This week, I looked at America priced in gold — and noted that America is experiencing gold-denominated deflation. This means that when assets are priced in gold they have consistently fallen in price. Lets re-cap. Here’s the Dow Jones Industrial Average:
Here’s retail gasoline:
Here’s the U.S. Dollar and a selection of other currencies:
Here’s two-year Treasury debt:
And here’s twenty-year Treasury debt:
From the perspective of central banks, and particularly through the lens of quantitative easing — which seeks to remove non-productive assets from the open market to encourage investment in more riskier ones — this phenomenon of gold-denominated deflation is another factor contributing to the global slowdown. If the gold price keeps going up, lots of investors are going to choose to park their liquidity in gold, and not riskier productive investments.
Bernanke has already heavily targeted yields on treasuries which have absorbed liquidity that has departed from productive ventures. But in recent years gold has offered a significantly increased return over treasuries.
So what’s a central banker who wants to force investors into productive ventures to do? You can’t print gold — but you can buy it, and take it out of the marketplace.
And as the price of gold (in fiat) continues to rise due to the ongoing global slowdown, and gold’s increasingly attractive yields, buying gold is exactly what central bankers may do.
Ultimately, the rise in gold prices is indicative of the global slowdown. It is proof that investors are shying away from productive assets.
Fiat-denominated prices tell us very little; fiat currency that can be pumped out at whim is merely a mask to hide the massive underlying asset deflation that we see when we price assets in gold.
Just as Roosevelt went out of his way to remove gold from the marketplace, the central bankers of today may eventually determine to do the same thing.
I don’t have time to search for the data right now, but I’ve gathered from plenty of sources that gold is one of the few “commodities” where supply cannot be affected by producers – I mean almost AT ALL. All of the gold mined over the last > 3000 years is still in existence, and the yearly production (which likely already peaked) adds very, very little to this – no matter how many more mines could reasonably be opened.
Anyway, I doubt Bernanke cares much about gold; they’d just be happy to find any way they can to keep the current system running. Also, very few people/funds are invested in gold, so I doubt this (at least now) is having a significant impact on “not spending”. Even a 5% allocation of assets into gold (by major investment/pension funds) which would send prices probably > $10000/oz doesn’t seem like a target worth Bernanke’s attention in order to stimulate the economy.
And to finish this, you’d probably agree that keynesian stimulus might have its merits for a generally healthy economy that caught an occasional flu, but not in the context of deleveraging after 70 years of debt accumulation. So, not much luck for the economy even if printing gold would be possible.
Hope I made some sense in the very short while I had to write this.
Another thing: if my assumption about the almost constant quantity of gold in existence is correct (and I’m pretty certain it is, and will be, until we get to mine asteroids), this is something that will pose problems for a potential new gold standard. General economic theory suggests that the supply of money should be increased with the growth of the economy. I may be wrong about this, I await your thoughts on this. The problem could be solved through rules regarding the devaluation of the gold-backed paper currency by a constant amount that should take into account the growth of the economy (which will likely exceed the increase in the supply of gold).
Also, this issue regarding the limited/constant quantity of the monetary base (of gold) has been raised with regards to the electronic equivalent of gold – BitCoin (there is a ceiling – about 21 million I think – for how many BitCoins can come into existence). For the same reasons, some economists say that it’s not a valid model for a currency because people will tend to hoard it instead of spending it, expecting that it will rise in value w.r.t. other assets.
which is exactly why it should be money. it is a safe place to keep one’s wealth and know that it will steadily rise in value with the rise in the size of the economy. how do you know it will rise in value? because it is limited in supply. it is untrue that gold would not work as a legitimate money ‘because the supply cannot expand as quickly as the economy’. it simply means that gold will be revalued to a higher price.
as such, people will tend to hold on to their gold, unless they find a promising, well-vetted venture to invest in – one that will return more than the gold would have risen in value.
this is how a free-market calibrates itself, encouraging conservatism in investment rather than speculation; it is how mis-allocation of capital is reduced to its lowest feasible level, and what will ultimately cause the economy to grow at its best rate – the market-determined rate – through intelligent savings & investing decisions.
Camden Crenshaw, that’s a very interesting thing about the need for investors to be conservative by default, and I fully agree.
