or pegged to another currency have failed repeatedly.”

    This is only true of gold “exchange” currencies and there is a HUGE difference between a gold exchange and a gold standard or one that is fully backed by gold:

    If a currency is fully backed by gold the only way for the currency to fail is if gold became worthless. Gold has stood the test of time lasting thousands of years whereas fiat currencies last typically 40 years:

    Lastly I suggest you read this

  22. This is the classic argument made by gold believers. If the currency is backed up 100% by gold then how can it ever lose value or fail?

    How realistic or plausible is this though? Is there enough gold to meet the world’s growing demands? Even more important, is there enough gold to go around so that countries can meet their spending needs in times of trade imbalances?

    The overwhelming evidence is NO. It is not plausible and that is why we moved to a convertible system which ultimately failed as well due to its own inflexibility.

    A pure gold standard is absolutely impossible to meet the demands of the growing global economy. This is not a theory, but a pure fact.

  23. Its funny TPC you ripped on Chris the other day for not supporting his argument with any facts.

    Then you post this, “The overwhelming evidence is NO. It is not plausible and that is why we moved to a convertible system which ultimately failed as well due to its own inflexibility.

    A pure gold standard is absolutely impossible to meet the demands of the growing global economy. This is not a theory, but a pure fact.”

    Where is this overwhelming evidence and pure fact you speak of?

    Please enlighten me.

    You really should read the link I posted above on Zero Hedge written by Alan Greenspan it might change your opinion on why we’ve moved away from a gold standard, its not for the reasons you think.

    There are problems with a gold standard, but they are not the ones you state:

    BTW, I prefer Freedom Vision’s monetary reform policy:

  24. TPC, I disagree with you about Britain in 1931 being a great example. The Genoa Conference of 1922 lead to a quasi gold standard which was really a crazy gold exchange agreement, see the Mises article I linked to above for a full explanation to what really happened to Britain in 1931.

    Yes, Governments moved away from the convertible exchange rate system because it was too restrictive. But, this was just because they prefer deficit spending which is really just a scheme to confiscate wealth.

    I agree with you about gold not being a good price stabilizer, but the reason for this is the quantity of money backing gold. If you read the link I sent about “The Fallacy of Gold Backed Money” you’d understand this.

    I also agree with you about Greenspan being a failed central banker, however; the article I linked too was written in 1967. This is well before he changed his stripes or was simply corrupted. Its worth the read.

    As for our most prosperous 40 years in history, its been a debt fueled binge, bringing forward consumption. Now we’re going to have a 20 year+ hangover, so is that so great?

    Like I said, I’m a supporter of Freedom Vision’s Monetary Reform Policy, see the link above.

    Anyways, great discussion and keep up the excellent work!

  25. Reading all the post here I feel the best way to make money is to short gold WHEN its bull market comes to end. it will drop 10 times faster than it rose, trap a lot people who believe they know fundamentals. I think that day may not be far away, as Marc Faber and Richard Russell speak out to buy/hold gold forever. There is no one asset you can buy/hold forever, especially for gold, the price is driven by people’s greed and fear most of times.

    I still long gold, but If we get another spike this year I will turn to net short.

  26. >I continue to fail to grasp the rationale for gold as a safehaven in this environment.<

    Gold survives the collapse of governments and has done so for thousands of years. It will continue to do so.

  27. To expand on the preceding post, the US federal govt is in the collapse portion of an empire life cycle. When the collapse will be complete is unclear.

    The USD will cease to be the reserve currency (or have much more value than a note from the Confederate States of America) prior to completion of the collapse.

  28. It should be noted that the collapse the US federal govt does not imply or require the collapse of state or local governments. For the vast majority of Americans, the federal govt provides no useful services. War is not a useful service except to a tiny minority. Transfer payments do not require a federal govt. At any rate the feds primarily transfer money from the masses to the likes of Goldman Sachs. This does create public support. State and local govts do provide useful services and will continue to enjoy the support of the majority of the people.

