Tuesday, January 8, 2008

Gold hard money

Gold is the new global currency

This FT article adds it's 2p worth. "Gold’s rise shows investors are nervous. That is an important message for central banks contemplating interest rate cuts. The Fed must show it is not prepared to allow inflation to take off. Keynes called gold a barbarous relic. It has life left in it. But it is in the interests of business and consumers that its most bullish fans are proved wrong."

Posted by happyrenterz @ 11:19 AM (1022 views)
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20 thoughts on “Gold hard money

  • I really enjoyed yesterdays discussion on this site about how gold will perform in deflation. I found this slightly dated article by Gary North. He questions whether gold is really a hedge against inflation at all. Instead he thinks it is a hedge against deflation. However, then it gets complicated because we have no historical precedent for where we are today.

    “In times of monetary deflation, which meant failing banks, gold did well. It was the safest currency to own. Prices fell in relation to gold coins. So, gold did well in deflations. A detailed article on this is here.
    There is much talk in “gold bug” circles about gold’s performance in a future deflation. All such talk is sheer speculation. There is no historical data to back it up. The following facts make comparisons with the past illegitimate:
    1. Prior to 1933, American banks were allowed to go bankrupt, taking depositors’ balances with them. No longer. The FDIC officially insures deposits up to $100,000.
    2. The United States government was legally obligated to pay a fixed amount of paper money in exchange for an ounce of .999 fine gold. This was a legal price floor for gold.
    3. Gold coins circulated as money. The public was familiar with gold.

    …There is never monetary deflation for as long as 12 consecutive months. A tight-money policy produces recessions, which in turn threaten incumbents. So, we occasionally get a few months of monetary deflation. Then the Federal Reserve returns to the policy of inflation.
    Prices year to year have not dropped in the United States for over half a century. The last time they did, for one year, in 1955, they dropped about one percent.
    Yet throughout the entire period, there have been forecasters who have predicted price deflation. They have been wrong for 50 years. This does not faze them. Then they die.”

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  • One key point to note is that there is a difference between monetary and credit inflation/deflation. The Fed is trying to push credit inflation by dropping rates to make people borrow.

    It can drop rates all it wants, but what if people still don’t borrow? Happened in Japan – they still haven’t recovered from it.

    If we really live in inflationary times, why have US Treasury yields been falling steadily from around 15% since the 70s (which truly was an inflationary period) to under 5% now?

    So the Fed is not printing dollars. Yet.

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  • sold 2 rent 1 says:

    happyrenterz,

    Interesting article by Gary North written 12 months ago.
    With gold at $874 it is looking a bit dated.

    “The further you look into the past the further you see into the future” – Winston churchill.
    And I am looking back all the way to the Big Bang.

    paul,
    Be careful of ETFs and other paper claims on gold. When the sh*t hits the fan you may be standing in the queue like NR customers were.

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  • happyrenterz: Quite right, there is no historical precedent. Deflation never happens in a fiat currency. Here’s why:

    Deflation is a government’s worst nightmare. People delay consumption because they know prices will be cheaper next week or next year. Jobs are lost, the economy suffers, etc. We always think of deflation as meaning falling prices; however it also entails falling salaries. This means borrowers are more likely to default on their repayments – how can you keep paying the mortgage if your salary is falling? When borrowers can’t pay, that means banks are more likely to collapse. That means a lot of savers lose their deposits. Obviously if one bank collapses, it’s likely to cause a run on other banks. Sooner or later the whole thing collapses. That’s why deflation is so bad.

    Another way of looking at it is to say that fractional reserve banking is bad, and savers should accept a degree of risk when they place their money into anything other than zero-interest current accounts. That goes against people’s natural instincts and wouldn’t float politically.

    Overall it’s far easier for the government to just keep inflating. People keep consuming, buying sofas or cars or houses because they expect them to cost more next year. Rising salaries make people feel better, as do rising asset (house+share) prices. Steady moderate inflation induces a false sense of wealth in everyone. Rigging the inflation figure makes everyone feel better: savers think they are getting good interest, workers think they are getting a good raise, and asset buyers feel confident about their purchases.

    That’s why the government will always choose inflation, and that’s why they are more likely than not to choose the inflationary path out of falling house prices. That’s why gold is rising.

