Wednesday, December 1, 2010
The Value of Gold
The concept of value can be a bit tricky. Value is one of those words that is tossed around as if there were universal agreement on its meaning. There is not. Often in such cases I simply use a different word, just to be sure we are on the same page. Years ago Town Crier did this with "value", substituting in the word "dearness":
TownCrier (8/24/2000; 18:08:49MT - usagold.com msg#: 35476)
Nice table, Sir Mitchell:
Column 1 = Year
Column 2 = Avg. annual nominal price of gold
Column 3 = Avg. annual price of gold in 1999 US dollars
Column 4 = Avg. annual price of gold in 1970 US dollars
1970 35.94 158.75 35.94
1971 40.80 170.18 38.53
1972 58.16 232.59 52.66
1973 97.32 376.76 85.29
1974 159.26 580.57 131.44
1975 161.02 528.81 119.72
1976 124.84 375.79 85.08
1977 147.71 420.26 95.14
1978 193.22 516.19 116.86
1979 306.68 761.43 172.38
1980 612.56 1,364.05 308.79
1981 460.03 902.53 204.30
1982 375.67 668.20 151.28
1983 424.35 710.70 160.91
1984 360.48 585.02 132.44
1985 317.26 493.66 111.77
1986 367.66 552.19 125.00
1987 446.46 658.04 148.98
1988 436.94 621.63 140.74
1989 381.44 521.31 118.02
1990 383.51 500.14 113.21
1991 362.11 448.04 101.43
1992 343.82 408.25 92.42
1993 359.77 414.74 93.90
1994 384.00 429.77 97.31
1995 384.17 419.09 94.89
1996 387.77 412.70 93.41
1997 330.98 342.00 77.42
1998 294.24 298.95 67.68
1999 278.88 278.88 63.14
The third column (representing prices based on the purchasing power of 1999 dollars) clearly shows that gold is currently at the best bargain for buyers since way back in 1972.
Meanwhile, the fourth column (representing the equivalent prices in terms of the 1970 dollar which was itself officially defined as one-thirtyfifth ounce of gold) clearly shows that despite the massive mining effort and flood of derivatives since that time, the "dearness" of gold has still managed to almost double; otherwise, we must all admit, the price of an ounce today as represented in "1970 dollars" would still be $35. It isn't. One ounce as of 1999 is as dear as 63.14 of those "gold-backed" dollars, or put another way, despite production and derivatives, one ounce today is as dear as 1.8 ounces then. All things considered, that's not bad performance for an item that many are content to view as a neutral "insurance" asset.
Now just imagine how much dearer an ounce might become in the event of a derivatives bust...
(I have used the term "dear" in deference to the recent disputes on the meaning of "price" and of "value". To say "dearness" is my attempt at splitting the middle so that the message reaches both sides of this debate.)
Quite clever that was. But value is a vital concept to understand. So here we will explore some misconceptions associated with this most dear and valuable word.
Probably the most common misconception is that price and value are the same thing. They are not. They are related but different. Price can be precisely known, but true value can only be estimated or guessed. And because price changes, price is always wrong while true value is always right, even though it is unknown. So price and value are always different. Value is always either higher or lower than price.
There is a little trick to knowing whether value is higher or lower than price. This trick will reveal the direction of value, but not the magnitude of the disparity. The trick is to look at which direction the government wants to influence any price. If the government is attempting to manage a price upward, then it is a safe bet that the value is lower than the price. And if the government would like to keep a price down, then you can be pretty sure the value is higher than the price.
It is certainly fair play to place your bets on the ability of government to overpower the gravitational pull of value. But when you do, you should be aware that you have just purchased the opposite of real value. And to understand why this may be detrimental to our financial wellbeing, we must first understand the concept of value.
A Brief History of Value Theory
The concept of value is primary and central to the study of all human society. Economics is just one branch of study that uses this concept. And value theory is fundamental to all schools of economic thought.
At the most basic level value theory reveals the concept of "the good." This concept can refer to either people or objects. When referring to people (or the conduct of people) we talk about "the moral good." And when referring to an object we call it "a natural good." Value Theory could also be called "Goodness Theory," and it covers two branches of study: Ethics, which deals mostly with "moral goods," and Economics, which focuses primarily on "natural goods."
Plato wrote about value 2,400 years ago in "The Republic" where he distinguished "instrumental value" and "intrinsic value." Something with "instrumental value" is worth having only as a means to get something else. It is not an ends-in-itself but merely a means to an end, a medium. An object with "intrinsic value" is regarded as an end or end-in-itself. It is a thing worth having for itself, not as a means to something else. COMEX gold futures versus physical gold is an example of instrumental versus intrinsic value. In fact, the dollar itself (or any medium of exchange for that matter) is a good example of something with instrumental value.
The Modern Era
Because this is a "brief" (and extremely generalized) history of value, we will now leap forward through time 2,251 years from 380 BC to 1871 AD when the economics branch of value theory itself branched off in two directions. We are now traveling down the economics branch, so we are dealing with "natural goods" which are non-moral goods (and services), like houses, cars, hamburgers and gold.
The study of economics grew throughout the Renaissance period of transition from the Middle Ages into the Modern Era. Notable figures during this transitional period are Sir Thomas Gresham (1519–1579), John Locke (1632–1704) and John Law (1671–1729). And the era of Modern Economics (also called Classical Economics) began in 1776 with Adam Smith's (1723–1790) "The Wealth of Nations."
