Why Invest
In Gold Now? Part II
By:  Dr
David Evans
Introduction
The reasons involve currencies, banking, and monetary
history. These are complex areas, unfamiliar to most. Everyone
knows how money works on an everyday level, but most people are
surprised at the way the money system works at the high-finance
level. The current money system has some systematic problems
and is likely to undergo great stress in the next few years.
These stresses will affect the financial lives of everyone—many
will lose, some will profit.
I've tried to present the case as simply and briefly as possible.
Due to the inherent complexity of the topic, it's almost impossible
to do it justice in a shorter piece. No special background or
knowledge is required to understand what follows, just some time
and an inquiring attitude.
Summary
Here are the fundamental reasons to invest in gold soon
(in summary form):
1. Gold is more than just another commodity, it's
a currency. It is THE currency that evolved in the marketplace
over the last 5,000 years.
2. Gold and silver are the only currencies not created
and controlled by governments. All of today's other currencies
(dollars, euros, yen, pounds, renminbis, rupees, etc) are ‘fiat'
currencies, which means they do not represent anything tangible
but are only worth something due to government decree (namely
legal tender laws).
3. Governments always end up creating too much fiat
currency out of thin air. All fiat currencies in the past have
ended up worth very little, collapsing into hyperinflation or
threatening to. All of today's fiat currencies have been fiat
currencies for less than 34 years (all government currencies
were convertable to gold until 1971).
4. The rate of creating fiat currency accelerated
markedly in 1995, leading to today's worldwide bubble in asset
prices. In September 2003 the rate started to slow, suggesting
that the bubble might end soon.
5. In the pain of the post-bubble period, governments
will come under pressure to return to backing their currencies
with gold.
6. Returning to currencies backed by gold is practical.
Even the possibility that it might happen will cause the value
of gold to rise considerably.
7. Today's fiat currencies are unfair. For example,
because the U.S. issues the world's reserve currency, the rest
of the world sends the U.S. real goods and services and just
receives bits of paper or electronic bookkeeping entries in return—many
ships travel to the U.S. full of goods, but return half empty.
8. Governments and central banks have been suppressing
the price of gold since 1995 by lending and selling their gold.
They won't be able to keep it up forever. Then the price of gold
and silver will soar.
9. The pressures of enormous debts will increasingly
tempt the United States to inflate the it's dollar so much that
it will become almost worthless. In order that the debts can
easily be repaid in near-worthless dollars. Gold will
gain as the falling U.S. dollar destroys trust in fiat currencies.
10. The finance industry and governments have promoted fiat
currencies at the expense of gold in the public's mind for decades.
From here, the investing public's attitude to gold can only become
more positive.
Details
1. Gold is more than just another commodity,
it's a currency. It is THE currency that evolved in the marketplace
over the last 5,000 years.
Gold was the main currency in most of Europe, Asia and the Americas for most
of the last few thousand years, up until 1971. Silver was also widely used,
though to a lesser extent.
Gold evolved independently as money in the world's main civilizations,
because it is:
1. Rare
About 5 parts per billion of the earth's crust. Difficult and
expensive to mine.
2. Indestructible
It does not tarnish or decay.
3. Compact
If all the gold ever mined were made into a solid block whose
base was the size of a football field, then it would be about
1.5 meters (5 feet) high.
4. Malleable and divisible
You can easily reshape it, flatten it, and divide it into tiny
pieces.
5. Hard to find
The amount of mined gold has increased very slowly. Rarely more
than 2% per year.
Until 1971, government currencies were
backed by gold. You could, at any time, exchange a unit of
any of the world's main government currencies (such as a dollar,
a yen, a pound, or a rupee) for a prescribed amount of gold.
Currency notes were just certificates for various weights of
gold. For example, from 1934 to 1971 you could exchange 35
US dollars for one ounce of gold.
Progressively from
1913 to 1971 governments withdrew the right to exchange government
currency for gold. For example, from 1944 to 1971 a non-U.S.
currency unit (such as a yen or a pound) could only be exchanged
for U.S. dollars, and only national governments could go to the
U.S. government to exchange those U.S. dollars for gold.
