Gold bashing seems to have become the favourite pastime of finance minister P Chidambaram these days. He has repeatedly warned Indians to get over their fascination for gold.
But Mr Chidambaram does not know his history well enough. If he did he wouldn’t be saying the things that he has been.
Gold over the centuries became universal money and there were several reasons for the same. It is not fragile and is durable. It does not rot. It is chemically inert unlike copper, silver and iron, which means its radiance is timeless.
Given its chemically inert nature most of the gold mined since eternity is still around. Estimates suggest that the world has 1,65,000 tonnes of gold. The supply of gold rarely goes up suddenly.
A report released by Standard Chartered in 2011, expected the supply of gold to go up at the rate of 3.6% per year between 2011 and 2015, suggesting the stable supply of the yellow metal. In a bear case scenario the report said that the supply would grow at an even slower rate of 1.2% per year. The price of gold has rallied over the last 2 decades even then there has hardly been any significant growth in supply of gold, with production going up at the rate of minuscule 0.7% per year. During the period 1900 to 1990 the production of gold grew at the rate of 1.9% per year.
This has historically held good as well. Since 1492, the supply of gold has never gone up by more than 5% in any given year. In fact, during the normal course of things gold supplies have grown between 1 to 2% every year. The exception to this is when new gold discoveries happen and lead to a gold rush. These are the only occasions, as was the case with California and Australia in the 1850s or South Africa in the 1890s, when gold supplies went up faster than 4% per year. With the supply of gold being limited, what it means is that it has held its value much better than other forms of saving money over the centuries.
Gold is 20 times as dense as water and twice as dense as lead, which means a lot of it can be packed into a very small size. One cubic metre of gold would weigh around 19.3 metric tonnes (i.e. 19,300 kilograms). What this means is that very high value of money can be easily moved around if it’s in the form of gold.
When it came to rarity something like a diamond or a ruby was a better bet. But figuring out the quality of a diamond and other stones was difficult. Experts could easily haggle on it, with different experts having a different opinion. When it came to gold such problems did not exist.
As Aristotle, the Greek philosopher and teacher of Alexander the Great put it “It became necessary to think of certain commodities, easily manageable, safely transportable, and of which the uses are so general and so numerous, that they insured the certainty of always obtaining for them the articles wanted in exchange.” Gold had all these qualities.
And that’s how over the centuries gold emerged as money that everyone preferred to use. What also helped was the “uselessness” of gold. Despite the fact that it is highly malleable (can be beaten into sheets easily) and ductile(can be easily drawn into wires) and the best conductor of electricity, gold does not have many industrial uses like other metals like silver have primarily because there is very little of it going around.
Also when commodities are used as money they are taken away from their primary use. So if rice or wheat is used as money for daily transactions and to preserve wealth, it means a lesser amount of rice and wheat in the market. This in turn would mean higher prices of grains which are staple food in large parts of the world. Gold doesn’t have many practical uses. So if people hoard gold, it doesn’t hurt anyone.
As the blogger FOFOA put it, “Gold’s utility is that for thousands of years it has held its value relatively well. And because it is not used for many things other than mere hoarding, the act of hoarding gold is not an infringement on the natural rights of others to enjoy the utility value of “real world” things like BMW’s and oil and wheat… If one were to corner, say, the copper market or the chocolate market, there would likely be repercussions as those industries fought back through the power of the collective that likes to consume chocolate and copper. But with gold there is no such worry.”
Gold started giving away to simple paper money at the start of the First World War in 1914. While it did make a few comebacks as money over the years, the world moved onto a complete paper money system in the early 1970s.
What this did was that it allowed governments around the world to print as much money as they wanted to. And this has led to paper money rapidly losing its purchasing power over the years. Things have become particularly worse since the start of the financial crisis in September 2008. The government of Western nations have been printing more and more paper money and pumping it into their financial systems. This was been done in the hope that their citizens will spend that money, which will help revive their economies.
Given that the global money supply has increased dramatically over the last few years, there is a grave danger that paper money will lose value rapidly in the years to come. And this has led to people buying gold all over the world which is seen as the ultimate store of value.
People in India have bought gold because of this reason as well. The other reason has been our high rate of inflation which has led to the purchasing power of the rupee going down dramatically, motivating people to buy gold which is seen as a commodity which holds its value relatively well.
And the good part is that people in India have been buying ‘hoarding’ gold to ensure that the value of their accumulated wealth does not fall.
