For the best browsing experience on this site, we recommend you upgrade your browser
AboutSubscribe Your Editors Contact Us RSS

Gold is Really the Only Alternative to the U.S. Dollar

Gold critics often say that the shiny yellow metal has few industrial uses, compared with, say, silver or copper. That happens to be what we call a half-truth. It’s also beside the point. It is usually lamented by bears refusing to accept the market’s valuation of gold.

The whole truth is that gold has very few industrial uses at current prices. Gold is worth about 55 times silver and more than 3,000 times copper per unit of comparable weight. If it were as cheap as copper, we would have wired our houses with it, as well as the Internet; if it were even cheaper, you’d probably be sitting on it in the bathroom, as that Commie Lenin advocated.

We don’t use gold in more common applications because of its finer qualities: relative scarcity, our vanity, to name just a few. And the bulk of gold’s value is still monetary, a fact that its enemies are loath to admit. Consequently, changes in the price of gold tend to reflect mainly changing monetary factors.

Gold bugs can’t ignore the market’s judgment, either. They must acknowledge that the monetary demand for gold had in fact ebbed during the 1980s and 1990s in favor of the dollar standard – a standard launched by default in the early 1970s.

The waning view of gold as money helps explain why gold didn’t keep up with the CPI through the ’80s and ’90s, despite the three-fold increase in narrow money (M1) and the five-fold increase in broad money (MZM). The bears claim this poor record shows just how bad an inflation hedge it is. But their time horizon is both short and selective. The full record of the Federal Reserve Note (since its 1913 inception) is poor.

I’ll give the bears credit for identifying the drop in the monetary demand for gold as the reason it lagged the CPI in the ’80s and ’90s. But they are hopelessly naïve if they believe that the 35-year-old dollar standard is an evolution in the monetary system, as if it were progress. Gold served as the market’s solution for money for thousands of years.

The government forced the dollar onto the U.S. producer by legal tender and other laws. It forced the dollar onto trading partners by extortion. These partners were already drowning in dollars no longer backed by gold. They had to choose between letting the whole system fall apart and using the new “dollar standard” to their advantage. America had the largest and most developed consumer market in the world at that time, and they all wanted in.

Fast-forward to today: After a couple of decades of experimenting with this system, it is no longer working to anyone’s satisfaction. In order to maintain their trade advantage, America’s trading partners have to inflate at an ever faster pace (than the Fed) and soak up increasing quantities of dollars. This scheme always was untenable, but now it’s falling apart. There’s even talk of the need for a new global reserve currency.

So far, the media spotlight has been on the euro as contender, but the media will see that is untenable too. Gold is really the only alternative to the dollar. But that’s a lesson the gold bull market has yet to teach. Let me know when you can use the euro on the streets of Bombay or in a Wal-Mart in California as easily as you can use the U.S. dollar, or at least when the price of gold stops outperforming the euro. Then I might consider taking it seriously. Meanwhile, we’re likely heading back to where this story left off in 1980.

Before I delve into a rudimentary analysis and probably futile attempt to value gold, let me admit that I don’t know how high it is going to go. No one really does. We’re all just guessing. A bull market in gold basically means that gold’s monetary allure is on the rise. That is, market participants are beginning to prefer it again – either as a hedge against inflation (investment), a measure of monetary value, a means of international settlement, a monetary reference point, or even as a genuine medium. These reasons all constitute what I mean by “monetary demand.”

Of course, no such thing as a bull or bear market in gold would exist if gold were already money, because the total demand for money does not fluctuate very much. On the other hand, the total demand for a particular kind of money may. The bull market in gold is a byproduct of the decline of the dollar standard. Not surprisingly, it is outperforming the CPI again.

If the CPI were an accurate measure of changes in the value of money, and the monetary demand for gold were constant, the CPI-adjusted gold price in the first chart above might represent some notion of fair value for gold prices. But the CPI is anything but a reliable measure of change in money values. Chances are it understates this problem.

I have been forecasting “Gold: $2,000-2,650″ for many years now. My early forecasts, back in 1999 and 2000, called for a straight-up move to $2,000 per ounce. That forecast overestimated the willingness of investors to grasp the gold story and underestimated their addiction to the prevailing monetary policy, and I scrapped it in 2001 in favor of a more drawn-out affair.