In
1971 President Nixon of the United States broke that nation's
promise to always exchange 35 U.S. dollars for an ounce of
gold. Since then the world's government currencies have been ‘fiat'
currencies (see point 2 below)— they are not defined as a
weight of gold, they have no connection to any commodity
or anything tangible, and they are only worth what someone
else is prepared to trade for them. The fiat currencies now ‘float'
against one another, with their relative values going up
and down with economic trends or fashions.
The only
significant use of gold today is for investment, that is,
as a currency or a store of value. This includes jewelry—the
fundamental purpose of gold jewelry is to store something valuable
in your personal safekeeping. Gold has some non-investment uses
such as in electronics, but the amount of gold used in these
ways is relatively tiny. Almost all the gold ever mined is still
in use today. Silver is different—the industrial uses of silver
(photography, utensils, medicinal, electronics) outweigh its
investment use, and much of the silver ever mined has been effectively
lost because it is hard to recover.
2. Gold and silver are the only currencies not created
and controlled by governments. All of today's other currencies
(dollars, euros, yen, pounds, renminbis, rupees, etc) are ‘fiat'
currencies, which means they do not represent anything tangible
but are only worth something due to government decree (namely
legal tender laws).
All today's government
currencies are ‘fiat' currencies. A fiat
currency is defined and created by a government. It is given
meaning only by legal tender laws, national laws that say that
the fiat currency has to be accepted as payment in that country,
and thus force people to use the fiat currency.
The
term ‘fiat currency' came about because the legal tender
laws that give it value are a ‘fiat' (or authoritative pronouncement)
of government. A fiat currency is a currency brought into existence
by government decree (that is, by fiat).
The value
of gold, on the other hand, is independent of any government
laws. Unlike fiat currencies, gold is accepted as valuable
without needing protection by laws.
3. Governments always end up creating too
much fiat currency out of thin air. All fiat currencies in
the past have ended up worth very little, collapsing into hyperinflation
or threatening to. All of today's fiat currencies have been
fiat currencies for less than 34 years (all government currencies
were convertible to gold until 1971).
Fiat
currency is created at the whim of politicians and bureaucrats.
History's lesson on this point is clear: those in charge of
a fiat currency always, eventually, due to some urgent government
priority, create too much of the currency and it becomes worth
less, and ultimately worthless.
As a government creates
more of its fiat currency then there is an increasing amount
of currency to pay for the same amount of goods and services,
so the prices of the goods and services rises. The increase
in the quantity of currency is called ‘inflation',
and the consequent rise in prices is measured to some degree
by the CPI (consumer price index). The ‘value' of a currency
(how many goods and services a unit of the currency can buy)
depends, in the long run, on how much the country's government
inflates its currency.
Gold, on the other hand, treats everyone
equally. Unlike fiat currency, no one can conjure gold up
out of thin air to spend for themselves and get others to do
their bidding. Gold has to be mined, ounce by hard-won ounce.
Because the supply of gold can only ever increase slowly, prices
in terms of gold tend to stay roughly constant for centuries—changing
mainly due to technological influences that make some goods
relatively easier or harder to make.
There have been hundreds
of fiat currencies in the past, in various countries at various
times. In every single case, the currency eventually became
worth much less and was abandoned because the people in charge
of making it eventually succumbed to the temptation of making
far too much of it.
Examples of fiat currencies include:
1. Chinese bark currency (notes printed on tree
bark, as recorded by Marco Polo), 1260 – 1360. One of the earliest
fiat currencies, ended in hyperinflation.
2. Banque Royale Notes in France, the ‘Mississippi
system' (designed by John Law). Issued in 1716. Collapsed worth
nothing by 1720.
3. Continental bills, printed by the US Congress
during the American Revolution. Began issue in 1775, shrank to
1/40 of their original value by 1780. Hence the saying ‘not worth
a Continental'.
4. Assignats in France during the French Revolution.
Issued 1790–1796, collapsed to 1/600 of their original value
by 1797.
5. Marks in Weimar Germany, after WWI. Issued from
1919 to 1924, collapsed to three trillionths of their original
value. This was the currency that was carried in wheelbarrows
towards the end.
The only fiat currencies that have not collapsed
are today's fiat currencies (that is, none of the hundreds
of previous fiat currencies ceased to be legal tender without
first undergoing a massive loss of value). All of those currencies
effectively became fiat currencies in 1971, when the United
States abandoned its commitment to pay 35 U.S. dollars for an
ounce of gold (see reason
1, above). In the decades prior to 1971 there were no fiat currencies,
because each currency unit was ultimately defined as a certain
weight of gold.