Imagine if they had tried to hold wealth in the form of rice or wheat. In a world where nearly 79 million people are being added to the dinner table every year (and a lot of them in India), hoarding rice and wheat could have caused food riots. Imagine if all the Indians would have actively speculated on metals used across industries. There prices would have gone through the roof. (in fact with huge demand for industrial metals from China these metals had been rallying for the last few years. Imagine what would have happened to the price if Indians had started actively speculating in them?)
So its good that people are buying gold to hoard their wealth and not something which is actually useful. As FOFOA puts it “Thankfully we have a commodity that is mostly used for hoarding, and little else. Like Warren Buffet said, we dig it up and then bury it again in a vault. And all it does is one little thing: it maintains its value over thousands of years. That’s gold’s utility.”
And Mr Chidambaram should thank his stars for that.
Chen,Y and others. 2011. In Gold We Trust. Standard Chartered
Bernstein, P. 2000. The Power of Gold – The History of an Obsession. John Wiley and Sons.
FOFOA. 2010. The Value of Gold. Available at www.fofoa.blogspot.com
Skousen, M. 2010. Economics of a Pure Gold Standard. Foundation for Economic Education
The article originally appeared on www.firstpost.com on January 10, 2013.
(Vivek Kaul is a writer. He can be reached at [email protected])
Half way through the interview, I ask him where does he see the price of gold reaching in the days to come. “Well, I don’t see gold’s trajectory being typical of what you’d expect to see in a bull market….And I expect that physical gold will be repriced somewhere around $55,000 per ounce in today’s purchasing power. I have to add that purchasing power part because it will likely be concurrent with currency devaluation,” he replies. Meet FOFOA, an anonymous blogger whose writings on fofoa.blogspot.com have taken the world by storm over the last few years. In a rare interview he talks to Vivek Kaul on paper money, the fall of the dollar, the coming hyperinflation and the rise of “physical” gold.
The world is printing a lot paper money to solve the economic problems. But that doesn’t seem to be happening. What are your views on that?
Paper money being printed to solve the problems… this was *always* on the cards. It doesn’t surprise me, nor does it anger me, because I understand that it was always to be expected. The monetary and financial system we’ve been living with—immersed in like fish in water—for the past 90 years uses the obligations of counterparties as its foundation. These obligations are noted on paper. In describing the specific obligations these papers represent, we use well-known words like dollars, euro, yen, rupees and yuan. But what do these purely symbolic words really mean? What are these paper obligations really worth in the physical world? Ultimately, after 90 years, we have arrived at our inevitable destination: the intractable problem of an unimaginably intertwined, interconnected Gordian knot of purely symbolic obligations. A Gordian knot is like an unsolvable puzzle. It cannot be untangled. The only solution comes from “thinking outside the box.” You’ve got to cut the knot to untangle it. So the endgame was always going to be debasing these purely symbolic units. Anyone who expected anything else simply fooled themselves into believing the rules wouldn’t be changed.
Do you see the paper money continuing in the days to come?
Yes, of course! Paper money, or today’s equivalent which is electronic currency, is the most efficient primary medium of exchange ever used in all of human history. To see this you only need to abandon the idea of accumulating these symbolic units for your future financial security. They aren’t meant for that! They are great for trading in the here-and-now, not for storing for the unknown future. To paraphrase Silvio Gesell, an economist in favor of symbolic currency almost a century ago, “All the physical assets of the world are at the disposal of those who wish to save, so why should they make their savings in the form of money? Money was not made to be saved!” In hindsight, this statement is true whether money is a hard commodity like gold or silver, or a symbolic word like dollar, euro or rupee. In both cases, saving in “money” leads to monetary tension between the debtors and the savers. When money was a hard commodity, this tension was sometimes even released through bloodshed, like the French Revolution. So no, I don’t think we’re swinging back to a hard currency this time.
Do you see the world going back to the gold standard?
No, of course not! “The gold standard” means different things depending on which period you are talking about. But in all cases it used gold to denominate credit, the economy’s primary medium of exchange. Today we have a really efficient and ultimately flexible currency. Bank runs like the 1930s are a thing of the past. But that’s not to say that gold will not play a central role in the future. It will! The signs of it already happening are everywhere! Gold is not going to replace our primary medium of exchange which is paper or electronic units with those names I mentioned above. Instead, physical gold will replace paper obligations as the reserves—or store of value—within the system. Physical gold in unambiguous ownership has no counterparty. This is a much more resilient foundation than the tangled web of obligations we have today.
Can you give an example?
