gold

Superior money

To answer this question is not straightforward. As the gold-sceptics keep reminding us, gold pays no coupon and no dividend, it does not offer a running yield, so traditional measures of ‘fair value’ do not apply. But gold is money, and just as the paper ticket in your wallet does not pay interest, neither does gold. Gold is a monetary asset that has functioned as a medium of exchange and a store of value for thousands of years, around the world and in almost all societies and cultures. Many modern economists believe that gold has now been successfully replaced with state paper money, such as paper dollars, paper euros, paper yen, and so forth. Holding gold is therefore redundant. The present crisis is a stark reminder that this faith in fiat money is misplaced.

Gold is still a superior monetary asset. It is not under the control of any political institution. It cannot be printed to artificially lower interest rates and to ‘stimulate’ the economy, to create fake booms in financial assets and in real estate, to fund credit growth with printed money rather than true savings, to subsidize the banking sector and then bail it out when the banks overreached, to allow the government to run never-ending budget deficits, to make unfunded promises to voters and fund wars. Gold is hard, inelastic, apolitical and truly international money. It does not bow to anybody. Paper money is a political tool.

Now that humankind’s latest and most ambitious experiment with fiat money, launched in 1971, has once again created massive imbalances and led the world into financial crisis, gold is experiencing a renaissance. But after the spectacular rally in the gold price over recent years many observers ask if the precious metal has not moved ahead of its fundamentals – even though it is not that easy to assess these fundamentals. They ask if gold has not entered speculative bubble territory. Even fiat money sceptics such as Bill Bonner and Marc Faber, who have long been fans of the precious metal, warn that this is not a one-way street. From its all-time high of $1,900 in September of last year, gold has already corrected by about 20 percent. The current price action in gold is certainly disappointing given the ongoing and even intensifying Euro Zone debt crisis, which should encourage additional shifts out of fiat money and into gold. This week The Wall Street Journal concluded that “Gold’s status as a safe haven is looking shaky.”

The question is therefore, if and how we can assess gold’s fundamental value, and by fundamental value I mean its role as money and a store of value, not its role as an industrial commodity. Are there any quantitative tools to determine if gold is in a bubble?

In this essay I will try and provide some back-of-the-envelope calculations that can give us some guidance as to the fundamental drivers of the gold price and the relative weight of these drivers through time. This is not meant to be a definitive analysis of the gold price and I certainly do not intend to give investment advice (my usual disclaimer!) or make any predictions as to where the gold price is heading. What I am doing here is a simple mental exercise that may be useful as a framework for how to think about the dollar-price of gold.

Gold’s PPP-price

Over long periods of time gold has done an extraordinary job at preserving purchasing power. Not surprisingly, it has beaten all fiat monies as a store of value.

Since the dollar came off the gold standard domestically in 1933, and in particular since it came off the international gold-standard-light (Bretton Woods) in 1971, massive quantities of new dollar currency units have been created, thus substantially reducing the dollar’s purchasing power. The question I asked myself was this: at what price would an ounce of gold have had to trade in any given year to exactly compensate its owner for the loss in the dollar’s purchasing power since 1933, the year the dollar became an irredeemable piece of paper?

In 1933, one ounce of gold was fixed at $35. By using the US Inflation Calculator we can determine, based on official US inflation statistics, how many dollars it would have taken in any subsequent year to buy the same quantity of goods and services that $35 dollars bought in 1933. For example, in 1970 it would have taken $104 to buy the same goods that $35 bought in 1933. In 1996, it would have taken $422. Therefore, if the ounce price for gold had been $104 in 1970 and $466 in 1996, gold would have exactly compensated its owner for the loss of purchasing power that the inflating paper dollar experienced.

Given gold’s historic role as money and its superiority as a store of value over longer periods of time, it is not unreasonable for the owner of gold to expect that – on trend and in the long run – he should be compensated for inflation. I call this synthetic price the purchasing-power-protection price of gold, or the PPP-price of gold, which can be thought of as some long-run lower limit of the actual gold-price.

Mises in his library

Ludwig von Mises; photo by mises.org

Of course, it is unlikely that gold would trade precisely at that price. At any moment in time, the price of gold will reflect many other factors, too. There are, first and foremost, expectations as to future inflation. Then there are potential concerns about the stability of the banking system, or geopolitical considerations. Additionally, a lot of gold has been mined since 1933, and in particular since 1950. Furthermore, we can debate whether official CPI statistics are really a good measure of the dollar’s declining purchasing power. As Mises has explained, there is no such thing as a clearly identifiable and measurable purchasing power of money. Every index that is being used is a compromise, and we know that the US government has repeatedly changed its methodology of how to calculate the debasement of its own fiat money. It would be reasonable to assume that the market has a superior way of assessing the dollar’s loss in purchasing power and that this would then be the true driver of the gold price, rather than the government’s official measure. Then there is the question if $35 is the right staring point. Before all privately held gold was confiscated by Roosevelt’s executive order in April 1933, the dollar was fixed at $20 dollars an ounce. $35 dollars was simply a new, administratively set price.