In 1971 a U.S. dollar was worth 1/35 of an ounce
of gold. Today it is worth less than a tenth of that, about
1/400 of an ounce of gold (because gold is about US$400 per ounce).
From an historical perspective, the only question is how
quickly the U.S. dollar loses value, not whether it will
continue to lose value.
4. The rate of creation of fiat currency
accelerated markedly in 1995, leading to today's worldwide bubble in
asset prices. In September 2003 the rate started to slow, suggesting
that the bubble might end soon.
The world's main currency
and the currency used for most international transactions
is the U.S. dollar. Vast amounts of US dollars are used outside
the United States. All countries hold the US dollar as their
main reserve currency. The health of the world's economy
depends on the U.S. dollar.
In 1995 the number of U.S. dollars
started increasing quite markedly. The evidence is here in
these monthly money supply statistics and graphs.
http://www.economagic.com/em-cgi/data.exe/fedstl/m3ns+1
http://www.economagic.com/chartg/fedstl/m3ns.gif
(‘M3 money supply' is about the best measure of the number of
U.S. dollars, albeit imperfect. NSA means ‘non-seasonally adjusted'.
It is the ‘hidden' money supply increase, the M3 increase less
than the CPI, which is most relevant to bubble formation—because
the extra money raises prices of items that are not well represented
in the CPI, principally assets such as bonds, stocks, and housing.
High M3 growth rates prior to 1990 were matched by similar CPI
rates—they did not lead to bubbles because the rising prices
were plainly visible in the CPI and monetary authorities were
forced to take appropriate actions.)
In the early 1990's
the money supply increased at about the CPI, just a few percent
per year at most. But from 1995 to September 2003 the number
of U.S. dollars increased at about 8% per year, far faster
than the combined rates of increase of goods and services and
of the CPI. This extra currency flowed into buying assets, thereby,
pushing up asset prices. In a bubble, the principle supply-or-demand
factor is the oversupply of currency. Similar increases in
the amount of currency occurred in most of the world's fiat currencies,
and a worldwide bubble in asset prices developed. As of early
2004, the prices of real estate, stocks, and bonds are all
well above historical norms.
Starting in September 2003
the rate of increase in the number of US dollars has slowed
to about 4% per year. A bubble requires rising asset prices to
be maintained, because once a belief develops that asset prices
are not rising then many people sell assets to repay the borrowed
currency they used to buy those assets. Historically, bubbles
usually end shortly after the flow of currency into the assets
stops or reverses. The data thus suggests that the bubble may
end in late 2004 or early 2008.
5. In the pain
of the post-bubble period, governments will come under pressure
to return to backing their currencies with gold.
This requires some understanding of the current fiat currency
systems, and how the current bubble came about.
How today's fiat currency systems work
In all the world's fiat currency systems, all currency is technically
created by the act of borrowing. Currency is initially created
by the government borrowing currency from its central bank (or ‘reserve'
bank), which the central bank creates out of thin air (the act
of borrowing is inseparable from the act of creating the currency
out of thin air, so we say the currency is ‘created by borrowing').
All other currency is created by someone borrowing from a bank:
- About
90% of deposits made to a bank can be lent out by the bank.
This system is called ‘fractional reserve banking',
because the bank retains a fraction of deposits as a reserve
then lends out the rest.
- The depositors effectively still
have their currency in the bank, while borrowers also have
currency to spend. Hence, borrowing creates new currency.
- The
borrowed currency generally ends up as a deposit in a bank,
where 90% of it can be lent out again. And so on. In this
manner, for each dollar that is deposited, $10 worth of loans
are eventually created by the banking system.
- The system is safe
enough as long as not too many bank depositors withdraw their
currency at once.
By the way, ‘printing' only creates physical notes or coins to be substituted
as required for the currency created by borrowing—printing does not actually
create the currency. Most currency exists as numbers in bank accounts.
Thus:
- All fiat currency is someone's debt. Someone out
there is paying interest on every unit of fiat currency.
- A
fiat currency is essentially a system of IOU's. A system
of credit.