95 years later a new branch, sometimes called Neo-Classical Economics, emerged from the old school of Classical Economics branch. Classical Economics held that value should be donor-derived or determined by the cost to supply a good to market rather than the demand for the good from the market. This is generally called the Labor Theory of Value. Neo-Classical Economics grew out of the realization that it is the utility of a good that matters more to its value than how much labor it took to produce.
Karl or Carl?
The Labor Theory of Value (LTV) was the mainstream and widely accepted value theory prior to the 1870's, culminating in the controversial economic theories of Karl Marx (1818–1883). Then, in 1867, a young journalist named Carl Menger (1840–1921) noticed a discrepancy between what the classical economics he had been taught in school said about price determination, and what real world market participants were paying for goods. Stirred by this observation, Menger left journalism to spend the next four years studying "political economy" which, at the time, was basically the study of capitalism, or the relationship between markets and government.
In 1871 Menger published "Principles of Economics" (Grundsätze der Volkswirtschaftslehre), thus becoming the father of the Austrian School of economic thought. It was in this work that Menger challenged the classical cost-based theories of value with his own marginal utility theory of value.
From what I can tell, the basic difference between the approach of Marx versus Menger is that of activist versus observer. The Marxian Labor Theory of Value tells you what something's value should be, while marginal utility observes what it actually is, and then attempts to explain the observation.
Someone here recently asked, How can an ounce of gold ever be more valuable than a new BMW since the BMW embodies a vast amount of energy, human capital expenditure and significant utility in the real world?
I found this question to be quite valuable, embodying significant utility for this blog. The implication in the question is that an ounce of gold cannot be more valuable than a new BMW for two stated reasons:
1. The Marxian LTV tells us that the cost to produce a BMW is much higher than the cost to produce an ounce of gold, and,
2. The BMW is "significantly" more useful to mankind than an ounce of gold.
These two "value fallacies" cover almost all of the arguments against the sustainability of the unfolding Freegold revaluation. So let's take a look at them one at a time.
1. Marx's LTV view suggests that market actors pay more attention to what an item cost the seller of that item in determining the price they, the buyer, are willing to pay, rather than to how useful the item will be to them, the buyer. It goes even further, though, in suggesting the supplier's cost is the true value and therefore should be reflected in the price. Any price above that cost or "labor value" is considered to be exploitation, super profit, or unjust benefit as far as the Marxist activist is concerned, and therefore should be controlled through communal enforcement.
But clearly, commodities do not follow this labor value theory in a free market. Especially in globally fungible commodities, where price is the same all over the world yet production costs vary vastly from region to region. Oil is a good example. In fact, the production of oil is impossible in many regions lacking viable reserves. Menger writes in "Principles of Economics":
"There is no necessary and direct connection between the value of a good and whether, or in what quantities, labor and other goods of higher order were applied to its production. A non-economic good (a quantity of timber in a virgin forest, for example) does not attain value for men since large quantities of labor or other economic goods were not applied to its production. Whether a diamond was found accidentally or was obtained from a diamond pit with the employment of a thousand days of labor is completely irrelevant for its value. In general, no one in practical life asks for the history of the origin of a good in estimating its value, but considers solely the services that the good will render him and which he would have to forgo if he did not have it at his command...The quantities of labor or of other means of production applied to its production cannot, therefore, be the determining factor in the value of a good. Comparison of the value of a good with the value of the means of production employed in its production does, of course, show whether and to what extent its production, an act of past human activity, was appropriate or economic. But the quantities of goods employed in the production of a good have neither a necessary nor a directly determining influence on its value." (Menger)
Timber in a virgin forest has some value separate from labor, just like gold known to be deep in the hillside of your property has value, even though it has never been touched by mankind. So even in a Marxian view of value, applying the value of the raw material (the land with gold underground) to the labor involved to dig it up, we could easily put an ounce of gold higher than the value of a new BMW.
Imagine that physical gold is trading for $55,000 per ounce. If you own a hill with 100 ounces of gold underground, that hill must have a value somewhere south of $5.5 million, assuming you are legally allowed to remove the gold. Now imagine the labor and production cost of removing that gold from your hill and having it refined into tradable ingots comes to $300,000. For your small lot, that works out to a cost of $3,000 per ounce (not economically viable until recently), and it puts the value of your virgin hill somewhere under $5.2 million.
So in our exercise here, your input costs would be <$5.2 million plus $300,000 and your output would be $5.5 million. In fact, it doesn't matter if you bought the hill last week for $5.2 million or if your great grandfather bought it in 1920 for $1,500. All that matters is the present value of that hill. So in this scenario, your total energy and human capital expenditure for each ounce of gold dug up from your hill is equal to $55,000, or more than a new BMW (some models excluded). The Marxist, however, would say that the gold in your hill is the property of the collective (common ownership of the means of production). He might still let you dig it out at a cost of $3,000 per ounce, but then he would tax you $50,000 per ounce for the privileged of digging on communal land and removing (privatizing) communal gold. And of course this government action would do nothing to either the $55,000 price of an ounce of gold or to the >1:1 BMW:gold value ratio.
Gold in the ground would be the raw material or the "means of production" for producing gold, the global (private) commodity. The former is communally owned while the latter is privately owned, which transfers value from the latter to the former and its owner, the commune at large.
