So I wrote a comment (edited below), that I had the hardest time swallowing this one line from Graham:
“Commodity prices do not reflect reality.”
I don’t disagree that commodities could be in a bubble per se–that could be the case, and the recent rise in the oil price might see a pull back. Rather, I am bemused because it assumes that our current financial markets have anything at all to do with reality. You and I are in fundamental disagreement about fiat currency. Considering that fiat currency is a derivative and has no intrinsic value, it is curious that you could determine value of a commodity based on its nominal dollar value. This is what philosophers call reification. You are trying to determine the value of a concrete object (a commodity) on the basis of an abstraction (the value of the dollar).
Commodities are real. Money is not. When high/hyperinflation hits, I will be focussing on what is real, as fiat money will no longer represent anything of value. That is to say, my spam collection, my hoard of wine kits, and my unused toilet paper have intrinsic value, but the dollar, not so much. Commodity prices do not reflect reality, because money itself is not real. When money is debased, it is better to have something that is real than a derivative of a symbol of the collective worth of an insolvent nation.
To understand the value of gold as a currency with intrinsic value versus paper currencies which have only derivative value, it is perhaps helpful to consider what happens when a war comes to a conclusion. The victors, if they ask for tribute or war reparations, will only accept gold. Consider that throughout history, when conquerors overtook cities, they would strip them of gold and silver and other precious real goods, such as when Alaric sacked Rome in 410. They didn’t say, “Oh please, would you print some images of the Emperor and give them to us.” Instead, the barbarians forcefully took away the intrinsic wealth of the city.
In our more recent past, we see that the United States has been able to force its paper currency on the losers of wars. At the end of the Civil War, the Confederate dollar became worthless paper. The loser cannot make the winner accept its paper. Then, at the end of World War II, the US was able to begin to impose its currency on the rest of the world, until it became the world’s reserve currency. Originally the US dollar was a derivative for gold; but afterwards, Nixon took it off the gold standard, and it became a purely fiat currency. But had the United States not won World War II, we’d be speaking German and Japanese and Yen and Marks would have become the world’s reserve currencies.
At the end of World War I, the Treaty of Versailles imposed war reparations upon Germany, mind you not in the paper currency of the Weimar Republic, the Deutsche Mark, which became so much wallpaper in a few years, as it began to fill the wheel barrows of the country. No, the treaty required that the Germans pay back their debt in gold. Funny, isn’t it? How is it that the loser of a war can impose upon the winner the acceptance of a metal which has been in a 6000 year bubble?
Gold hit $1700 in overnight trading last night, and it is time that I write a post celebrating this $100 incremental increase. This is only a mere three weeks after thanking Ben “Gold-is-not-money” Bernanke for $1600 gold. It used to be that dollars were fixed in price to money, gold and silver. Then, it was taken off the precious metals standard and become “money”–but it is what is called a “fiat” currency, a currency that has nothing real backing it. This means that the dollar has no “intrinsic value”. Nouriel Roubini and the other bright luminaries with PhD degrees have said that gold has no intrinsic value, and thus I created this series to remind them that the dollar is not money. It was once a note that gave the bearer the right to money on demand, but now it cannot be used to demand money any more.
This is a basic economic fact that I’ve known since my teen years when Carter was president and the US Federal government was likewise devaluing the dollar. It took Paul Volcker and severe interest rates and austerity to put the dollar back on track. Now the United States has suffered a belated downgrade in its credit rating from AAA to AA+ and we are seeing a renewed debauching of the currency. Still, there are those who claim that it is gold that is in the bubble, because look at how high the price is in dollars! I would remind people that the dollar has no intrinsic value, and the fact that we measure things in a currency with no set value is a form of reification–the value of the dollar is an abstraction because it is the ultimate derivative product, which has no discernible reason that it should be worth anything except that it can be used to pay debts and taxes. To measure gold, which has real intrinsic value, in dollars, which have none, is reification, the assigning of a concrete value to an abstraction.
“There is no means of avoiding a final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion or later as a final and total catastrophe of the currency system involved.” – Ludwig von Mises (hat tip Jim Quinn)
My prediction for the current debt crisis: John Boehner and the establishment Republicans will form a coalition with the Congressional democrats to sell out the American people. They will raise the debt ceiling, Obama will sign the bill, Bernanke will officially begin QE3, and it will be business as usual. The dollar will continue its downward spiral and much of world is going to starve to death. During the Weimar Republic, food became the most expensive part of people’s budget. Gonzalo Lira explains why food production fails during times of hyperinflation: Is Farmland A Smart Hedge Against Inflation?