If you’d like to see this change in action, go to the ECB (European Central Bank) website and look at the Eurosystem’s balance sheet. On the asset side gold is on line 1 and obligations from counterparties are below it. Additionally, they adjust all their assets to the market price every three months. I have a chart of these MTM (marked to market) adjustments on my blog. Over the last decade you can see gold rising from around 30% of total reserves to over 60% while paper obligations have fallen from 70% to less than 40%. I expect this to continue until gold is more than 90% of the reserves behind the euro.
Where do you see all this money printing heading to? Will the world see hyperinflation?
Yes, this will end. I am pretty well known for predicting dollar hyperinflation. As controversial as that prediction is, I think it is a fairly certain and obvious end. I don’t like to guess at the timing because there are so many factors to consider and I’m no supercomputer, but ever since I started following this stuff I’ve always said it is overdue in the same way an earthquake can be overdue. As for other currencies, I don’t know. Perhaps yes for the UK pound and the yen, but I don’t know about the rupee. The important things to watch are the balance of trade and the government’s control over the printing press. If you’re running a trade deficit and your government can (and will) print, then you are a candidate for hyperinflation.
In that context what price do you see gold going to?
Well, I don’t see gold’s trajectory being typical of what you’d expect to see in a bull market. Instead it will be a reset of sorts, kind of like an overnight revaluation of a currency. I’m sure some of your readers have experienced a bank holiday followed by a devaluation. This will be similar. And I expect that gold will be repriced somewhere around $55,000 per ounce in today’s purchasing power. I have to add that purchasing power part because it will likely be concurrent with currency devaluation. So, in rupee terms, I guess that’s about Rs3.2 million per ounce at today’s exchange rate.
The price of gold has been rather flat lately. What are the reasons for the same? Where do you see the price of gold going over the next couple of years?
“The price of gold” is an interesting turn of phrase because I use it often to express “all things goldish” in the gold market. In today’s market, “gold” is very loosely defined. What passes for “gold” in the financial market is mostly the paper obligations of counterparties. These include forward sales, futures contracts, swaps, options and unallocated accounts. I often use the abbreviation “$PoG” to refer to the going dollar price for this loose financial “gold”.
The LBMA (London Bullion Market Association) recently released a survey of the total daily trading volume of unallocated (paper) gold. That survey revealed a trading flow of such magnitude that it compares to every ounce of gold that has ever been mined in all of history changing hands in just three months, or about 250 times faster than gold miners are actually pulling metal out of the ground. Equally stunning were the net sales during the survey period. The rate at which the banking system created “paper gold” was 11 times faster than real gold was being mined.
What is the point you are trying to make?
The point is that gold is being used by the global money market as a hard currency. But it is being treated by the marketplace as both a commodity that gets consumed and also as a fiat currency that can be credited at will. It is neither, and gold’s global traders are in for a rude awakening when they find out that ounce-denominated credits will not be exchangeable for a price anywhere near a physical ounce of gold in extremis—ironically failing at the very stage where they were expected to perform.
So what are you predicting?
But don’t get me wrong. It is not a short squeeze that I am predicting. In a short squeeze, the paper price runs up until it draws out enough real supply to cover all of the paper. But this paper will not be covered by physical gold in the end. It will be cash settled, and it will be cash settled at a price much lower than the price of a real ounce of gold, like a check written by an overstretched counterparty. It is a tough job to make my case for the future of the $PoG in just a few paragraphs. The $PoG will fall and then some short time later we will find that the market has changed out of necessity into a physical-only market at a much higher price. If you were holding paper you will be sad. If you were holding the real thing you’ll be very happy
Why is the gold price so flat these days?
Today’s surprisingly stabilized $PoG tells me that someone is throwing money into the fire to delay the inevitable. Where do I see the $PoG going over the next couple of years? Maybe to $500 or less, but you won’t be able to get any physical at that price. I think that today’s price of $1,575 is still a fantastic bargain for physical gold.
Franklin Roosevelt had confiscated all the gold that Americans had in 1933. Do you see something similar happening in the days to come?
Not at all! The purpose of the confiscation was to stop the bank run epidemic at that time. There’s no need to do it again. The dollar is no longer defined as a fixed weight of gold, so the reason for the last confiscation—and subsequent devaluation—no longer exists. Gold that’s still in the ground is a different story, however. Gold mines will likely be considered strategically important national assets after the revaluation, and will therefore fall under tight government control.
The irony of the entire situation is that a currency like “dollar” which is being printed big time has become the safe haven. How safe do you think is the safe haven?