- Lower interest rates encourage borrowing and thus
increase the rate of growth in the amount of currency (which
causes some prices to increase).
- Higher interest rates discourage
borrowing and thus decrease the rate of growth in the amount
of currency (which causes some prices to decrease).
- The amount
of currency owing on loans (the amounts borrowed plus interest)
is more than the total amount
of the fiat currency in existence (the amounts borrowed). So
either the amount of fiat currency must continually increase,
or there will be many failures to repay loans. A fiat currency
system must expand to survive.
Governments, via their central banks, set short term interest rates, essentially
by decree. Due to fractional reserve banking, the amount of money expands
or contracts in response. Consequently, we get the ‘business cycle'. More
borrowing creates more currency, so prices start to rise, so the government
increases interest rates, borrowing decreases, which reduces the rate
of growth in the amount of currency, prices fall, the government decreases
interest rates, more borrowing occurs, more currency is created, … and
so on. This is normal, but today's bubble is not like this.
The current bubble
The current bubble started in 1995 when the government of the
United States and then some other countries lowered their interest
rates and left them low. The amount of US dollars increased by
8% per year over 1995–2003, and the amount of the goods and services
increased by about 3% each year, implying about a 5% per year
increase in prices due to the extra currency. However, U.S. CPI
only increased at about 1% per year over this period, because:
- The CPI only measures a narrow range of goods and
services, many of which became cheaper in 1995–2003. This
happened because of a couple of reasons (a) their manufacture
switched, for example, from the U.S. to China, and (b)
the retail chain became more efficient (for example, Walmart).
- The U.S. government changed the methods
used to calculate the CPI in about 1996, so as to reduce
CPI increases. The most significant of these is ‘hedonic'
calculations for computers, which alone reduced the U.S.
CPI increases by at least 20% during 1997–2003. (The justification
for hedonic calculations is to correct for qualitative
improvements. For example, a 1,000 MHz computer bought
in 2001 for $1,000 is considered to be ten times as much
computer as a 100 MHz computer bought in 1997 for $1,000,
so the CPI component for computers shows prices plummeting
by 90% over the period. Of course, to buy a computer to
write articles like this with still cost me $1,000, so
the computer part of my cost of living stayed the same.)
Another significant change is a system of simply lowering
the weighting in the CPI of items whose prices are going
up the quickest.
So which prices went up? The extra newly created currency was used to bid up
asset prices. First stocks and bonds then real estate. Rising asset prices
encouraged people to borrow to buy more assets, and that newly created currency
further increased asset prices. A bubble developed. However, the central
banks, particularly the US Federal Reserve under Alan Greenspan, did not
raise interest rates to slow the rate of currency production. On the contrary,
in response to various problems such as the Asian Crisis or the stock market
fall of 2000, Greenspan acted to increase the number of US dollars.
As
of early 2004, we now have the world's biggest bubble ever. Biggest by
amount of assets (measured in any sensible way you like), biggest
in scope (worldwide), and one of the most extreme (measured in
terms of ratios such as debt to GDP or stock PE's).
The
bubble is built on debt. The currency brought into existence
to bid up the asset prices is all debt. There are record amounts
of debt in every sector of Western societies today; the ratio
of debt to GDP in the West is substantially higher than it
was in 1929. There is now so much debt that the central banks
can no longer raise interest rates substantially without bankrupting
much of the population. We are past the point of no return.
The central banks can no longer stop the bubble, they have to
let it run its course. When no one has enough confidence or collateral
to borrow any more currency then the bubble has to end, because
asset prices cannot rise any further.
When the bubble
bursts, asset prices will fall. Many people will find that
their assets sell for less currency than they borrowed to
buy those assets, and they won't be able to repay their debts.
Fire sales of assets will lower asset prices further, making
the problem worse and more widespread.
Where we are now
Governments are currently
attempting to postpone the bursting of the bubble by creating
more fiat currency. To date they have been successful: the
bubble did not burst even in 2000 when stock markets fell severely,
as evidenced by the growth rate of 9% that year in the number
of US dollars (see the US money supply statistics in point
4). As the size and duration of the bubble grows, efforts to
keep the bubble growing need to become more extreme—for example,
worldwide interest rates are at record lows.
