Monday, May 24, 2010

Revisiting the gold standard

As the Greek crisis engulfed Europe, the euro fell against both the US Dollar and gold. The most interesting thing to emerge out of this episode is that gold appears to have re-asserted itself as a reserve currency as its price climbed in USD terms.

I had previously written an article questioning the role of gold. With the Eurozone crisis fresh in our minds, is it time to revisit the idea of a gold standard?


Do we really want currency inflexibility?
To put the idea of a gold standard in context, consider this comment at Pragmatic Capitalism [emphasis added]:

The irony behind the Euro crisis is that it is not at all a condemnation of fiat money. In fact, it is a condemnation on single currency systems such as the gold standard. I have long argued that the mess the EMU created in 1999 with the inception of the Euro was unlikely to survive a serious global recession. This was due to one primary argument. The gold standard and single currency systems have all ended in demise for similar reasons. This was due to their inherent inflexibility and inherent weaknesses imposed on particular trade partners within the currency system.
Despite of the problems in the UK, the British must be thanking their lucky stars that they didn't join the eurozone as they have the flexibility to devalue their currency if necessary.

What about a hedge against chaos?
The other classic argument for holding gold is that it is the ultimate store of value during periods of political chaos. Fortunately, most of us haven’t experienced that kind of chaos in our lifetimes, or our parents’ lifetimes, so we are only relying on the theory of gold as an ultimate store of value. Consider this discussion posted by Cassandra does Tokyo, who spoke with someone that came from the former Yugoslavia and had first-hand experience of political chaos [emphasis added]:

Starting with the [now seemingly forgotten] crisis, we talked of many things, before it turned to "Gold", which he volunteered, he thought was dumb. Not that he thought the vaulting price was stupid. He offered no opinion of that. But, he said, the war years were tough. Really tough. (He was not of Serbian descent, as it would happen). He'd seen his friends, he explained, do the smash-n-grab (not literally) thing following the disintegration of what was Yugoslavia, rolling up ill-gotten gains into (amongst other material objects) hoards of gold. Their hedge. Their so-called mad money, for which he said chided them at the time, though to little effect. But, he went on, when things got really dire, there was no market for it. There was no way under the circumstances to reasonably convert the hoards to what one really needed. As a result, the going rate was all over the map, but half-ounce or ounces were commonly traded for sugar and flour in ratios that would make the wealth-hedging gold-bug weep. I listened intently, though it was just an anecdote, but an interesting one nonetheless.
So it turns out that gold may not be such a flexible store of value if everything fell apart. Cassandra does Tokyo went on to state that basic necessities such as sugar and petrol (gasoline) would be better stores of value under cirumstances of social chaos:
Viewed from this point, gold is a trade, for ruminating upon my Bosnian acquaintance's anecdote, there is a point - call it the "Oh Fuck moment" beyond which Gold is quite sub-optimal, and sugar, petrol, some vegetable seeds, a goat or two, an alembic, all make seeming better sense. Or, perhaps in the extreme, the best hedge in the event (if you believe in the event) of a breakdown in the rule of law, is to BE the baddest thug, and/or join/align yourself with the meanest thugs around, a paradoxical feedback loop that leads one down a disturbing rathole indeed.


A gold and commodity bubble
Despite all these negatives, I remain a long-term gold and commodity bull. George Soros believes that gold is in a bubble – and I agree. While some have interpreted Soros' comment as gold could collapse at any time, I have a different take. Recall that I wrote before about his belief about recognizing bubbles and to ride the wave of euphoria as a way of making money.

If this were indeed a gold bubble, then I would not be surprised to see bullion top out at between 5K and 10K or more before this is all over. As an indication of bubble conditions, Patrick Chovanec recently wrote that China is catching the gold bug – which is an indication that this gold bull may have a long way to go.

Am I a long-term gold and commodity bull? Yes. Fiat currencies are in decline and hard assets are in a secular bull market, though it will have cyclical ups and downs.

Do I support the idea of bringing back the gold standard? No, that’s a really bad idea.

5 comments:

keithpiccirillo said...

Do you listen to the Donald Coxe weeklies, and do you have respect for his body of work? He's also bullish gold longer term.
In Italy on a hot summer day you may want Italian ice (sorbet) but the street vendor may convince you to buy the ice cream, because you are unaware that's all he has.
I follow him because of his self proclaimed "Mr. Ted Spread" label, but realise everyone sells you what they have.
I know the commodity mix and the importance of carrying different non-correlated asset classes.

Humble Student of the Markets said...

Yes I do listen to Don Coxe. I am in general agreement with his views, but unfortunately he has "jumped the shark" and started writing "why I am right and the market is wrong" pieces when things moved against him.

chwee said...

Your excerpt from Cassandra's blog was a bit selective. At least one other survivor from Yugoslavia or WWII pointed out that without gold, they would have had no other medium of exchange for essential goods needed for survival in those chaotic conditions. The Jews who were let into Switzerland as Hitler advanced? They were the ones with gold in their car trunks. What's the true value of gold then?

Mike C said...

Despite of the problems in the UK, the British must be thanking their lucky stars that they didn't join the eurozone as they have the flexibility to devalue their currency if necessary.

I'm still trying to "put it all together"/"connect all the dots" when it comes to currencies especially regarding relative currency values and intentional currency devaluation.

What you say above regarding currency devaluation, I think I understand why that may be beneficial at the aggregate country/societal level (cheaper exports, more competitive labor), but isn't true that by definition an intentional currency devaluation is essentially the destruction of savings for anyone who by "unlucky stars" happened to have the bulk of their lifetime savings denominated in that particular currency especially with respect to purchase of foreign goods is appreciating currencies?

I am a U.S. citizen, and ultimately I expect an official dollar devaluation down the road similar to what Roosevelt did. I see no other way out of the debt mess. And that is fine. I don't really care as long as I can find a functional way to maintain the real purchasing power of my accumulated savings and let most everyone else take the hit.

You seem ambivalent about gold? If not gold, then what? Oil? Jeff Saut in his weekly piece quoted someone suggesting oil could be the new world currency. Currencies of particular countries such as Canada because of its oil reserves?

Will it even ultimately matter if one takes theses measures in response to currency devaluation? Will governments simply enact punitive taxation and/or confiscation against people with the foresight to protect themselves with the convenient message of labeling them currency speculators (I recently saw a 1974 video of Nixon that was just unreal in terms of the populist nonsense message against "currency speculators").

I agree that in a situation of total social/political chaos gold won't matter, neither will fiat cash, or stocks or anything. It will law of the jungle with brutality ruling the day. I see that outcome as so remote as not worth even considering. In Western civilized countries like the U.S. and Candas the powers that be would never let it get that far. Given that, I am more worried about just a plain vanilla wipeout of paper currency similar to 20s Germany. Seems to me like sovereign governments and central banks are conducting a grand experiment, and the situation was allowed over the past 2 decades to get to a point where there are no good solutions left, and the line between a spiraling deflationary loop and hyperinflation is a thin one.

Thanks for any comments/feedback.

Arnold said...

19th century U.S. monetary history shows the imperfection of a gold standard. I prefer a Gold Exchange Standard, where Central Bank (Federal Reserve) assets and liability creation are limited to the gold owned. This can run any where from 25 to 40 per cent. This would prevent the Greenspan / Bernacke business, but not the necessary addition of money to the money supply.