    This is not to say that the transition through the collapse of the federal govt will be a comfortable one. However, govts collapse. People and civilizations survive.

  29. great article TPC,

    couldn´t agree with you more.

    one point i´d like to add is that there is no model to figure out a fair price of gold.

    today 1.100 could well be the equivalent of the dotcoms sky high PE ratios.
    who knows?

    the current move is almost entirely driven by psychology.
    if faith in gold one day reverts no one can accurately predict where it´s gonna fall to.

    looking at the chart there hasn´t been a real shakeout even during the height of the financial crisis.
    everyone would bought over the last 5 years is comfortabely in the green after one year of holding.
    the 06,08 and 2010 corrections never went sifnificantly below the base of the preceding breakout.

    when the tide turns i would expect gold to fall at least to 470 from a technical standpoint.

  30. Gold is a commodity, Commodities are MONEY, US$ or £ is Currency, I agree 100%
    Commodities cant be printed, Currency can be, Thats the fundamental differance.
    I agree a gold standard is a no go.
    The fundamentals with gold is its limited new supply and easy to value and store.
    The currency price of gold will change up and down so it carrys a risk/reward.
    Gold may be near worthless in 500 years I cant dissagree. Fine art too, But these things I think will hold up.
    Place your bets on fiat currency, stocks, or commodities, All three are fine and all carry risk, I havnt a clue how things will pan out other than things look very bad.


    One factor you haven’t taken into account.

    The American system is broken.

    Not only the banking system.

    The manufacturing system has been destroyed by offshore Chindiacompetition, fueled largely by American buyers, but the rest of the world as well.

    The economic motors of the United States are all siezed up, all of them.

    Without those motors, how can we expect to carry on with our journey?

    About the only way I see out of this conundrum, is to buy out Chindia, just like Canada was bought out, but instead of resource based corporations, manufacturing corporations. That is, if there is any money left now that Obama has doubled the debt, with nothing to really show for it other than a few new wealthy people were created, and a few thousand short term, but not permanent, jobs.

    Enduring jobs were what was needed. Enduring jobs are non-existent in these days.


  32. From 1800 to 1912 the value of the US dollar went from $1.00 to $1.04. From 1912 to today the value has gone from $1.00 to.04 cents. Please note: For most of the 19th century the currency of the United States was backed by gold. In 1913 we established the Federal Reserve. Do we observe a connection? The purchasing power of gold when translated into a basket of commodities is almost perfectly correlated over the last 100 years.

    Gold has certain physical characteristics, derived from nature, that makes it the perfect store of value. It would seem far superior to a handful so called ” smart ” guys at a big round table making policies that control the fate of a great nation and its citizens.

    One additional thought: Alan Greenspan as a devoted follower of Ayn Rand was well aware of the flaws inherent in a fiat money system. Read his essay on gold in the book ” Capitalism the Unknown Ideal”. His total capitulation to a fiat money system has ruined his reputation and I’m sure he knows it. Love of the public spot light can extract a terrible price!

  33. Gold is only as good as the confidence i.e. faith behind it. For now everyone is so uncertain and skeptical about anything fiat that they’re going back to gold for what they perceive as safety. Since enough people, especially those with excess income (i.e. wealth) to store, share the same belief, gold price is rising. The big question is: Is that consensus going to last forever or will people abandon the golden god one day? They may not want to but they may be forced to. Here’s my thesis: Investors are losing confidence in governments that issue fiat currencies, hence the loss of faith in the money. However, mismanagement of the state, especially in a democracy, to a large extent reflects the flaws and weaknesses of the people. Witness the rioting in Greece when the government announced austerity measures that may seem perfectly reasonable and necessary to the fiscally prudent. Think about all the strikes and union problems, and the sense of entitlement for free health care, education, welfare and this and that. The culture of entitlement especially in Western democracies have become so pervasive that the people as an aggregate will not have the discipline nor integrity to live within their collective means. The fiat currency show will go on because to the majority of the people in the world other than perhaps the wealthy, it must. Geopolitically speaking, I do not see any single nation or region that is “clean” enough from this problem and also powerful enough to convince or force other nations to adopt an honest currency system such as that backed by gold. Everybody has an incentive, perhaps even a need, to cheat and will continue to do so. At some point, the values that gold represents such as honesty and certainty will be rendered moot.
    Just like any token, gold’s value has to be enforced in order to be maintained. If, for whatever reason, oil producing countries will only accept gold as payment (at least until oil’s crucial role in modern human existence is replaced, if that’s at all possible), and these countries are militarily mighty enough to defend their oil, then gold’s value will be legitimized.

