Previously published at Paper Money Collapse on Wednesday, 4 October.
In today’s Financial Times Mark Williams argues that the recent correction in gold means the gold “bubble” is finally bursting. Unfortunately, he does not provide a single reason for why the 10-year bull market in the precious metal constitutes a “bubble”, nor why this rally must end now.
According to the narrative of this article, investing in gold must have always been quite an irrational endeavour. Such folly was simply made easier with the advent of liquid ETFs (exchange-traded funds), which made the gold market more accessible to the small investor and trader. From than on, an irrational rally must have just fed on itself. Quote Mr. Williams:
“By 2005, more and more investors tried to rationalise why gold was no longer a fringe investment. It was a hedge against a weak dollar, global turmoil, incompetent central bankers and inflation. As trust in the financial system declined, gold would naturally rise, they reasoned.”
How silly! How could they believe that?
So according to Mr. Williams, gold has been going up because….it had been going up before. The investors simply rationalized it with hindsight. But gold recently went down, and down quite hard. Measured in US dollars, gold is down 16% from its peak on September 5. And now it has to go down further, so reasons Mr. Williams. If people bought it because it was going up, they must now sell it because it is going down.
Toward the end of his article we get the usual bon mot – by now repeated ad nauseam by Warren Buffett – that gold does not produce anything, does not create jobs, and does not pay a dividend. Yawn.
Gold is money
To compare gold with investment goods is wrong. Gold is money. It is the market’s chosen monetary asset. It has been the world’s foremost monetary asset for thousands of years. It has been remonetised over the past 10 years as the global fiat money system has been check-mating itself into an ever more intractable crisis. Faith in paper money as a store of value is diminishing rapidly. That is why people rush into gold. It doesn’t replace corporate equity or productive capital. It replaces paper money.
At every point in time you can break down your total wealth into three categories: consumption goods, investment goods and money. If you buy gold as jewellery, it is mostly a consumption good. If you buy gold as an industrial metal to be used in production processes, it is mostly an investment good. However, most people buy gold today as a monetary asset, as a store of value that is neither a consumption good nor an investment good. Therefore, you have to compare it with paper money. That is the alternative asset.
The paper dollars and electronic dollars that Mr. Bernanke can create at zero cost and without limit, simply by pressing a button, equally do not produce anything, do not create jobs, and do not pay dividends either. Although, sadly, the reflationists and advocates of more and more quantitative easing – many of them writing for the FT – seem to think that this is what paper money does. Alas, it doesn’t. It only fools the public into believing that lots of savings exist that need to be invested, or that enormous real demand exists for financial and other assets. Expanding money is a trick that is beginning to lose its magic.
The dollars in your pockets do not generate a dividend, neither does the gold in your vault or your ETF. So why do you even hold money?
Because of uncertainty. You want to stay on the sidelines but want to maintain your purchasing power without spending it on consumption and investment goods in the present environment and at current prices.
Stocks, bonds and real estate have been boosted for decades by persistent fiat money expansion. Now that the credit boom has turned into a bust it is little wonder that people are reluctant to buy more of these inflated assets. (Some real estate and some stock markets are currently already deflating, which is urgently needed. But bonds are not. If there is a “bubble” at all, it is in government bonds, although that bubble seems to begin to deflate as well — one European sovereign at a time.)
People want to preserve spending power for when the bizarrely inflated debt edifice has finally been liquidated and things are cheap again. But policymakers and their economic advisors do not want that to happen (“Oh no, that dreadful deflation! No! Anything but a drop in prices!”) and they are using the printing press to avoid, or better postpone the inevitable at all cost, even at the cost of destroying their own paper money in the process. And that is why you cannot hold paper money and have to revert to eternal money: gold.
