Category Archives: Gold

A Brief Note on Gold As a Currency

With the refinements our ideas on money in Understanding Money: Part 5 – It’s All Money, we decided to apply them to a topic we have addressed in the past, that of the return to a gold standard.

There is an audience for the idea that the change from a gold standard to a pure fiat paper currency is a root cause for the current financial crisis. In particular, a paper currency allows for the expansion of the monetary base in an undisciplined fashion. We suggest that a pure fiat currency and a gold-backed currency both represent MZMc or the currency component of money with zero maturity whose composition or nature is irrelevant to the money creation process. To understand our thinking, refer to the series of articles on “Understanding Money” at the end of this essay.

More Thoughts on a Gold Standard

The article The Long Wave Versus the Printing Press: Central Banks Go All-In posted on DollarCollapse.com motivated us to test an idea. The author states (the emphasis is ours):

This time around the world’s central banks have a new set of tools. In past cycles money was mostly gold and silver, which is to say it was real and in limited supply. Credit might have been flexible because of fractional reserve banking, but the money at the base of the financial system couldn’t be created out of thin air. Today, in contrast, it can. Since the US broke the final link between national currencies and gold in 1971, everyone has been running fiat currencies that can be created in infinite quantities and depend for their value on the trust we place in the competence and honesty of our leaders.

Indeed, the primary reason proponents urge a return to a gold standard is to contain the money supply and indirectly, the credit market and the economy. The effect on the economy we will put aside, but we do want to consider the relationship between base money and the total money supply and the credit market.

Comments on Gold for Currency Purposes

In a private communication with our friend JR we wrote

Again we go back to people with an agenda or bias – they don’t think. The article [http://www.theburningplatform.com/?p=37942] identifies the single advantage fiat currency has over a fixed base currency – the ability to create more on demand. Fiat currencies collapse when the multiplication gets out of control. Until that point they are fine. Gold-backed currencies collapse when the sovereign has a sudden need for more money and the fixed-base doesn’t have the flexibility to allow this. Look at the last hundred or so years of the so-called gold standard. Countries were forced off it when they needed a sudden expansion of the money supply to fight a war. Both the US and Europe have this in their past.

As we have observed before, every PM-based [precious metals] currency has collapsed because the sovereign has always found a way to expand the supply (debase it). This should give the advocates looking for a golden nirvana pause – but it doesn’t. They don’t think. The empirical evidence is that ALL currencies collapse. Some survive longer than others but they all go to that currency graveyard in the sky.

In this post we answer some of his subsequent questions and then move onto some current thoughts on PM-backed currencies.

A Swiss Gold-backed Currency? Don’t Bet Your Bottom (Fiat) Dollar On It

In two posts, Gold: Always a Store of Value but Never a Currency and The Case for a Genuine Gold Dollar by Murray N. Rothbard – Commentary, we argued against the likelihood of gold or gold-backed currencies reemerging. Today, Egon von Greyerz, in a King World News blog article, mentions a Swiss initiative to try and introduce a 20% gold-backed currency. There is a very simple reason why the Swiss cannot do this on their own.

The Case for a Genuine Gold Dollar by Murray N. Rothbard – Commentary

When we recently encountered “The Case for a Genuine Gold Dollar” by Murray Rothbard, we decided it deserved a critical read and commentary, especially in the context of our post: “Gold: Always a Store of Value but Never a Currency“. Since the issue of gold or gold-backed currency will never die, any informed input to the debate is important. Ours follows:

Gold: Always a Store of Value but Never a Currency

We have been reflecting and writing on money lately. Now we turn to the question of can we return to gold or gold-backed currencies?

For a large part of human history, warfare has been motivated by and certainly directed at the acquisition of a neighboring country’s gold which represented a country’s wealth. Gold was the basis of a sovereign’s wealth and power and no sovereign, of today included, has ever had enough wealth. Until recent times, gold has been the predominate metal of currency, supported by silver and copper.