So as we can see, the free market does not follow the LTV rules that Marx proposed, and even Marxist communal enforcement and elimination of the "exploitation, super profit and unjust benefit" of producing new gold will have no effect on the price or value of private, physical, above-ground gold. It may, however, have a deleterious effect on the price and value of gold mines. But that's a subject for another day.
2. Part 1 of my look at the question above focused on how and why the Labor Theory of Value will not prevent a high value for gold. But it did little to explain how the price will get from here to there. That's what part 2 is about. The marginal utility of physical gold.
What is the utility of a BMW? According to the above question is it "significantly" greater than gold "in the real world." So what is this significant, real world utility?
Well, you can drive a BMW around. Can't do that with gold! It will even get you to work. Gold won't get you to work and back home. And a BMW will do these things in comfort, style and safety! In fact, a BMW may even improve the image of your status in society. I suppose gold could be useful in this regard if you are Mr. T. But then someone might steal it from you. A BMW is harder to steal than loose gold because it has redundant locking mechanisms and carries a visible registration number that can be tracked by a vast police force. Gold in your pocket or around your neck doesn't have these "real world" features.
And what is the utility of gold? Well, it used to be a medium of exchange and a unit of account. But today it is neither of those things. And yes, it does have a few industrial uses, but not many, and certainly not very many when compared to other industrial commodities. So what is gold's utility?
Gold's utility is that for thousands of years it has held its value relatively well. And because it is not used for many things other than mere hoarding, the act of hoarding gold is not an infringement on the natural rights of others to enjoy the utility value of "real world" things like BMW's and oil and wheat and pork bellies. If one were to corner, say, the copper market or the chocolate market, there would likely be repercussions as those industries fought back through the power of the collective that likes to consume chocolate and copper. But with gold there is no such worry.
Can you imagine if central banks hoarded 20% of the world's wheat in giant CB silos while millions of people went hungry? Or how about if the old money aristocrats accumulated and hoarded 20% of the lumber produced every year, preventing it from being used to build shelter? Do you think there might be cries of outrage and a wholly justified uprising against the CB's and the rich?
Thankfully we have a commodity that is mostly used for hoarding, and little else. Like Warren Buffet said, we dig it up and then bury it again in a vault. And all it does is one little thing: it maintains its value over thousands of years. That's gold's utility.
So now that we have looked at the utility of BMW's and gold, let's look at the marginal utility of each, that which gives value to an item. But first, what is "marginal" utility?
In this use, the term marginal refers to the effects of small changes in the consumption of any commodity we possess or are considering buying. It is a measurement of relative values because in order to increase our consumption of one commodity, it is thought that we must forgo another. Or perhaps we must work more hours, forgoing an equal amount of leisure time.
For example, if you didn't have a refrigerator you might be willing to forgo something quite significant in order to obtain your first fridge. But once you have one refrigerator, the second one you buy has less use value to you, because most people only have room specifically designated for one fridge. And someone who already has an extra fridge in the garage and a small beer fridge in the laundry room is unlikely to give up anything else for another refrigerator. It has no use to him. With each subsequent fridge he bought, the utility dropped. This is the law of diminishing marginal utility, or diminishing returns on expanded consumption.
Think about the bare necessities of life: Food, water, shelter and air to breathe. If you didn't have one of these things, you would pay any price to obtain your first unit of it. But once you have what you need to survive, the marginal utility of additional units drops off a cliff. So the bare necessities of life actually have very low marginal utility, or very high diminishing marginal utility. For this reason, their prices stand right near where Marx's LTV would put them.
A BMW also has low marginal utility. After you have bought so many BMW's, how many more can you possibly need? Imagine a man with a "disposable" $1.5 million. He may buy a $50,000 BMW. He may even buy two! If he buys one, the utility of that BMW could be said to be 30 days of "speed, comfort, style and safety" use per month. If he buys two and uses them equally, then the utility of his marginal (most recent) purchase could be said to be half that of his first purchase, or 15 days of use per month.
Now imagine that he disposed of his whole $1.5 million into $50,000 BMW's. He would have one for every day of the month! And if we include his newfound need for a very large garage, it could be said that the marginal utility of additional BMW purchases, for him, had diminished to well below 1/30th of the first BMW he bought. So while the price of another BMW would still be $50,000, the value, to him, might be less than a thousand bucks.
This concept of diminishing marginal utility can even be found as far back as the fourth century BC, in Aristotle's "Politics", in which he wrote, "external goods have a limit, like any other instrument, and all things useful are of such a nature that where there is too much of them they must either do harm, or at any rate be of no use."
There is more to this story, but before we proceed, let's take a quick look at the marginal utility of gold as a store of value. Take the man above with $1.5 million in disposable cash. Say he buys himself one $50,000 BMW and one $55,000 gold eagle coin. He has just obtained the full utility of a fine automobile as well as the value preservation of that same purchasing power, for up to thousands of years if he should so choose.
Now say he buys one more $55,000 gold eagle coin, and then another, and another, and so on until all his cash is gone. In the end he will have 26 gold coins. And here's the question: Will that 26th gold coin purchase provide the same utility or diminished (less) utility than the first? Remember, the only utility of gold coins is that they retain their value for thousands of years. That's all they do. And hoarding them doesn't interfere with any other economic activity, at least not when they are not "official money."
