Wednesday, November 4, 2009

Why Gold?

We're hearing an awful lot about gold in the news of late. In case you missed it, the IMF sold a tremendous lot of its gold, about 400 tons, half of which which was promptly snapped up by the Reserve Bank of India. Ironically, on news of this tremendous sale, gold made an all-time high. Increased supply hitting the market is supposed to reduce prices, not raise them. We are in the midst of a financial crisis. We all understand that. We also understand that gold is supposed to be an inflation hedge, though for some reason it didn't act as much of one from 1980 to 2000. But how has supply and demand come unhinged? Why has gold, dismissed for so long as a relic, suddenly become so important in the age of the computer? Why doesn't this stuff ever just die? What in the world is so darn special about gold? What Is So Special About Gold What is so special about gold is that it makes the best money. The central banks of the world have created a royal mess of their money systems, so in fear they are reverting to gold, which was the preferred banking asset of antiquity rather than the paper assets that had been preferred up until very recently. Rather than base their systems on the US dollar as the reserve currency, which like every other currency has come under intense scrutiny, they are reverting to reserves of gold. For gold enthusiasts, this should come as no surprise. Of the many articles tried as money over the centuries -- stones, seashells, tobacco leaves, green slips of paper with dead politicians printed on them, electrons sitting in a bank's computer system -- the precious metals have proven the most robust systems ever devised. This hasn't changed despite every advance of human technology. Why does gold make the best money? You can read a lot about the subject, but the most important properties that are typically cited for making the best money are:
  • durability, e.g. resistance to decay
  • divisibility
  • recognizability
  • portability
  • high value to size ratio
  • limited availability, e.g. relatively steady supply over time
Gold has all of these, but the key property with respect to our present predicament is the property of limited availability. Our government has manged to get us into a fantastic pickle, and it appears that it has decided that the best way out is to print lots and lots of money, which is not going to be good for anybody. Not only that, but half the reason it is in the pickle in the first place is that it has been in the habit of printing lots and lots of money even when it didn't have to. It would have been nice if all this time the government had been limited as to how much money it could put into circulation. And that's just the point: it can't print gold. Nobody can. There is nothing magical or mysterious about gold. It doesn't have any supernatural properties. It just has a combination of a few very normal properties that make it work better as money than most anything else. Is gold the only solution? Based on this discussion, probably not. From what I hear, the rare earth metals of the lanthanide series have a similar property of being difficult to isolate and limited in abundance, though they are not nearly as corrosion resistant as gold in pure form. But a lanthanide-chromium alloy would likely hold up quite well. So, if others are game, I'm perfectly willing to entertain the idea of a money system based on gadolinium ingots and alloy coins. It would work just as well. But this probably sounds even less reasonable than a return to gold. Politically, it just wouldn't be doable. Gold it is, then. Will Gold Stop the Business Cycle? No, probably not. The business cycle is caused by inflation, which leads to pricing estimation errors that wind up misinforming investors and therefore investment patterns. These errors must eventually be corrected. There will probably always be more gold being mined out of the ground, so there will always be some level of inflation. Arguably, though, since this gold is not preferentially entering credit markets, it could be argued that the effects of mispricing caused by inflation of the gold supply would not be quite as severe. Better still, barring such events as the discovery of an entire planet made of gold during some mission to space, or the invention of some sort of gadget that can produce or interconvert matter into any desired form, the absolute level of inflation would be far less severe. It couldn't possibly approach what we have experienced under the present global fiat currency regime which includes the paper US dollar. Aside from government actions, there would also still be fractional reserve banking to contend with, which increases the number of certificates redeemable for gold stored at the bank and therefore causes inflation. Putting a stop to this practice would probably be even more difficult politically than returning to a gold money system. So, it is likely that the business cycle would still be with us, supposing we ever get to return to gold. Of Free Men and Free Lunches OK. Given all that, just suppose we managed to accomplish both -- gold money and 100% reserve banking. Then what? Even under these conditions, I do not think we would ever eradicate the business cycle in every possible form. This is because man finds the concept of the Free Lunch so irresistible, obvious a fallacy though it is. Man's Relentless Pursuit of the Ever Elusive Free Lunch, or, as the Mighty Mogambo Guru might say TRPEEFL, is really the crux of the matter, as it is the demon spirit that animates such institutions as central banking, paper money, and every other Madoff/Ponzi/Social Security/pyramid scheme that we humans so reliably come up with. And buy into. HAHAHAHAHAHA! So, this side of Kingdom Come, I imagine we'll never fail to find innovative and creative ways to set up phony accounting schemes, delude ourselves into believing in them, engage in manic frenzies in the pursuit of imaginary wealth, and generally act like the race of economic lemmings that we are. Man has a way of perverting and defrauding virtually any scheme set before him. We had gold money for a good while. It devolved into a "gold standard," then a "gold exchange standard," and finally the fiat garbage that we do business in today. Supposing we could get back to a gold money system, I have every faith that mankind will manage to screw it up again. But I do think that while it could be maintained, a gold money system and 100% reserve banking would result in a significant drop in the magnitude of such cycles, as it would make such schemes more difficult to implement and easier to spot. We certainly wouldn't be able to sustain these multi-decade bubbles that blow themselves all out of proportion and threaten civilization itself when they burst. We'll just never see the end of the business cycle altogether, in my opinion, for precisely one reason: man is, on the whole, evil. The Ethics of Gold This, in the end, is the entire point. There is really nothing all that special about gold. The business cycle, with its wild frenzies and destruction of wealth and well-being, is actually an outward manifestation of the darker side of the human heart. Gold acts as a crutch to support fallen man's better moral impulses by limiting the money supply and upholding a modicum of accountability to monetary practice. It accomplishes this through a most primitive mechanism, the simple yet ironclad Law of the Conservation of Matter, as applied to a substance exceedingly difficult to obtain from nature. Why must we rely on the "barbarous relic" of gold? Could we not achieve a "Law of the Conservation of Money" on our own with paper money, which is so much easier and cheaper to produce? Probably not, again because we humans are innately evil. Token coins and paper money will never compare, and no appeals to modernity or sophistication will ever prevail over the primitive logic of gold, simply because technology is not the issue. Evil is. If money can be produced cheaply and easily, robbing other holders of money of their purchasing power and warping the pricing system, rest assured that it will be, despite any law or convention erected to thwart such activities. Such a money is inherently dishonest as a store of value and will not sustain a productive economy. Insulting as it may be to our inflated little egos, with all our modern technology and supposedly sophisticated scientific understanding of the world, we are still better off limiting ourselves with the moral crutch of gold.

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