I adopted the view that this bull market would last 10-15 years and include two-three sequences.

We are now on year seven of the current advance – the first primary sequence. There is little doubt in my mind that the dollar standard is on its way out and that the monetary demand for gold will return to the levels of the late ’70s. But the exact prognosis is anyone’s guess.

As a trader, I can tell you that nothing goes straight up. The market tends to change the rules just when most people have become accustomed to a particular set. Hence, every bull market contains surprisingly violent corrections. These corrections convince many latecomers that the bull market has ended.

None of the corrections we’ve seen in gold during the past seven years qualify as this type of correction. The rise in gold prices to this point has been steady and sustainable. For much of its rise, gold has been in a stealth bull market. But the gold price advance is no longer stealth. It’s not as spectacular as oil’s advance or some of the base metals’ advance in 2006, yet. But the chart says it wants to go parabolic.

That’s the good news. The bad news is that such moves bring in weak hands, which set the stage for a big correction. Remember this whether you want to trade the trends or buy and hold.

Ed Bugos
for The Daily Reckoning Australia

Editor’s Note: Ed Bugos is a frequent contributor to Strategic Investment.

11 Comments

  1. namius says:

    The only 2 things accepted as money by all people for the last 5000 years are silver and gold.

    For most of that time silver has been slightly more liquid. In the rare instances where silver was more rare it was of course considered more valuable. Today silver is more rare globally and not just in one locale. In fact considering extreme industrial consumption there is no reason to think that there will ever be more silver than gold again (above ground).

    Thats right there is a PERMANENT silver shortage.

    Even if all industrial consuption ended today and you dug up all the gold and silver in the ground there would only be about twice as much silver as gold. Keep in mind that silver and gold have ALWAYS (except in the last 35 years) been exchanged with respect to rarity.

    Considering that the silver to gold ratio has always been based on rarity (considered equal as money) and that silver is by far more than twice as usefull industrially silver is thus more valuable!

    With only 12 years left of silver in the ground at current production rates and with a global flight to safety because of an impending credit catastophe at some point in the next 2 to 12 years the market should figure this out.

  2. christina says:

    With all this stuff happening in the economy, it’s easy to lose sight of the fact that money is just an invention. That’s right, in the old old days they used to trade stuff, like a guy who caught fish would swap fish with a guy who weaved baskets. And the guy who weaved baskets would swap baskets for meat with a gut who hunted and had meat. Than it got tricky becuase’ what if the guy who had fish wanted meat, but the guy who had meat didn’t want a basket, he wanted a fish instead. So they dicided to invent something that everybody wanted- and they invented money. Little could they have known what it would have come to all this time later. What the currant credit crisis is is like some guy in the ancient times saying to the fish guy “give me some of you fish dude, and I’ll pay you later” And then the next day he goes again to the fish guy and says “hey, give me some more fish and I’ll pay you later” Then he does that for 30 years. Sooner or later the fish guy is going to want to get paid. That is a wrap up of the credit cruch that is happening today- people all over the world went into the shops and said “Hey let me take what I want, and I’ll pay you later, and doing that for 30 years” Soemthings got to give! And it’s amazing and fascinating how they picked gold as the substance to be valuable in our world- when you analyse it, its just sludge that comes out of the mud. Mud sludge if you will. Humanity decided to base all of it’s welath and prosperity on mud sludge :-) Imagine they had picked something else like flowers or something, how different would things be. It’s funny how the fact that gold is valuable is just because some people in ancient times decided that the sludge they found in the ground should be called valuable. After all, it wouldn’t be valuable at all if the ancient people hadn’t decided that it would be. It would still just be mud sludge. Since human beings decided that that was the stuff that was going to be valuable- couldn’t they have picked something better, like honey or something. Why did they have to pick something that is so rare, were they trying to make life tough for future generations so they’d always have to go around digging. What if gold became extinct so to say. WHat if one day there was none left in the ground? Would we all starve? Or could we just decide that the ancients were wrong and we could then pick something better to represent the wealth of the world. If we did, we wouldn’t pick something stupidly rare like truffles in the ground, we could pick something easier to mine. Like cucumbers. Now wouldn’t that be something?

