Month: December 2010

War, Gold and Larry Norman

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While in Grand Cayman over the Christmas holiday, I finished Justinian’s Flea by William Rosen–a little light historical reading.  In the sixth century AD, when armies would besiege, cities could pay a ransom and avoid violence that could result in a massacre or a selling into slavery of the population.  But in no case did the besiegers accept fiat currency–their preference was for gold and silver.  Imagine the Emperor at Constantinople asking the invading hoards if they would accept a promissory note or nice pieces of papyrus with his picture on it?  Thus, history teaches us that war helps people to sort out their values.  The enemy wants what is mine, and the main thing I have besides my very life is gold and silver; otherwise, I am unable to ransom myself.  It is better to relinquish precious metals than to die or to become a slave for the rest of my life.

Larry Norman wrote in his 1969 song, “I’d wish we’d all been ready”:

Children died, the days grew cold.

A piece of bread could buy a bag of gold.

I wish we’d all been ready.

It is a beautiful song marred by the flawed dispensational theology of the Rapture.  Yet these lines have always haunted me.  What has value in a time of war when everyone is desperately seeking merely to survive with life and limb and to protect their loved ones?  Norman’s song evokes an image of a time so desperate that gold would have no value–only bread.  Could this fit the mantra of some that gold has no intrinsic value?  I would argue that in such a scenario it is not that gold has lost value: it’s that bread has become so scarce so as to increase in market value, and this is what actually happens in war.

Some of my African colleagues testified that during one of the many wars that Bangui experienced, the seminary community remained on campus fearing for their lives as shooting and shelling raged in the city’s streets.  Some brave bread vendors dared to distribute despite the danger.  But instead of asking the pre-war price of 50 CFA per mini-baguette (=$0.125US), they wanted 200 CFA.  Those who were too afraid to step out into the open paid the premium or they went without.  Scarcity led to higher prices.  Economics 101.  Even graduates of Father Guido Sarducci’s 5-minute University should be able to apprehend this basic concept.

The increased price of commodities during times of war notwithstanding, it is clear to me that history teaches us that in the most severe economic crises, gold and silver retain their value while currencies do not–particularly the debt instruments of the war’s vanquished.  As a child growing up in America, I read several tales of people who had found millions of dollars only to learn that they were worthless Confederate notes.  Bank notes are debt.  Debt which the issuer cannot repay is worthless.  Gold, however, does not suffer from such issues.  So in the end, the victor walks away with the gold and the loser sits upon a pile of worthless paper.  In times of war, it can be difficult to pay for supplies and soldiers with the promissory notes that we call currency.  So for example, Niall Ferguson writes in his The Ascent of Money (81-85) about how the British, facing the refusal of their promissory notes, successfully received gold, thanks to the shipments arranged by the Rothchilds, and were able to win a decisive victory against the French at the Battle of Waterloo in 1815.

Quote of the day

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From the Mogambo Guru:
There are increasingly those who predict hyperinflation, which is popularly defined as rapidly-rising prices that soon reach un-payable levels, and which is always caused by the true definition of inflation, which is (according to the Mogambo Big Book Of Economic Stuff (MBBOES), “A gigantic growth in the money supply, which is caused by banks deliberately acting like greedy, lying, filthy pigs who deserve to be thrown in jail.”

Read more: The Daily Reckoning – Entertaining Ideas on the Economy, Markets, Gold, Oil and Investing Strategieshttp://dailyreckoning.com/#ixzz19Y0Qb0bR

Gold has intrinsic value

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Pure brass door handle which has intrinsic value

 

I have nothing but disdain for the view that gold has no intrinsic value.  A friend sent me a link to Howard Marks most recent newsletter, “All that Glitters“.  Marks is the chairman and principal of Oaktree Capital, which largely invests in distressed debt.  If that works for him, brilliant.  But perhaps pressure from clients has caused him to defend himself regarding his firm’s failure to have any gold exposure.  It leads him to write the following nonsense (emphasis his):

There’s little intrinsic to gold that enables it to serve as a store of value and a hedge against inflation. Gold serves those purposes only because people impute to it the ability to do so. It’s self-deception, nothing but the object of mass hysteria like that exhibited in “The Emperor’s New Clothes.” Gold has no financial value other than that which people accord it, and thus it should have no role in a serious investment program. Of this I’m certain.

Marks continues by saying that currencies are also flawed in this regard, but no matter.  Gold’s value is only what people impute to it.  His main point is that currency investments create cash flow, but gold doesn’t, and therefore it is not a safe investment vehicle because it depends entirely on this uncontrollable factor of what value the “people” place upon it.

Gold however does have intrinsic value.  So much, in fact, that one would never imagine using it as a door handle in the place of brass–unless one had a security detachment to guard the handle from theft.  Stylish brass door handles are expensive, though well within the price range of the average house owner.  But even brass has intrinsic value.  So why do people insist that gold has little or no intrinsic value?  Because they have completely lost a grip on reality, that’s why.  Gold would make better door handles than brass because gold doesn’t tarnish.  It would make prettier counter top than stainless steel.    Gold makes better cutlery than tarnishable silver.  And why don’t jewelers use brass in jewelry?  Because after a year or two brass jewelry would look hideous–just like the brass handle to our front door.

This whole “gold-has-no-intrinsic-value” mantra is so pervasive that Marks entitles his letter, “All that glitters”; this line of traditional wisdom that says more fully, “All that glitters is not gold.”  This is a warning that while there may be all kinds of things that are as pretty and shiny like gold, they are not substitutes for the real thing and that one should not be fooled by them.  So those who use this saying to insult the intrinsic value of gold are turning the traditional wisdom on its head and claiming that gold may glitter but its not gold.  What nonsense.