The answer is "the same utility," because unlike ANYTHING else, (yes, even silver), gold has INFINITE marginal utility in this particular role.
Back when gold was "official money," the hoarding of gold to store value actually did interfere with economic activity as it put a deflationary squeeze on the global monetary system. Here is a paper that discusses this subject:
Did France cause the Great Depression?
The gold standard was a key factor behind the Great Depression, but why did it produce such an intense worldwide deflation and associated economic contraction? While the tightening of U.S. monetary policy in 1928 is often blamed for having initiated the downturn, France increased its share of world gold reserves from 7 percent to 27 percent between 1927 and 1932 and effectively sterilized most of this accumulation. This “gold hoarding” created an artificial shortage of reserves and put other countries under enormous deflationary pressure. Counterfactual simulations indicate that world prices would have increased slightly between 1929 and 1933, instead of declining calamitously, if the historical relationship between world gold reserves and world prices had continued. The results indicate that France was somewhat more to blame than the United States for the worldwide deflation of 1929-33. The deflation could have been avoided if central banks had simply maintained their 1928 cover ratios.
The introduction of the concept of "marginal utility" to the study of economics in the 1870's created a revolution in economics, called The Marginal Revolution. All modern schools of economic thought (except for Marxism and those related to Marxism) grew out of this Marginal Revolution. As I said earlier, the theory of value is fundamental to the study of economics, and all human society for that matter, making any shift in this theory a "revolution."
In modern economics, the idea of marginal utility has led to "marginal rates of substitution" and "indifference curves" which are used in "consumer preference theory" in modern applications. The focus today is on choice and substitution. And this sets gold apart from not only BMW's, but from everything else in the physical world today.
In 1918, Silvio Gesell, a "free money" (easy money) economist with many radical ideas, wrote:
"And it is clear that money cannot be simultaneously the medium of exchange and the medium of saving - simultaneously spur and brake."
"I therefore propose a complete separation of the medium of exchange from the medium of saving. All the commodities of the world are at the disposal of those who wish to save, so why should they make their savings in the form of money? Money was not made to be saved!"
While Gesell's "free money, free land, social equality for all, full employment, shorter work weeks for all and economic growth on demand" ideas appear quite impossible and dangerously utopian to this blogger, he was certainly on to SOMETHING of value in the above quotes. But while those selected quotes sound an awful lot like Freegold, can you spot the one problem in them?
That's right, he suggested that "all commodities of the world" could serve relatively equally as stores of value outside the monetary plane. This suggestion ignores the difference in marginal utility between the one commodity used ONLY as a store of value and all the rest that rely on their other uses for value.
Substitution, indifference and preference do not apply only to consumer products and food. They also apply to industrial commodities.
In applications of marginal utility, it is often assumed that commodities are continuously divisible. And as you divide a commodity (which you might do as the price rises) you reduce its consumption and increase the likelihood of substitution. For example, a consumer who previously enjoyed 1 lb. steaks may face a substitution dilemma if the price of steak doubles. He may have to choose between a ½ lb. steak and 2 lbs. of ground beef. Steak is divisible but dividing that steak reduces its utility.
This is true for all commodities on Earth in their "real world" uses… except gold!
Say gold doubles in price just like the steak. It is also divisible, just like the steak. Prior to doubling you could have gotten an ounce of gold for $25,000. After the doubling, you can only get ½ ounce for $25,000. Like the steak, you are only getting half as much. Or are you?
Unlike the steak, the utility of the ½ ounce of gold has not diminished. If anything, it actually INCREASED! How? Well, this ½ ounce will protect your present purchasing power of $25,000 for thousands of years just as well as a full ounce, but it will only require half the storage space and expense! (Keep in mind that the utility of gold is protecting your purchasing power, not increasing it. The fact that the price and value of gold have an extremely wide disparity right now is a separate issue.)
As any other commodity used in industry or consumption rises in price, the necessary division reduces its utility and encourages substitution. So all other commodities have this value-limiting characteristic. But not gold. Gold becomes MORE useful at higher prices while industrial commodities become less useful and subsequently get swapped out.
Now let's take a closer look at gold's highest and best (most valuable) use and compare to gold's present utility. But first, we must get one fallacy out of the way. Is gold's value derived from its industrial uses? Of course not. There, I'm glad that's out of the way. Gold is not just another commodity like all others. Got it?
So what is gold's highest and best (most valuable) use? I'm sure a lot of you said "money!" And by "money," I'm sure you meant currency, or at least base money as it was during the gold standard. As the mysterious blogger Mencius Moldbug (one of my favs btw) and his even more mysterious alter-ego John Law points out:
"Money is always fundamentally overvalued. Its purchasing power is independent of its direct physical usefulness to anyone. This is obvious for paper money, but true even for gold and silver."
And he goes on to show that "precious metals" will at some point be spontaneously remonetized (overvalued), which is why you should buy gold and silver today.
He is right about official money being overvalued. Even Karl Marx agrees with that statement:
"The function of gold as coin becomes completely independent of the metallic value of that gold. Therefore things that are relatively without value, such as paper notes, can serve as coins in its place."
(Das Kapital, Vol 1, Part 1, Section 2)
And Robert Mundell, Nobel laureate economist and "father of the euro" tells us how ancient rulers profited by overvaluing gold and stamping it into coins:
"The introduction of overvalued coinage provided a strong economic motive for the cultivation of a mystique. From its very beginning, probably in Lydia in the 7th century B.C., coinage was overvalued; one could say that was its very purpose.
