18 Comments

  1. cyber_rigger April 21, 2008 @ 6:59 pm

    Technology and automation has made things cheaper, even though the inflated money doesn’t show it.

    How much would chicken feed cost if you had to hand plow, hand plant, hand water, hand harvest, hand shuck and dry corn?

    A not even decent computer used to cost several million.

    You need to use an example of something that automation has not made cheaper.

    For example an hour of human labor.

  2. Matt April 21, 2008 @ 10:23 pm

    In 1980 gold was worth $850 U.S per ounce and at that time in a bubble – that’s a fact. All asset classes go from undervalued to fair valued to overvalued. This is not rocket science. Regarding Nixon and the unpegging of the dollar from gold, you are way off the mark. What then happened to the price of gold after he unpegged it and when the U.S almost inflated their currency out of existence – it went from $35 U.S per ounce to $850 U.S per ounce. Gold was simply tracking the equivalent of M3 – do the math. Why did your Government ban the private hoarding of gold? These are not hard questions so please reply. Greenspan and Bernanke understand this so shouldn’t you at least listen to what they have both written and said. There are some gems for hard money economists to investigate further. Please refer to my orginal posting regarding Greenspans comments – which He has gone on record as still confirming as fact. And if gold isn’t money why then instead of issueing your military with U.S federal reserve notes do they each carry gold coins in the event they need to buy there way out of the country they are in – because even the U.S government understands that one day their currency will collapse. It’s as if you have never read a history book or looked outside of your lifetime. There is nothing new under the sun. If you can’t answer my simple questions without going on a tangent you undermine your own credibility.Those involved central banks at the top level have almost all explained how this works in their memoirs, will you disagree with them all? I live outside your borders but do I need to school you as to your own economic history? (by the way enjoying the debate)

  3. Franklin April 22, 2008 @ 8:32 am

    @Matt,
    If gold tracked the equivalent of the M3, the price of gold should have kept rising from 35 to 850, to now about 10,000 or more, because M3 has grown exponentially.
    Check the previous article at http://thepoliticsofdebt.com/?p=231. It tracks the relationship between gold and M1 (not M3 because as you know it is discontinued). The is no correlation between M1 and gold. I may check later with the available M3, but since the las run in gold coincides with the discontinuation of the M3 publication I doubt I will be able to find anything.

    If you refer to the banning of private hoarding of gold during the New Deal, the answer is simple. The FDR administration moved the country from a laizzes fair system (which had failed around the world making peril democracies and in general all capitalist society) to a Keynesian system and used private gold to finance the restructuring of the country’s economy. Had not he had done that, the US would have become either a fascist or socialist country (in other words, right-socialist or left-socialist). I still think that was the right thing to do at the time.

    I did not know they did, but I can understand that the military personnel are issued gold when on a mission, because it is something easy to carry and barter for things you may need. But it is a bartering instrument, not money. Do not confuse both.

    Regarding Greenspan’s comments in 1967: Yes. I do disagree. Greenspan is an economic opportunist and he single handily destroyed more wealth in this country than a horde of rabid monkeys.
    Greenspan says he is for free markets, but he intervened heavily in the economy, given even advice to homeowners to take variable interest rate loans. While he created the conditions for a housing bubble he fed the fire of speculation encouraging the mad expansion of M3 while stopping the publication of the M3 numbers. So, the answer is no. I don’t think Greenspan has anything valuable to say about gold, or credit expansion.

