Posts Tagged ‘fiat currency’

If gold has no intrinsic value, is it a bubble?

Tuesday, March 17th, 2009

Today, we just received a comment from one of our readers,

I got two emails in my inbox today from sources I subscribe to that made me think of you and your hoard of gold. Firstly, the view of a smart guy who knows a lot about investing:

Gold is very expensive

Secondly, the views of another smart guy who knows a lot about technical analysis:

Gold Divergence Poses A Question

I think the gold/oil ratio is particularly telling, in that a gold bubble began forming in late 2008. Like I said previously, I don?t want to try to timing getting out of gold and into real assets, but good luck to you.

We took a read at the first link and saw this:

I know the gold bugs will hate this idea – because it harks back to the argument against gold – which is that it has no intrinsic value.

This is one of the most common argument against gold. While this argument is true in itself, the person who wrote that sentence has clearly forgotten the mirror image of that argument. As we wrote in October 2006 at Is gold an investment?,

This is because with its extremely limited industrial use, gold will not be worth that much at all.

So, we will repeat this point again: Gold has no intrinsic value. So, if gold has no intrinsic value and if you see its price going up, it is easy to conclude that it is a bubble. Now, having established the fact that gold has no intrinsic value, we will ask a mirror image question. What intrinsic value does a crisp piece of paper called the US dollar has?

You see, like gold, a crisp piece of US dollar has no intrinsic value too! There are completely no industrial uses for that piece of paper called the US dollar. Now, ask yourself this question: if that piece of paper called the US dollar has practical industrial use or is consumable the way tissue paper and tooth-pastes are, do you think people will still want to treat it as money? Now, imagine if one day the US government decree that all tooth-pastes become legal tender for payment and settlement of debt (i.e. function as money), how would you feel if you have to physically consume your money daily for the sake of oral hygiene?

Therefore, as we said before in Properties of good money, one important property of money is that it must not be something that is consumable. The only way for this property to be fulfilled is for money not to have any intrinsic value.

Now, back to gold. As we wrote before in What should be your fundamental reason for accumulating gold?,

We accumulate gold not just simply because we believe its ?price? is going up (though we think it is most likely to be so as a side effect?in case you are confused by what we mean, read on). This is because if we do so, the implication is that we are calibrating the value of gold in terms of units of fiat paper money (see Entrenched perception on the value of paper money).

Therefore, the fundamental reason for accumulating gold is not to ‘make’ money. The reason why you do so, is because you lack confidence in legal tender money. The bull market for gold since 2001 is an indication of a declining confidence in legal tender money, which like gold, has no intrinsic value. So, if you are very suspicious of central bankers playing hanky panky with the crisp piece of paper money called the dollar/ poound/ yen/ franc/ yuan/ etc, then your only alternative is to exchange those funny paper for physical gold.

Now that you understand this very fundamental point, what if you are still concerned about timing the market? If you are getting more and more suspicious of legal tender money (or getting more and more worried of a doomsday scenario), then market timing will be the least of your concern. Sure, you may want to time the market to get the maximum bang (gold) for your buck (paper money). But if market timing is still your over-ridding concern, then you are really missing the big picture. If you see gold price going up and up, it means you will have much greater worries than just market timing.

But if after all these explanations, you are still concerned about marketing timing, Marc Faber has this to say in his latest commentary:

I really dislike being called a gold bug. I wish I could be positive about the global economy and social and geopolitical condition, but the more I think about current condition, the more depressed I become. Amidst a global slump I believe that we are moving toward high inflation (a further depreciation in paper money?s purchasing power), evil fascism, and vicious military confrontations. In theory, gold would be the best asset to own in this condition. Also, in theory, gold should be the perfect insurance against economic, social, and political Armageddon. However, I have some reservations.