"The earliest function of coinage was therefore profit. Coinage not only helped to market the [gold and silver] found in the Patroclus but the markup on them generated a substantial profit, helping these kings to achieve their dynasty's ambition of extending the Lydian Empire throughout Asia Minor. Accepted at face value as if they had a high gold content, the Lydian staters started out with a high proportion of gold but got progressively smaller, increasing the markup and the revenue for the fiscal authorities."
But then he goes on to tell us what ultimately happens:
"Coins cannot of course remain overvalued in a free market. Gyges and his successors were no libertarians. Overvalued coinage implies artificial scarcity, a monopoly and government control."
So the face (fiat) value stamped onto the coins ultimately falls from *above* the value of the metal to *below* the value of the metal, without fail. It did in the 600's BC Lydia, the 200's AD Rome, and again in the 1960's AD United States. Prior to 1964, the silver metal minted into a quarter was worth less than 25 cents. The quarter was overvalued, "inked" silver metal.
After 1964 they had to eliminate silver from the coins because people were starting to hoard that particular form of money for its greater melt value, putting a certain "squeeze" on the money supply and inverting the profit or "seigniorage" the government derives from making coins. Today a 1964 U.S. quarter is valued at $5 while the metal content of a 2010 quarter is only worth five cents!
So is money (currency) the best and highest (most valuable) use for gold? I think not. Is it the likely "next" use of gold in our near future? Not a chance! Another, FOA, FOFOA and the computer literate reincarnation of Aristotle all agree. And as a bonus, we can see clearly that the best, highest and most valuable use for gold is ALSO the most likely use of gold in our future!
Please read the following post carefully as Aristotle describes a pendulum with "gold money idealists" on one side and "easy money idealists" on the other. Notice that while he calls Freegold the "perfect bottom," he also points out that it is the most pragmatic and realistic point in an arc between two opposing idealisms:
Aristotle (8/25/2000; 4:02:42MT - usagold.com msg#: 35502)
The evolution and confessions of an unrepentant Gold advocate
There was a time I gave very little thought to the nature of the money I earned and spent and saved. But as certain thoughts drew me years ago to investigate Gold, as a result of my reckless nature I listened too attentively to the standard Goldbug rhetoric of others and was not well-served regarding the influence it had on my pursuit of clearer monetary understanding or on my discussions with others on this subject. Fortunately I had no investment commitments during that period of tainted perspective, so only my perception of monetary affairs was temporarily damaged, not my meager savings at the time.
Fortunately, my mother raised me right, and I still possessed the capacity to think for myself despite the heavy influences of the Goldbug dogma I had eagerly absorbed with gusto. As I came to realize how many pieces of their puzzle didn't fit, I came to see that the explanation was owing to the well-intentioned reason that much of the "standard Goldbug rhetoric" was based on idealism. Well, that's fine and all, and something worthy to strive for, but in the end, we all must live in a pragmatic world. Happily for the buggiest Goldbugs, this same pragmatism also renders equally null and void the successful implementations of any notions of an idealistic paper-only world as seen in the wildest dreams of Keynesians, governments, and many bankers. As things are, Gold has a very important role squarely in the middle of a pragmatic world, yet too few people give much "theoretical thought" to this middle ground. Arguments are always made from the merits of the lofty points on opposite ends of a pendulum's arc. Pointless for making meaningful progress, to be sure, but God bless the idealists, anyway. (For the record, the Goldbug (Goldheart!) idealism--however unworkable it happens to be--is at least noble in the "eyes" of the individual human spirit, whereas the paper idealism is not.)
After a period of slower talking and deeper thinking, I arrived at a position with a realistic eye on the middle ground giving me clearer monetary understanding as it works in the real world, and also how it COULD in fact (and should) be made to work immeasurably better. Simply put, my thoughts had evolved from their starting point, and I became comfortable with my own concepts of a unique kind of monetary idealism that existed at the nadir--the bottom of the pendulum's arc. Despite reservations about beginning to share such radical monetary thoughts at this Goldbug-infested forum, in truth, it happens to be the finest economics discussion forum to be found anywhere on the web, and the credit goes to the good hosts (MK and TC) along with the high quality of those individuals who "infest" it. And to my delight, there are in fact some here, past and present, (I won't name them because it is obvious to them who they are) who also have grappled this monetary pendulum at the "perfect bottom" at the risk of receiving slings and arrows from those feeling ill-tempered on any given day who occupy the "perfect top" on either side--although given the Golden nature of this forum, our position at the bottom center surely looks like the opposite paper side due to the complete absence of those folks making their case here. In their presence, I have been further nurtured and heartened in my convictions that the international monetary system could and seemingly IS evolving toward this position.
Such has been my evolution toward monetary "enlightenment," and such is my position here--as a pilgrim, not a teacher--at the very bottom and on the fringe of the admirable and idealistic gentlemen who gather here to share their thoughts and visions of a better world and a better monetary system. I certainly didn't come here as perhaps some of the traders have--after having gotten themselves into an investment hole, hoping to argue, defend, and justify their way out of it. I don't feel stressed or defensive in any degree because my investment strategy has not put me on the ropes as others perhaps are. I have maintained a savings/investment position that is consistent with my understanding of how the world works, and to that end, I hold physical Gold at this time in such a large percentage of my net worth that most Gold bugs would tarnish green with envy, or else think ME to be the idealistic one.
