You Can't Eat Gold!

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Slogans come
and go. Popular political slogans reflect the prevailing political
lies of a generation, which get replaced by the political lies
of the next generation.

When my parents
were in college, President Roosevelt made famous this phrase,
regarding the national debt, meaning the debt of the U.S. government
to investors in U.S. government debt: "We owe it to ourselves."
These days, the fundamental reality of that slogan is becoming
apparent: some people owe it to other people. Those who owe have
different goals from those who are owed. But in 1935, the slogan
was widely believed. It is amazing what the public will believe,
despite counter-evidence.

Nobody in
1935 would have imagined that the 6,000 banks that had gone bust,
1930—33, had owed it to each other. They had owed it to their
depositors, who lost their money when their local banks went bust.
There was no government-subsidized FDIC insurance in those days.
As borrowers, most of these same people had owed money to the
now defunct banks, whose assets (the debtors’ obligations) had
been bought up cheap by surviving banks, who then pressed the
debtors for payment. So, the farmer who was being evicted from
his land because he could not pay the mortgage now owed this money
to a different bank from the one that had owed him money in his
savings account, which was gone with the wind, along with the
original bank. In private banking, another slogan ruled: "Heads,
you lose. Tails, you lose."

Those voters
who had experienced this two-way squeeze on their net worth knew
better than to believe "we owe it to ourselves" with
respect to commercial banking. Yet they bought the same slogan
when it was applied to the biggest debtor of all, the U.S. government.

I can still
remember someone in 1959 telling me, "we owe it to ourselves."
But that slogan was fading in popularity by then. I have not heard
it in years.


Forty years
ago, when I was just getting started, this slogan was widespread,
though not part of the national consciousness: "You can’t
eat gold." That was back in the dear, dead days of the 1944
Bretton Woods agreement, when 35 dollars could be exchanged for
an ounce of gold, if the dollars were held by a foreign government
or a foreign central bank. Roosevelt had stolen the gold from
the public in 1933 for $20 an ounce and then turned it over to
the Federal Reserve System. Then he raised the price in 1934 to
$35, which enabled the FED to expand its reserves, thereby expanding
the money supply. The great winners in 1934 were investors who
had bought gold mining shares in 1933. The great losers were the
voters, who lost their ability to pressure the banks to stop issuing
fiat money.

The flow
of gold out of the FED began in 1957 and continued until Nixon
unilaterally revoked the Bretton Woods agreement on August 15,
1971. He closed the gold window, as the media put it at the time.
In between 1957 and 1971, those few people who believed that the
country should return to a "gold standard for citizens"
rather than a "gold standard for central bankers" were
challenged by this slogan: "You can’t eat gold." The
sloganeer then sat back, proud of his insight. My response was
always the same: "You can’t eat Federal Reserve Notes, either."
The sloganeer always became confused. I would sometimes add, "By
the way, in some primitive societies, women are the means of exchange."
This observation usually ended the chat.

I have not
heard "You can’t eat gold" in 25 years. All it took
was the rise in the price of gold from $35 to over $800, 1971
to January, 1980, to put the slogan out of circulation. Gold’s
post-1980 retreat in price did not revive the old slogan. Gold
has not approached $35 an ounce since 1971. When gold bugs quadrupled
their money by ignoring "You can’t eat gold," the sloganeers
retreated. They got tired of hearing about the capital gains made
by unbelievers who had never believed in the slogan. There is
nothing like tripling your money at the expense of a slogan’s
believers to reduce the popularity of the slogan.

Of course
gold is inedible. In most societies, money is inedible. This is
a sign of social progress, I say. It is a primitive society indeed
where people eat the currency unit. This is especially true in
societies where women are money.

Money is
the most marketable commodity. A marketable commodity has five

  1. Portability
  2. Recognizability
  3. Durability
  4. Divisibility
  5. High
    value in relation to weight/volume

Note: point
four is a real hindrance to societies in which women are money.

Gold has
long served as money because it has all five characteristics.
But gold substitutes have become popular: bank notes, letters
of credit, credit cards, and Federal Reserve Notes. Gold is heavy.
It is risky to transport. It is quite valuable, so making change
is a problem. But the fact that it is inedible was never a downside
of the gold standard.


