Gold and the strong state

March 19th, 2009

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Have you walked into a shop that specialises in selling paper money from the past and present from all over the world? Indeed, when holding a Riechmark (the German currency from the 1930s) on our hands, we felt a sense of nostalgia from the past. At some point in time, that piece of paper was used as money by another person to buy his/her daily essentials. Or if you want to be a billionaire, you can easily buy one of Zimbabwe’s currency at a price of say, AU$10.

Alas, all these paper money (currency) met their end and became of value only to collectors. Perhaps as an exercise, you may want to immerse yourself in one of those paper money shops and get yourself acquainted with the history of some of these currencies. Who knows, perhaps one day, the currency that you hold in your wallet will find its way into that paper money shop?

As we explained in our previous article, the whole idea of gold is money. The proper way to understand gold is to see it as money that is not currency. The fundamental reason why you accumulate gold is that (as we said before in What should be your fundamental reason for accumulating gold?) you want it as a hedge against loss of confidence in currently legal tender currency. On the other hand, if you have supreme confidence in currencies, then you will have no reason to hold gold.

As one of our readers, Pete, astutely pointed out before, there are many ways for currencies to lose the people’s rejection as money. Hyperinflation is only one of them. To illustrate this point, we have a story…

In 1940, as the German tanks rolled down to France, many French citizens hopped on to their cars to flee Paris. On the way to somewhere, some had to stop by petrol stations to refuel. It turned out that petrol stations did not accept the French currency as payment. After all, who will trust that the French currency will still be money once the Germans took charge? But if you had some gold coins in that situation, then you are in luck. Of course, when the Germans took over, they issued their own occupation currency and gold went underground.

The point we are trying to make is that gold as money is anti-thesis to a strong state. A strong political state may seek to ban gold on pain of death. That was what happened to China during the Mongol occupation of the 13th century. Marco Polo marvelled that the Mongol Khan had mastered the art of alchemy because paper currency issued by the Mongol empire became money on pain of death. It came to the point that gold, silver and other treasures were exchanged for the Khan’s paper money. Thus, Marco Polo remarked that the Khan was the richest person on earth. Thus, from this perspective, we can see that gold is a symbol of resistance against tyranny, subversion against state power and freedom.

But if you look at history, gold wins in the end because the strong state eventually falls (but the catch is, they may not fail within your lifetime). The Mongols, in enforcing their expensive occupation of China, printed money until there was hyperinflation. It was at that time that the Chinese rebelled against the Mongols and eventually drove them out of China. The subsequent Ming Dynasty continued the Mongol’s monetary policy of using paper as money. But by 1455, China had to revert back to commodity money.

Thus, the major risk of holding gold is that you can be up against the strong state (assuming that strong centralised political power will be the future) who may want to ban gold. But yet again, who knows? For example, Zimbabwe, for all the despotism of Robert Mugabe, has not or were powerless to ban gold.

But if the future turns out to be one in which political power is weak, de-centralised and rivalled by non-state power, then gold is a better bet than pieces of paper called the US dollar. This is the thesis of a strategist in the US Army War College (see From the New Middle Ages to a New Dark Age The Decline of the State and U.S. Strategy).

So, in summary, there’s risk in holding gold. But there’s also risk in NOT holding gold. So, what’s the alternative? Hold real asset (farm land, timber land, barrels of oil, food, guns, etc) instead? Well, there’s also risk as well and furthermore real assets serve a different function from gold. We will talk more about holding real assets later.

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