The
problem for governments is to increase the amount of fiat currency
fast enough to stop the bubble from busting, while maintaining
people's confidence in its value. The principal objective of
creating more fiat currency is to keep both short and long term
interest rates low. The principal means of maintaining confidence
is to promote the CPI as a measure of fiat currency unit purchasing
power, while altering the CPI calculations so as to disguise the loss of
purchasing power. Until 1990 or so, the CPI measured the growth of money
supply, but after that they have increasingly diverged—the CPI
now greatly underestimates the growth in fiat currency and thus
its loss in purchasing power.
If
the bubble bursts and the money supply growth rate goes negative then
we will get deflation. There won't be enough currency in the
economy to repay debts, and asset prices will fall. This is what
happened in the Great Depression of the 1930's. The economy
really suffered and unemployment was very high.
If government
measures to create more fiat currency to keep the bubble going
are too successful, or people lose confidence in the continuing
value of the fiat currency because the CPI increases significantly,
then we will tend to see hyperinflation, as
ever-increasing amounts of fiat currency are required. Most
fiat currencies in the past have ended in hyperinflation. Hyperinflation
destroys savings and jobs.
If governments can create enough, but not
too much, new fiat currency, while maintaining people's belief in the
continuing value of fiat currencies by increasing the CPI only
slightly or slowly, then they will successfully have steered
between deflation on one side and hyperinflation on the other.
They have steered this course for the last few years, but it
is becoming increasingly difficult. The bubble damages the real
economy by misallocating resources, so unemployment creeps up.
The CPI will creep up eventually due to the extra fiat currency
and the dynamics of international trade. Simultaneous high unemployment
and high CPI rises are a phenomenon known as ‘stagflation',
which we saw in the 1970's and which was ultimately cured by raising interest
rates to over 15%. However due to today's high debt levels, such high interest
rates are politically unacceptable.
Reforms to prevent a disastrous bubble from happening
again
The economic pain, like the current bubble, will be
huge. Many voters will have more debt than they can handle.
This will lead to a huge political urge to do something.
Interest
rates could be set by the market, not by bureaucrats. A historical
lesson of the old Soviet Union is that its economy failed largely
because bureaucrats could not set prices properly. In a market
economy, a price is a mechanism that combines all the relevant
information about the item into a single number. The price
reflects all the factors of supply and demand, and rations the
use of items to those willing to pay for them. The Soviet economy
did not fail because its bureaucrats were stupid or lazy, but
because it was just not humanly possible to know all the relevant
information and to combine it properly to come up with a price
that results in a good outcome for the economy. Without good
pricing, people waste time and effort doing the wrong things.
Markets, however, perform this function automatically and well,
without bureaucratic interference, and have done for centuries.
The
most important price in today's economies is the price of currency—the
interest rate. High interest rates are a high price for new currency, and
low interest rates mean new currency is cheap. In today's fiat
currency systems, even in the western so-called ‘market' economies,
interest rates are decreed by a bureaucrat or politician. (Actually
it is short term interest rates that are set by decree. Although
long term interest rates are set by the bond market, they are
heavily influenced by the central banks.) For example, in the
United States the Federal Reserve under Alan Greenspan
sets interest rates. The current bubble developed because those
in charge of setting interest rates set them too low for too
long. The political advantages of low interest rates are compelling
in the short term: an expanding economy, extra spending power
for voters willing to borrow, and rising asset prices.
If we
are going to persist with using fiat currencies, the most important and
basic reform is to use a market mechanism to set interest rates.
However, for various technical reasons (to do with synchronizing
the interest rates charged by different banks and homogenizing
the currencies issued by different banks into one currency) it
is difficult to use a market mechanism to set interest rates
in a fiat currency system.
Modern central banks have
been around since before 1700, and virtually every type of
fiat currency experiment has been tried and rejected before.
For example, Andrew Jackson won the U.S. presidential election
in 1832 on a platform of eliminating the third central bank of
the United States (today's U.S. Federal Reserve, which started
in 1913, is the fourth central bank in the U.S., the
previous three failed and were abandoned). There is nothing essentially
new about today's system, except its worldwide reach. So, perhaps
we should consider a return to the centuries-old practice of
backing our currencies with gold.
It will take something of a
crisis before we return to gold-backed currencies, because
the finance industry and governments will resist it mightily.