But then again, someone might say: how do you know that the current structure of the economy and the future expected growth of the economy is fully calibrated to yield positive results (given the implied conservatism by the divergence between the monetary base and the expected growth) when using a constant monetary base? (for all intents and purposes, the gold monetary base is constant – no matter how many mines we could reasonably open – and that’s a good thing).
To which you might answer: we don’t know, but better be constrained by a leash that feels uncomfortable at times, rather than invent financial constructs that sooner or later will implode the world economy.
But then again, no one expects the people of the world will actually carry gold in their pockets to buy groceries. We’ll still use paper in a gold-standard-world, only that that paper will somehow be tied to gold.
Bottom line: I don’t think it’s a bad thing to tie the paper money to gold in a more complicated (meaning not a 1:1 ratio as in a hard/full gold standard) way, as long as the means to do so, and the way this relation can be changed in the future is made clear to all.
To the first part about someone’s reply; I would reference the profit motive. I know the economy is ‘calibrated’ to yield positive results because the vast majority of people – in aggregate, called the economy – care if they lose money, and so are not likely to risk it unless they see the potential for profit – as well as a realistic means to capturing it. that means the capital at work in the economy, the way it is calibrated, is employed in a manner that is likely to be productive, and virtually guaranteed to be so in the aggregate.
and any lack of investment would mean greater divergence, and therefore greater profit –> greater incentive to invest.
since people who do not employ their resources through productive means will not be competitive in the free market, this means there will be ‘three’ types of people in the economy other than the consumer: Those who do not employ their capital – the savers, those who do but who are not careful – and so will lose it, and those who employ their capital yet are careful – and who will end up both being productive and receiving the invested capital of the foolish crew.
This means that capital will either be saved to benefit the future when it will be spent, or flow toward the more productive members of society. Either way this means a positive future result.
I feel like the second-point is just confused semantics, though. Since, essentially, if you are basing your money on something such as gold, you are agreeing that gold is the valuable item in the transaction, not the piece of paper. As such, a 100 lb. bag of salamis that would cost one dollar in a one-to-one dollar-to-ounce standard monetary system, would just cost 10 dollars in a ten-to-one standard monetary system. Either way, the salami still costs one ounce of gold.
The danger of such a scheme however is in avoiding admitting that you essentially have a one-to-one standard no matter what dollar value you put on it, since the paper is just a convenient tool –and not actually money. A dollar could be equal to a gram of gold, or an ounce, or a ton, but it doesn’t matter since prices would adjust to cost the same amount of gold. The problem is in changing the ratio, since adjusting it is effectively stealing purchasing power from one person and giving it to another. In the case of inflation, under a so-called ‘partial’ gold standard, you would be stealing from the creditors and giving to debtors, as well as any savers of gold, but in a deflation you’d be stealing purchasing power from debtors and giving to creditors.
Another thing I wanted to mention that is seldom addressed: gold does not rise only when inflation rises or when fears of increased inflation arise. It also rises dramatically during deflationary (deflationary in paper currencies I mean) environments. It’s a general hedge against monetary problems no matter which direction they might take. The latest explanation I’ve read for gold rising in a (say) USD-deflationary environment is that there are not enough traditional “good” assets to invest in and hence, a good portion of the money will flow towards gold.
There’s no chance this will be tried without the pension/mutual funds getting heavily involved, as I suggest in the piece. But, they will, very shortly. J.P. Morgan’s point about $2500 in 2011 is about right. But in 2012 we’ll go well past that. I am really shooting into the medium-to-long term with this suggestion. Like — for example — the depression drives on into 2015 (I expect it to).
I think Bernanke would be more concerned about the potential multiplier effect than anything else. I don’t know how effective it would actually be at driving gold prices down long term, but it would have a short-to-medium term effect on gold price expectations (traders are very tetchy).
Perhaps in the end if they can’t address gold-denominated deflation (it will look much worse with gold at $5,000 or $10,000) they will pull another FDR and confiscate. Marc Faber is right. Spread your wealth around jurisdictions.
the deflationary spiral is not really a threat in a gold-standard economy; at least not on an economy wide basis.
in general, things will decline in price, but not in the classic ‘deflationary crash’ sense. instead, things will drop in price as we become more productive. the decline in prices we see from efficiency improvements from robotics, computers, etc. are examples of this. but the only reason we were able to see those results was because the efficiency improvements outpaced inflation – the expansion of the money supply – through the use of the new tech.
money is not something that needs to change – it needs to stay constant. this is for the same reason that all tools of measurement do, to get a good measurement, or stated differently, to gauge true value. if something goes down in price with a constant money supply, it’s because it is -worth- less.
in that sense, once the monetary system were properly placed on and priced in gold, the deflation you would witness would be the good kind, indicating increases in productivity and not the collapse of a debt bubble, caused by excessive speculative credit, and causing a flight to ‘safety’ in paper money.
