Around the world, investors are buying gold. They have been doing this for nine consecutive years. There was a temporary dip in gold's price from about $1000 to about $750 in 2008, but the reversal has been substantial, as we all know. This has not just been in the United States. This is not uniquely a phenomenon of the United States dollar. This is an international phenomenon, and it involves the major currencies of the world.
You will sometimes hear that the movement of gold is primarily due to a decline in the value of the dollar. The person who offers this argument is probably suggesting that gold's price has not been moving up because of fundamental conditions that persist around the world. He is arguing that there is something fundamentally wrong with the dollar. Or maybe he is arguing that the dollar is in a temporary decline, which has raised the price of gold as denominated in dollars.
One of the best ways to assess the logic of an argument that explains the move upward in the price of gold by means of an appeal to a falling dollar is to check the price of gold in several other currencies. If you find that, over several years, the price of gold has moved up in a number of major currencies, then you can conclude that the driving force behind gold is not the Federal Reserve System acting alone. The cause is the policies of other central banks around the world. In other words, if gold moves upward in multiple currencies, investors worldwide have determined that gold is a way to hedge their economic futures against a decline in the purchasing power of their own currencies.
If gold's move were simply a result of expansionary monetary policies by the Federal Reserve System, then the price of gold ought to be flat in relation to the other currencies. Under these circumstances, we would expect the purchasing power of the dollar in relation to those other currencies to be falling. "See? The other currencies are stable; the problem is the declining value of the United States dollar."
On the other hand, if the relationship between the dollar and the other currencies is fairly stable, and the price of gold has been rising in those other currencies, then we ought to conclude that the problem is not unique to the dollar, and that the move upward of the price of gold is due to more fundamental causes than the policies of the Federal Reserve System.
MONITORING THE PRICE OF GOLD
On the home page of my website, GaryNorth.com, I have a link that you can click to see price of gold, as denominated in United States dollars, over the previous five business days. Click that link, and it takes you to a page on my site that is devoted to various aspects of gold. Immediately beneath the graph of the price of gold over the last five days is a link that you can click which will take you to a series of graphs of the price of gold in several other major currencies.
I suggest that you take a look at the price of gold in these other currencies. If you do, you will find that there has been a general movement upward in the price of gold in all of these currencies. The parallel, currency by currency, to the rise in the price of gold in the United States dollar is visible. You can see for yourself the rise in the price of gold is an international phenomenon. It is not due simply to the policies of the Federal Reserve System. Only to the extent that the central banks of those other nations have followed the same policies of the Federal Reserve can it be argued that the upward pressure on the price of gold is due to the Federal Reserve. If this is the case, then the other central banks are simply following the lead of the Federal Reserve. This is what I think has been going on.
When you follow the international price of gold, as denominated in several currencies, you get the sense that there is a declining faith internationally in the reliability of domestic currency systems. A rise in the price of gold in multiple currencies indicates a vote of no-confidence by members of several nations in the monetary policies of those nations' central banks. The public cannot veto the policies of their central banks, but they can seek to evade the effects of these policies by selling their domestic currencies and purchasing gold.
I think we are seeing a loss of faith internationally in the reliability of the decision-makers of the nations' central banks. Around the world, investors have begun to conclude that their domestic central banks are likely to inflate, and therefore the future purchasing power of their domestic currencies is at risk. A growing number of investors have decided that it is better to unload their domestic currencies and to substitute ownership of gold in some form.
We are not yet seeing a true gold rush. We are not in the midst of a mania comparable to the mania of 1979. We are seeing a steady increase in the distrust of domestic currencies by citizens of several nations. This loss of trust indicates that people have begun to conclude that they cannot trust promises of politicians to preserve the purchasing power of their national currencies. When people lose faith in the promises of politicians, they look for investments that have historically proven to be ports in the storm when politicians' promises have turned to dust. Gold historically has been the most sought-after alternative currency to paper money currencies around the world.
THE LEGACY OF GORDON BROWN
When Gordon Brown, as the Chancellor of the Exchequer for Great Britain, sold off half of the bank of England's supply of gold in the late 1990s and early years of this century, he provided an enormous subsidy to those of us do not trust paper money. He in effect subsidized those of us who are gold bugs. I certainly am very grateful for Mr. Brown for being a Keynesian idiot, and also a Keynesian idiot in a position to implement his idiocy by selling off half of the gold of Great Britain. He certainly did me a great favor, and did a great favor to my subscribers who bought gold under $300 an ounce.