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  • @drewster – we have only had a pure fiat system globally for the first time ever since the Nixon abandoned the gold standard in the early 70s. Before that, one or more currencies were always backed by gold.

    Therefore, all you can truly claim is that we have not seen deflation yet. But, in truth, credit deflation is already here. Banks won’t lend to each other. It’s much harder to get a mortgage. This is deflation – don’t be fooled by press talk of inflation.

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  • Gold price looks more toppy – the Apex of the (4th wave) triangle on spot, is on the 10th or 11th Jan. Projecting a parrallel trend line from the fourth wave bottom from the (previous) top at 846 gives a target of 888. That may overshoot a little but then expect a top, failing that wave equality gives $903. So we have a short term target of $888 – $903 in the next few days. From then I’d be out of longs for a while. (would need more action to go short – thats a conservative approach. Of course thats my view not a recommendation!

    @ Drewster – Yes – they know they are in the do do at the moment, which is why i found it strange that a lot of people here were surprised by the last rate cut. However what the Government wants to do, and what happens are 2 separate things. A credit deflation is well deflationary whever self liquidating credit or not. They can offset that by “printing” oney – although these days the Fed does not really create money that way. The question is can Central Banks offset enough and what implications does that have??

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  • Governments would certainly choose inflation over deflation if such a choice was available to them. However, maybe we should not presume that Governments are the ones making these choices. For instance,did Japan choose deflation, or was it forced upon them?

    Massive liquidity injections and -0% real rates did nothing to stop over 16 yrs of deflation there. Nobody could accuse the Government of Japan of not trying to reflate. Even if accepting the BOE might not be as independent as Government would like us to believe it is, what additional tools does the BOE have that the BOJ didn’t?

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  • s2r1, what else can I do with my money? I’m not going to buy property, I’m holding cash and the BoE’s finger is on the “CUT RATES” trigger …

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  • M3 wasnt it Gerald Ford in 1975, rather than Nixon? Dont want to seem pedantic!

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  • happyrenterz says:

    ETF’s hold physical gold and that amount rivals the reserves by states check this for example. But I keep a few krugerrands buried in the garden just in case 😉

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  • happyrenterz says:

    I have bought krugerrands from ATS Bullion in London although you always have a premium on coins above the cost of the gold itself.

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  • @techieman – it was Nixon who closed the so-called gold window on 15 August 1971, forever suspending official convertibility between the dollar and gold. In the Bretton-Woods setup after WWII, all other currencies were backed by the dollar. Therefore , it was at this point that the great fiat currency experiment began.

    Here’s Ron Paul on the subject: http://www.house.gov/paul/congrec/congrec2006/cr021506.htm

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  • happyrenterz says:

    Interesting article on ETFs that, since our paper money is not linked to gold we have made paper/electronic claim that is linked to gold. The government snatching an ETF’s reserves at a price they dictate sounds pretty apocalyptic. But then again that is the whole point of gold I suppose to protect you from this worst case scenario!

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  • M3, techieman, tick tock:
    All three of you correctly pointed out that if governments really controlled inflation, then a situation like Japan’s lost decade would never have occurred. Arguably Japan did print money to try to boost inflation, but the money just wormed its way overseas through the carry trade instead of being invested at home. I’ve just posted an old BusinessWeek article from 2002 on the main blog – it’s about Japan’s deflationary period and it gives a taste of what we might come to expect in the not-too-distant future.

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  • sold 2 rent 1 says:

    From Gary North
    “Gold will do well in a time of price inflation at the double-digit level, but for now, it is subject to the same forces as any other commodity. It is subject to the business cycle.”

    Although price inflation is low the US money supply is growing at 18%. That is why gold is taking off.

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  • sold 2 rent 1 says:

    happyrenterz,

    At least with bullionvault you can choose Zurich as your storage location.
    The other vaults they offer is NY and London.

    The Yanks have form for stealing/getting cheap gold from their citizens.
    Our economy is in really bad shape and I wouldn’t trust GB not to pull a fast one.

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  • sold 2 rent 1 says:

    techieman,

    Any chance of some “Elliott wave” feedback on the comments posted in the thread above this one.

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  • s2r1 – I feel like the cavalry!!! I’ve done a bit but i really havent given the timings quite as much thought – basically because im tied up trying to extricate myself from an obligation (in a futures context)!

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