But the aftermath of the current bubble may provide enough of
a crisis.
6. Returning to currencies backed by gold is
practical. Even the possibility that it might happen will cause
the value of gold to rise considerably.
All
the world's government currencies were backed by gold in
the decades to 1971: a unit of government currency theoretically
represented a certain weight of gold, and under the right conditions
could be exchanged on demand for that amount of gold.
We
could return to that system. We would continue to use the
current notes and coins, continue to use credit and debit cards,
continue to order over the telephone or internet, and continue
to use other electronic financial transactions. It is very unlikely
we would ever use a gold coin for buying anything, just as
we didn't use gold coins for decades before 1971.
The
only difference would be that the notes and coins and amounts
of currency would represent gold—and could, on demand,
be exchanged for gold by banks or government. This would have
consequences:
- All the world would be on one currency, gold. Currencies
would no longer float against one another, so foreign currency
exchanges, currency risk, currency hedging, and currency
speculation would disappear (except perhaps for changing notes
and coins at borders). A nation's industries would no longer
risk losing their export markets because of fluctuations on
the foreign exchange markets. The finance industry would lose
a large source of easy income, but everyone else would benefit.
- Governments
would not be able to create new currency at whim. They would
have to repay their loans. Everyone else would benefit through
lower inflation (inflation is a hidden tax that acts by eroding
the value of any currency we have).
- The amount of currency
could no longer expand faster than about 2% per year (see
reason 1), so inflation would be very low, bubbles would
be much less likely to occur, and economy-wide bubbles
could not occur. Prices throughout the economy would be more
stable than under the current system.
- Interest rates could
be set by market forces, as they were until WWI. The financial
history of the decades prior to WWI strongly suggests that
interest rates would be more stable than the last few decades.
If the world returned to gold-backed currencies, the value of gold would rise.
If the U.S. were to back its current number of dollars (about U.S.$9 trillion)
with its current gold reserves (about 8,150 tonnes), the price of gold would
be about U.S. $34,000 per ounce! This figure is only a rough indication,
because the U.S. government might not fully back each dollar, or the amount
of U.S. dollars or U.S. gold might change between now and a return to the
gold standard.
Even
if the world doesn't return to gold-backed currencies, the possibility
that some or all countries might return to the gold standard
will send gold prices much higher as the bubble ends. In 1980
the slight prospect of a return to the gold standard (which did
not eventuate then) caused the gold price to rise to about U.S.
$880 per ounce, which is equivalent to about U.S. $3,400 per
ounce in today's dollars.
Don't confuse value with price in
U.S. dollars. Today an ounce of gold buys about 150 Big Macs
in the U.S.. In the event that the price of gold goes to U.S.
$20,000 per ounce (a fifty-fold increase), it may be that an
ounce of gold only buys 750 Big Macs (a five-fold increase).
7.
Today's fiat currencies are unfair. For example, because the
U.S. issues the world's reserve currency, the rest of the world
sends the U.S. real goods and services and just receives bits
of paper or electronic bookkeeping entries in return—many
ships travel to the U.S. full of goods, but return half empty.
Most
of us have to exchange our labor to get currency, and gold
miners have to go to a lot of effort to mine gold. But some
people in the economy (namely the government and the central
bank) have the privilege to create currency out of thin air,
effortlessly, thereby acquiring much power. Is that fair
or desirable?
Newly created money buys things at the price
levels that exist when the money is created and spent. But
that extra money raises the general price level, so the currency
saved by others loses value. Things are more expensive when
they later go and spend their money. So fiat currencies favor borrowing
at the expense of saving. It is no coincidence that every sector
of western societies is at record debt levels as of early 2004.
How fair or wise is a system that favors debt over saving?
The
United States manufactures the world's reserve currency, the
U.S. dollar. Governments of countries all around the world
hold vast numbers of U.S. dollars as currency reserves, needed
for international trade. To get those U.S. dollars, those countries
had to send real goods and services to the United States, and
the United States sent them U.S. dollars in the form of electronic
bookkeeping entries or bits of paper (notes and bonds). So the
United States gets massive amounts of goods and services in return
for a few pieces of paper or electronic bookkeeping entries—just
because the U.S. dollar is the world currency. Currently many
ships are arriving at the U.S. loaded full of goods, but return
from the U.S. half empty or with low-value back-fill loads. Is
it a coincidence that the United States is the world's richest
country and can afford the world's biggest military forces? Is
that fair or right?
