Why Invest in Gold? Fiat Fiascos

Why Invest in Gold? Fiat Fiascos
Feb, 08, 2008

I’ve been trying to tell anyone, who would listen, to diversify at least some of their assets into gold for some time now. Five years back, the lot of willing listeners was small. I clearly remember my voice going hoarse one night as a mix of beer and fruity margaritas made a b-line straight to my brain and unleashed a roaring spiel on my uninterested friends. As I recall, the rest of the night, I was rather enjoyable, so I make no apologies. We’ve come a long way since then. When I first became interested in the commodities market, I remember very specifically that gold was trading at $375 per ounce, interest in the sector was low and misguided information was plentiful. It certainly wasn’t the bottom of the bear market, which came around the turn of the millennium and was marked by the 400 tonne auction of bullion by the Bank of England at historically low prices around $250 per ounce. Today we’re looking at gold prices north of $900, interest has definitely perked up but misguided information is still plentiful. So it doesn’t surprise me that many of the people who once shunned my message with apathy have now turned to me for advice. Nothing gets a person moving like fear and greed. If you’re worried that you may have missed the train, there’s good news for you. I strongly believe that we’ll see prices upwards of $2500 before all is said and done.

My goal is to try and demystify some of the myths and try to simplify your foray into gold investing, which is no-doubt one of the main reasons you are reading this. So without further ado, let me delve into some of the fundamental reasons why you should own some gold.


MONETARY INFLATION LEADS TO PRICE INFLATION AND YOU”RE WEALTH SHRINKS OVER TIME.

There are several reasons to own gold in the current environment and the most prominent and insidious of these reasons is inflation. I refer to the current inflation problem as insidious because it is in essence a hidden tax on the holders of whatever currency is being inflated. It is a sad fact that the “buttons” to control the printing of more money is unarguably under the control of politicians who have little regard for the long-term economic health of our nation and are more interested in where their next votes will come from to keep them in power. So as a means of protection from the whims of idiot politicians and the throngs of “expert” economic yes-men screaming that everything is alright, there is no substitute for gold as a means of preserving your hard earned wealth.

Let’s delve a little deeper. Two millennia ago, gold was used as a medium of exchange and also as a store of wealth. Back in the ancient roman days, it is said that you could buy a nice outfit and a nice pair of sandals for an ounce of gold. Today the equivalent to an ounce of gold (currently $923) will buy you a fairly nice suit and a decent pair of dress shoes. Let me contrast that with a brief study of history and “money” as we know it now, namely fiat currencies much like that green paper in your pocket. We’ll begin with Germany in the early 1900’s.

“Before World War I Germany was a prosperous country, with a gold-backed currency, expanding industry, and world leadership in optics, chemicals, and machinery. The German Mark, the British shilling, the French franc, and the Italian lira all had about equal value, and all were exchanged four or five to the dollar. That was in 1914. In 1923, at the most fevered moment of the German hyperinflation, the exchange rate between the dollar and the Mark was one trillion Marks to one dollar, and a wheelbarrow full of money would not even buy a newspaper.”

(Commanding Heights : The German Hyperinflation, 1923 | on PBS)

Now we’ll jump forward a few decades and slide west to Argentina in the 1990’s.

“Argentina was subject to military dictatorship…for many years, that resulted in a number of significant economic problems. During the National Reorganization Process (1976-1983) huge debt was acquired for money that was later lost in different unfinished projects, the Falkland/Malvinas Islands War, and the state's takeover of private debts….. new government's plans included stabilizing Argentina's economy including the creation of a new currency (the Austral, first of its kind not to carry the word peso as part of its name), for which new loans were required. The state eventually became unable to pay the interest of this debt, the economy collapsed and inflation began increasing. In 1989, Argentina's inflation reached 200% per month, topping 3,000% annually.”

http://en.wikipedia.org/wiki/Argentine_economic_crisis_(1999-2002)

And more recently we have Zimbabwe under the criminal dictatorship of Robert Mugabe, where we’ve seen hyperinflation to the tune of nearly 1000% per year. The price of a 2-ply sheet of toilet paper went from pennies to $417. A whole roll now costs $$145,750. History is littered with similar stories of currencies being inflated to worthlessness. The point I want to make with all this is that the root cause of all these problems can be summed into a few bullet points which then leads to the reason for owning gold. And they are:

1. A government exists with an entirely fiat currency, which means that the “money” used as legal tender has no intrinsic value and is enforced by means of law and the threat of punishment.

2. For whatever reasons, the government finds itself in a position where it has entered into more obligations to pay (liabilities) than it has funds to cover payment of. This is known as “bankruptcy” or “insolvency” if you are an individual and business-as-usual if you are a government entity.

3. The government finds that it is easiest to print money out of thin air to cover the obligations it has committed itself to pay for. This is usually the most politically acceptable solution as opposed to cutting spending or raising taxes.

4. The constant creation of money (monetary inflation) leads to a greater and greater supply of “money” chasing after the same amount of goods, thus leading to (price inflation) which I’m sure everyone is painfully aware of.

Previously I referred to inflation as a “hidden tax” on the holders of the currency. You may be wondering why this is so. Well, I believe it is pretty evident to anyone who eats, drives, buys, sells; that the price of everything around us has gone up considerably over the years. Or, a better assessment, I think is to see it as the dollars in your pocket have lost considerable purchasing power over time. (I’m trying hard not to use the word “value” because dollars have no value in and of themselves) This is no accident.

The reason is simply because there is more money or “liquidity” floating around the economy and the supply of goods available for purchase has not increased by as much. I should mention, at this point the important difference between “monetary inflation” and “price inflation”. Monetary inflation is a direct result of the government creating too much money, which undoubtedly leads to higher prices for goods and services. But price inflation can occur without monetary inflation. Let’s say for example that a good or service becomes more scarce, and therefore more valuable, then the price of it will increase independently of what the monetary authorities are doing. However, when there is a general and sustained increase in the price of most goods and services, especially basic necessities, we definitely need to take a close look at what the government is doing with the printing presses.

I've taken the liberty of dissecting this enormous article into more digestible sections. Please check under the Gold Investing 101 sections for more on this series.

Editor for Gold-Speculator.com
Pip Tradewell

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