  4. Matt April 22, 2008 @ 10:17 pm

    The fed has gone on record that they have leased gold to supress the price in past days. They don’t report M3 because they don’t want the public to know what’s going on with our money. Gold is playing catch up and will for the next 7, 8, or nine years and then will be in a bubble of it’s own but it has a lot of catch up to make before that happens. You will see $10,000 gold in your lifetime, that i’m sure of. History will prove one of us right and one of us wrong – i’m a patient man and will enjoy that day when it comes.
    Keyenes himself was quite aware as to the destruction he would one day cause by having his theories accepted as fact amongst politicians and in one of his more lucid moments said:
    “Practical men who believe themselves to be quite
    exempt from any intellectual influence, are usually the
    slaves of some defunct economist. Madmen in authority,
    who hear voices in the air, are distilling their frenzy
    from some academic scribbler of a few years back.”
    M3 is still reported from private sources and is easily accessible if enough work is applied. For the record it’s up over 42% in the last two years – that’s money and credit growth into the system that was created out of thin air. Where will that new money go? According to your original argument prices go up because people bid them up??? Suppose you have $1000 and from nowhere I create $1,000,000, what does the freemarket do to your $1,000? Your $1,000 becomes diluted because the market has been flooded with new money that puts upward pressure on prices giving the illusion that prices are rising. But did the price rise or did your money lose value? Take cigarettes in prison. In prison cigarettes are currency, and the value of that currency can only be determined by knowing how many packs of cigarettes are in existence within the prison system. If the warden gave out a pack a day to every prisoner what would happen to the things that they were exchanging those cigarettes for? wouldn’t the price of those other products rise? Or would the value of what the cigarettes were once worth decrease because of the excess amount of cigarettes in existence? This is not rocket science… supply and demand. How do you feel knowing when you do a weeks work that by pay day that money will buy you less than it did the week before – you have been robbed of your time away from your family and friends working for a currency that is diluting everyday. The government does not need your takes to run the country – simply run the inflation rate at 17% p.a and they could still fund all that they do – even a trillion dollar war. Interestingly the same year the fed was formed was the same year your tax act was invoked as it’s is predominately today. The government doesn’t need your takes but if there was know tax you would soon work out was happening to your money wouldn’t you?

  5. Javi April 29, 2008 @ 3:41 pm

    Interesting comments from the both of you.
    I had been speculating on gold because I put my faith on presumably serious newspapers, though their arguments were far from complete (being myself a engineer/mathematician). I must admit that, it was pure faith. From what I’ve observed in the markets, nothing has inherent value. And I could explain that because if you can trade it, then it is subject to variations and thus, its value depends on other things’ value. So I would say that what we witnessed at the end of the past month, when the gold collapsed from 1030 to 940 and then to 910, and after timid gains it has recently (today) collapsed to 873 (June delivery), is a bubble.
    My axioms were that the mathematical expectancy of the gold was positive forward in time, so I had been trading the uptrend, making substantial profits. Then, when the market reversed following the joy of the rescue of Bear Stearns, I knew something was wrong with my axioms, so I stopped losses. Luckily, because the market kept going down. Furthermore, the correlation with the EURUSD has been very high even in the intra-day. That indicates that gold is not strong in itself. I don’t know where the fair value (supply-demand) is, but I know that, even now at the 870 level, we are at a speculative one, and the market knows it.

  6. Franklin April 30, 2008 @ 12:52 am

    Javi,
    I am going to publish soon how do I recognize when we are in a bubble. Basically, it is a divergence of the long term trend from the short term trend during some time. There are social indicators that help identify bubbles.
    What is more interesting, is that it may be possible to identify mathematically when a bubble is going to end. If you are interested, we could get together and work out the formula.
    By the way, I think the gold bubble is still alive and we may see a new run up after this period of consolidation. The key level I am watching is 850 now, while it stays above 850, I don’t see a real collapse coming. I normally keep the price-specific post to the site http://www.tradingurus.com and I make here more general comments.

  7. Javi April 30, 2008 @ 3:24 pm

    Hi Franklin,

    I’d certainly be interested in knowing about the bubble measurement. I don’t know to what extent I could collaborate since I will be doing a research on market dynamics.

    You commented that 850 would be a milestone for gold. I wouldn’t say so. I’ve found that psychological marks are broken as any other number is broken. Gold is very inflated nowadays. It’s long since it’s price depends more on EURUSD rate than on the supply-demand. That’s because people gamble on it with fairly predictable moves derived mainly from the EURUSD ones, with no logic at all. Why does it provide a hedge against the dollar? Does it provide food and PS3 games out of thin air when the dollar goes down? It’s just gambling, speculating, as everything else. And with the latests events, gold has gone down when adverse news were released (ie: American economy getting in shape) but it hasn’t recovered much when getting good ones (EURUSD up to 1,60 and gold didn’t even hit 940 again). So I think there’s enough room for it to tumble again. Perhaps another $150, and we would be reaching a fair price. I’d say the downtrend is still safer.

    On the other hand, I’d like to warn people against GATA and other groups heavily involved in gold. I believed these reports, out of faith, until I saw an article claiming that people should buy gold when it first reached 910 last month because it was as cheap as it had been in 2004 ($910 in 2004, jesus!). From then on I dismiss every piece of information that relies on GATA as a source.