I decided to take the $35 dollar price simply because at that stage (1933) so many paper dollars had already been printed – by the banks and with the encouragement, since 1913, from the Federal Reserve as the government’s backstop for Wall Street – that the $20 dollar price was no longer reflecting the true price of gold: Americans were ditching bank deposits and paper dollars and accumulating gold thus pulling the rug from under the banking system. This was the reason for Roosevelt’s intervention.

In any case, there are many reasons why we should take this analysis with a pinch of salt. But nevertheless, I do not think that this approach is entirely without merit as long as we understand that it is simply a rough framework and do not read too much into it.

I calculated the PPP-price of gold for the 43 years from 1970 to 2012 and compared it to the average market price for gold in every year. The time series for the average gold price was provided by my friend David Goldstone, who obtained it from http://www.measuringworth.com/datasets/gold/result.php.

It was a discussion about the gold price with David that gave me the idea for this analysis.

I also calculated a simple ratio between the two prices, the market price and the PPP price. When this ratio is below one, the gold price is below the PPP-price and gold at this level would not even compensate for the massive dollar debasement since 1933. If the ratio is above one, the gold price compensates fully for the dollar’s loss in purchasing power and also provides an additional margin on top.

Yr      Gold price      Gold Price at 1933 PPP           Ratio
       per oz

1970

$36

104.00

0.35

1971

$41

109

0.38

1972

$59

113

0.52

1973

$98

120

0.82

1974

$160

133

1.20

1975

$161

145

1.11

1976

$125

153

0.82

1977

$148

163

0.91

1978

$194

176

1.10

1979

$308

195

1.58

1980

$613

222

2.76

1981

$460

245

1.88

1982

$376

260

1.45

1983

$424

268

1.58

1984

$361

280

1.29

1985

$318

290

1.10

1986

$368

295

1.25

1987

$448

306

1.46

1988

$438

319

1.37

1989

$383

334

1.15

1990

$385

352

1.09

1991

$363

367

0.99

1992

$345

378

0.91

1993

$361

389

0.93

1994

$385

399

0.97

1995

$386

410

0.94

1996

$389

422

0.92

1997

$332

432

0.77

1998

$295

439

0.67

1999

$280

449

0.62

2000

$280

463

0.60

2001

$272

477

0.57

2002

$311

484

0.64

2003

$365

495

0.74

2004

$411

509

0.81

2005

$446

526

0.85

2006

$606

543

1.12

2007

$699

558

1.25

2008

$874

580

1.51

2009

$975

578

1.69

2010

$1,227

587

2.09

2011

$1,600

605

2.64

2012

$1,575

619

2.54

1.161173252

average

 As one would expect, both PPP-price and gold market price increased substantially over those forty-three years. The average ratio was 1.16, which means that gold traded on average at a 16 percent premium to its PPP price. This makes sense. We would expect gold to compensate – most of the time – not just for present inflation but also for the extra risk of accelerating inflation in the future, or to also compensate for other risks. It should neither be surprising that the volatility of the market price around PPP was substantial. Only in about half the years in our study was gold trading even within 25 percent on either side of its PPP price.

Using the PPP-measure, gold was most undervalued in the early 70s when it traded at a more than 60 percent discount to PPP, and between 1999 and 2001, when it traded at a 40 percent discount. I will discuss the reasons for this shortly. Gold seemed most overvalued in 1980, when it traded at more than twice its PPP price, and from 2010 until today, when its price is again more than twice the level that would be justified on up-to-date paper dollar inflation alone. It seems obvious that in both these instances the gold price reflected concerns about an imminent further acceleration in inflation or even, I would argue, imminent monetary regime change. Before we look at these instances a bit closer let’s try and develop a narrative for our time series.

Gold in the 1970s

Richard Nixon

Richard Nixon Photo White House

We start in 1970 when the gold price was massively undervalued. The golden shackles had come off in the US domestically 37 years earlier when relentless paper money printing had commenced, albeit at first at a somewhat moderate pace. However, in blatant disregard for economic reality, the official gold price was kept at $35 an ounce, which by 1970 had become a joke. Remember that the US state banned its own citizens from investing in physical gold (the currency that the country’s own constitution had decreed!), and that restrictions on private ownership of gold or on exporting and importing gold remained in place in many countries. Still, many foreigners could exchange dollars for gold, not least the central banks, and they did, which began to put further upward pressure on the gold price. In the 1960s, Western governments formed the gold pool – first secretly, then openly – to manipulate the gold market and to keep a lid on gold. (Yes, dear reader, the governments of the ‘free’ and ‘capitalist’ West banned their citizens from holding the world’s oldest monetary asset and were for years engaged in outright large-scale market manipulation to make their fiat monies look good. Be under no illusions what these ‘democratic’ governments will be prepared to do when the present system is on its last leg!)