Indeed, everyone seems to be piling into the dollar. Especially on the short end of the curve, helping drive interest rates ridiculously low. The dollar is as safe as a bomb shelter that’s rigged to blow up once everyone is “safely” inside. You can go check it out if you want to (sure, from the outside it might look like shelter), but you don’t want to be in there when it blows up. You’ve got to realize that it is both economically and politically undesirable for any currency to appreciate against its peer currencies due to its use as a safe haven. Remember the Swiss franc? As soon as it started rising due to safe haven use they started printing it back down. The dollar is no different except that it’s got a whole world full of paper obligations denominated in it. So when it blows, the fireworks will be something to behold.
What will change the confidence that people have in the dollar? Will there be some catastrophic event?
That’s the $55,000 question. It is impossible to predict the exact pin that will pop the bubble in a world full of pins, but I have an idea that it will be one of two things. I think the two most likely proximate triggers to a catastrophic loss of confidence are a major failure in the London gold market, or the U.S. government’s response to an unexpected budget crisis due to consumer price inflation. Most people who expect a catastrophic loss of confidence in the dollar seem to think it will begin in the financial markets, like a stock market crash or a Treasury auction failure or something like that. But I think it is more likely to come from where, as I like to say, the rubber meets the road. And here I’m talking about what connects the monetary world to the physical world: prices. I think these “worlds” are connected in two ways. The first is the general price level of goods and services and the second is the price of gold. If one of these two connections is broken by a failure to deliver the real-world items at the financial-system prices, then we suddenly have a real problem with the monetary side. So I think it will be a relatively quick and catastrophic event, but maybe not as dramatic as a major stock market crash. It will be confusing to most of the pundits as to what it really means, so it will take a little while for reality to sink in.
The Romans debased the denarius by almost 100% over a period of 500 years. The dollar on the other hand has lost more than 95% of its purchasing power since the Federal Reserve of United States was established in 1913, nearly 100 years back. Do you think the Federal Reserve has been responsible for the dollar losing almost all of its purchasing power in hundred years?
Yes, inflation was a lot slower in Roman times because it entailed the physical melting and reissuing of coins of a certain face value with less metal content than previous issues. This was a physical process so it occurred on a much longer time scale. The dollar, on the other hand, has lost nearly 97% of its purchasing power in roughly a hundred years. Do I think the Federal Reserve is responsible for this? Well, given that the lending/borrowing dynamic causes expansion of the money supply, I think the government and the people of the world share in the responsibility. But just because the dollar has lost 97% of its purchasing power doesn’t mean that any individual lost that much. How many people do you think are still holding onto dollars today that they earned a hundred years ago? How long would you hold dollars today? As long as the prices of things you want to buy don’t change during the time you are holding the currency, what have you lost? So imagine that you simply use currency for earning, borrowing and spending, but not for saving. Will it matter how much it falls over a hundred years? Your earning and spending will happen within a month or so, and prices won’t change much in a month. Also, your borrowing will be made easier on you as your currency depreciates. And your gold savings will rise. So with the proper use of money, there is no need for alarm if the currency is slowly falling at, say, 2% or 3% per year.
Do you see America repaying all the debt that they have taken from the rest of the world? Or will they just inflate it away by printing more and more dollars?
The debts that exist today can never be repaid in real terms. And as I mentioned before, they are all denominated in symbolic words like dollars, euro, yen, yuan and rupees. The debt of the U.S. Treasury, most of all, will of course be inflated away.
What are your views about the crisis in Europe? Will the euro hold?
Contrary to most of what we read in the Anglo-American press, I don’t think the euro currency is at risk from the sovereign debt crisis in Europe. They are two different things, the debt crisis and the euro. The euro currency faces none of the usual devaluation risks. Trade between the Eurozone and the rest of the world is balanced and the ECB has plenty of reserves. So aside from devaluation risk, which the euro doesn’t face, the only other risk is if the people decide to abandon the euro. Procedurally this would be so difficult for any country to do on a whim that I can confidently say it is virtually impossible aside from the most extreme situations like a revolutionary war or something like that. And I don’t see that happening. I think the euro survives come what may.
What does FOFOA stand for?
I remain anonymous because my blog is not about me. It is a tribute to “Another” and “Friend of Another” or “FOA” who wrote about this subject from 1997 through 2001. So FOFOA could stand for Friend of FOA or Follower of FOA or Fan of FOA. I never really stated what it stands for, so you can decide for yourself. 😉 Sincerely, FOFOA.
(The interview was originally published in the Daily News and Analysis(DNA) on July 2,2012)
(Interviewer Kaul is a writer and can be reached at [email protected])