  8. Franklin April 30, 2008 @ 3:54 pm

    I repeat, I don’t think the players involved in the gold bubble are going to have in earnest while gold is above 850. I did not mention a milestone, just an important support level than when broken will force a large number of players to exit very fast. This number is relevant now, and it will not be relevant in the future, it is just a number important to the current gold rush (over the past 3-4 months).
    We are far away, in my opinion from any substantial fall in gold prices. Bubbles tend to self perpetuate once formed, and they last until the conditions for the burst are present ;).

  9. Javi May 1, 2008 @ 11:33 am

    I didn’t say you re reasoning is wrong. I’ve read some articles on this site and they are sound.

    Still, I believe 850 is just another number. It might happen that a lot of stop losses are put there so once it passes the barrier they will trigger. That might send the price 20, 30 or even 40 dolars down, similar to what happened today. I don’t have tools powerful enough now to see if it passed the barrier now.

    Other than that, I don’t consider it to be of special concern to anybody. I bet it’ll go on decreasing as the dollar gains streght against the euro and (secondly) oil prices drop.

    The magic (don’t like this word, let’s say great thing) about markets is that you can always make money so long there’s volatility.

  10. Franklin May 1, 2008 @ 11:56 am

    By the way. As I write this, the price of gold is sitting at exactly 850 after falling 27.40. Pretty neat uh.

  11. Javi May 1, 2008 @ 6:13 pm

    If the Euro goes down any more in the next days, gold will resume its fall. A $27.40 is enough for 1 day. If goes on sinking, it can pass the $850 level and easily settle at 830. The dollar is doing really really well these days.

    Just note that gold for delivery in June lowest was 849.60 (now I have intra-day data), so it briefly pass the level… obviously May delivery was even lower, and there were not millions of selling orders. It is remarkable how that fall wasn’t backed by a fall in EURUSD so it went slightly up (nether were a couple of peaks I see and it went slightly down). Let’s see tomorrow if the dollar keeps rising.

  12. Franklin May 1, 2008 @ 11:21 pm

    Not sure I follow your reasoning here. If the Euro goes down, gold will go up against the Euro. The Euro and the Dollar may go down at the same time. The Dollar rally against the Yen and the Euro seems pretty much exhausted.
    There is no correlation, that I can tell, between the Euro/Dollar and Gold. Of course there is a correlation between any currency and gold (you can buy more or less gold with the same amount of x currency) but other than that, I don’t find a correlation.
    The support level of 850 is still holding. There needs to be a huge announcement to strengthen the dollar to break this level. At this point, gold traders are buying, not selling. If this level breaks down, they will be forced to sell, and the fall will be sharp. Again, I think a better forum for price discussion would be http://www.tradingurus.com, but I enjoy the conversation. :)

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    […] The Gold Scam […]

  14. Anonymous September 29, 2009 @ 7:50 pm

    One thing that you all seem to have missed is the fact that almost all gold (and silver) transactions are paper-based. Hardly any gold, actually trades hands. This is also true of people who purchase “gold” at their local bank and accept a certificate rather than delivery of the metal.
    TD Canada Trust, and Morgan Stanley have already been caught charging “storage fees” for precious metal that they do not actually possess. At some point people will realize that the precious metals market is clogged with junk certificates, and mostly a huge ponzi-scheme of precious metals derivatives.

  15. Anonymous August 11, 2010 @ 1:17 am

    a 1964 or older US quarter is worth around $3.15 today simply because its 90% silver. strange how a gallon of gas is about $3.15 a gallon today. so i guess if i still had real precious metal coinage, i could still buy a gallon of gas for 25 cents. so what changed, the gas? the 90% silver quarter? no. what changed was the paper money we are forced to use by law. it changed. it always becomes worth less until it becomes worth zero. don’t believe it? read a book people, every paper currency in history has failed completely.

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The Gold Scam

Economics, Finance, Thoughts Comments (18)

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.

  1. 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.
  2. Gold has no “inherent” value other than the market value. That value fluctuates.
  3. Gold is not money. It was, but it is not money anymore.
  4. Gold may become money again, but that’s speculation, not fact.
  5. 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.

Franklin @ April 20, 2008

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