By 1970 the US was hemorrhaging gold and by 1971 Nixon had to close the gold window (well, he could have stopped printing paper dollars but that no longer seemed an option).

Between 1974 and 1978, gold traded consistently within a 20 percent band on either side of PPP. In 1974 and 1975, gold traded for the first time above its PPP price and probably for the following reasons: From January 1975 onwards, US citizens were again allowed to hold gold privately. 1974 was also the first year since the late 1940s that the US registered official annual inflation rates of double-digit figures. Gold was in demand because ever-higher inflation seemed inevitable. Gold began to trade at a premium.

This was the time of the ‘oil shock’, which is often described as the nasty colluding of oil-producing countries to artificially boost the price of their produce but which can also be described as a pooling of interests of the oil exporters to make sure they were not selling their precious oil for constantly depreciating paper dollars. James Turk of the Gold Money Foundation has an interesting chart that shows that when measured in gold the oil price has hardly moved since the 1950s.

1980: First paper dollar crisis

Be that as it may, gold moved up relentlessly and in the late 70s did so at an even faster pace than the dollar’s purchasing power was plummeting, which was already pretty fast to begin with. In 1980, US inflation reached a peak of 13% p.a.; the gold price reached a then all-time high of over $800 and an average price for the year of $613, which was 2.7 times its PPP-price ($222). Gold was trading at a substantial spread over its inflation-protection price because the public feared that inflation could spin out of control any minute. Having a pure paper dollar with no anchor in any commodity suddenly appeared to be a bad idea. The fiat money concept seemed to be failing. The market began to contemplate imminent paper money meltdown and monetary regime change.

As John Butler has pointed out, at 1980 gold prices the 260-million-ounce gold hoard of the US government (at least that is the number that I have in my head) would have covered the entire US monetary base (between $133 and $144 billion in 1980 – those were the days!) The gold price thus reflected the prospect of an imminent return to a gold standard.

Ron Paul

Ron Paul (photo: United States Congress)

Indeed, Ronald Reagan campaigned on a promise to investigate a return to gold and upon being elected president he set up a gold commission to do so. The 17-member commission decided almost unanimously against a return to hard money and voted to keep the paper dollar. I say ‘almost unanimously’ as two members objected to this verdict. They were Lewis E. Lehrman and ….Rep. Ron Paul from Texas!

 But it was Jimmy-Carter-nominated Fed Chairman Paul Volcker who gave the paper dollar another lease on life. He stopped the printing press, allowed short rates to shoot up and liquidate the misallocations of capital from the inflationary boom. The US went through a biting recession – then the worst since the 1930s – but inflation was crushed, so were inflation expectations and the gold price. Paper money collapse had for once been averted.

The premium over PPP declined from 2.7 times PPP to around 1.5 times PPP by 1983. Throughout the 1980s, gold continued to trade substantially above its inflation-protection price although by 1990 the premium had disappeared completely.  From 1990 to 1996 gold still traded exceptionally close to PPP but then the gold price went down in the late 1990s and for the first time since the early 1970s gold traded at a considerable discount to its PPP. How can we explain this?

The gold underperformance from 1996 to 2000

Gold market analysts such as Ferdinand Lips point toward various technical factors, such as massive gold sales by certain central banks, in particular the Swiss National Bank and the Bank of England in the late 1990s, and the growth of the gold-lease market, which gave mining companies cheap tools to sell gold production forward using again the substantial gold hoards of the central banks. I find it difficult to independently evaluate the impact of these factors but am willing to believe they played a role. I also believe that the overall macro-environment between 1996 and 2000 was very unusual. With hindsight we may say that, structurally, politically and cyclically, not everything was as squeaky-clean as it may have appeared at the time. But still, if there was ever a period over the past 43 years during which all major problems of the paper money economy seemed to be under control or even solved for good, this was it.

Ex-Fed Chairman Paul Volcker

Paul Volcker

These were the ‘good Greenspan years’. Real short-term interest rates were positive, bank reserves grew slowly, the yield curve was flat and the dollar fairly strong. There was a new belief in entrepreneurship and innovation, particularly in information technology. NASDAQ boomed. Productivity gains seemed high and there seemed to be no limit to growth. The business cycle was declared dead; the New Economy had arrived. In any case, growth was not manufactured by the government through deficit spending and money printing. The US was top dog, politically, economically and ideologically.

President Clinton had been elected on the promise to introduce state health care but once in office had to bow to the zeitgeist and advocate free trade instead (NAFTA), and even cut taxes. In 1994, the Gingrich Republicans shut down the government for some time, loudly contemplated closing various government departments for good, and started blocking much of Clinton’s spending proposals.