Gold versus paper money
Mr. Williams quotes the market value of the world’s largest gold ETF, GLD, at $65 billion at present, apparently considering this already proof of how mad things have become in the world of gold investing. Well, consider this: in just the first 8 months of the year 2011, Bernanke created $640 billion – out of thin air – and handed it to the banks. Since the collapse of Lehman Brothers, the Fed has created reserve dollars to the tune of $1,800 billion, or more than twice as much as the Fed had created from its inception in 1913 up to the Lehman collapse in 2008. Or, if you like, 27 GLDs at present market value. The money supply in the M2 definition has gone up also by $1,750 billion since Lehman. Mr. Williams, why is anybody still holding these absurd amounts of paper cash? Isn’t that the more interesting question rather than the tiny amounts that they hold in the form of physical gold?
The biggest owner of gold is allegedly the United States government. I say ‘allegedly’ because they have not done a proper audit for a while. Supposedly, the U.S. has 261 million ounces of gold in their vaults at Fort Knox. At current market price that is a market value of $423 billion. Bernanke created more paper money between last Christmas and last Easter!
And those who, like Mr. Buffett, feel like joking that the entire stock of gold fits under the Eiffel tower – ha! ha! ha! – let they be reminded that the trillions that Mr. Bernanke created fit on the SIM cards in their mobile phones. It is all electronic money – and when Mr. B turns into a monetary Dr. Strangelove and goes bonkers with those nuclear buttons, there will be much more fiat money around.
Let me be clear on this point: the fact that money today consists of paper or is even immaterial money and consists of no substance at all is, no pun intended, immaterial to me. It doesn’t matter. As an Austrian School economist, the concept of “intrinsic value” that some gold bugs cite in defence of gold money is meaningless to me. Money does not need a substance to be money. The problem with modern money is not its lack of substance but its perfectly elastic supply. The privileged money producers create – for political reasons – ever more of it. That is the problem. And that is why the market remonetises gold. Nobody can produce it at will.
Here is Mr. Bernanke again:
“The U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost…We conclude that under a paper-money system, a determined government can always generate higher spending and hence positive inflation.”
But to Mr. Williams, paper dollars are now a safer bet than gold:
“Fears of a Greek default and eurozone turmoil are now prompting investors to buy US dollars – which many are starting to see as a safer bet than the euro or volatile gold.”
Hmmm. Safer? Are you sure?
What’s next for gold?
Mr. Williams may, of course, be right in predicting that the gold price may go down from here. For that to happen the faith in paper money has to be restored, at least to some degree. The printing presses have to stop and liquidation must be allowed to proceed. And that is precisely what happened under Fed chairman Volcker in 1979. That is what caused the previous correction in the gold “bubble”.
The question is this: How likely is this now?
In my view the present sell-off in gold is the result of the market going through another deflationary liquidation phase, yet at the same time the central bankers seem reluctant to throw more money at the problem. The ECB is buying unloved Italian sovereign bonds rather joylessly at present, and Bernanke seems for the time being happy to reorganize his bond portfolio rather than to print more money. Alas, I don’t think it will last. I am fairly confident it won’t last. They won’t have the stomach to sit tight.
Pressure is already building everywhere for more quantitative easing. Ironically, on the very same page of the FT, on which Mr. Williams argues that the gold bubble has burst, Harvard economist Kenneth Rogoff presents his case that this time is not so different, and that we can simply kick the can down the road once more by easing monetary policy, just as we have done for decades. In China, in Europe, everywhere, just print more money. And I already made ample references to Martin “Bring-out-the-bazooka” Wolf, who desperately urges the central banks to print more money.
Will the central bankers ignore these calls, as they should? I don’t think so. Remember, the dislocations are now astronomically larger than they were in 1979. The system is more leveraged and much more dependent on cheap credit. In the next proper liquidation, sovereign states and banks will default – no central banker will be able or willing to sit on his hands when that happens. But in order to postpone it (they won’t avoid it) they need to print ever more ever faster.
We are in a gold bull market for a reason, and a very good reason indeed. Unless the underlying fundamentals change (or policy changes fundamentally), I consider this sell-off in gold rather a buying opportunity.