We have not seen any other national figure equally ignorant of economics, equally committed to Keynesianism, and equally powerful. Gordon Brown was unique in the late 20th century. It would be hard to find any other political figure who cost his government more money in forfeited assets in peacetime than Gordon Brown.
We should not expect to see any national political figure as economically ignorant as Gordon Brown. It is unlikely that any of them wants to wind up as Gordon Brown did. No politician wants to run for national office after having sold half of his nation's gold reserves at the bottom of the market two decades after the peak. In the history of finance, no other decision-maker at the senior level matched what Gordon Brown did. Nobody lost that much money on the basis of setting a single policy that backfired more loudly than he did.
Because of this, we should not expect to see governments and central banks selling off large quantities of gold in order to depress the price. Brown did it for ideological reasons, for he took seriously the words of Keynes, namely, that gold is a barbarous relic. Gordon Brown is now a political relic. Other politicians are not interested in matching his legacy.
While it is likely that there will be occasional sell-offs of gold by central banks in order to depress the price of gold, it is also likely that the main purchasers of this sold off gold will be other central banks. India and China are interested in increasing their holdings of gold, and if Western central bankers are stupid enough to sell their nations' gold, then India and China would be happy to oblige them. They will be happy to take the subsidy provided by Western governments, and take delivery of the gold.
Here is a crucial fact: central banks take delivery of gold. They are not operating in the futures market, where 97% of individuals take positions either long or short, but never intend to take delivery. Central banks are quite willing to take delivery, and if they can get a good price from another central bank, they do so.
This is a fundamental change in the pricing of gold. There have been times in the past the central banks sold gold into the general marketplace. This transferred the holdings of gold to private citizens. When central banks have leased gold to bullion banks, those banks have sold gold into the general markets. This transferred the ownership of gold out of the hands of central banks and into the hands of private investors. Officially, these sales were not sales. The gold is on the books of the central banks. This is an enormous deception. It is deliberate on the part of the central bankers. They have wanted to push down the price of gold, but they have not wanted to admit to the voters that the nation's gold is gone.
There are people who argue that central banks will continue to sell gold as a way keep the price of gold down. I believe that the central banks will continue to lease gold, which is a disguised form of sales, but I do not think that there will be major announcements of gold sales into the private sector. There may be sales, but the purchasers will be other central banks. So, we should not expect to see a major decline in the price of gold as a result of threatened sales by central banks or even the International Monetary Fund. The real sales are disguised sales: gold leasing.
Anyone who argues that gold is in a bubble is arguing that this bubble is international. If it were not international, the price of gold would be rising in terms of the United States dollar, but it would not be rising in terms of other foreign currencies. Yet we have seen that the price of gold and foreign currencies has risen. So, if this is a bubble, it is being caused by central bank policies, not simply the policy of the Federal Reserve System. If this is a bubble, then it is an internationally engineered bubble.
This is why I do not believe that we are seeing a bubble in gold. The rise in the price of gold is not simply the result of Federal Reserve policies. When we look for a bubble, we must begin with Federal Reserve policy. When we look for an international bubble, we should look at Federal Reserve policy that has been imitated by central banks in other nations.
There was a bubble in real estate that popped. The bubble existed because there were parallel policies implemented by central banks around the world. This was especially true in English-speaking nations. To this extent, the rise in the price of gold since 2001 is the result of central bank policies. But these policies were not centrally administered. Central bankers imitated Alan Greenspan, and they have also imitated Ben Bernanke. But for the bubble to pop, there ought to be simultaneous reversals of central bank policy around the world. If the same inflationary policies led to an increase in the price of gold in multiple currencies, then any sustained fall in the price of gold will be the result of similar policies in the future.