In 2000, the US had a budget surplus for the first time since it had severed its last link to gold in 1971.  In 2001, the gold price reached a low of $272 an once and thus traded 43% below its PPP price, its largest ‘undervaluation’ since 1972. Then the wheels came off the US economy and economic policy-making became outright bizarre.

2001 to today: crisis, deficits and cheap money

The NASDAQ boom turned out to be a bubble and it ended like all bubbles eventually do. The record bankruptcies of Enron and WorldCom in 2002 exposed recklessness and even fraud at the top of America’s New Economy. The 9/11 attacks in 2001 put America on a war footing. The Gingrich-Republicans were replaced with the neoconservatives, and instead of closing government departments many new departments and agencies were created, most infamously the Department for Homeland Security. As the ‘War on Terror’ had from the start no clearly defined enemy and no clearly defined objective it promised to be an instance of ‘never-ending peace through never-ending war’.  The budget deficit exploded.

Short-term economic growth was now engineered through easy monetary policy. Greenspan kept rates at 1 percent for 3 years and blew a massive housing bubble, and when that popped in 2007, a much worse financial correction than in 2001/2002 commenced. Lehman and AIG collapsed and a run on the entire system seemed imminent. The new policy tools included TARP, nationalization, massive stimulus packages, zero interest rates and repeated rounds of debt monetization (“quantitative easing”).

Through Greenspan’s 1-percent policy phase the gold price had already begun to recover and by 2006 gold was again trading at a premium to its inflation-protection price, for the first time since 1990. Since the financial crisis commenced in 2007, gold moved up relentlessly, the market-price-to-PPP ratio moving from 1.25 to 2.64 last year. At its present price of $1,600 per ounce gold is trading at 2.6 times its PPP price, a ratio that is close to where it was in 1980.

So is gold in a bubble?

I do not think so.

That it is trading at an inflation premium similar to 1980 should not surprise us. Just as in 1980 there is again a clear and present danger that the authorities are losing control over their fiat money. There is a risk of monetary regime change, just as there was in 1980. That the authorities managed to pull this thing back from the brink thirty years ago does not mean they will succeed this time.

In 1980, the key point of concern was high headline inflation. This is not the reason for concern at present. Back then the official inflation rate was almost 14 percent. By contrast, last year’s CPI-inflation in the US was slightly more than 3 percent. The concern stems from two other areas in my view: the massively inflated monetary base and the out-of-control budget deficit. The former is a clear indication of how sick the financial system is. Since 2007 the Fed injected $1,800 billion in new reserve money into the financial system, or more than twice the amount of reserves that existed in 2007 when subprime fell out of bed, and more then ten times the amount of reserves that existed in 1980. This money is not circulating through the economy, hence inflation is still fairly low. But this money is needed by somebody. It is evidently required to keep the banks in business or at least to prevent them from shrinking and from selling assets that nobody wants to buy at present prices. In short, all this money is needed to sustain a mirage of solvency of the financial system and an illusion of ‘recovery’.

At the same time, there is no self-sustaining recovery that would allow the Fed to reduce its balance sheet. Quite to the contrary, the weak employment report today will ignite new calls for another round of debt monetization (‘quantitative easing’). The Fed is boxed in. Without their massive support the chimera of recovery and of solvency would quickly disappear.

At the same time, the hyperinflated monetary base is a gigantic powder keg. When this money starts dripping into economy, inflation will go up and then what? Will the Fed be able to hike rates and stop the printing press to restore faith in paper money, just as they managed to do in 1980?

The key difference between 1980 and 2012 is this: In 1980 inflation was high but the Fed had room to maneuver. All that was needed was the political will to stop the printing press, to allow rates to go up and to allow a painful but cleansing recession. I am not saying that it was easy but it only took will. Paul Volcker had that will and resolve, and Reagan managed to sell it to the public.

Ben Bernanke

Ben Bernanke

Today, inflation is still fairly contained and without the Fed’s ultra-generous reserve policy there would even be deflation. But the Fed has no room to maneuver. The Fed has to stay super-easy to support an incredibly overstretched and bloated financial system, a system that is addicted to cheap credit much more than anything in 1980. If this easy policy leads to rising inflation or even rising inflation expectations, the Fed will be in a heap of trouble. If they hike rates they pull the rug from under a system that is on constant life support.

Also, the disappointing ‘recovery’ is bound to increase the pressure on the Fed to become even more accommodative and that increases the risk that things will ultimately slip out of their hands.