  34. It is a frequent misconception that Keynes called gold a barbarous relic — he was in fact referring to the gold standard. The original quote and citation is:

    * In truth, the gold standard is already a barbarous relic.
    o Monetary Reform (1924), p. 172


  35. Thanks for a well researched article.
    However, there’s something which still seems not quite clear to me. I do agree that we will never revert to the gold standard or to any other possible variation of it. The monetary base needs to expand to take into account the more goods produced and an ever growing population.
    So it makes sense that States should print more money as more goods are produced tryng to keep prices relatively stable and provide their citizens with adequate means of payment. There’s one problem however: States never retire money from circulation when fewer goods are produced. This is inherently inflationary over the long term as is amply demonstrated by empiric evidence.
    What happens then when States resort to the printing press ( or button press, as you are fond of calling it)with abandon? The answer is very simple.
    And even if I agree that at the moment we are in deflation ( for countless reasons some of which you clearly enumerated) and will be in it for some time, the States ( US Governement in this case) will not eventually incinerate all the money that is being generated. We are producing less but the monetary base is expanding dramatically and if the effect is muted for now, eventually there will be be too much money chasing fewer goods. In fact, if we have to believe the data being released, the amount of ” button pressing” is unprecedented in history and we are in uncharted territory here.

    So, even discarding the option of gold as a currency ( people don’t own gold in the hope of using it to pay their bills with it!), what’s wrong with owning ” goods” instead of a currency that can be printed at the press of a button? And if so, why not gold which we know exists in finite quantities and has proved itself as having lots of desired qualities and of being appealing to people over so many millennia?
    And, why not other rare “goods” like ancient art ( which I actually prefer)?
    In Europe we have a long history of confiscation by our governments, through inflation mostly or otherwise, and probably feel for this a bit better.
    And finally, and I apologize if as a foreigner and a non-native speaker my writing is not clear enough, going back to your analogy of the tea packet that needs stirring: try leaving it in the jar long enough… You will get tea,anyway. And if you apply some heath ( in the form for instance of social unrest or further problems like war)the process could be very quick…
    BTW thanks to Anonymous for setting the record straight on Keynes words on gold.

  36. I’m befuddled. In your piece you comment on Roubini quoting Keynes in describing gold as a “barbarous relic” and say you don’t “entirely agree” but ackowledge an element of truth. You then argue your point and conclude “The truth is, the gold standard as a currency system is a barbarous relic.”

    So to say now the distinction is “semantics” is a bit strange, as you make *exactly* this distinction in your piece when you conclude “The truth is, the gold standard as a currency system is a barbarous relic”. What I fond surprising is that you and Roubini (and many other informed commentators) are arguing about whether gold is a barbarous relic, when Keynes correctly described this nearly a century ago (it’s the gold standard people).

    Don’t get me wrong, I love your blog, your tone, and the fact that you take the time to respond to us directly. But after reading the 6,000th blog post incorrectly attributing Keynes, I decided to take a stand. Expect to see me correcting the public record on the next 5,999 blog posts going forward.

    Thanks again for what may be the best financial blog out there.


  37. Well, as it’s been pointed out, I clearly got the original quote wrong in the article (which is a mistake I fully admit and accept). So I guess it should read: Keynes referred to the gold standard as a barbarous relic and I entirely agree.

    Thanks for keeping me honest. I must have overlooked the Keynes quote by mistake.