  3. chandrakant patel says:

    I agree with this article and investors should be clever to dump the dollar as early as the can and hold gold for the next 10 years.

  4. Joseph says:

    What a nice statement Christina. Many thanks.
    May I add something for good – ancient humans seem to have been much smarter than their modern counterparts are today, They picked something hard to find, hard to dig out and complicated in process … after all – something difficult to “bring to life” within the economic world. This fact – after all – may have actually paved the long way of gold as the only means of worth over centuries. Same applies to silver, I guess.
    Under this statement – Dollars are of no worth anymore – because they are legion – printed paper – and they are definitely not hard to “bring to life” within the economic world, as everyone may have realized already.
    So what will happen, if there is no real worth behind paper anymore ? People will turn towards the “hard-to-bring-to-life” stuff, such as gold. Just to have an emperic, ever reliable measure for goods and services. Money has reached defenitely to its end, when it loses exactly this ability: to measure goods and services. This is the real crisis of today and of the monetary system in total – so logically, yes, it will be the evergreen rise of gold again, I guess.

  5. Anna Merikin says:

    Your references to flowers and other means of exchange brings to mind that for a short while in Holland, tulips were what gold was elsewhere.

    Eventually, a bad harvest drove up prices dramatically, and, for a while, one tulip was worth much more than its weight in gold. Of course, this was followed by the collapse of the tulip, not the collapse of the value of gold!

    Silver is nice. So is theory. But not only is reality much, much richer than theory, it is more profitable.

    Look to history to repeat, not fantasy to (finally)come true.

    I have been hearing that silver is superior as an investment to gold for more than fifty years.

    I own gold.

  6. Pier Johnson says:

    christina writes:

    “And it’s amazing … how they picked gold … to be valuable in our world …its … sludge that comes out of the mud … gold is valuable is … because … people in ancient times decided that the sludge … they found … should be called valuable. ”

    Of course, her expression reflects many false beliefs shoved into her head by Bookhead PhDuhs.

    Gold has value because —

    [1] humans burn many calories to dig for gold — incurring a true cost (growing food for calories,keeping land for growing food and defending this land)

    [2] gold is fireproof, rustproof

    [3] humans can shape gold into goods

  7. Chris says:

    If cucumbers were money, what would pickles be worth?

  8. Pete says:

    I agree Pier. Christina’s rant adds up to not a whole lot of anything, in economic terms.

    Gold has value because it can be shaped easily, and it is rare.
    I am, for example, sure diamonds also have value, but their value depends on their size, etc as they cannot be smelted. Diamonds are also a real hassle to check for purity.

    I think the typical argument essentially boils down to this:
    Why is there a demand for gold?

    From a practical perspective, there really shouldn’t be a huge demand. But, as gold is considered a monetary institution in itself that is embedded in global society, it is still considered highly valuable.
    If one person decides to sell their gold because they don’t believe in practical value, there will be another person ready to buy that gold before you can blink. The only way to reduce the value of gold to its practical value (eg, industrial use, consumer use) would be for a mass selloff of gold to occur, killing everyone’s faith in it.

    One way to do that would be to reduce demand for it, by…overproduction. And since that is not likely to happen any time soon, the only other way I can think of doing it is via propaganda and governmental economic policy.

  9. Pete says:

    Gold critics are really just idealists…the problem with idealism is that it does not work in reality.

    Eg: Communism, the United Nations (haha)

  10. Jaime says:

    The thing is that in today’s world of different kinds of crises, there are a lot of distortions and one of them is the value of several things, some of them are over valuated and some other are under valuated, and people do not realize them, and since we are in crises, we will go back to our story because always happens that way, and one of the things we missed in this “prosperity”, is the value of the real money, Silver and Gold, is just a matter of time and this is happening right now in our face, if you denied it wont go away. Don’t miss the train!

  11. Jodie says:

    Like long term bond yields Gold prices discount the future. In the early 1980s Gold prices were predicting double digit inflation going forward. Once these expectations were not realized Gold prices had to go down just like what happened to long term bond yields.

    It is incorrect to say Gold isn’t an inflation hedge. It is but only relative to expections. If inflation trends reverse and go down in an unexpected disinflationary reversal Gold prices would definitely be impacted. This will happen even if inflation stayed in an absolute sense positive. It is all about expectations.

Leave a Comment