There is
one major reason: the conditions that favored their popularity
fade. There are two ways that changing conditions kill a slogan:
(1) by removing any need to challenge the slogan; (2)
by destroying the believability of the slogan. In other words,
a slogan fades when the sloganeers completely win or completely

In the case
of "We owe it to ourselves," the fading came because
nobody with any influence challenged the growth of federal debt
after 1941. The supply-side economists in the 1980s announced
that "deficits don’t matter." The Keynesians had always
believed that deficits do matter most of the time: positively.
"The larger the better in recessions, and don’t worry about
them during the boom." The monetarists believed, "deficits
don’t matter at the margin." But the economy is always operating
at the margin. This calms the monetarists. Only the Austrian school
kept yelling that deficits do matter. Nobody listened.

can’t eat gold" faded for two reasons: (1) nobody except
the Austrians defended the gold standard after Nixon ended it;
(2) the legalization of gold ownership for Americans came in 1974,
after which gold was just another commodity, as far as most financially
alert people were concerned. "You can’t eat gold" was
no more relevant in a debate over monetary policy than "You
can’t eat copper."

So the two
slogans faded because of the complete victory by the defenders
of permanent government debt, who were very often critics of the
traditional gold standard. The two positions were related: rising
government debt and the absence of the traditional gold standard.

That the
two are related operationally had been one of the core arguments
in favor of the traditional, government-guaranteed gold standard.
The gold standard economists had argued that the primary restraint
on the creation of money by the central bank had been the threat
of a run on gold by the public. Remove this threat by breaking
the legal link between money in circulation and gold in government
or bank vaults, said gold standard economists, and both the money
supply and government debt will soar. That prediction has been
borne out by events after 1933 and 1971.

Here is the
government’s procedure. The government sells debt to the public.
It also sells to the central bank, which buys this debt with newly
created money. This newly created money drives up the price of
goods and services. Rising prices create rising demand by voters
for the government to do something to help them. The government
then passes a cost-of-living-adjustment (COLA) law governing welfare,
including Social Security. It raises Medicare payments. More money
flows out. More tax revenue is therefore needed. There is always
tax resistance. But new money puts people into higher tax brackets.
A graduated income tax then skims off a rising percentage of the
taxpayers’ income. The government likes this. Inflation is good
for its revenues. Politicians do not complain when the central
bank buys more debt and creates more money.

The boom
in commodities that took place in the late 1970s drove up commodity
prices. Then, when Volcker’s FED tightened money in the fall of
1979, the recessions of 1980 and 1981 drove down the price of
commodities. So, when the FED’s reinflation began after August
13, 1982, when Mexico nationalized the banks and threatened default,
the price of commodities stayed low. There had been overproduction
in the boom period. Producers had been fooled by monetary policy
to expect further price inflation. They guessed wrong. They guessed
wrong especially in mining and oil production. So, the result
was low commodity prices for two decades, despite rising prices
of final products, such as housing, and rising wages.

Now we are
seeing the recovery of commodity prices. Oil is the obvious example.
The price of gold has risen almost in lock step with oil. Sellers
of raw materials are facing what every seller wants: more people
at the auction. China and India are coming into the world of mass
production. Mass production of consumer goods requires the mass
consumption of raw materials.

Asia is not
burdened with the political liabilities of Social Security and
Medicare. This means Asia has extra capital to invest. It can
increase workers’ productivity, now that capitalism has begun
to replace socialism. Socialism kills the productivity of capital.
Even without high savings rates, Asia would become more productive,
merely by turning decisions over the allocation of capital to
private owners. But Asia is also thrifty. This double benefit
gives Asians a tremendous advantage. Low labor costs are a product
of low productivity. The masses of Asia are about to increase
their productivity. They will do so by becoming ever more competitive
with Western producers.

What I am
saying is this: the conditions that led to the abandonment of
the old slogans are about to be reversed. The old slogans are
forgotten today, but the conditions that provided the sloganeers
with such a victory that they abandoned the slogans are now fading.

owe it to ourselves" is not going to sell in a world in which
retirees are absorbing an ever-larger percentage of the productivity
of workers. "You owe it to us" has replaced "We
owe it to ourselves." The victims — younger workers — have not
yet come up with a slogan to match "You owe it to us,"
but they will. When the bite gets larger, they will. Count on
it. "We owe it to the children" is on the slogan short
list. "The right to die" is in reserve. If it gets big,
"the need to die" will move up a notch. "The obligation
to die" is always in reserve. "There comes a time to
pull the plug" will have its day in the court of public opinion.

But what
about "You can’t eat gold"? Will it ever return? I doubt
it. Old slogans, once discarded, are like Presidential candidates
who lost. They remain discarded. The case against the gold standard
is so widely believed today that I don’t expect to see a gold
standard installed anywhere in my lifetime. But the case against
the dollar is likely to become widely accepted in capital markets.
What will replace the dollar as the world’s reserve currency is
problematic. My guess is that no single currency will. The efficiency
of the currency markets is so great that investors can go from
one currency to another at a moment’s notice.