Then there is the gigantic budget deficit. In 1980 the US budget deficit was $73.8 billion in 1980 dollars, or $206 billion in 2012 dollars. In 2012 the deficit is likely to be $1,330 billion. In 1980 public debt was 33% of GDP, in 2012 it is 100% of GDP. Already the Fed is the largest buyer and the single largest owner of the government’s debt. Last year, 61% of new Treasurys were placed with the central bank.

Strangely, US Treasurys still seem to enjoy safe haven status in the private capital markets. Should this change and should investors begin to demand a higher running yield on these bonds, then the Fed would have to step in and buy even more in order to avoid a rise in the state’s funding cost and to mitigate the hugely deflationary impact on the inflated financial infrastructure that higher yields would have.

Everywhere we look things seem unsustainable and fragile, and everything seems to point in the direction of more accommodation rather than ‘exit strategy’. The printing press has become the last line of defense for a hopelessly over-leveraged financial system and an out-of-control government. And the gold market knows it.

 But our analysis can also explain why gold has traded sideways for the past 12 months. The monetary base is roughly unchanged from where it was last spring as the Fed has refrained from additional net asset purchases and has ‘only’ manipulated the yield curve via ‘Operation Twist’. The unchanged base seems to have caused the gold market to pause. The fiscal situation is still very bad but nobody expects any change here until after the election anyway.

In summary, gold is not cheap but its high price does not seem unreasonable either given the current policy predicament. If the Fed refrains from further easing measures and if there are no shocks to the system, the gold price could drift lower as the market decreases the premium over the PPP price. However, I would be very surprised if the ratio would fall below 1.5. That would mean a gold price of about $950. This would also constitute a retracement of 50% from last-year’s all-time high, a fairly brutal correction but one that also occurred in previous bull markets.

On the other hand, any additional measures from the Fed to ‘stimulate’ the economy, or any ‘accidents’ in the financial system, and the premium could even expand further. Additionally, any rise in inflation from still fairly low levels should also feed through into a higher gold price, even if the premium over PPP was unchanged.

Personally, I can still not envision an endgame here that does not involve either high inflation or a substantial correction (meaning collapse) of large parts of the financial infrastructure. In either case I want to hold gold, the superior monetary asset that is no-one’s liability, that is outside the banking system and outside of political control. Gold remains my favourite asset because it is a self-defense asset rather than a quick way to make a (paper money) buck. And don’t forget:

In the meantime, the debasement of paper money continues.

 

 

 

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36 Responses to Is gold in a bubble?

  1. [...] to crash back down to $275 dollars, by next Tuesday), Detlev Schlichter asks a very rhetorical question. Share this:TwitterFacebookEmailDiggMoreStumbleUponPinterestTumblrPrintLinkedInRedditLike [...]

  2. Joseph says:

    Great post, once again. You mention that massive quantities of dollar currency units have been created. Surely you are not taking into account the growth of consumer credit, let alone the growth of the derivatives space. Keen to get your reasoning on whether or not this should be factored in – and if so, what the Gold/PPP price would look like.

    • Rune K. Svendsen says:

      If we calculate the gold price in dollars based on the M2 money supply and the official amount of gold held by the Federal Reserve, the price of one ounce of gold would be around $40,000. In other words: if we view the Federal Reserve as a bank that issues paper tickets (dollars) redeemable in gold, the assets of this bank would comprise about 8,100 tonnes of gold (official figure). If all holders of these paper tickets (dollars) were eligible for an equal amount of gold from this bank, they would have to provide 40,000 Federal Reserve notes (dollars) to redeem one ounce of gold.
      The amount of consumer credit in existence is reflected in the M2 money supply. So this figure should take this into account.

      Wrt. to the derivatives market, I see no reason that this should affect the price of gold in any direct way. A derivative is simply a contract that obligates party A to pay party B depending on some event. The derivatives market doesn’t expand the money supply in the same way that if you and I make a one billion dollar bet, we don’t increase the amount of dollars in existence; the loser would have to pay the winner in already-existing dollars.

      • Joseph says:

        Thanks Rune. Just to add, there are countless billions worth of derivatives built around gold (i.e. ETF’s and vehicles designed to give exposure or leverage to the price of gold), so I would assume that they do in fact impact the price of the underlying commodity?

      • Peter says:

        Rune, where can we find more data on the gold price based on the USD M2 money supply over time?

        Detlev, what insights could we get from redoing your analysis using the “Gold price over M2 supply” measure instead of the “Gold price over government-published inflation numbers” measure used in your essay?

  3. azazel says:

    My friends house cost £400 in 1880, which is about 100 ounces of gold. 100 ounces in GBP would be around £100,000 and yet his house is £250,000, tired and far from its glory in the 1880s. Gold could more than double from here and still be only fair value. silver at its 16 to 1 ratio to gold would require 1600 ounces to buy the average house. (currently only 10 ounces of silver are mined to each ounce of gold) 1600 ounces of silver would cost £32,000 nowhere near enough to buy a house. Silver has a great upside potential, according to my “back of the envelope calculations”

    • Common Sense says:

      What’s your point? That shows the size of the UK housing bubble, not how undervalued gold is, methinks?

