Sunday, September 6, 2009

Gold is a Currency You Can Rely On

I get comments and questions from people who don't understand why Gold is money and don't understand why it has any value other than as jewelry. The two most important functions of money in my opinion is that is function as a unit of exchange and a store of value. Money should also be durable, portable, divisible, acceptable, uniform and in limited supply to function effectively.

Gold meets all of these characteristics with the exception of acceptability. It is true that you cannot use pieces of Gold to buy things in most modern settings. This is because most governments around the world have made Gold illegal for daily transactions because they do not want competition for their fiat (i.e. "by decree") paper currency. However, Gold can be exchanged for local currency almost everywhere in the world, so in a sense, it does have a limited form of widespread acceptability.

Paper money, we all know, is a terrible store of value. The U.S. Dollar has been losing value rapidly ever since we severed our link to a true Gold standard. Let me give you an example of the difference between Gold and paper money over the long haul. Let's say you had $100 worth of U.S. paper Dollars in 1930 and $100 worth of Gold at 1930 prices (Gold was fixed at $20.67/ounce back then by the government). Today, you would still have $100 in nominal U.S. Dollars, but it would buy much, much less in actual goods than it did in 1930. The Gold, however, could be traded in for slightly more than $4800 U.S. Dollars today (as of Friday's closing spot price for Gold).

But Gold hasn't changed over the years, hasn't grown, hasn't paid dividends and hasn't increased in its intrinsic value. Gold essentially has not become more valuable, paper fiat Dollars have become less valuable. Those who think steady inflation year after year is healthy are either bankers, politicians, or brainwashed by modern economic theories espoused by jokers like Paul Krugman. Up is down, right is left, and increasing debt and punishing savers is healthy!

People wonder why money can't be backed by oil or rocks or food. With rocks, the problem is the same as with paper only rocks are less portable, namely that rocks aren't scarce enough and thus inflation would be rampant under such a system. With oil, portability is also a problem. Who wants to carry around a cup of oil in their pocket? Food spoils, so durability is a problem.

Why is scarcity an important quality for money? If you don't know the answer to this question, look at what the U.S. Government and their non-federal, private, for-profit federal reserve corporation are doing. "Stimulating" the economy by printing new money and debt requires no more effort than a keystroke on their part! This leads to excessive monetary expansion, excessive debt, and rolling bubbles and collapses in asset prices.

Under a Gold standard, if the government expands its promises too far, people simply exchange their paper notes for actual Gold and deplete the government of its resources. In other words, those who hold paper exchange notes can act as a "check" on government power by redeeming them for Gold. Spendthrift governments have their Gold stores depleted, which eliminates their economic power and prevents them from pursuing their harebrained schemes. This is why Nixon had to suspend even the quasi-Gold standard in 1971 - we couldn't afford all of our social programs and our war and the rest of the world knew it!

The other issue with Gold is a long-standing history as a form of money extending on and off over thousands of years. This cannot be ignored. America as a country is so young relative to much of the world. Gold is steeped in the tradition of certain countries like India. When the shit hits the fan, Gold has always functioned as a medium of exchange and store of value. So a strong reason for its continued role as a "currency of last resort" is that it has always worked in the past.

I am not saying a Gold standard is without problems and I am not saying it is the solution to all our problems. Even if we returned to one some day, a government would come along during a crisis and just suspend it again. But keep in mind that both the United States and Britain enjoyed their greatest years of growth and steady prosperity on a Gold standard and both began to decline shortly after abandoning the Gold standard. This is not a coincidence!

Give politicians (who are trying to get elected by winning a popularity contest) a nearly unlimited ability to make promises with other people's money and they are going to continue to make promises until they destroy the system. This is how it has worked with every fiat system in history and how it will continue to work as long as human beings are in charge. What politician can resist such power? Who can resist taking the easy way out, whether citizen or politician? Who as a citizen can resist asking for more free stuff when every wish seems to be granted and seems to have no cost?

In essence, Gold meets all the criteria needed for a successful form of money except where governments have stepped in and suspended reality under threat of force (they have used this force before and will again). But when things get bad, the smarter citizens of the world will ignore their apparatchiks as they have throughout history and turn to what actually works. Economic self preservation overrides concerns over following the mandates or whims of some elected bureaucrat trying to lead his or her flock to an economic slaughter. The global fiat system we have currently is on its last legs. That doesn't mean it can't last a few more years and that doesn't mean we won't jump from one fiat system to another new one, but it does mean that every country involved in international trade is at risk for massive currency fluctuations throughout this process. When the change comes for whatever countries are involved (many are at risk), it won't be announced in advance and you won't be given time to prepare.

The United States has the most to lose if the fiat currency regime is altered, as the new system will certainly be more equitable to other nations. Though I believe the U.S. Dollar is set to rise on an intermediate-term basis while another vicious leg of asset and debt liquidation creates a bid for Dollars, I also believe Gold has a much brighter outlook as a form of money and store of value over the longer term than the U.S. Dollar. Since I believe we are in deflation and a Kondratieff Winter has begun, I prefer cash to stocks, commodities, corporate bonds and real estate.

For those who are not nimble traders and when ignoring the short-term swings, Gold will remain the best form of cash for the foreseeable future. Maybe the Dollar and Yen are better over the next few months, then the Euro may rally again, then the Aussie Dollar may run, etc. But the entire global fiat system is in a bear market relative to Gold and that bear market in paper has a ways to go.

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