I think gold
will remain linked inversely to the dollar. As the dollar falls
internationally, gold will rise. If gold starts rising in relation
to other currencies, too, that will mark a break with the fiat
money world of central banks.

I think gold
is ultimately tied to oil. You can’t drink oil, and you can’t
eat gold. But if you own either oil or gold, you surely will have
caterers lining up to cover your banquet table.


Mark Thornton recently published an article
that argues the
case for gold from technical analysis. His charts are impressive.
I recommend that you take a look at them.

The first
chart shows the ups and downs of gold, 1975 to the present. It
does not chart gold at $35/oz in 1971. Gold at $400 is not much
above what it was in 1996. The question is: Has there been a permanent
turnaround? Thornton thinks there has been. So do I. He writes:

Trend lines
are figments for illustration purposes. What they show in this
case is that the price of gold has trended downward for the
last 23 years. The trend lines start from the very top of the
bubble and the next two "tops" in the early 1980s.
Starting from the top of the bubble, the trend line intersects
the gold price (in red) in early 2001 at around $265/oz. Gold
lost 70% of its value over this 20-year period, more if you
account for the depreciation in the dollar. The second trend
line starting at the next top intersects the gold price in early
2002 at around $300/oz. and the third trend line, starting from
the second peak and touching all subsequent peaks, intersects
the gold price in early 2003 at around $350/oz.

Had someone
taken his gold, sold it, and bought a mixture of stocks and bonds,
he would have earned in the range of 15% per annum. At 15% per
annum, not counting taxes (such as in a tax-deferred retirement
fund), 15% for 20 years would earn 16 to one. So, we should compare
a $1,000 investment in gold vs. $1,000 in a stock/bond mixture.
That’s $300 vs. $16,000. It was bad news for investors in gold.

Is this likely
to repeat? I think this highly unlikely. The swing will go the
other way, though I have no idea what the percentage swing will

second chart is revealing. It shows a major reversal in the trend.

It displays
one major cyclical bear market from early 1996 to early 2000
and a major cyclical bull market from early 2001 to the present.
The graph presents a pattern of prices that looks like a "W"
or what in technical analysis is referred to as a "double
bottom." This is a highly favorable pattern, and gold prices
have increased by over $150 since their low point in early 2001.
Technical analysis would suggest a high probability that gold
prices will go higher, but do not expect to get rich in a matter
of days.

He does not
rely on technical analysis alone. He also considers fundamentals.
Here, too, he sees a bull market.

analysis paints a picture of the past and provides a few clues
to the future direction of markets. However, fundamental economic
analysis is a far more important tool both for constructing
technical analysis and for anticipating future changes in markets.
My best guess based on fundamental economic analysis is that
we have indeed begun a secular bull market in gold. Both the
dollar and gold could stabilize for some time before continuing
their present long-term courses. In the case of the dollar it
is in a downward trend, and in the case of gold there is an
upward trend. These trends are fundamentally based on the inflationary
policy of the Federal Reserve, the deficit spending of the federal
government, and the continued weakening of the US economy.

Is the U.S.
economy weak? Compared to Asia, yes. Compared to Europe, no. Is
the FED in inflation mode? No more than usual. Is the deficit
in crisis? Yes. This is where the old argument for the gold standard
as a restraining factor comes into play once again. It is the
astronomical increase in the deficit that offers gold bulls a
major hope. This deficit must be funded. Asian central banks are
now funding it. They will not do so indefinitely. When they decide
to stop the policy of offering below-market loans for the U.S.
government, paid for by inflating their own currencies, the dollar
will fall, interest rates in the U.S. will rise, and the economic
boom will end.

Woe unto
the political party whose man is in the White House when this


The fall
of the dollar seems as sure as any forecast that rational people
could make. This will bring with it a rise in commodity prices.
Gold and oil are now linked, I believe. Gold is no longer a restraining
factor in government policy, but oil is. Gold will follow oil,
and oil looks to be in a bull market because energy is in a bull
market. Asia and India are plugging in.

The closest
thing to the Bretton Woods agreement today is the decision of
Arab policy-makers to sell oil for dollars. I do not expect this
policy to survive beyond this decade. When Arabs select another
currency, the dollar’s monopoly will go the way of all monopolies.
The party will be over for Americans, who have been able to buy
the world’s crucial commodity with fiat money. Fiat money always
goes the way of all flesh.

Don’t plan
to eat Federal Reserve Notes. But they could make a good fire-starter.

31, 2004

North [send him mail]
is the author of Mises
on Money
. Visit
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