Well there is a legitimate problem with debt-deflation, but I think it’s soluble through making all debts scalable by law.
Something else the anti-gold crowd fail to note is that it is totally viable to expand the money supply under the gold standard. You can expand the money supply. You just have to mine more gold. Which — as far as I can tell — creates a hell of a lot more jobs in a depressed economy than cranking the printing press.
Gold prices may reflect the real cost of capital, which I think explains why it can rise in both inflationary and deflationary (in terms of USD) environments.Unnaturally low rates set by the Fed -> excessive consumption through debt accumulation + misallocation of capital -> growth per marginal debt goes down -> more “stimulus” by the Fed through some form of QE -> rinse and repeat. In such an environment the real cost of capital is bound to rise, which is captured in gold appreciation.
If this holds true, gold appreciation should only accelerate, as the inevitable unwinding of accumulated debt would make true cost of capital rise by that much more.
But I do agree with Andrei when it comes to going back to the gold standard. Money supply becomes fixed, so as the economy grows money becomes more valuable, leading to high interest rates and a deflationary spiral. I actually came across an interesting article the other day, which argued that a gold-backed currency would not work for a country with a constant trade deficit like the US. Chronic current account deficit + fixed money supply -> rising interest rates + deflation -> recession. I guess the solution to that would be a global gold-backed currency with eventual devaluation of gold in lockstep with economic growth, as Andrei pointed out.
The aim is to avoid the gold standard by significantly lowering the net yearly yields on gold. It would be like “QE gold”: targeting year-on-year gold yields, rather than trying to get enough gold to compete with the gold-backed yuan (that is just a nice side-effect).
This can’t happen without the pension funds/ institutional investors getting much more heavily involved. But they will — they will go wherever the real yields are highest.
The nice thing about this global-currency devaluating against gold by some globally agreed amount each year is that gold does not need to be confiscated. You can choose to either hold gold which will guarantee your purchasing power remains untouched, or you can choose to hold this global-currency which WILL devaluate, but ONLY if you keep it under your mattress. Presumably, if you keep it in a savings account (you’d want this because of the liquidity provided by a bank, so that you can easily conduct transactions), you’ll earn the same amount (or more) that would cover the loss due to devaluation.
With regards to all other arguments against a gold standard, as long as this devaluation is in place (described above), I believe all other arguments are moot. Yeah, some countries will complain because they’ll lose control of their monetary policies, and they’ll think they can be smarter – but likely this is a short term gain the kind of which leads to catastrophes later on (the kinds of which we’re witnessing today).
I may have been too quick in coming up with this: actually, if the economy grows while the supply of gold remains constant, this will mean that the purchasing power of gold will increase, so yes, they may want to confiscate gold before moving to a gold standard (gold will only be held by central banks). It would be interesting to know what Bill Bonner thinks a gold-standard should look like (he said the Feds are the problem and gold is the solution). A post from John on this matter would help – if you have any ideas. Jim Grant said a few days ago that a gold standard would be the least imperfect of all monetary systems. All systems have warts, and certainly, we can’t say the current one come into being as the choice of efficient free markets.
Then again, there are millions of ways to tie your currency to gold, so I’m just grasping at straws here.
After giving some more thought to this: overall however, the fact that gold has a relatively constant quantity – notwithstanding very slight increases due to production/mining should ultimately be viewed as a QUALITY and not a liability. There are very few “commodities” that have this quality, and this can be leveraged/used in a monetary system based on gold – meaning: you have a “constant” (the non-printability of gold) you can rely on that you can later use to build some other system upon it.
I saw an ad for investor information, all contained on a 24 Karat plated USN stick.. But only for the first 100 callers. Now that is a gimmick!
Combine this with Gold vending machines, and a historical real rate equal to the 1980’s bubble top, and I feel we are going to see the Gold price come back to normal.
