Posts Tagged ‘Marco Polo’

Is gold going parabolic?

Tuesday, December 8th, 2009

No doubt, as gold prices run up in the latter half of 2009, a lot of commentators are saying that gold is in a bubble territory. Their justification for such a claim is that when an industrially useless metal to go up in price so quickly, irrationality is the only explanation. Hence, according to them, it can only be described as a “bubble.” Even the Sydney Morning Herald, came up with an article titled, Gold a ‘useless asset to own’.

But as contrarian investors, we welcome such ignorance. That is how wealth is transferred from the weak hands to the strong hands. If you have not already, we recommend that you read If gold has no intrinsic value, is it a bubble?. Those who believe that gold is in a bubble do not understand the fundamental of what money is- they fail to see the mirror image irrationality. With that, we shall take a quote from Marco Polo in our book, How to buy and invest in physical gold and silver bullion,

With regard to the money of Kambalu the great be called a perfect alchymist for he makes it himself. He orders people to collect the bark of a whose leaves are eaten by the worms that spin silk thin rind between the bark and the interior wood is taken and from it cards are formed like those of paper all black He then causes them to be cut into pieces and each is declared worth respectively half a livre a whole one a silver grosso of Venice and so on to the value of ten bezants All these cards are stamped with his seal and so many are fabricated that they would buy all the treasuries in the world He makes all his payments in them and circulates them through the kingdoms and provinces over which he holds dominion and none dares to refuse them under pain of death All the nations under his sway receive and pay this money for their merchandise gold silver precious stones and whatever they transport buy or sell The merchants often bring to him goods worth 400,000 bezants and he pays them all in these cards which they willingly accept because they can make purchases with them throughout the whole empire He frequently commands those who have gold silver cloths of silk and gold or other precious commodities to bring them to him Then he calls twelve men skilful in these matters and commands them to look at the articles and fix their price Whatever they name is paid in these cards which the merchant cordially receives In this manner the great sire possesses all the gold silver pearls and precious stones in his dominions When any of the cards are torn or spoiled the owner carries them to the place whence they were issued and receives fresh ones with a deduction of 3 per cent If a man wishes gold or silver to make plate girdles or other ornaments he goes to the office carrying a sufficient number of cards and gives them in payment for the quantity which he requires. This is the reason why the khan has more treasure than other lord in the world nay all the princes in the together have not an equal amount.

Chapter XXVI, Paper Money Immense Wealth of the Great Khan, The Travels of Marco Polo

To understand gold, one needs to understand the history of money (which our book, How to buy and invest in physical gold and silver bullion has more information on). If we can laugh at the irrationality of the ancients as described in Marco Polo’s memoirs, then we certainly have to laugh at humanity’s irrationality today with regards to money.

But at the same time, we are not saying that gold is the cure-all for the the ills of today’s monetary system. In other words, we are not worshipping gold (see When to sell your gold?).

But if you are still worried that gold prices are running up too fast, you ain’t seen nothing yet. This speed in price increase is nothing compared to what happened in 1980. Let’s take a look at the gold price chart back then:

Gold price from 1975

Gold price from 1975

By 1979, inflation in most countries was running in double digits in most countries. Oil prices was spiking and the Iranian revolution toppled the Shahs. The Soviets was entering Afghanistan. Back then, there was a real fear that the world will end and that seemed like the end of fiat currencies (8 years after President Nixon cut the final link between gold and the US dollar). The price of gold doubled in a few weeks between December 1979 and January 1980. That’s really a parabolic movement. Today’s run up in gold prices is nothing compared what happened in 1979/1980. We have friends who bought gold in 1980 at around US$800. Back then, there was talk that gold price would be hitting US$1000. Unfortunately, gold price fell and our friends lost half their capital in a flash.

But fortunately, fiat currencies survived and the world did not end. But those who ridiculed gold used that as a basis to believe fiat currencies will still survive i.e. fiat currencies will survive because they did survive after 1979. This is an example of a mental pitfall that we call “lazy induction” (see Mental pitfall: Lazy Induction). That’s because if you take an even bigger picture view, there were many countless examples whereby all the other fiat currencies in the entire history of human civilisation failed to survive. The Mongol currency during Marco Polo’s time was such an example.

As Nassimb Nicholas Taleb wrote in The Black Swan: The Impact of the Highly Improbable, the wrong way to learn from history and looked at happened and then extrapolate it into today. It is equally important to look at what could have happened and evaluate whether it is still applicable today. In his words, we have to study the “alternative paths” of history. For all we know, fiat currencies could have died after 1979. Maybe, someone powerful back then could have made a slightly different decision and that could have set a chain reaction that would culminate in the death of fiat currencies.