We are not seeing mass inflation of the monetary bases of the central banks of the West, including Japan. There was monetary inflation in October 2008, and this was international. Today, in contrast, central banks are exercising restraint in the expansion of their holdings of government debt. This has stabilized the growth of money. Nevertheless, the price of gold has continued to rise. Why should this be? I think the obvious answer is that investors have become concerned that the recent stabilization of the various central banks' monetary bases is a temporary phenomenon. Investors have concluded that central banks will inflate in order to keep their national economies from falling back into recession.
In every nation, commercial banks are refusing to lend money. They are increasing their holdings of excess reserves in their respective central banks. What Japan has experienced over the last two decades, Western nations now have begun to experience. The price level in each nation is not shooting upward, even though the expansion of the monetary bases of these nations was substantial in late 2008. The money multiplier has dropped to unprecedented low levels.
LONG-TERM CENTRAL BANK POLICY
The rise in the price of gold indicates that a minority of investors believe that this period of stable money is unlikely to continue. They believe that, despite a slowdown in the domestic economies, the price of gold will continue upward, because there is no way that central bankers will stabilize the money supply, despite the fact that their nations are falling into secondary recessions, or at least are not experiencing economic growth. Central bankers have only one solution. That solution is to inflate. They expand their holdings of government debt, and this expands the monetary base. Only commercial bankers, who decide not to lend all the money that they are legally allowed to lend, keep the expansion of the monetary bases from resulting in the expansion of the money supplies and rising consumer prices.
Because investors perceive all of the central bankers as being in the same boat, and because gold is the familiar lifeboat available to people living in nations whose central banks are inflating, the price of gold in multiple currencies has been rising. It is true that mainstream investors still have not begun to purchase gold. It is also true that, until the final phase of the great inflation finally arrives, mainstream investors are not going to buy gold. There is enormous hostility to gold among politicians and Keynesians. The propaganda against gold has been going on for over seven decades. These people will not change their minds about gold until such time as private citizens who hold their money in mutual funds finally conclude they have got to get a larger percentage of their wealth into gold, or what appears to be gold, some form of supposedly legal claim to gold.
The move into gold will not come as a result of a decision by the managers of hundreds of mutual funds to buy gold mining shares. It will come as a result of investors switching out of stock mutual funds, bond funds, and money market funds in order to buy what they hope is gold, rather than just an unsecured promise to pay gold at some future time. When the average investor finally figures out that he cannot trust the central bankers, then we will see a major move into gold, at which time, someone who says that the gold mania is a bubble may actually be correct.
This is why I suggest that you discount any statement from a hedge fund manager or other major pooled investment fund that gold is in a bubble, and the price of gold will soon collapse. If the central banks of the world really were committed to the stabilization of money, and if they really were committed to staying out of the equities market, the mortgage market, the bond market, and the commodity futures market, then a collapse in the price of gold would be a reasonable forecast. But this is not the world we live in.
So, on the one hand, we see a slowdown in central banks' purchase of reserves. This has called a halt to the expansion of the monetary bases of the world. On the other hand, gold still has continued to rise in price in multiple currencies. This tells me that we are not in a mania, but that we are experiencing a steady loss of faith in the future of digital money that is not backed by gold or silver. We are seeing a change of opinion that is worldwide. These sorts of events do not take place very often. But when they do take place, they are widely based and difficult to reverse.
The day-to-day fluctuations of the price of gold are of no particular interest to me. I do not think they should be of any interest to you, either. What is significant is the long-term trend of the price of gold, as denominated in multiple currencies. That trend has been up for almost a decade.
The experts, so-called, who did not see this coming continue to tell us that it will end soon. I think it will go on until such time as gold-holding investors believe that they can once again trust the policies of their own central banks. When they once again are convinced, as they were in 1980, that the Federal Reserve is not going to expand the money supply, no matter what the rate of unemployment is, no matter what the international value of the dollar is, no matter what, gold's price will peak. When gold bugs are convinced this is true, and when Indian fathers are convinced that gold prices are too high, and they might as well wait for a lower price of gold to build up the dowries of their daughters, then the bubble is getting close to popping. So far, I do not see this.
There was a bubble in January 1980. The price of gold rose from one day above $800. In today's money, that would be close to $2300. This is why I do not regard the present price of gold as a bubble. If it is a bubble, it is not the only bubble. There is also the commodities bubble, an oil bubble, and a farm land bubble. It is not just a gold bubble.
October 1, 2010
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