People or countries that feel these
aspects of the fiat currency system are unfair will welcome
(indeed, insist upon) a return to the gold standard. Moves in
this direction have already been made recently by Malaysia.
8.
Governments and central banks have been suppressing the price
of gold since 1995 by lending and selling their gold. They
won't be able to keep it up forever. Then the price of gold
and silver will soar.
Governments
and central banks routinely intervene in currency markets.
They generally don't acknowledge that they are manipulating
the market while they are doing it, because that would dilute
the effect of the intervention. However they usually acknowledge
their interventions after the fact—it's not a secret, and is
considered normal by everyone connected with currency markets.
Gold and silver are currencies, albeit private currencies.
Governments and central banks have routinely intervened in
the gold and silver markets in the past, so it is reasonable
to assume they might be doing so now. They don't directly and
comprehensively deny it.
Governments benefit from the
use of their fiat currencies. All the government currencies
are thus in competition with gold and silver. Governments
have an interest in promoting fiat currencies against gold and
silver, that
is, an interest in lowering the prices of gold and silver.
The competition between gold and the U.S. dollar is particularly
intense, because the United States gains great advantage
by the use of the U.S. dollar as the world's reserve currency
(see reason 7 above).
Thus governments, particularly the
U.S. Government, have the means, the motivation, and a track
record of suppressing the price of gold and silver. It would
be standard practice for them to suppress the price of gold
and silver but not acknowledge it.
In 1995, governments,
through their central banks, owned about 25% of the world's
mined gold, about 32,000 tonnes. There is a lot of evidence
to suggest (for example, see http://gata.org/ )
that the central banks have been lending their gold to bullion
banks on long-term leases, who then sold the gold on the open
market, which lowered the price of gold. The IMF even changed
its rules for reporting central bank gold holdings in about 1997
so that the central banks no longer had to distinguish between
how much gold they physically have and how much they have lent out. They
just report both categories combined as how much they ‘own'.
This word game allows the central banks to hide the extent
of their gold lending. For example, Australia reports that
it ‘owns' about 79.9 tonnes of gold, but there are
only a few bars of gold left in the Australian central bank because nearly
all of it has been lent out.
The gold lent out by central banks has been
sold at the retail level, largely in India. The bullion banks who owe the
gold to the central banks will have to buy the gold on the open market
when it comes time to repay the gold. Either this will force
the price of gold up, or, because they don't want the price
of gold to soar, the central banks will allow the lenders to
repay in fiat currency rather than in gold. The lent gold will
probably not be recovered from the individuals in India etc.
who now wear it as jewelry. Thus much of the gold lent out by
central banks will probably never be repaid as gold. Official
sales of central bank gold nowadays are often just a matter of
the bank receiving fiat currency for gold that they previously
lent out.
The amount of gold lent out by the central banks
since 1995 is hard to estimate without official figures (of
which there are few), but is probably about 15,000 tonnes, or
about half of the gold that the central banks say they now ‘own'.
Spread over the nine years 1995–2004, that's about 1,700 tonnes
per year. Annual ‘consumption' of gold per year is only about 4,700 tonnes
per year (the gold is mainly used in jewelry, but very little of it is
actually lost forever from circulation), and the annual production of gold
from mining and scrap is about 3,400 tonnes per year. So the surreptitious
sale of 1,700 tonnes per year due to central bank lending would have had
a large downward effect on the price of gold in that period.
For various
reasons nearly all the remaining gold in the central banks simply cannot
be lent out. There are indications that the central banks are already
scraping the bottom of the barrel. As the central banks run out
of physical gold to sell, the market price of gold will rise.
The gold price rises of the last year suggests that this has
already started.
It appears that the Western governments
have effectively been selling their gold reserves at artificially
low prices to people in Asia, particularly India, in order
to promote their fiat currencies at the expense of gold. If the
West is forced by the failure of its fiat currencies to return
to gold-backed currencies, it may have to offer a lot to the
gold owners in Asia to get that gold back again—that is, the
value of gold will rise considerably.
