Similar to credit as the lifeblood of the financial market, trust is everything about money. Otherwise paper is just a paper, only with trust, a piece of paper suddenly has value, so we can preserve it or pass to someone else for goods and services. Trust becomes a bridge between two trading parties, just like credit as the critical link between two trades in the financial markets.
When a Brazilian model and Taj Mahal tour guide refused to accept US $, for some contrarians, it is a sign of the end of US $ decline, since how would a model and tour guide know anything about the complicated financial market? Is this the same story as shoe shine boy or taxi driver talk about hot stock tips at the peak of the bubble? To me, this is a misguided use of contrarian approach. My view is totally the opposite. It shows the deterioration of the trust on US $ by the world which US $ is depending on for its support. The only reason US $ becomes the world reserve currency is because people trust it. With this trust, US can issue all its papers to the world and pay for all the cheap oil, raw material, finished goods around the World, with foreign central banks holding these papers to finance the US high living standards.
However, as Warren Buffett said at his popular annual letter published on Friday, this kind of imbalance is unsustainable, the $2B daily force-fed to the rest of the world produces unpleasant indigestion. He pointed out, the current sovereign wealth funds investing in US is actually our own doing, the weakening US $ is not the fault of OPEC and China but our own. This is why he has been bearish on US $ for a while. In my view, the problem is worse than unpleasant indigestion, it is the loss of trust which might end US $ as the world reserve currency. Why gold is going faster last 2 years than previously? Maybe higher inflation expectation is part of it, but probably more due to the reason that gold provides an alternative vehicle and safe-haven for this potential trust crisis if US $ loses its reserve status. The current credit crisis is obviously not helping, when people lose trust on financial markets and their products, and they can't even dump paper assets due to lack of liquidity in the fixed income market with no buyers, what would they want to hold on to? What would make them feel safe? Commodities, especially gold. I feel this is at least part of the reason behind the current commodity boom cycle. it is a era of asset rotation by dumping questionable paper assets and buying into real physical assets which people can see, feel, know and trust for certain their true values.
Why gold? I think it is more a world tradition by our human being's own selection. Aristotle indicated: “Gold is durable, not like wheat, divisible, not like diamonds, convenient, not like lead, constant, not like real estate, and best of all, as jewelry, it has intrinsic value”. Why not other metals such as copper with the same properties? I don't know, maybe gold just looks and feels better. You never see a jewelry made of copper, do you? Magically all major nations and civilizations in separation without talking to each other and without consensus had uniformly picked gold (to some extent, silver too). Gold is precious and lasts forever. We can’t create new gold through alchemy out of thin air, not like all the financial alchemy by creating various tranches from subprime mortgages in modern days. Milton Friedman mentioned that there is a tribe in the pacific that uses rocks as their currency. Why don't we use rocks instead of gold? Obviously rocks are lack of such properties mentioned by Aristotle, otherwise the world would be flooded with cheap money (rocks) like the US $ today. Why does the tribe use rocks? Because there is no gold or any other metal in this isolated pacific island, and rocks are the closest to the properties of durable, divisible, convenient and constant currency, not sure about intrinsic value though. Outside the island, rocks are worthless. I think it is the same thing on gold, outside the mother earth, gold means nothing to aliens either if they exist.
Thomas Tan, CFA, MBA
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Disclaimer: The contents of this article represent the opinion and analysis of Thomas Tan, who cannot accept responsibility for any trading losses you may incur as a result of your reliance on this opinion and analysis and will not be held liable for the consequence of reliance upon any opinion or statement contained herein or any omission. Individuals should consult with their broker and personal financial advisors before engaging in any trading activities. Do your own due diligence regarding personal investment decisions.