Believe it or not, Gold within the system I endeavor to describe during my time here, though my views are unpopular, will be far more valuable (yes, and priced accordingly) than Gold ever could be in the more popular Gold-standard system. Such a radical vision? It promises vast wealth (for current Gold owners) AND international monetary stability (for everyone), whereas the Gold-standard vision won't propel your physical Gold near as high in value and has already shown itself in the past to fail under natural worldly pressures. Which system (and outcome) would YOU rather wish upon yourself and also leave to your children?
Keynes didn't call Gold itself a "barbarous relic," but he rightly called the Gold STANDARD a "barbarous relic," which is also precisely what the system of Gold derivatives and bullion banking of today has become--a relic of a clever scheme originally to offer life-support to a failing dollar-based international system at a time when the world had no other option. This patchwork scheme is no longer needed. On the other hand, freemarket physical Gold, as the pure and essential reserve/savings asset (unlent with no derivatives) is desperately needed in the modern world to indiscriminately bolster each of us alongside modern currencies which are now a permanent feature in the financial landscape. Simply put, Freemarket Gold is the only way for a man to safely coexist with his currency.
Gold. Get you some. ---Aristotle
Somewhere above I said that while the present price of something can be known with precision and certainty, value can only be estimated or guessed at until it is finally revealed. I have explained how paper gold and dollars have "instrumental value" while physical gold has "intrinsic value." I have described how value flows from the use of, or the marginal utility of any commodity rather than from its cost.
I have often alluded to the separation of the monetary functions of medium of exchange and store of value unfolding within our global monetary system today. And I have frequently inferred that gold will not only be most valuable in the monetary role of store of value par excellence, but that once it is, as Aristotle stated, even our purely symbolic medium of exchange will reveal a new stability not seen in decades. I have also touched on the importance of choice, preference and substitution in determining value. And with a little thought about some of the paper alternative stores of value in competition with gold today, you may just discover for yourself a little A-HA moment. (Those are always fun!)
Now I will estimate and guess at gold's value in different roles. The present price, as you know, is $1,390 per ounce. But that price is not gold's value. That price does not reflect any particular use or role for gold. What it reflects is today's position in the journey along the Gold Trail, because gold's use is in the process of transition right now. Gold's use is changing, and so is its value, tugging like gravity (or Jim Sinclair's magnetic angels) on its price.
If gold was only an industrial commodity its true value would be relatively close to its LTV price because of the limited industrial uses for gold, or somewhere around $500 per ounce. (Think of central banks and "giants" as the REAL commercial users of gold.) If gold were returning to its past role as base money in a fractionally reserved dollar-gold standard, its value would probably be around Jim Rickard's low estimate of $5,000. If gold were to take a more prominent role, as say an international currency, it would probably be closer to Rickard's high estimate of $11,000.
And as the international CB reserve asset (NOT currency) standard designed into the Eurosystem quarterly MTM reserve concept, gold's value is probably around $55,000 per ounce. And lastly, if all fiat money caves in like a house of cards and oil is forced to bid directly for gold, we're looking at a value closer to $100,000 per ounce. But that scenario would be relatively short until a new super sovereign currency was resourced. Aristotle wrote, "I discovered that we absolutely NEEDED fiat currency in order to set Gold free." And this includes an international trade currency like the SDR or the euro.
Of course these values are mere guesses on my part. But I'll tell you that the Eurosystem MTM Freegold concept looks to be most probable by a longshot. And perhaps somewhat imminent as well.
If you still cannot see how a wealth reserve ASSET can be more valuable than a currency, look no further than the $IMFS. Look at the total value of currency versus the total value of wealth reserve assets denominated in currency. It is something like 10 to 1. Not dissimilar to my 55,000:5,000 ratio above! And for more on this train of thought, as you read FOA's post below, think about how a PHYSICAL wealth reserve asset in FINITE supply will hold REAL value differently than the currency-denominated paper assets of today.
Now here's the FOA comment that seeded this post. The above is just my long-winded intro. ;) It is a comment about value (obviously) and a checklist for the unfolding of Freegold. FOA had wanted to post this on the Gold Trail, but it never made it due to technical difficulties. It only appeared as a link a week later. So some of you may never have read this before. A few final words by me are at the bottom. Enjoy!
Trail Guide (8/26/2000; 19:16:31MT - usagold.com msg#: 35569)
Couldn't post this on the Gold Trail? Something Wrong?
Hello Cavan Man!
In your post of ---- Cavan Man (08/21/00; 19:49:05MT - usagold.com msg#: 35278)---- you asked for more detail. Something like a grocery list to check off as events move along (smile). The exact question came as: ----"What are some of the impediments to moving ahead with your "freegold" scenario?"----
Well, Cavan Man, one of the toughest problems investors have with following the Gold Trail stems from their perception of how our modern dollar money values things in the market place. I, we, all of us have discussed this extensively. Often from a somewhat different view than mine.
From my interaction with people of various far reaching world backgrounds, one thing is clear: Investors and regular workers with a Western slant do not grasp what wealth is. Overwhelmingly they see their currency and paper investment portfolios on an equal footing in value with the same "real things" that raise our living standards. Yet, in real life, they cannot be equal because these paper assets are only an exercisable future claim on our "real things in life".