For one, gold has already experienced a powerful bull market between 2001 and the present. As a result, gold has become relatively expensive compared to equities and the CRB Index. I am not suggesting that this outperformance of gold compared to other commodities and equities cannot continue. In fact, I believe that in time one Dow Jones will buy less than one ounce of gold. However, near term, gold would seem to be both over-bought against the Dow Jones and the CRB Index. I concede that the overbought condition of gold compared to the Dow Jones and compared to the CRB Index could be corrected by a strong rebound in the Dow and the CRB Index rather than a further downward correction in gold. My bet would be that the CRB Index has significant rebound potential and…

The other concern I have about owning physical gold (and as I just said, I am holding on to my physical gold) is that things will get one day so bad in the world that governments will expropriate gold, as the US did in 1933. This is unlikely to happen this year but it is a concern I have for the long term, especially if gold rallies to several thousand dollars per ounce as a result of money printing by all central banks or because of wars! As Voltaire remarked, ?it is dangerous to be right when the government is wrong.?

Whether you should be buying, holding or selling gold today will depend on your personal circumstances, which includes what percentage of your wealth are currently in gold, your level of suspicion against fiat money and your level fear for a doomsday scenario. But remember, having some gold is better than having zero gold.

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Posted in Gold | 40 Comments »

Is gold an investment?

Saturday, February 23rd, 2008

Remember that we said before in What should be your fundamental reason for accumulating gold?,

If you cannot remember anything else, please remember this: gold is a hedge against loss of confidence in fiat paper currencies.

In other words, gold is the inconvenient torn in the flesh for fiat paper currencies. It has, for centuries (or even millenniums) being chosen by the free market to function as money in most societies (see A brief history of money and its breakdown- Part 1). It was only until recently (in 1971) that the last official monetary role of gold was abolished (see A brief history of money and its breakdown- Part 2). But given the extended historical role of gold, do you think a mere 3½ decades of government decree can really completely erase the perception of its monetary value from the consciousness of humanity? We doubt so. Many ancient governments had tried but none succeeded (see Ancient Chinese fiat paper money).

Therefore, conventional supply and demand analysis cannot be applied for gold because it is not a commodity (see Is gold a commodity?). This is because with its extremely limited industrial use, gold will not be worth that much at all. It is worth so much because its value is largely derived from outside the realm of industrial and pragmatic usage (i.e. monetary value). Similarly, how much industrial and practical value is a piece of crisp US dollar? If there is no pragmatic use for a piece of paper called the US dollar, then why is it in so much demand (e.g. drug dealers use them for transactions)? Therefore, in conventional supply and demand analysis jargon, the monetary value of gold is consigned into a conveniently labelled group called “investment demand.” But in reality, since gold is a boring, inert metal that does not have much pragmatic use and does not pay dividends, income or interests, it is completely unfit for ‘investment.’ Therefore, it has ‘demand’ the same way the US dollar has ‘demand.’

Next, armed with this understanding, we will then talk about gold’s sister, silver, in the next article.

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Posted in Gold | 8 Comments »

?Top metals analysts bullish on bullion??Impending bubble?

Thursday, January 18th, 2007

Today, this article, Top metals analysts bullish on bullion, caught our eye.

It looks to us that the crowd are soon becoming fixated with gold again. When that happens, we can be sure another short-term bubble will emerge again?it will be once more history repeating itself (see The story of gold). Again, we would like to repeat our reason for wanting to buy gold: What should be your real reason for buying gold?.

So, are we bullish on gold?

The truth is, we are not bullish on gold?rather, we are bearish on fiat currencies. This is the difference between the crowd and us. Since there is no good reason to be bullish on gold, the crowd who buy it can easily change their minds and dump gold. On the other hand, since we have good reasons to be bearish on fiat currencies, we will remain steadfast and hang on to our gold, perhaps buying even more when the crowd dump it to us.