  4. Michael J R Jose says:

    I like nearly everything that Mr Schlicter says, in public and in his book, which I am reading very diligently. But I wish to pick up on a slight problem with language, just a slip probably…”Gold is hard, inelastic, immaterial and truly international money.” I think that should read: “Gold is hard, inelastic, MATERIAL and truly international money.” Gold is an element of the periodic table, definitely material, and not at all immaterial like the soul, free will, subjective concepts, or morality, obective or otherwise.

    Another interesting Schlicterism, if I may make so bold as to coin a word, is the use of the term ‘secular deflation/inflation’. This is harder to pin down, I normally mentally delete the word ‘secular’ when reading PMC or listening to Detlev speak. My problem is that the time honoured meaning of secular is in contrast to spiritual – in the religious sense – the laity versus the clergy. I think the use of the term as ‘secular inflation’ = ‘world inflation’, if we take it so to mean, is too risky and too vague in that it is has no measurable accepted parameters – all currencies float relative to one another. So just ‘inflation’ or just ‘deflation’ on its own works when substituted, and is much less vague and ambiguous.

    Another example would be Detlev’s resistance to the term ‘intrinsic value’ when applied to gold (I picked this up when Detlev came to Brussels at the Mises event). If we qualify and state that it means ‘has objective physical qualities that lead to it being voted by public opinion the best form of commodity money’ then we are safe, and this is a very powerful term to use with the public who do not study economics, Austrian school or otherwise. In other words, it sells. Of course, academically and Mengerianly it means nothing more that it is widely and subjectively desired and found to have ideal exchange value properties in usage. But let us not be too purist in preaching the gospel of sound money.

    • Michael, thanks for the comments. “Immaterial” was a complete slip. Not sure how that happened. I corrected it. It should be “material” as you say, although I don’t think it is necessary to stress this in this context so I put “apolitical” as another outstanding quality of gold in its place. — “Secular deflation” – not sure where I picked up that phrase. I guess in this context “secular” means “lasting for a long time” or “occurring slowly over a long period of time”. “Secular” is used with the latter meaning in astronomy, for example. Both of these uses of the word are cited in the English dictionaries but I appreciate that today “secular” is mainly used as opposite to “spiritual” or “something to do with the church”. I will be more careful in how I use it in future. Thanks again. As to “intrinsic value” I think that this term is bound to get economists into all sorts of trouble. As an economist of the Austrian School I think I will remain a purist when it comes to this term.

      • Lex says:

        Did you mean secular inflation/deflation as in secular bull market/bear market? The word ‘secular’ here refers to the long-term trend.

      • Count Saknussemm says:

        The adjective ‘intrinsic’ applies to the properties of the thing in question. Some of the intrinsic properties of gold are: it has 79 protons, a density of 19.32 grams per cubic centimeter, melts at 1064.2 degrees Celsius, is very malleable, doesn’t tarnish, etcetera. Conversely, ‘value’ is something given to it by humans, so it would be better to say that gold has imputed value or, more correctly, humans impute value to gold because of its intrinsic properties.

  5. azazel says:

    As we are putting the boot into poor old Detlev, Id like to point out that you over use the word “essentially”. As I was reading your book, every time I read the word “essentially” I would read it out loud, much to the annoyance of my wife! Other than that, I cant see any fault in what or how you write.

  6. Chase Taylor says:

    Friday’s action in the gold market should silence the crowd for a few days at least. Bad jobs data led to a $60 spike in Gold in 2 hours. I guess it does still hold safe haven status after all. It seems people have simply believed the ‘recovery’ hype. I am glad the public believes the rhetoric because it simply hands us a blue light special on precious metals. With QE coming in June or August, the sale will end. Thanks for another fine essay Detlev.

  7. Laird says:

    It seems to me that “PPP” calculation could be improved by adjusting it for the annual increase in the world’s quantity of gold. I would think that the (approximate) total extant quantity of gold, and the amount mined in each year, should be relatively easy to find (having not done the research myself, so perhaps I’m underestimating the difficulty). Normalizing the PPP ratios to reflect the increase in quantity over time should be simple, and I suspect it would eliminate much of the apparent “overvaluation” in the last few years.

    By the way, I very much *like* the phrase “secular deflation”, and did from the first time I read it in your writings (I’ve never seen it elsewhere, but I’ve taken to using it myself). Yes, in ordinary usage the term “secular” does have a “non-religious” connotation, but that’s not its only meaning and in this context the different meaning is quite apparent. To me, it means deflation which is naturally-occurring and extrinsic to governmental action (just as in the usual sense it means something which is worldly and extrinsic to the church). Specifically, it is the normal deflationary effect one would expect in a growing economy where the monetary base remains relatively constant. I find it a very useful term; please don’t abandon it.