Take my debate "Against" Goldhunter as an explanation example. His perception is typical in that the ---"prices bid for futures contracts are the market value of gold"---- (see msg#: 35427). These future contracts serve no more purpose in setting pricing function than do all modern paper assets we today hold as wealth.
In this larger sense, after rereading my post to him,,,,, one can see where the entire dollar world itself has become a "futures pricing arena" that "undervalues" almost every real usable item we function with in daily life. The dollar asset system, as we know it today is used as a value setting tool even though it,,,, like gold futures,,,, does not entail the removal of real goods from circulation.
But wait, you say,,, of course it does,,,, we buy and sell for our life's needs every day using dollars! Yes, this is true, Cavan Man but in that process we as an economic society only use a tiny fraction of this paper asset wealth to do that physical trading. As an example:
Look at the daily trading of gold futures and gold future "look-alikes" in London as they trade in a huge volume multiple of the actual physical market. As this lopsided trading is a comparison valuation that understates the value of gold,,,,, so too does the collective acceptance that dollar assets are held as equal to life's physical needs,,,,,, also understates the real value of all things in our lives.
You see, a futures system that functions as our currency or currency contracts, values physical assets without taking these assets into our lives and by extension taking the assets out of the market. This is the current money world we live in. The dollar in your pocket is part of a much larger paper wealth system that has evolved into today's money system. A reserve system that is not tested against real "supply and demand" values. With these money futures we may leverage our perceived wealth by thinking we actually control "real assets" just by holding contracts or dollar denominated paper assets. In reality we only own claims on each other's ability to produce,,,,, just as a futures contract holder only holds a claim on another to produce physical. Expand this function to a level where today's dollar world is and we can grasp what others see in the real value of gold.
This is the reality of perception that Another speaks of when he said -----"your wealth, it not what your currency say it is"-----.
Truly, this statement was larger than life to anyone that could understand its implications then and correctly act on it today! Unfortunately, most readers just went out and brought more paper denominated dollar gold assets. Many have lost a bundle thinking they were hedging when they were just playing the same dollar game.
This takes us back to your initial question:
Western society and Western influenced investors cannot grasp gold's value because they mentally must denominate it into currency first. To do this they turn to the "market place" as the undisputed tester of values. But, as shown above, our market place uses a currency system that is entering the end of its timeline and therefore can no longer measure "things" on a simple supply and demand value basis.
Some of the things on our "grocery list" are being checked off as we walk this Golden Trail.
This currency systems and the evolving nature of our current society that created this system is in the process of radically changing its paper wealth structure. The government, as an extension of that society begins to support and maintain the asset value of almost everything. This is the engine that drives an eventual hyperinflation. Not a typical business expansion inflation we are used to, rather an all-consuming, ending inflation that does not stop. At this point the concept of sound money takes a back seat to maintaining majority asset holdings on a permanent plateau. By extension, the official stance is moved to promote all paper assets as "national money". Stocks, bonds, business function and even general welfare is elevated to an equal footing with the need for a good sound money in your pocket. The mood becomes one of "what good is a sound dollar if we are deflating"? Check that one off your list because we are well on that road.
The international value of major currencies become more a function of "who can manipulate them the best" rather than their soundness. Forget the trade deficits, asset price bubbles, debt overflows or interest rates,,,,, it's who is best at controlling currency derivative function. Traders buy using "official control" as their determining value fundamentals. Truly, at this stage the prospects of a price deflation and its opposing currency hardness are a distant joke. The US has now moved to using measures once reserved for third world systems when it comes to playing the money game. Example: "our national debt is being paid off"! Or the CPI rising .01%! Check this one off your list, it's happening now.
Those with power outside this game are seen making long term preparations for the day when the US dollar inflates away. They see where the dollar value is only a function of trade flow manipulations. Not real economic progress. They see where throwing ones entire economic system wide open to "bubble expansion" policy in a "come and get it while you can" experience,,,,, can only end one way. So they play the game while there is time and they play to win with gold! As USAGOLD poster Henri put it today in msg#: 35547:
---- " If one considers wealth to be the accumulation of unencumbered assets of enduring value, then the pursuit of fiat profit to be converted to real wealth makes sense.-----
(nice post Henri)
The unanswered question that "no one" could ever understand was "outside the other CBs, who has been buying all this gold over these years?" Check this one off your list my friend.
The Washington Agreement has placed us "on the road" to one of the most exciting changes for our current physical gold market in its short 25 year history. This part of the world reserve currency system was about to radically evolve with respect to the world dollar gold values. To date, the ongoing dramatic fall off of LBMA trading from its (also) short public life is leading to an eventual official evaporation of dollar based paper gold banking.
Someone in Another's group pointed to that spike in paper trading long before most had ever heard of LBMA,,,, and did so by saying that a drop below $360 would cause it. That ensuing round of massive paper playing was but a backstop to maintain the dollar reputation with low paper prices prior to Euro presentation.
I point this out because many new watchers of our gold wars have no knowledge of this important play on the political currency chess board.
This paper game got out of hand before the Euro was born and the BIS was ready to hold the gold line at $280 if needed. But, the Euro was born and is now a functioning currency. Today our paper gold game has come full circle and most of the players that know anything are shaking at the prospect of a pure physical market that will stand next to the Euro.