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Posted in Gold, Looking Forward | No Comments »

A brief history of money and its breakdown- Part 2

Wednesday, January 10th, 2007

In today?s topic, we will continue from the previous topic, A brief history of money and its breakdown- Part 1 by touching on the gradual breakdown of the monetary system from two centuries ago till now. Today, the world?s money is totally fiat (money that enjoys legal tender status through the authority of the government instead of through the choice of the free market). Again, the recommended reading for today is Murray Rothbard?s What Has Government Done to Our Money? As Rothbard said in that book:

To understand the current monetary chaos, it is necessary to trace briefly the international monetary developments of the twentieth century, and to see how each set of unsound inflationist interventions has collapsed of its own inherent problems, only to set the stage for another round of interventions. The twentieth century history of the world monetary order can be divided into nine phases.

In the first phase, lasting from 1815 to 1914, the Western world was on a classical gold standard. Each national ?currency? was just a definition of a weight of gold. For example, the ?dollar? was defined as 1/20 of an ounce of gold. Each national currency was redeemable for gold on its pre-defined weight. Thus, if a nation were to recklessly inflate the supply of its money, it would run into danger of having its gold drained from its treasury. At this point, we must stress that gold was not any arbitrary choice by the government. Rather, it was the choice of the free market over the course of centuries as the best money. Thus, at that time, the world had a uniform money medium, which as Rothbard said, ?facilitated freedom of trade, investment, and travel throughout that trading and monetary area, with the consequent growth of specialization and the international division of labour.? Furthermore, such an international gold standard put a rein on government inflating the money supply as well as helped kept the balance of payment of each nation in equilibrium. Though it was not perfect, it ?provided us with by far the best monetary order the world has ever known, an order which worked, which kept business cycles from getting out of hand, and which enabled the development of free international trade, exchange, and investment.?

Next, the First World War arrived. Under the confusion of a wide-scale war, each warring government (except the United States) came off the gold standard and printed money to fund the prohibitive cost of waging war, which would not be possible under the gold standard. Thus, national currencies were devalued and fell in relative value to gold and the US dollar.

After the First World War, the most logical step would be to return to the gold standard at a redefined weight of gold for each national currency. However, British insistence at maintaining the unrealistic pre-war definition (due to national pride) led to their economic malaise. Instead of rectifying the folly of their ways, they induced and coerced foreign governments into the same mistakes at the Genoa Conference of 1922. This resulted in a gold exchange standard whereby (1) the US remained in the gold standard, (2) the British remained in a pseudo-gold standard and ?US-dollar standard,? and (3) the rest on the ?pound standard.? The outcome was a ridiculous pyramid of US dollars on gold, pounds on dollars and the other European currencies on pound. By 1931, as expected, the absurd gold exchange standard collapsed.

At this point in time, it was back to the post-war chaos of fiat currencies again. The US went off the gold standard partially?US dollars were only redeemable to foreign governments and central banks at a re-defined rate of 1/35 of an ounce. International trade and investment were at a standstill and ensuing economic conflict was said to be one of the leading causes of World War Two.

After World War Two, the United States led the way to a new monetary system?the Bretton Woods system. In this system, the US remained in a partial gold standard?US dollars were redeemable for gold by foreign governments. Other countries pyramid their currencies on top of the US dollars. Initially, the US dollar was undervalued and European currencies were overvalued. However, as time went by, with the US inflating their supply of dollars, their gold was increasingly being redeemed by European governments. Soon, it became harder and harder for the US to maintain the free market value of gold at $35.

By 1968, there was a crisis in confidence in the US dollars. The US then decided to abandon maintaining the US dollar at $35 in the free market. From then on, the US decided to ignore the gold free market and maintain the inter-government gold peg at $35. As expected, the free market value of gold soared above $35.

In August 15 1971, the US severed the last link between gold and the dollar. As a result, from then on, the world?s monetary system became totally fiat.

In December 1971, the Smithsonian Agreement was introduced to create some order by maintaining fixed exchange rates among currencies and without any gold backing. With the US continuing to inflate their dollars, fixed exchange rates were untenable. Finally, the agreement collapsed in February 1973.

Finally, that is what we have today?freely fluctuating fiat currencies. As Rothbard said,

Since the U.S. went completely off gold in August 1971 and established the Friedmanite fluctuating fiat system in March 1973, the United States and the world have suffered the most intense and most sustained bout of peacetime inflation in the history of the world. It should be clear by now that this is scarcely a coincidence.