    Another terrific essay, by the way. Thank you.

    • Thank you, Laird. I am sure that there are various ways in which this analysis could be improved. As I said in my text, it is a very rough framework, a “back-of-the-envelope” calculation. One of the concerns I have with your approach is that you are mixing price-data with volume-data. The present analysis only compares prices. As a friend of mine put it, it is an exchange rate analysis, namely of the exchange rate between the currency “dollar” and the currency “gold”, adjusted for the dollar’s official inflation rate. Mixing this with quantity data is dangerous. What one could do is to compare the volume of mined gold with the volume of global paper money (some international M2, for example), since 1933. Obviously, M2 global expanded much faster. One could then put these two data series next to one another and compare them.

  8. Peter says:

    Dear Detlev,
    Your work in making me aware of what is going on in invaluable. Anyone who thinks the ponzi-scheme of monetary/credit/debt creating can go on ad-infinitum is deluded.
    The KEY THING about Friday’s gold shift is this – It has increased a significant amount relative to all other commodities (outside what people would consider “normal”). That is the USD didn’t tank/devalue enough to justify it’s massive increase. Similarly a majority of the other commodities (for example OIL/Copper) all tracked sideways or moved lower in USD terms. If this decoupling on Friday, combined with record low yields on German Bunds, US-Treasuries (10yr/30yr), isn’t worrying then I think people are really not seeing what is happening.
    The stock market here in AUS has been red today, and the futures are point for the DJA to move lower as well. I thought that +1/-1 week from the Greek elections a major crunch would be seen in say a big investment bank falling over (e.g. JPM), maybe it will happen this week with all the big meetings/figures to be released. I will be watching the numbers tonight (AUS time) as to what gold does, as if it goes higher still this would be VERY VERY worrying.
    Finally I see the US being on 0% interest rates for years, unless the bond bubble blows up before then.
    Remember boys and girls if you don’t have your gold and silver in your possession you don’t own it. The COMEX is a fraud, don’t be defrauded when the crunch hits.

    Thank you again Detlev for your fantastic work (I have watched your talk/lecture @ the Adam Smith institute as well as the lecture @ the Libertarian Alliance in London) both were incredibly informative and invaluable. There’s a high probability I will purchase your book too in the not too near future.

    Thank you again!
    Peace

  9. Adriano says:

    Gold to be Declared Tier 1 Asset Under New Basel III Rules:

    https://www.ainsliebullion.com.au/gold-silver-bullion-news/gold-to-be-declared-tier-1-asset-under-new-basel-iii-rules/tabid/78/a/62/default.aspx

    About “secular deflation” I would like to mention that Gottfried von Haberler uses some kind of expression like “seculare decline of prices” (not sure to remember well) in his work “Prosperity and Depression”

    mises.org/document/4617/Prosperity-and-Depression

  10. Adriano says:

    Typo as usual… I meant: “secular decline of prices”

  11. philip walling says:

    Dear Detlev,

    With all this emphasis on gold (with which I agree) are we not ignoring the potential of silver to give a greater percentage increase during the coming storm?
    All right, it’s heavier to carry around for the same value, but it is trading at historically low prices, and it might be being overshadowed by its noisier brother.
    Do you agree?

    • I know more about gold than silver but I am an expert on neither. I really look at these precious metals from the point of view of an Austrian School economist. I have said before that I consider gold the “purer” monetary metal. Silver is still more of an industrial metal. That is why I focus most of my analysis on gold. But some of my friends in the investment business make a very convincing case for silver. Whether it will do better than gold I cannot say but in your allocation to essential “self defense” assets there should probably also be a place for silver.

  12. R. Richard Schweitzer says:

    In discussing a price “bubble” are we not dealing with a question of a “market” for gold?

    If so, should we not address the composition of the market(s), the participants, their motivations; and the possibility that there is not just a single market.

    To study a “bubble” properly should we not consider who “owns” or “holds” the physical commodity and the sources of its accretions?
    Is there such a thing as “float?” “Limited Float?” How would that affect price volatility? Do futures vary from spot in prices?
    Would that make multiple markets.

    Since it is largely a non-productive, very limited consumption (withdrawal from exchange) commodity, should we not examine the role of the use of purchase (and holding collateral) credits and their sources?

    Is there a separate form of exchange pricing (through settlements)used by the major holders – for specific purposes?

    Are we risking something like comparing the “bubble” in a caldera to forms of bubbles in other substances?

  13. [...] This article was previously published at Paper Money Collapse. [...]

