Every time there is an article about gold warning about a possible bubble, a cohort of gold worshipers (an activity which, by the way, is frowned upon by the Old Testament God) answer that gold has maintained its value for 3,000 years, or 5,000 years, and so on.
They will give you impressive and unsubstantiated (also useless) figures. They will say, a chicken was worth 1 Talent in the I Century and it is worth 1 Talent now. For argument’s sake, I will admit that they are right, and that the data has an origin that is higher than their collective asses. A commenter in the blog brought up the all important information that “A chicken 1400 years ago cost 1 gold dirham – today it still costs 1 gold dirham” (you can see the complete comment here). This argument has a number of problems, the first, and more obvious one, is that 1 dirham weighs 3.2 grams and the gram of gold is worth today $29.45 US Dollars, which brings the price of that mythical chicken to 94.4 US Dollars. Now, I buy my chicken at Whole Foods, and not even they dare to charge $94.4 for one chicken.
But that is not actually the problem. Maybe chickens were worth, historically, not 1 dirham (and that was an honest mistake) but a twentieth of a dirham, and the relationship has been always the same. The actual problem is that, even at a twentieth of dirham, the argument that gold maintains its value is dishonest, and can only be sustained through lies, and by throwing in data to that can’t be easily disproved.
For argument’s sake, I will assume that 1 chicken equals 1 dirham, and it is worth $94.4 dollars. The problem with this argument is that the same chicken was worth $94.4 dollars in 1980. If the price of the chicken almost 30 years ago is the same as today, it means that over the past 30 years we haven’t had any inflation in dollars at all. That’s a pretty neat fantasy, but a fantasy nonetheless.
The other problem with the argument is that unless you can eat gold, you are better off buying chickens; after all, if you buy a chicken you will have always 1 dirham of gold. Better yet, if you want to speculate in gold, ask your employer and your customers to pay you in chickens. Absurd as it sounds, that’s the logical conclusion of the argument of the constant value of gold.
Now, my question is whether it is a series of honest errors, the lucubration of imaginative minds, or a scam perpetrated by gold hoarders who bought gold at $800 in 1980-81, and now need it to be worth $2000 to make their money back. The good guy in me says that it is just a series of compounded misconceptions; the cynic in me says that it is a scam perpetrated by a small group of gold speculators who are trying to inflate the price of gold for their own benefit, disregarding the consequences.
So, let’s sort out the fiction and reality of the gold thing.
- Gold is not related in any way to the Dollar. It has not been since Richard Nixon broke the last connection between gold and the dollar in 1972.
- Gold has no “inherent” value other than the market value. That value fluctuates.
- Gold is not money. It was, but it is not money anymore.
- Gold may become money again, but that’s speculation, not fact.
- Some international transactions are still conducted in gold, but are based, for practical reasons, on the relative price of gold in the different currencies, and not in the value of gold.
The gold scammers claim that gold has a constant value -which I just proved is not true- and that there is a relationship between gold and currency, which is a falsehood. The problem with those two assertions is that they create the conditions for the mass psychology phenomenon of inflation.
By now, almost everybody starts to understand how financial bubbles work: People bid higher prices on the expectation that those prices are going to be higher in the future. For a bubble to form you need two conditions: The mass conviction that the price of something will be higher in the future, and readily available initial money to be able to bid the price higher.
The following explanation is slightly more complex, but bear with me, because, once you get it, you will be better off.
Once the bubble starts, the second condition is not necessary anymore, the bubble starts to feed upon itself. I’ll give you an example with the housing bubble.
You buy a house for $100,000 with $10,000 down (10% down) and you pay 5% on the $90,000 you owe to the bank. You sell it for $150,000 and now you have $50,000 to buy a $500,000 house with 10% down, now you pay 5% on the $450,000 you owe to the bank. You are happy, and the bank is happy because, while you paid $4,500 in interest before, you now pay $27,000. No problem, you say, because you are going to hold on to that house for a short time and you are going to sell it for $1,000,000 (you have the conviction that the price is going to be higher in the future). Now, the bubble keeps going, and you sell the house for $1,000,000. Now you can buy yourself a neat $10,000,000 home, for which you will pay $77,000 in interests to the bank.
As you can see, you went from a cost of leverage of $4,500 to a cost of leverage of $77,000, in other words, you are overleveraged, and any blip now will force you to liquidate the $10,000,000 home. That same blip will force other overleveraged players to liquidate at the same time as you, and now everybody will be betting the price of the goods lower in order to be able to exit the market before it goes even lower.
For the bank, each one of those transactions was a good transaction: you were never a subprime borrower, and you always had 10% of equity in your home. If you were a subprime borrower the problem only compounds, but your initial liquidity is not the problem, the problem is the conviction of the public and the banks that the prices of homes will go up forever.
The bubble creates the money to feed the bubble until the bubble players are so leveraged that their gains are not enough to service the debt of the leverage.
Now that you understand the bubbles, let’s move to the inflationary process.
General inflation (in my opinion, and this can be hotly argued) is just a bubble of each and every asset. It can be triggered for many reasons, and there is no particular reason over others to trigger inflation. Inflation can be triggered by an initial scarcity of goods, which convince the public that, since there are not many goods, their prices are going to be higher in the future. In general the inflationary bubble is triggered by disequilibrium between the amount of money at hand, and the amount of goods for sale. But that’s not the origin or the cause of inflation, just the trigger.
My problem with the two main arguments of the gold scammers is that if enough people believe them, they will become part of the next bubble, a bubble of all assets which will ultimately destroy large quantities of real value. Now, I know by experience that arguments like mine are likely to be completely useless to counter the mounting strength of an inflationary tsunami. I know that if we enter a period of high inflation, everybody will feel left out of the game if they don’t buy something that is perceived as a candidate for higher prices in the near future. During that period, the scammers of today will feel vindicated, and will be finally be able to unload the gold they bought in 1980 at $2000 current dollars.
What is important for me is that the general public understands that there is no reality behind the process -or fundamental reasons, or eternal periods of inflation. The inflationary bubble, once formed, will burst, and only those who understand how bubbles form and burst will be able to obtain some gain from them.
When the inflationary bubble bursts, we will enter a period of general deflation of all assets which may be nasty (like the 1929-1942 periods) or relatively benign (like the 1980-2000 periods). It is impossible to tell which, right now, but you must understand that those committed to a certain fundamental fantasy will spend the 20 post bubble years peddling a commodity nobody is interested in buying.
This article is part of the series "Documenting The Hyperinflationary Genesis"
- Bernanke’s creative solution: Let’s do it again
- At a financial crossroads
- How to survive hyperinflation
- Let the party begin. We will be dead tomorrow
- I have $ 100,000,000,000 and yet I can’t retire
- Is the Dow Jones at a new high?
- Stagflation: This Time It Is Different
- The Myth Of Gold as Inflation Hedge
- Is Gold a Hedge Against Excess Liquidity?
- Disposable Personal Income Shows Disturbing Historical Trend
- Things That Go Bump in the Night
- Greenspan: Give Homeowners Financial Aid: Financial News – Yahoo! Finance
- Black Swans, Bell Curves and Stagflation
- The Gold Scam
- And Now They Tell US
- Some Historical Perspective on the Current Recession
- Gold Correction Seems Over
- Gold Chatter
Franklin @ April 20, 2008