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Posted in Economics/Finance, Gold, History | 6 Comments »

Learning from history

Monday, December 4th, 2006

To our dear readers, you may be wondering whether we are unduly pessimistic, cynical and strange advocate of doom and gloom. Haven?t the global economic system been running fine for a long time like a well-oiled machine? So far, have any of our nightmare scenarios turn out to be true? Weren?t there plenty of alarmists and scaremongers before us who turned out to be completely wrong and a waste of everybody else?s time? Haven?t the global financial system bounced back from crisis after crisis before and turned out stronger? Has the world ever ended?

But make no mistake about this: most of us did not exist during the 1929 Great Depression. We are sure none of us existed during many of history?s litter of financial disasters. When we look at the past millenniums of human history, we see plenty of economies breaking down before in the ancient past. We see plenty of nightmare scenarios when ancient civilisations rose and fell. We see many astute thinkers and prophets who warned of impending disasters and we marvelled at how the majority could have missed the evil omens. We see many instances of ancient nations and dynasties breaking down and never rise again. We see many poor souls of the ancient past who saw their world had ended. Indeed, we take heed at the wisdom of this ancient writer:

What has been is what will be, and what has been done is what will be done, and there is nothing new under the sun. Is there a thing of which it is said, “See, this is new”? It has been already in the ages before us. There is no remembrance of former things, nor will there be any remembrance of later things yet to be among those who come after. (Ecclesiastes 1:9-11)

We believe that despite the vast strides of humanity, one thing never changes: human nature. When we look at history, we see humanity repeating the same mistakes over and over again. We see how people of the past got into a frenzy of price bubbles that eventually burst and bring about serious losses to many (Issac Newton was one of those). Today, the same happened all over again, from the bubbles of real estates to bubbles of Internet stocks.

At present, the world is using a fiat currency system. But this is not the first time the world had experimented with fiat money. Just look at ancient Chinese history and you will find plenty of attempts at making fiat money work?all the time it failed. We would dare to assert that so far in all of human history, there was not once when fiat money works. Thus, with history on our side, we would rather bet that today?s fiat currency system will eventually break down. We suspect that we will live long enough to see the day when it happens. Meanwhile, we will be stockpiling gold.

Learn from history. It will do you good.

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Posted in Investor Education, Looking Forward | No Comments »

What should be your real reason for buying gold?

Monday, November 20th, 2006

Speculators are always in the market. Where speculators congregate, there will be herd behaviour, mob rule and rumours. Late last year, gold pierced the psychological US$500 market, which heralded in a ‘gold rush,’ culminating in a short-term price bubble of around US$730 in May this year (see our article, The story of gold). After the bubble burst, the gold price, till today, remained trapped in volatile range.

The aim of these gold speculators was to make as much money as possible in the shortest possible time. When they saw the price of gold moving up with great momentum, they joined in the party, resulting in a dangerous price bubble. Since they did not care about understanding the underlying value of gold that they were punting their money on (for hedge funds, it is usually other people’s money), the only reason for them buying is because the price was going up. As investors, we prefer to invest, not bet. When we look at gold, we perceive it differently from the gold speculators.

At this point in time, the gold price is still in a long-term uptrend. There is a good reason for it?its underlying trend is a big hint to us that something amiss is going on in the global currency system. Thus, as we said before, the root reason for investing in gold lies in your confidence (or rather, the lack of) in the fiat currency system which the world is using right now. And we would like to repeat this point again: the ?money? that we commonly use everyday is the fiat paper currency, which has no intrinsic value because it is not backed by anything physical (e.g. gold). Such ?money? can be conjured up at will by the central bank?s printing press. Thus, its value merely lies in everyone?s confidence in it (see our previous article, Gold & Oil, hand-in-hand).

Thus, your real reason for investing in gold is not to ?make money??you do so as a hedge to preserve your wealth.

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Posted in Gold | No Comments »