Forget the gross volumes of derivatives on the books of majors, they don't mean a thing. They can keep writing contracts all they want but with trading volume falling away, eventually there will be no market to value these assets.
If this process is allowed to mature fully, major pain is coming to paper hard money investors worldwide. They have hitched their wagon to assets that require an operating paper system to sell into. Outside the private markets for existing and circulating bullion and coins, the entire industry will shutter to a halt as the mess is worked out. Investors will be kicking themselves as bullion soars while an extended workout phase brings their asset values to almost zero. Sure, something will give,,,, maybe? Maybe we are at the paper price lows now?
But most "regular" hard money people that read these Thoughts are in the game for asset preservation during a world currency crisis and or inflation. Ten ounces of French gold coins and $60,000 in mining stocks and derivatives will make them sick during such a paper work out. Other proud hard paper asset holders proclaim they have millions in the industry and are not the least worried. They also said the Euro would never happen, oil will never see $30 without $600 gold and $280 gold would mean a major US depression! Well,,,, Don't check this one off yet. It's still playing out.
Then there is oil. I will repost my recent and now "edited" post to oldgold:
Trail Guide (8/25/2000; 8:55:32MT - usagold.com msg#: 35512) Comment
oldgold (8/25/2000; 8:12:54MT - usagold.com msg#: 35510)
Energy and Gold
I know you have held a forceful opinion for some time that the US can and is still controlling oil producers. Your thinking was no doubt rightfully influenced by our last ten to twenty years of experience with the political world of oil.
What has been changing for the last number of years was our realization that a new currency would be available to the world. True, this Euro is nothing to write home about now but we as a Western thinking group tend to underweight its strategic importance as an "available alternative" to the dollar if needed. This subtle fact has shifted the playing field considerably when viewing the US ability to control oil flow.
Edited note: this next item is where we should watch for the dollar to be impacted by an increase in oil prices. For oil prices to be this high after all the political favors we are owed,,,, something must be countering that leverage. The US must be endorsing the move?
---------- Today, oil flow has moved from playing a fundamental game of pricing "use value" with supply and demand to pricing its "monetary value" in supporting any major currency block. Concessions are now there for the taking by oil producers. Dollar prices for oil can rise considerably higher with the US giving behind the scene support for this action. In addition, the world paper gold markets can and are being dismantled as a further concession to retain dollar settlement of oil. -------------
Strangely, the coming surge in physical prices are now a 180 degree shift from keeping them low in support of oil flow.
Edited note: This next was the purpose for the short history of the LBMA high volume. Its use is now behind us.
In the future, rising physical bullion stores (and dollar prices) will play an important role in playing a failing inflationary dollar against an ever likely increasing shift towards Euro oil settlement. No matter how this eventually plays, our dollar paper gold markets will dissolve as free priced bullion supports the EBS / Euro system.
Oldgold, Your posted article goes a long way to seeing the mental shift some Western thinkers are only just now grasping. It seems even Goldman has printed a paper calling for 50 oil! It will be very interesting to see how their stock price is valued as they try to ride the middle ground between a short gold position vs. long oil. In the end their much vaulted paper gold game should make them a ton of money, but without a market available to realize those gains? The more GATA talks, the more the paper world sweats. Not from a short squeeze, but from their market being officially evaporated. I know you, oldgold must also (smile) as I do at that thought!
Cavan Man, check off rising oil prices.
We are on the road to "Freegold"!
A Final Word
Many have asked about an eventual exit from gold after the Freegold (physical gold market) one-time revaluation is complete. Aside from the obvious answer of using your wealth in ways that will rebuild a broken economy, this is a complicated question about value storage to which I will now give a grossly simple answer, only because it pertains to the subject of this post. And it's probably not what you'd expect.
It is an extremely small group of people that followed ANOTHER's advice 13 years ago and sunk their retirement nest egg entirely into physical gold. And the following is my personal opinion only as it pertains to this extremely small group.
The whole point of an over-sized position in physical gold now, like Aristotle described above, and as explained by ANOTHER, is to let your wealth ride out this inevitable earthquake in the one asset that will benefit the most. Once the earthquake has passed, such a large position will not be as necessary.
Giants don't go "all in" to gold. And they won't exit their positions for reasons I have explained in other posts. CB's are different, they don't collect non-monetary assets. They also won't exit their gold positions. And most average gold investors will be lucky to retain their present purchasing power. They won't exit their gold positions until they need the money for expenses.
So the "exit" of this extremely small group I am talking about will be inconsequential to the Freegold price of gold. In fact, there will still be a rush INTO physical gold while ANOTHER's followers quietly exit a portion of their over-sized position in favor of other wealth assets that can be a little more enjoyable in everyday life than gold hidden away in a vault.
During normal times there are many valuable, non-essential, non-industrial, non-economic physical assets other than gold that protect your purchasing power just as well as gold. And they can also be enjoyed more openly in your home and your life. These are what Richard Maybury calls "endurables". They include: Real estate, fine art, antique furniture, rare collectibles, ancient artifacts, fine gemstones, fine jewelry and rare classic cars. None of these items will do well in the brief gold revaluation as ANOTHER explained. But other than that one, historic, brief burst in time, they do quite well.
 While Carl Menger is considered the father of Austrian economics, he was not the only "father" of marginalism. Per Wikipedia there were three: Jevons in England, Menger in Austria, and Walras in Switzerland, followed by many more in "the second generation."