No country for GOLD men

Posted by Chan Akya -Asia Times

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I don’t think the question really is what is gold worth but what are currencies not worth – Shayne McGuire

My title’s awful pun on a recent Hollywood movie (No country for old men, directed by the Coen Brothers in 2007) represents not so much an environment associated with the lack of places for Austrian economists to hide; indeed it is meant to suggest the opposite result, namely that all users of fiat money will eventually lose faith and turn to the one commodity that cannot be mal-adjusted by central banks, namely gold.

Just over two years ago, when gold was still trading at US$600 or so an ounce, I wrote an article titled In gold we trust (Asia Times Online, September 8, 2007), the title of that article being a wordplay on the motto on all US dollar currency notes (“In God We Trust”). As the precious metal has now gone to new stratospheric levels since then, reaching a high of over $1,118 this week, the question is raised – what is the future?

At the basic level, and before delving into the outlook for financial instruments and their opposite (namely gold), it must be stated quite clearly that this article isn’t about providing investment advice. Rather, it is meant to highlight certain arguments in favor of, as well as against, the notion of using gold as a replacement for everyday financial instruments.

The most common financial instrument of all is the US dollar (see The dead dollar sketch, March 4, 2008). The problem is that the US dollar does not carry the purchasing power associated with currency when that dollar was first granted to you.

In other words, if you were to rifle through grandpa’s old trench coat pockets and find a US dollar note from the 1950s, one can be sure of only one thing – what the US dollar would have purchased in the 1950s would be far in excess of what it could purchase today, pretty much anywhere in the world.

On the other hand, while the price of gold has moved around a fair bit over the intervening period, it is unlikely that you will find many countries in which an ounce of gold today purchases markedly fewer items than it did in the 1950s. At the very least, it would reflect the same purchasing power of an equalized basket of goods (example – an average household’s monthly expenses on food and clothing) as it did back then. In effect, it is a true store of purchasing power.

This is an important distinction to make between any notion of price changes as we look ahead: the point about gold is not whether its price will go up or down; but that the value at the end of the cycle would likely be equal to the same purchasing power as it has today. Likely, not positively.

What do central bankers want?

If the notion of defining what gold is proves difficult, then perhaps a negative feedback loop addressing what other alleged stores of value (that is, fiat currencies) are not would prove useful.

The one thing that fiat currencies are not is a hedge against inflation. The person who is most likely the world’s most cerebral central banker, Mervyn King of the Bank of England, made a remarkable speech on November 11 wherein he stated the bank’s intention to adopt an easy monetary policy over the near term.

As a famously inflation-targeting central banker of the school of Paul Volcker, the former US Fed chairman, these comments were clearly in need of explanation, which King provided:

Inflation has been unusually volatile recently. It is currently 1.1%, having been 5.2% only a year ago. Such volatility is likely to continue in the short run. Inflation is likely to rise sharply over the next few months, to above the target, reflecting higher petrol price inflation and the reversal of last year’s temporary reduction in VAT [value-added tax]. Monetary policy can do very little to affect these short-run movements in inflation. So the MPC [monetary policy committee] must look to the medium term when inflation is determined by the path of nominal spending relative to the supply capacity of the economy. To do that the MPC must restore the level of money spending to a path consistent with eliminating the margin of spare capacity, and ensuring that the outlook for inflation is in line with the 2% target.

Anyone who invests in fixed-income markets will read that paragraph with dread; for those without a full background in the market I would explain as follows: the focus on pushing inflation targeting away from the near term towards an undefined medium term (is that three months or three years?) suggests that the Bank of England is effectively targeting negative real interest rates (that is, the difference between interest rates and inflation is negative).

… interesting 2nd half of the page 2 HERE