  14. azazel says:

    Hi Detlev. Did you hear that interview with Steve Keen on Radio4 on Monday night? He recons we need a debt jubilee and that everyone should get a sum of fiat money so that they can spend and pay down debt. I know what Id do with mine, buy some shiny stuff, silver probably even if I had debt. It seems to me that these “economists” solutions are only to prop up the system, maintain the status quo.

  15. Rob says:

    Detlev,

    Re: “last year’s CPI-inflation in the US was slightly more than 3 percent.”
    I haven’t seen you address how doctored the CPI numbers are today vs. the way they more represented real-world experience in the late 70′s. If the rate of price increase (the result of Inflation) were measured today the same way as back then, we would have a CPI of ~10%. This purposeful deception emphasizes how screwed we are with regard to trying to save the dollar, correct?

    • I refer to this issue briefly in my blog. It would be interesting to run the data series against the “ShadowStats” inflation data by John Williams. My problem is that I am simply no expert on price index composition. I cannot pass any qualified judgement on how good any of these index series are. I am willing to believe that the U.S. government has changed the methodology to make inflation look lower than it actually is. I have lived in the UK for 16 years and my sense is that inflation here is also higher than the officially reported data but I also know that any index data is suspect, that there simply is no clearly definable purchasing power of money, and that any measure of inflation is a compromise. In the end I decided to stick to the official CPI data but you certainly should take this with a heavy pinch of salt.

  16. ManAboutDallas says:

    Gold will be in a “bubble” when Warren Buffett breathlessly tells us he’s gone “all in!” .

  17. SteveC says:

    It would be interesting to see a comparison of the dollar price of gold to the U.S. monetary base (M2 and M3) since 1971. Have you done such an analysis?

    • Steve, no I have not done it yet. Please also see my response to Laird’s comment above. I have to think about this some more.

      • David Goldstone says:

        The problem of choosing the relevant data series and of mixing quantity and price data is compounded by a further difficulty.

        Let’s suppose we want to take into account the annual expansion of the gold supply by reference to mine production, when comparing the expansion of the gold supply to some defined money supply But then what measure of the existing gold stock do we use?

        Just as the “money supply” is a malleable concept (Base, M1, M2, M3 etc) arguably so is the gold supply. Are we looking at the totality of above-ground gold in the world that has ever been mined/found? Or only gold held for investment and store of value purposes? What about the many thousands of tonnes held by Indian women as jewelry? And if for example we restrict ourselves to gold held by central banks and private investors in bar and coin form, do we then exclude mine production that satisfies industrial or jewelry demand when calculating the increase in the gold supply over time? More food for thought…….

        ps. Great article Detlev, though I suppose I would say that ;-)

  18. That article can be one of the best articles I have read i a long while on the topic.

    Thanks.

  19. Randall says:

    As long as we allow banks to create money as debt and the central banks/government policies, as agents/desires of the commercial banks, keep interest rates low, there is no escape from this system of ever increasing money supply and thus inflation. Sustainability and exponential growth in GDP are completely opposite concepts. The countries in the EU that are in trouble are seeing much higher interest rates because the ever growing debts stopped expanding, thus with no new debt, there is no new money (or much less money is being created than before). It is the same story being played out as it did in the early 80s when interest rates, at least in my country, soared into the low 20s.

    I am very curious to understand what sort of investment vehicles make sense in this situation. Yes, gold is a good defensive hedge, but the government could make decisions that cause gold to correct substantially, so there is also a risk there too – it feels like we are in the “Matrix” where there is a splinter in our minds, but we just can’t put our finger on it.

    Detlev – what about other physical assets? Any opinion on commodity holdings? Corn, oil, wheat, etc

  20. [...] as I explained last week in detail, gold is not cheap. I believe its price already reflects the expectation that the Fed will print [...]

  21. [...] Is Gold in a Bubble? – Paper Money Collapse Be Sociable, Share! Tweet June 12th, 2012 | [...]

  22. Erwin Witt says:

    All the talk about what gold should do or will do means nothing to traders. Traders look at charts and the huge descending triangle chart formation that gold has painted over the last ten months usually indicates the end of a long-term bull market trend. A confirmation of the end will be close below 1520 with a substantial increase in commercial short positions.

  23. Rune K. Svendsen says:

    I just came across an insightful article regarding commodities-prices that I want to share, and I’m sharing it here because it seems relevant to Detlev’s article.

    Among other things, it suggests that commodity ETFs and ETNs, in their essence, constitute a voluntary return of the market to a form of commodity money. That the uncertainties of paper money are forcing large market participants (pension funds, sovereign funds, etc.) to reduce their exposure to government fiat money, and move over to a store of value of limited supply.

    http://unenumerated.blogspot.dk/2008/06/commodity-hysteria-overview.html

  24. [...] people who prefer them to gold. I see the rationale but disagree with the conclusion. Gold may no longer be cheap because what I explain here has been a powerful force behind gold for a decade. But I would argue [...]

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