Sunday, November 2, 2008

Is Gold Money?

Today, the world is awash in what is called liquidity. Central banks everywhere are furiously printing money to salvage the world financial system before it runs completely aground.

The threat they are facing is not merely the disappearance of everyone's savings. The larger problem is deflation, a systematic reduction of prices and wages.

When you have a lot of debt, deflation is a catastrophe.

Lower prices, lower wages, same amount of debt... a very bad formula, indeed.

Deflation keeps Ben Bernanke awake at night. He has said that if he were forced to choose between deflation and inflation, he would inflate the currency, even if it meant dropping money from helicopters.

According to James Grant, a leading authority on the credit markets, this is good news for gold. And people in the know pay close attention to Grant's opinions.

At the end of a recent analysis of monetary policy, Grant declares: "We envision great things for the gold price." Link here.

Why, pray tell? Grant quotes British economist T. S. Gregory, who said in 1925: "Gold is not a perfect standard of value: it is certain that paper has shown itself a still more imperfect one."

Grant's opinion is based on a philosophical analysis. He is assuming that paper money is a social construct, while gold is the real thing, an intrinsically valuable substance.

The issue is simple: if a piece of paper is money because a government says that it is money, and because people believe that it is money, and because they all accept it as money, why not say that same about gold.

Why should there be any intrinsic value at all.

Of course, some few intrepid souls still believe that gold is intrinsically valuable. It is eternal and immutable; it does not corrode, even when used as dental crowns. Gold has always been accepted as a medium of exchange. It is virtually indestructible and is intrinsically beautiful.

Gold's detractors believe that gold is a commodity like another, only that it is better looking than most.

Where a central bank can print as much money as it likes, there is a finite amount of gold. Alchemy aside, you cannot produce it with magic.

When Jim Grant says that this is going to be a good time for gold, he assumes that gold is real money, and that when people tire of collecting increasingly worthless paper, they will rush to buy gold.

As of today, Grant does not look very prescient. Over the past couple of months the price of gold has been declining with all other commodities.

Right now cash is king. It's the place to be. People who own cash are sleeping better than people who have accumulated other assets. After all, it appears that we are heading straight off the deflationary cliff.

And yet, one should never be too complacent about money. Cash has rarely been a good long term investment.

Jim Grant is counting on the Federal Reserve to inflate the currency, because the alternative is too awful to contemplate.

You may think that he is a prophet of gloom and doom. Quite the contrary. I see him as a great optimist. He is banking on the Fed to produce inflation, because systemic deflation would be far, far worse.

So, if you believe that gold is intrinsically valuable, we are approaching the time when it will be better to put your gold where your money is. By all appearances we are not there yet, but that does not mean that the time will never come.

1 comment:

Mark Herpel said...

Grant=Smart man

I wouldn't hold cash now if you gave it to me! When the Fed opens the counter to ANYONE who begs for a loan, inflation can't be far behind.