We never know whether the “alternative path” of history will happen today. But it pays to be prepared.

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Posted in Gold, History | 11 Comments »

Gold and the strong state

Thursday, March 19th, 2009

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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Posted in Economics/Finance, Geopolitics & Politics, Gold, History, Looking Forward | 28 Comments »

Is gold transitioning to become money?

Thursday, February 12th, 2009

In response to our previous article (What will happen if RBA cuts to zero?), one of our readers asked,

Hi, This article concludes with a disturbing scenario. Asset price deflation with consumer price inflation. Gold is as asset class, how will it fare in this scenario? It seems that gold is starting its transition back to being money, what would it take for that transition to happen, do you think its under way or likely?

Firstly, for those who are new to this publication, we would first refer you to this guide, Why should you invest in gold?. It contains quite a number of useful articles for you to understand gold. We recommend you to read them first.

Now, back to our reader’s questions. The first one is, how will gold fare in times of debt deflation, foreign capital flight and price inflation? Let us go through each asset class one by one:

  1. Property is definitely a loser because it is highly geared asset class. Since business and personal solvencies will be threatened en masse in a debt deflation, highly geared assets will be falling rapidly in prices. Rising price inflation of inelastic non-discretionary goods will worsen the solvency situation of many.
  2. Stocks are unlikely to well in a sick economy.
  3. The same goes for debt securities.
  4. Assuming that more and more foreigners are holding Commonwealth Government bonds (thanks to the growing budget deficit from the bigger and bigger ‘stimulus’ packages), they will become increasingly nervous of the falling Aussie dollar. Thus, a sell-off in government bonds cannot be ruled out. This implies foreigners’ fear of sovereign debt default.
  5. As foreign capital flees Australia (due to the deteriorating economic situation), a banking crisis cannot be ruled out. It’s one thing for the government to guarantee bank deposits but another to actually implement the guarantee. How much can cash at bank be trusted? Perhaps the government will ‘guarantee’ bank deposits and at the same time, put in capital controls (e.g. restrict foreign capital from fleeing, limit the amount of cash that can be withdrawn, etc)?

As you can see, this disturbing scenario is one in which there are no textbooks to refer to. The government will be making rapid-fire decisions in real-time. Thus, all our projections here are guesstimates and speculations. But one thing is certain: uncertainty and unpredictability will rule the day. As a result, physical gold (and silver) is the only asset class that can give you a sense of security. In such a day, the nominal price of gold is irrelevant.

Next, our reader asked: Is gold starting its transition back to being money?

We do not know the answer to this question. But we are sure the government will be hell-bent in preventing it from happening as long as it remains strong. The qualifier in bold is a very important one that you should take note. Hitler once said that the gold standard is not needed because the state will be so strong that such a standard is unnecessary (we do not know whether this is true or not, but history buffs may want to dig out the reference for that). Also, Marco Polo was astounded that the authority of the Khan could turn paper into something that was as good as gold and silver, on pain of death. In the US in the 1930s, gold ownership became illegal. Hence, a strong government is anti-thesis to gold being money. Conversely, if the government is weak, gold stands a much better chance of functioning as money.

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Posted in Gold, Looking Forward | 20 Comments »

Understanding the big picture in the inflation-deflation debate

Sunday, August 24th, 2008

Right now, there are just too much confusion over the inflation-deflation debate. In fact, this debate is so polarising that many of our readers are thoroughly confused and bewildered by the many millions of conflicting reports, chatter and opinions on the blogs, forums and media. As one of our readers said in Will deflation win?,


I’m getting more and more conflict signals from bases put forward by those who argue for inflation and those who argue for deflation.

So, which will win? Inflation or deflation? Today, we will attempt again to explain the big picture so that you can understand what is going on. As we said before in Failure to understand Black Swan leads to fallacious thinking,

For this reason, that is why we delve more on the big picture and economic history and get mired less on minute statistics and detailed numbers. In technically philosophical terms, it means we are taking on a meta-view i.e. we are taking on a view of our view. At times, this means we have to expand our circle of understanding and venture outside of finance, investing and economics into fields such as psychology, politics and history. The broader our circle of wisdom and experience (that includes borrowed experience from a study of history), the less vulnerable we will be to being caught out like that turkey.

First, let’s take a brief look at the history of money at A brief history of money and its breakdown- Part 1. As that article explained, humanity started off with bartering, which was highly inefficient. Eventually, for whatever reason, the free market chose gold and silver as money. It is interesting to note that gold and silver was the coincidental choice across almost every ancient civilization. In any case, regardless of your view on gold, the point is that in most of the 6000 years worth history of human civilization, money always existed in the form of a physical commodity. That is not to say that monetary inflation cannot happen- ancient Rome debased their own silver coins by diluting the silver with some other less precious metals.

