Misunderstanding Gold

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I am a gold
bug. A gold bug is a believer in the public’s use of gold coins
as the basis for a nation’s money supply. Because very few university-certified
economists are gold bugs, and very few gold bugs are academic economists,
there is enormous confusion on all sides regarding gold: why it
is valuable, why it serves as money, why gold money is necessary
for freedom, and why we don’t need a government-guaranteed gold
standard in order to have a gold standard.

I begin with
a
recent observation by Hans Sennholz
, the dean of the Austrian
School of economics. He has written on all aspects of the economy,
as his teacher, Ludwig von Mises, also did. He has written more
than any other living Austrian School economist. Here is his recent
assessment of gold as a way to attain stable money.

Money is
no yardstick of prices. It is subject to man’s valuations and
actions in the same way that all other economic goods are. Its
subjective, as well as objective, exchange values continually
fluctuate and, in turn, affect the exchange ratios of other goods
at different times and to different extents. There is no true
stability of money, whether it is fiat or commodity money. There
is no fixed point or relationship in economic exchange. Yet, despite
this inherent instability of economic value and purchasing power,
man is forever searching for a dependable medium of exchange.

The precious
metals have served him well throughout the ages. Because of their
natural qualities and their relative scarcity, both gold and silver
were dependable media of exchange. They were marketable goods
that gradually gained universal acceptance and employment in exchanges.
They even could be used to serve as tools of economic calculation
because their quantities changed very slowly over time. This kept
changes in their purchasing power at rates that could be disregarded
in business accounting and bookkeeping. In this sense, we may
speak of an accounting stability that permits acting man to compare
the countless objects of his economic concern.

We can hope
for usable price stability over the time period of accounting, but
if we seek to establish a fixed-value currency, we will gain only
government-issued money and monetary instability.

So, the goal
of price stability is an illegitimate goal. All that we can legitimately
hope for is loose predictability of those specific prices that affect
us as individuals, so that we can make accurate plans for the future.

Any attempt
by the government or its agent, the central bank, to attain general
price stability is inherently self-defeating.

First, what
matters is not some committee’s official price index, but rather
specific prices as they affect acting individuals. To get the official
national price index to stabilize, the planners must raise some
prices, which would otherwise have fallen, and reduce some prices,
which otherwise would have risen. This is beyond any committee’s
ability to forecast or administer.

Second, even
if politics did not intrude, which it will, the central planners
of money will be forced to adjust the money supply to the committee’s
central plan. The wisdom of this market-insulated bureaucracy’s
central plan will not match the combined wisdom of profit-seeking,
loss-avoiding forecasters and entrepreneurs in an economy that has
a gold coin standard.

HOW GOLD
INVESTORS LOST A LOT OF MONEY

If you have
taken my free email course on gold, "The
Gold Wars
," you understand the basics.

If not, then
allow me to summarize.

There is a
nave view of gold that teaches that the price of gold doesn’t vary.
Only the value of paper money varies. Sennholz is arguing against
this view. The price of every good and every service varies as conditions
change: supply and demand. There is no fixed standard. There is
no yardstick for money. There is no such thing as a free lunch,
and there is no such thing as a measure of value. Economic value
is subjective. Prices change as subjective values change.

When you buy
a gold coin — which I suggest you do — you should not do so on the
expectation that its price will automatically rise when the dollar
falls in value. I realize that sophisticated investors say to themselves,
"I know this." But when they buy gold, they often move
from commodity investors to true believers. They read articles written
by people with no background in economic theory or history, who
become acolytes for gold. They become vulnerable to hype.

Gold bullion
was an illegal investment for Americans from 1933 through 1974.
This fact kept the average American from buying gold bullion coins.
This reduced the demand for gold. Gold’s price did not change on
international markets from 1934 to 1967. People made money buying
collector gold coins from 1967 to 1974. Then gold fell by almost
50% in 1975—76. Only after September, 1976, did it soar: from
$106 to $850 for one day: January 20, 1980. After that, it became
a very bad investment until 2001. It was then that I began promoting
gold once again.

Yet year after
year, 1934 to 2006, the dollar has depreciated. Decade after decade,
the Federal Reserve System has created money to buy U.S. government
debt, thereby lowering the purchasing power of the dollar, as estimated
in terms of various official price indexes, private and governmental.