Japan delevered in the 90’s and it has survived. I feel the world will tread water like Japan has.
I think global name shares that provide a dividend will be the only asset class worth getting into. I am waiting for a catastrophic economic event to ensure “blood in the streets”, then I am going to position into this asset class.
Caterpillar, GE, Siemens, BHP. Most will be heavily geared to an infrastructure lead recovery. Much like Germany in the 30’s. Massive infrastructure spending to keep people employed.
I think we’re five years away from the “get out of gold and into blue chips” moment.
Hey, no. Actually look at Japan’s debts. As John Mauldin said, Japan is a bug in search of a windshield. Currently they borrow at very low rates because they haven’t borrowed in the international markets almost AT ALL. Most of their debt is held by their own citizens/banks. John Mauldin says he has no idea what will happen when their aging population will start to liquidate their bonds (to spend) and when Japan will be forced to borrow in the international markets for the first time.
So… if you picked Japan as the role model, you’ve picked the wrong candidate. Their problems are catastrophic. The tragic thing is that US is almost not that far from their situation even before starting their own-US lost decade.
But then again, John Mauldin says he has no idea how much longer it will take before things start to unwind (he said that many trading floors are littered with the dead bodies of traders who have bet against the Japanese bonds – metaphorically of course).
The key to squashing bugs is oil and supply chain infrastructure, and any possible breakdown (oil shock, trade war, etc)
Actually, for some reason, it seems there are some powerful players out there that really do care about the price of gold:
– see how the gold price fell off a cliff, minutes before the last safe haven fiat currency was destroyed (more or less).
Who knows what their ultimate endgame may be?
Whoever they are, they can’t hold this monster down with paper manipulation. Hence QE Gold.
Hmm, yet another shady move: right after the QE3-non-announcement which was supposed to actually be bearish for gold, CME raises the margin requirements – seemingly for maximum effect. If gold is not important for them why do they keep playing with it like this?
Y-o-Y rates on gold are extremely important. As I have shown, true inflation/deflation is measured in gold. Fiat is just an intermediary and medium of exchange. Measuring in fiat just smudges the underlying dynamics of the economy.
Keeping gold low keeps fiat — and the system — stable.
They won’t win.
Can’t say that I fully agree with your explanation… Not that it’s incorrect, but the reasons might be deeper.
They can always say that gold is a barbarous and irrelevant relic in a bubble (that’s what most “mainstream” economists say anyway).
Maybe CME is trying to avoid a possible looming default by curbing the enthusiasm by striking at the most vulnerable moments; also, as gold is the anti-status-quo money, the USD-price-increases in gold would probably put more and more into question the status-quo.
IMO, I think Japan worsened the longevity of its slump through continued monetary stimulus. By keeping rates way too low, capital didn’t flow into the most productive investments, leading to more public debt and low growth. Continued low rates was only possible by high savings from the Japanese people and their willingness to lend the government their money.
Which brings us to the US. Essentially the Fed is doing the same thing, except that debt owed to foreign creditors(esp. China) are much, much greater than Japan. Due to excessive consumption, savings are also way too low to absorb all this debt. My conclusion is that if the US does follow the Japanese path, it will be in a far worse situation than what Japan has experienced for the past decade. Maybe the foreign creditors will still think the dollar as the go-to reserve currency, and demand will keep up. But at the current rate where China openly criticizes US addiction to debt, I wouldn’t bet on it.
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Your reply is very insightful.
w.r.t. point #2: I just meant that we’ll still be using paper intermediaries which led to my suggestion that having a clear mechanism to alter the relation between the intermediary and gold may not be that bad (but of course, I’m not sure about this, it was just a suggestion).
Bottom line after reading your reply:
1. Do you see any downsides for a gold standard (either partial or full)? – as there are many who do (esp. those who like to point out the correlation – for various countries – between the quickness in dropping the gold standard after the Great Depression with the speed of the economic recovery after that).
2. Do you see a gold standard returning in the coming years? How would they go about doing this? – as no one seems to have any idea and people keep bouncing back between complaints about dollar debasement to SDRs to Yuan flotation and so forth etc. etc.
PS: This was a reply to Camden Crenshaw’s reply (just doesn’t appear to be properly positioned in this thread).
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