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Monday, November 15, 2010

More on Gold: Bad Choice for A Currency and At Some Point A Bubble That Will Burst

 my comments below in blue

James Grant has the gold standard "argument" in the NYT

A far more comprehensive article on gold appeared in the FT over the weekend. It had many great points but here is one to ponder for those advocating a move to a gold standard particularly in the midst of the deepest economic decline since the great depression. A gold standard  policy is a sure path to continued economic contracion.

To casual observers, central bank policy looks like printing money; the beauty of gold has always been that no one can make any more of it than what is already under lock and key or remains in the ground. The very extent of the rise in its price, however, shows the difficulty of using gold as money. Since the turn of the millennium, the Fed’s favourite price index has risen by 22 per cent, while over the same period the price of gold in dollars has risen by 498 per cent. Put another way: if there were no dollar, and US shoppers paid for their groceries with gold coins, since 2000 the amount of gold needed to buy a loaf of bread or rent an apartment would have fallen by three-quarters.
Deflation of 75 per cent in a decade is not an ideal characteristic for money. From a central banker’s point of view, the problem is that the rise in the gold price has not done a good job at predicting rises in the price of everything else. “Gold is a very poor reference point because it fluctuates so widely,” says Fred Bergsten of Washington’s Peterson Institute for International Economics....

the long term factors controlling gold's price, supply and ultimately money supply and economic growth in a gold standard system:

Among fundamental factors, traders highlight stagnant mine output in spite of record high prices. Global gold production hit a peak of about 2,645 tonnes in 2001 and stayed below that level until this year, according to estimates from GFMS, a consultancy. Worse, mining output is shifting to riskier producers in Africa and central Asia and away from the four traditional – and now mature – producing regions: South Africa, the US, Canada and Australia. Their combined output fell to 756 tonnes last year from 1,260 tonnes in 2000.
Only a surge in gold scrap, as owners of old jewellery cashed in on high prices, has cushioned the drop in mine output. Demand has also been robust as the growing middle class in countries such as India turns some of its new wealth into golden baubles.
Such factors are specific to gold and say nothing about wider inflationary pressure

The current factors pulling up gold's price:

But there have also been dramatic changes to financial buying of gold. New investors – such as pension funds and insurance companies – have piled into gold through novel instruments known as exchange traded funds, which make it easier to buy and sell bullion
The pension funds, insurance companies and some other longer term investors may be holding gold as part of a long term allocation to commodities. But the marginal buyer pushing the price at this point are speculators and uninformed individuals who know can easily buy gold through low cost instruments such as etfs or expensive illiquid ones touted on cable tv and talk radio. Their main rationale for buying gold is either doomsday scenarios peddled by the personalities on those programs with gold ads or for others they're buying it because it keeps going up. At some point, I have no idea when, this will end and it won't be pretty.
As for a gold standard... it;s the ultimate conrtractionary monetary policy: Here's what a scholar at a conservative think tank has to say:

While it may be useful to know that investors would prefer to own renminbi rather than dollars or euros, it is difficult to do anything about it. “Fed critics who cite the rise in the price of gold as a signal of incipient higher inflation have to acknowledge that they are in effect calling for the Fed to tighten policy,” warns John Makin, resident scholar at the American Enterprise Institute in Washington. “They need to consider the profoundly negative impact on asset prices and economic growth that would follow.”

wsj nov 15

Precious-Metals ETFs Explode; Are Investors Late? 

Exchange-traded funds are making it easier for individuals to place sophisticated bets on precious metals, but there are concerns these buyers are hopping on the bandwagon late.

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