In my travels across the internet, I often hear a disparaging label being thrown around to describe libertarians and adherents of Austrian economics: goldbug.
The Economist’s Free Exchange column from last July encapsulates this perfectly:
The disappointing thing about Ron Paul’s goldbuggery is the weakness of the analysis behind it. His support seems almost mystic in nature: that gold is money is a law of economics that’s held for 6,000 years! In his defence, this quasi-mystical belief in the sanctity of gold in a monetary system was shared by the world’s financial leaders for much of the industrial period. That’s not much of a defence, though. Gold worship repeatedly drove the economy into ditches and off cliffs, but for a few lucky years in which the pace of new gold discoveries fortuitously matched growth in the global economy.
I can do a pretty good job of analysing and deconstructing that (and indeed have already strongly questioned the claim that it was “gold worship” that drove the economy off a cliff in the 1930s) but in the interests of economic “progress”, I would rather outsource my analysis to China. If it’s good enough for Apple, it’s good enough for me.
More specifically, I want to outsource my analysis to Zhang Jianhua of the People’s Bank of China.
Analysts believe China bought as much as 490 tons of gold in 2011, double the estimated 245 tons in 2010. “The thing that’s caught people’s minds is the massive increase in Chinese buying,” remarked Ross Norman of Sharps Pixley, a London gold brokerage, this month.
So who in China is buying all this gold?
The People’s Bank of China, the central bank, has been hinting that it is purchasing. “No asset is safe now,” said the PBOC’s Zhang Jianhua at the end of last month. “The only choice to hedge risks is to hold hard currency — gold.” He also said it was smart strategy to buy on market dips. Analysts naturally jumped on his comment as proof that China, the world’s fifth-largest holder of the metal, is in the market for more.
Wow. This, more or less, is the argument about gold that I advanced last month:
[Gold] doesn’t do anything. It doesn’t create any return. It just sits. It’s a store of long-term purchasing power.
And most importantly it is a hedge against counter-party risk.
What is counter-party risk?
Counter-party risk is the external risk investments face. The counter-party risk to fiat currency is that the counter-party — in this case the government — will fail to deliver a system where that fiat money will be acceptable as payment for goods and services. The counter-party risk to a bond or a derivative or a swap is that the counter-party will default on their obligations.
Gold — at least the physical form — has negligible counter-party risk. It’s been recognised as valuable for thousands of years.
Counter-party risk is a symptom of dependency. And the global financial system is a paradigm of interdependency: inter-connected leverage, soaring gross derivatives exposure, abstract securitisations.
When everyone in the system owes shedloads of money to everyone else the failure of one can often snowball into the failure of the many.
All-denominated fiat securities are touched by counterparty risk, because of the nature of the hyper-interconnected global financial system. Physical gold will still be physical gold, even after the dust settles, even after all the unpayable debt has liquidated, and after the new global financial order has taken shape. That is what Zhang Jianhua — and presumably the PBOC — have understood. For those who possess physical gold, there will be no haircuts or write-downs on that asset. There are precisely zero historical examples of gold-denominated hyperinflation.
This is an entirely different argument to claiming that the monetary base should solely consist gold, of course. The gold standard doesn’t seem to prevent credit-driven bubbles, because it merely restricts the size of the monetary base.
But gold has retained its moneyness, its for 6,000 years for a reason. While value is subjective, I would suggest that its liquidity, its freedom from counterparty risk, its fungibility, and above all its natural scarcity have played a huge part in that.