9. The pressures
of enormous debts will increasingly tempt the United States
to inflate the U.S. dollar so much that it will become almost
worthless, in order that the debts can be easily repaid in
near-worthless dollars. Gold will gain as the falling U.S.
dollar destroys trust in fiat currencies.
Many
people and organizations in the United States are deeply
in debt.
The net present value of the unfunded liabilities of
the U.S. Government is over U.S. $44 trillion, which is the
value of everything produced in the world for about a year and
half, or about four times the yearly GDP of the United States.
To pay these liabilities, the U.S. government would have to raise
income taxes by 69% indefinitely, or cut all Social Security
and Medicare benefits by 56% indefinitely. In addition, the debt
of the U.S. Government is about U.S. $7 trillion, increasing
by about half a trillion each year. The current account deficit
of the U.S. is another half a trillion per year. Or, per person
in the United States: U.S. $150,000 of unfunded liabilities,
$25,000 of federal debt, and $1,700 of extra federal debt and
$1,700 of current account deficit per year. And there are state
debts too. In addition, the ratio of private debt to GDP is at
a record high, even higher than in 1929.
But the United States has an ace up
its sleeve: nearly all that debt is denominated in U.S. dollars.
If the meaning of a ‘U.S. dollar'
were to change to something worth very little, then most of
that debt could be painlessly repaid (but not all of the debt.
Many of the unfunded liabilities of the U.S. government are
tied to the cost of living, so they could not be escaped so
easily). That is, because much of those debts are in terms
of nominal U.S. dollars, if the U.S. dollar became worth very
little then much of the debts could be easily repaid. For example,
if you borrow U.S. $100,000 in 2003 when you are earning U.S.
$40,000 per year, you have a large debt. But if the U.S. dollar
inflates 100-fold by 2013 your income might be around U.S.
$4,000,000 per year, and repaying that U.S. $100,000 will be
easy. (However U.S. $100,000 in 2003 would buy 37,000 Big Macs,
but only 370 Big Macs in 2013.)
At the moment, the United States gains greatly by having
a U.S. dollar that is worth a lot and is used as the world's
reserve currency—because the United
States exchanges a few bits of paper for massive amounts of real goods
and services (reason 8). But the debt being incurred by U.S.
voters is huge and growing quickly. Eventually the gain from
supplying the world's reserve currency will be outweighed
by the pain of the interest and repayments on the debts.
At some point in the future, the only rational course for
the United States will be to cause its dollar to be worth
as little as possible.
The
way for the United States to make its currency unit worth very little
is to inflate it dramatically, that is, to increase the number
of U.S. dollars enormously. It would start down this path by
reducing interest rates towards zero, to encourage as much borrowing
and thus currency creation as possible. A next step would be
for the government to create new money out of thin air to pay
some of its bills. Both of these trends are already underway.
Repayment
of those debts would be in name only, a technicality, because
the value of the repayment as measured in say gold or Big Macs
would be tiny compared to the original value of those debts.
The lenders would feel ripped off. Only the United States has
this option, because it provides the world's reserve currency.
If the U.S. Government can bring this off, it will be the world's
biggest ever financial scam by several orders of magnitude.
The next few years might be, as the Chinese say, ‘interesting'.
The
effect on commerce of this maneuver would be to scare people
off fiat currencies for decades. No one would write a future
contract in terms of a fiat currency. Only tangibles would
be accepted, preferably gold. The world would return to a full
classical gold standard very quickly. The value of gold would
rise as dramatically as the value of the US dollar would fall.
10.
The finance industry and governments have promoted fiat currencies
at the expense of gold in the public's mind for decades. From
here, the investing public's attitude to gold can only become
more positive.
Gold and silver have been
in competition with the fiat currencies (especially the U.S.
dollar) since 1971, and to a lesser extent since 1913. There
is a great deal of power at stake. They say that “all's fair
in love and war”, but perhaps they should
amend that to “all's fair in love, war, and high finance”.
The finance industry and, to a lesser extent, governments
would be the losers in a return to gold-backed currencies.
The rest of us would be winners. With some of their power
at stake, you might suspect that those in the finance industry
and government would exaggerate, obscure, or deceive when
it comes to gold and currencies. By Dr. Evans citigold.com
Continue
Tutorial >>
|