Anyone who
bought collector gold coins after 1933 or gold bullion coins in
1973 lost money most of the time. There was a brief period of high
profits, from 1975 to late 1979, but the losses sustained after
mid-January, 1980, were horrendous.

I repeat all
this because I want readers to recognize the nature of gold. It
is a hedge against serious and generally unexpected monetary inflation.
But the investing public remains unfamiliar with gold. Only a few
tiny companies sell gold coins. The big brokerage firms downplay
gold.

Gold and silver
were bubble markets, 1975—1979. They popped in January, 1980. In
terms of purchasing power, gold at $600 today is the equivalent
of gold at $250 in 1980. But gold peaked at $850 in 1980.

It will take
unexpected and extensive monetary inflation to create a comparable
boom in gold.

THE CASE
FOR GOLD

The case for
gold is the case against government control over the money supply.
It is the case against experts who invariably substitute their judgment
of what is best for society in place of the decisions of individuals
regarding what is best for themselves. The case for gold is the
case against the civil government’s manipulation of the money supply.

Today, gold
has been demonetized for everyone except central banks. Large nations’
central banks do keep some gold reserves as the legal basis of their
nations’ currencies. But government bonds make up the bulk of central
bank reserves: their national debt and foreign governments’ debts
— mainly U.S. government debts.

The fall in
value of the dollar against the euro began in January, 2002. The
move upward of gold had begun in the previous quarter. People forget
how long this decline of the dollar has been going on. It did not
begin this year.

Gold peaked
at $725 on May 12, 2006. The fall of the dollar against the euro
has been attracting attention in recent months.

If
you follow the monetary statistics
, you are aware that the crucial
statistic, the adjusted monetary base, has barely moved since February.
The other monetary indicators have also fallen from their highs
late in 2005.

Bernanke’s
Federal Reserve has put on the monetary brakes. The fact that gold
is down against the dollar since the May high is consistent with
the FED’s policy. What has surprised people is the fall of the dollar
against the euro.

This tells
us that there is no one-to-one correlation between monetary policy
and prices. At best, there is a broad correlation. Gold rose, 2001—2006.
The euro rose, 2002—2006. But they did not rise in a straight line.

THE DECLINE
OF THE DOLLAR

The dollar
will decline. Of that, I am confident. At some point, it will begin
to decline much faster than it is declining today. When that era
comes, gold will be a fundamental investment to buy and hold. It
will preserve purchasing power.

We must not
be nave about gold’s potential during an era of relative monetary
stability, which we are in today. The FED can shift back to inflation
at any time. But Bernanke will resist this. He has bet his new career
on fighting price inflation. He says that price inflation is too
high. Yet the CPI, year to year, is under 2%. The Median CPI is
under 3%. He will pressure the Board of Governors to accept a monetary
policy that keeps all of the official price indexes under 2%.

When this monetary
policy produces a recession, there will be great pressure put on
him by Congress to lower interest rates to get the economy out of
the doldrums. At that time, we will see how committed the FED is
to Bernanke’s litany about inflation being too high. But we had
better take him seriously when he says that prices are rising too
much.

CONCLUSION

Because of
the war, which is not going away in 2007, gold should be in everyone’s
portfolio. But because recession looks increasingly likely in 2007,
the case for gold as an inflation hedge looks much less relevant.

Long-term,
the case for gold is the case against central banking. But central
bankers have managed to gain power over money for over three centuries.
Whenever they attain their goal, as they did in December, 1913,
they have not surrendered this control. I do not expect them to
do so in my lifetime.

As
the government’s debt obligation increases, the politicians will
look to the FED to buy the debt with fiat money. But, in 2006, the
FED has bought almost no debt. It will take a lot of political pressure
to force the FED to create a sufficient amount of fiat money to
get a replay of the bubble market of 1976—1979.

Assume this
when you buy gold.

December
13, 2006

Gary
North [send him mail] is the
author of Mises
on Money
. Visit http://www.garynorth.com.
He is also the author of a free 19-volume series, An
Economic Commentary on the Bible
.

Gary
North Archives

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