If you think about it, it was un-intuitive for money not to be in the form of a commodity. In one of the movies about Marco Polo, it showed a scene whereby Marco Polo was astonished to see his Chinese slave exchanging goods for pieces of paper:

He ask, “What are you doing??!!!?”

His slave replied, “I am buying something.”

“But money is gold and silver! How can a piece of paper be money?!?!”

If you lived back then, it was obvious why money should not be pieces of paper backed by nothing. Firstly, such money is vulnerable to forgery. Secondly, it can be re-produced at almost no cost. Thirdly, as we said before in Recipe for hyperinflation, the integrity of such money depends on the integrity of the authority that issues it:

To illustrate this point further, imagine you are the only person in town who has the authority to create money out of any piece of paper with your own signature. Wouldn?t this make you a pretty powerful person in town? With such power, you can acquire anything you wish at the expense of others.

Basically, it WAS obvious why paper money, especially the ones backed by nothing but ‘confidence’ and made legal tender by government decree, is not a good form money. Such money is called “fiat money.” The free market, if left to its own devices, will never favour it. But that did not stop ancient governments from dabbling with fiat money. The ancient Chinese was probably the first to try that (see Ancient Chinese fiat paper money) and failed. Today, the entire world is back to using fiat money again (see A brief history of money and its breakdown- Part 2). History shows that there were many attempts to make fiat money work and all of them failed. In other words, excluding the current one, the failure rate of fiat money is 100%.

To make fiat money work even for a time, some kinds of rules or ‘mechanism’ are needed to maintain its integrity (if it can really be achieved indefinitely). As we said before in Recipe for hyperinflation,

Therefore, some kinds of ?rules? are necessary to fetter and curb such vast power. Without these ?rules,? it is impossible to maintain the integrity of money. If money loses its integrity, the financial system and economy will break down and we will be reduced to primitive bartering.

That is why an independent central bank is part of this complex system of ‘mechanism’ (see Why should central banks be independent from the government?).

What are the ‘mechanisms’ that are used?

  1. Commodity backing– Technically, if a paper money is backed by a commodity (i.e. the paper can be redeemed for a commodity), it is not a fiat money. Today’s fiat money was originally warehouse receipts for gold. If too much warehouse receipts are issued than there are gold in the vault, then the issuer has essentially committed fraud and runs the risk of legal/economic repercussions.
  2. Self-expiry– In ancient China, during the Song Dynasty, paper money had a limited life-span, after which it would become no longer be legal tender. As this article from Financial Sense explained,

    The S’ung dynasty was the first to issue true paper money in 1023, and it did so at first cautiously, issuing small amounts, used in a limited area, and good for a specific time period. The notes would be redeemed after three year’s service, to be replaced by new notes for a 3% service charge, a neat way for the government to make money.

    The abuses started immediately. Though the notes were valued at a certain exchange rate for gold, silver, or silk, in practice convertibility was never allowed. Then, the notes were not retired as they printed many more of them. The government made several attempts to support the paper by demanding taxes partly in currency and making other laws, but the damage had been done, and the notes fell out of favour.

    The idea is that at any one time, certain amount of self-expiry money will be retired from circulation and thus, ‘protect’ the integrity of the money. Today, if you look at Zimbabwe’s currency, you will find an expiry date on it.

  3. Credit-system– This is the system used in today’s money (see Are we heading for a deflationary type of recession?). The basic idea is that money is created in the context of credit, which must be returned plus interest.

So, the world’s fiat money system works under the ‘mechanism’ of credit. Because money has to be returned, it acts, in theory, as a check against abuse and rampant monetary inflation. But as we all know from the sub-prime crisis and credit crunch, it got abused to the extreme in practice.

The fact that the global financial system is facing acute deflation threat shows that this credit-system ‘mechanism’ is working to protect the integrity of fiat money! From that perspective, we can see why the US dollar is appreciating in the context of deflation. But at the same time, if the integrity of money is to be protected, then all these years of credit abuse will come home to roost in a colossal economic pain for the masses.

The issue is, do the masses want to avoid great financial pain or does it want to maintain the integrity of fiat money? Reality dictates that it can only choose one but not both. If they choose the former, the only way to do that will be to repeal the credit-system ‘mechanism,’ which will mean the loss of integrity for the current fiat monetary system. Such loss of integirty will manifest itself in the form of hyperinflation.

In summary, whether you believe the end game is deflation or inflation will depend on your faith in human nature.

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Posted in Economics/Finance, Gold, History, Looking Forward, Silver | 40 Comments »