Why Is the Price of Gold Falling?

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The Atlantic’s Jordan Weissmann writes:

Investors who love gold tend to think of it as a sort of bomb shelter. It’s supposed to be a secure place to park your money when the rest of the financial world is blowing up.

So some may find it surprising that in a year when Europe’s troubles have thrown the global economy into fits, gold has been a loser’s bet. The price per ounce of everyone’s favorite rock is down about 7 percent for the year and is off 15 percent from its September peak. According to a report released yesterday by the World Gold Council, total demand for gold fell 7 percent in the second quarter of 2012 compared to the year before.

Let this be a reminder that, no matter how long it’s been around, gold just isn’t that special. It’s a commodity that responds to the laws of supply and demand. Unlike commodities such as wheat or oil, which you can at least eat or burn for fuel, gold pretty much lacks any inherent value beyond what the market assigns to it. And in the past decade, much of the new demand that set gold off on a wild tear from around $300-an-ounce at the turn of the century to almost $1,900-an-ounce last year has come from two places: India and China. Combined, they account for 45 percent of the world’s demand for gold jewelry and bars.

Here we go again, the idiotic assertion that we can’t eat gold. Most things we can’t eat, including hard copies of The Atlantic. One of the most important things to evolve in economies is a medium of exchange. It allows indirect exchange and a greater division of labor. It is an important driver of economic growth. Without indirect exchange via a medium of exchange, it would be pretty difficult for Weissmann to earn a living as a writer. Think about it, he would have to go around offering his columns for food and shelter. Do farmers and carpenters have a demand for his writings in sufficient quantity to provide him with regular food and shelter?

Weismann could test this out right now, he could stop working for money, type up a column and head off to farmers, rental buildings and see if he can get food and shelter for his writings.

In short, the man is clueless about money. Money is much more important than wheat or oil. Since money is so important, you would be an idiot to want a money that you can eat, since food spoils. that is, it would deteriorate quickly. In other words, when I am looking for a medium of exchange, the last thing I want is to be able to eat it. But hey, if Weismann wants to test this out, after he fails to get home and shelter in exchange for his writings, he should try and offer ham sandwiches.

As for the items that have emerged as money, currently in the U.S. we have the U.S. dollar. The problem with the dollar is that the amount of dollars in circulation is controlled by the Federal Reserve. Since the Fed is for all practical purposes controlled by the banksters (JPMorgan’s Jamie Dimon is member of the board of directors of the New York Fed) and the Treasury, they will influence the Fed to print money whenever they need it. When they print, they cause price inflation, which screws the rest of us.

The alternative to paper money, such as the dollar, is gold. Governments hate gold, since they can’t control the supply of gold the way they can paper money. That’s why they push individuals toward paper money and at times (see FDR) have made it illegal to own gold.

Weismann is correct that demand from China and India can boost the price of gold, but the key driver is Fed money printing. As the Fed prints dollars, there are simply more dollars available to buy gold with and investors will choose to hedge against the price inflation by buying even more gold. This is when gold goes up. Since the start of the Fed, the Fed has been on one long money printing binge, with only minor slowdowns. There was a major slowdown in Fed printing in 2008 and more recently the Fed has slowed money printing once again. When the printing is slowed, which Weismann, does not mention at all, the climb in the gold price in terms of the dollar will start to decline. That’s what is going on now, but eventually the Fed will start printing aggressively again, maybe after a crash or after the elections,. The Treasury has too many bills to pay for the Fed not to prop up Treasury debt with newly printed dollars.

So while Weismann continues to look for a money that he can eat, the rest of us should take advantage of the temporary decline in gold, to stock up. The next round of Fed money printing is likely going to be very vicious, pushing gold to new heights, regardless of what buying comes out of China and India.

Reprinted with permission from Economic Policy Journal.

2012 Economic Policy Journal

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