It is true that precious metals fluctuate in value day to day.  But this is due largely to the increased instability in the value of fiat currencies.  Central banks have tacitly instructed the public that these instruments have no value by artificially setting the interest rates at or around zero.  I believe that gold will only exit its current bull market if interest rates are allowed to return to market rates:  I would guess that means they must rise to about 25%.  Paper currencies which have no deposit value, i.e., they cannot create adequate cash flow when deposited in savings accounts, GICs or even government debt instruments, cannot compete with hard money (gold and silver) which have intrinsic value.

Monopoly money vs. virtual money

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I argued in a previous post that when banks create money electronically we shouldn’t call it “printing money”; the metaphor doesn’t adequately describe a situation in which most money is not printed but created electronically on the balance sheets of the major financial institutions then passed on to the public through electronic transfers, credit cards, debit cards, and the like.  Most money is not printed–it is a virtual reality that people accept in exchange for very real goods and services.  In my view, this situation is analogous to a game of monopoly.  During the game, the money is received in the form of salaries, rents, gifts, and bonuses, and in turn it can be used to pay rent, mortgages, penalties, and taxes.   In the end, when the game is over, all the money goes back into the box and regresses to its intrinsic value of zero.  But Monopoly is just a game, you say? But so is our virtual economy.  It’s a game we are playing with non-real money which has no intrinsic value, not even the paper its printed on, because the central banks don’t bother to print much of it anymore.

Monopoly games last about 1-3 hours.  It is not certain how long virtual economy game will last, but it won’t be much longer with Ben Bernanke keeping interest rates at virtually nothing and creating virtual money ex nihilo–eventually the public will stop accepting it in exchange for real goods and services.  That will be the end of the game, and at real money with intrinsic value, like gold and silver, will become the norm.  And we shouldn’t make the mistake of saying that gold has no intrinsic value because it can’t be eaten.  That is a fallacious argument created by fascists trying to confuse the issue.  Gold and silver have intrinsic value by definition.

Intrinsic value and the world-wide Nouriel Roubini bubble

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Nouriel Roubini warned the world one year ago that gold was very likely in a bubble at just below $1200.

Gold prices, you will have noticed, have been rising sharply, breaching the $1,000 (U.S.) barrier and, in recent weeks, rising toward $1,200 an ounce and above. “Gold bugs” argue that the price could top $2,000. But the recent price surge looks suspiciously like a bubble, with the increase only partly justified by economic fundamentals.

Roubini has a PhD and is a professor of economics at New York University’s Stern School of Business. But still he writes that gold has no “intrinsic value”:

But, since gold has no intrinsic value, there are significant risks of a downward correction.

I found it remarkable that an economist didn’t have the slightest clue of the meaning of the term “intrinsic value”: an instrument of currency is said to have “intrinsic value” based upon the market value of the medium on which it is transmitted.  Since gold had a market value of nearly $1200 per oz, it had an intrinsic value of nearly $1200 per oz.  Since paper on that day had much less value, then dollars printed on paper had less intrinsic value than had it been minted on gold.  I therefore responded on the Globe and Mail forum as follows:

There seems to be a world-wide Roubini bubble. All his cautions are justified because in a bull market any asset class may be overbought and enthusiasm will temporarily wane. But it remains a long-term bull market for gold because there is already inflation, quite the opposite of what Roubini claims: Food, energy, and real estate (at least in Canada) are on the rise because of the “liquidity”. A “massive wave of liquidity” is a sudden excessive supply of money itself, which is another way of saying “inflation”.

Roubini is misguided about the meaning of “intrinsic value”. Gold is and has been, throughout human history, the very essence of intrinsic value; gold has never needed anything to back it, but has been used to back other kinds of money, and it maintains its value better than many other asset classes.

He is mocking us all and seeing if anyone out there will believe him. Ha ha, very funny Mr. Roubini.

A certain Anton B. Nym responded in agreement with Roubini:

Gold truly has very little, almost no, “intrinsic value”. It isn’t used in daily life; you can’t eat it, burn it, wear it to stay warm and dry, build a shelter from it, or even make much in the way of tools with it. (Though it is handy in the manufacture of electronics and a few esoteric processes.) Historically gold’s value comes from its malleability and lustre as well as its ease of refinement and relative scarcity. Whatever value we invest in gold is mainly esthetic and traditional… and thus subject to change by whim and fad. At a grand an ounce, and with the world economic situation gradually improving, I don’t see the current fad lasting much longer.

I responded to this reader of the Globe and Mail as follows:

Anton P. Nym: Your view of “intrinsic value” is far too utilitarian. Roubini is an extremist who’s gone off the deep end on this point. Gold has no intrinsic value? Give me a break.

Gold is beautiful to look, easy to forge, very malleable, and never tarnishes. It is rare and is the subject of metaphor and poetry. Many things that you can’t eat, burn, build a shelter or even make tools with have great value. Consider the song, “Happy Birthday” has made the owner of its rights millions of dollars in royalties. And what value has that except that it has become the tradition to sing it at the joyous occasion of celebrating one’s passage into another year of life. Small amounts of gold next to my wife’s heart have reminded her of my love for her and have made her feel good about herself. That is invaluable to me. Try giving your wife a barrel of oil on the occasion of your wedding anniversary and see if she says, “O thank you so much for giving me something with intrinsic value!”

Well, with gold at over $1370 a year later, I suppose Roubini is still waiting for the gold bubble to pop.  Don’t get your hopes up Prof. Roubini!

I guess the opinion editor thought that my rebuttal of Roubini and his ilk was witty (page no longer available at the globe, here is a screen snip).