Gold Coinage As Currency

Consider an Archimedean experiment. Suppose all world currencies were in gold coins. Suppose we created a large balance such that all the gold coins in the world were on the left side and all the tangible assets in the world, ex gold, were on the right side. Suppose the balance were constructed so it was initially in equilibrium (balanced) and what the balance is measuring is value.

If we multiplied the face values or denominations of the gold coins by their numbers and added them up, we would have the value of all the money in the world.

Since it takes years (typically 5 at a minimum) and huge amounts of money (typically half to multiple billions of dollars) to explore for, develop and put into production new gold deposits, the increase in the gold supply is at a slow, fairly fixed rate. The total value of money on the left side of the balance grows slowly and cannot be accelerated to any extent.

The quantity of tangible assets or durable goods (we will ignore services for our simple example) on the other hand has expanded much faster through industrialization and the utilization of modern technologies. The output per unit of labour in virtually all industries and agriculture has been increasing steadily for centuries. The total value of assets at a fixed price on the right side grows faster than the value of gold on the left.

The experiment we have created would move away from the initial equilibrium or balance quite quickly. A free market would restore balance naturally, but let’s see what we would have to do if we wanted to maintain the balance ourselves.  We would have to increase value on the left side or decrease value on the right side. Let’s look at the left side first.

Predictions for the Price of Gold

We periodically see arguments for gold prices all over the map. For investors, the future of gold prices may be critical. This post will collect such arguments and estimates as they emerge. This may help us to form an opinion on where gold is going. Estimates, sometimes with supporting reasons, are shown below (bolding ours). We recently have stopped following the estimates since they bear little relation if any to the actual price and its trend. We still believe these estimates will be achieved – someday.

Understanding Money: Part 4 – The Value of Money

Money and Value

As discussed in Understanding Money: Part 1 – Introduction when nations’ currencies were made of precious metals, the actual value of the currency was carried by the currency itself. It had intrinsic (see next section for a discussion on intrinsic value) value. For a gold coin, the measure of its value was the amount of gold in it. The value of gold as a metal is due in a large part to its scarcity and associated cost of production.

If a bushel of wheat were our commodity currency, we could plant more acreage. For gold, it takes an immense amount of money to find and develop new deposits. It takes years to develop a new deposit before the first ounce of gold is poured. So the supply of gold is what economists term as inelastic. It can’t readily be increased to meet demand. Today, the commercial producers that own significant deposits have a production cost of around $1100 per oz. So its minimum price or value is its cost of production.

Have you noticed that very few people have enough money? This is particularly true of sovereigns – monarchs and governments. A key aspect of a sovereign is it’s control of the money supply. A sovereign may control the ownership of all gold production but it cannot control the amount of production to any degree. What is a poor sovereign to do when it wants more short of stealing another sovereign’s gold through warfare? Fiat or paper currency to the rescue.

Central Banks and Gold: Part 2

Although central bankers talk down gold, gold remains an important, and in some cases dominant (Portugal at 89% and the USA at 75.5%) component of many countries’ international reserves. It is also a primary asset for interbank swaps and dealings. A case in point is the Bank for International Settlements.

Central Banks and Gold: Part 1

In this part on central banks and gold we answer the question who owns what. The question of where a country’s gold is is another matter. Many countries store their gold with the Federal reserve Bank of New York or in secure depositories in places like London and Zurich. Venezuela is in the process of repatriating their gold.

Gold has held a controversial position with central banks over the years. There was a period when countries such as Canada sold almost all their gold because the monetary return on their gold reserves was miniscule compared to the interest they could make on the cash equivalent. Despite this, may countries such as the US and Germany kept most of their gold and have a realized a considerable benefit on their balance sheets.

It should be noted that of the EU countries in financial difficulty, their world ranks in gold reserves are: Italy 4th, Portugal 14th, Spain 19th, Greece 31st and Ireland 72nd. Gold makes up 80% of Greece’s foreign reserves. To try and meet external financing obligations, EU countries are selling assets, implementing austerity programs and borrowing heavily but none are selling their gold!

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