Gold's Challenge
The gold standard failed because a gold
standard and central bank cannot coexist. It is as simple as that. That
is particularly true when the gold standard is not sound in the first
place, which many argue it wasn't. At any rate, when the dollar was backed
by gold prior to 1933, the fiat monetary boom (1914-1929) engendered by
the Federal Reserve System resulted in a bust sequence that in turn resulted
in a series of bank panics a few years after the stock market crash of
1929.
Oh my, bank runs are bad for the economy,
aren't they? They sure are if that means disciplining the engine of "growth."
After all, depositors lost confidence
in their banks. The system of inflation can't work without the confidence
of its participants.
Precisely. So they proceeded to withdraw
their "money," or gold. Roosevelt's bank holiday fixed them (us) though.
After the holiday was up, US citizens were fined if they held gold assets.
Hoarding was out, and spending was in. Within a year the first "Federal
Reserve" note, not backed by any amount of gold, was issued.
Think about it. The free banking system
uses a lender of last resort to sustain a monetary boom and, in the end,
de facto defaults on its own deposit liabilities. The citizen gets it
both ways: directly in his wallet now, and over time through consistent
debasement. Without a lender of last resort sponsoring the 1920's inflation,
it could be argued that the boom wouldn't have become so misguided in
the first place. Indeed, the gold standard in the end was the discipline,
which prevented the free banking system from continuing the inflation.
Depositors voted against banks and for their gold.
The lender of last resort is the political
connection between the banking industry and government. It is used by
the banks and paid for by the government, or its citizens in the long
run.
Anyhow, here's my point. There's a slight
wrinkle in history we need to iron out. In "Gold
and Economic Freedom," a 1967 essay (in Ayn Rand's book Capitalism,
the Unknown Ideal), Mr. Greenspan said that a free banking system was
the natural evolution of a gold standard. He argued it much like Menger
argued how money first came into being, that a free banking system backed
by a lender of last resort simoly became superior to the gold standard.
Aside from the arguable fact that sound money had already ended with the
National Bank Act of 1863, the truth could probably be more accurately
found in Gresham's law.
In the end, it was a political objection
to sound money that buried the so-called gold standard, and it arose out
of a checkmate. Depositors that wanted to protect their savings from the
"free banking system" had to choose between private property and government
help. In the end, again, they voted for government help.
As long as banks can lend out more than
they have, bank runs are inevitable, unless there is a lender of last
resort to sustain the (monetary) inflation.
The inevitability of the bank run lies
in theories explaining how monetary inflation affects the business cycle,
and even with some common sense. Credit expansions just cannot go on forever.
But today's society believes that they can. And they can for what seems
like forever with enough financial engineering, political wrangling, and
enormously growing derivative markets arising out of the need to shift
the growing systemic risk around to different counterparties, like a hot
potato.
If the dollar were backed by gold today,
none of this is possible. It is the reason that central banking and the
gold standard are at odds, and why they cannot coexist. A central bank
could not sustain these monetary booms to the extent it does, if gold
were allowed to function freely as money.
The free banking system is not the natural
evolution to a gold standard. It is, on the contrary, its enemy (Mises
might say that it is also simply an interruption, or setback, in the process
whereby the markets ultimately develop a sound money). And
the central bank is a political vehicle used to undermine it as well as
the system of private property / production (or capitalism), which gold-as-money
is intended to protect.
But so long as the system of fractional
reserve credit is not recognized as flawed, in the first place, the central
bank will have a mandate. Yet, if it becomes realized as flawed, depositors
will once again be forced to choose between economic justice and government
help - which includes the burden of hidden taxation.
So long as our policymakers continue to
perceive the cure for our economic problems (usually a manifestation of
inflation anyway) to be more credit or monetary inflation, government
and bureaucracy will grow and grow. It will have to, if only due to the
errors made by inflationist policy.
In the end, investors must choose between
exercising their Constitutional rights to private property, something
legally unique to American citizens, or more, and more, government. The
government's biggest influence today lies in its ability to persuade us
that it can stimulate the economy, through inflation. This is its main
weapon, and it stands in between the existence of the Federal Reserve
System and the investor's decision to hoard what he or she thinks is money,
in what may ultimately amount to a political objection of central banking.
For those of us bullish on gold today,
this is the Gold market's ultimate challenge.
We're looking for a three to five year
bull market in gold that should begin sometime this year, if it hasn't
already. This bull market in gold, we contend, will be all about overcoming
the State's global monopoly on money. For gold to win, in the end, will
require the utmost moral conviction on the part of every single individual
who holds the power to vote for the system of private property… to veto
the government, if you will. Long-term global prosperity depends on it.
If you accept this argument then it isn't
difficult to imagine the world's central banks all have a common goal.
Everyone must by now know they are the ones engaged to replace gold, after
all:
"In summary, then, although information
technology by its very nature has lowered risk, it has also engendered
a far more complex international financial system that will doubtless
bedevil central bankers and other financial regulators for decades to
come. I am sure that nostalgia for the relative automaticity of the
gold standard will rise among those of us engaged to replace it." -
Alan Greenspan, sometime in 1999.
So now that you know who "they"
are, it's funny that the Bundesbank is talking about diversifying out
of its bullion holdings and into equities, on the premise that over the
long run stocks outperform. The fact that central bankers are natural
opponents of gold-as-money is small in comparison to how grave the situation
must be for them. After all, their money is only good so long as there
is confidence in stock and bond markets. Unfortunately, today there is
this valuation problem in those markets.
Effectively, what Bubba is saying is not
different from what is said in any other market crisis by the main players
supporting the market. It isn't much different than what promoters do
or say to control their markets. The difference is they're allowed to
do it. Unfortunately for them, that's the only difference. For both the
promoter and central bank ultimately succumb to the laws, or discipline,
of markets.
This week was a tough week for gold. Bubba
came out on top as commodity prices blew off, by Monday, after a two-month
gain of better than 11% in the main indexes.
Oil prices ended the week back to where
they started, after meeting some technical objectives, probably influenced
by the bearish sentiment on Wall Street, in the other commodities, and
finally egged on by what seemed like Bush's final attempt at peace in
the region. Early in the week, Iraq and Iran threatened oil embargos against
any supporters of Israel's reportedly increasing aggression in the region.
The Saudis and Kuwait rejected the notion of an embargo, probably since
Bush was promoting their peace plan for the resolution of the conflict
between Israel and Arafat, the Palestinian authority.
Palladium prices fell because analysts
discovered that Ford Motor Company invented a technology that reduced
the amount of palladium they needed. Ford disclosed that it would reduce
its inventory of palladium by half. Palladium prices fell sharply.
Falling stock and commodity prices provided
impetus to bullish bond trade, however. The long bond was up about 3%
on the week by Friday, and Wall Street noticed. The Dow was able to bounce,
a little. The other averages weren't. They ended at their lows for the
week, as well as only slightly above support levels that could seriously
extend the bearish argument if breached.
The dollar ended down marginally, on the
week. We are of the opinion that it is going to suffer badly as a consequence
of shifting priorities in global trade, and as a consequence of an eroding
investment premium related to the dwindling of prospects for returns on
dollar denominated financial assets.
But we are also going to suggest that global
trade is breaking down because there is no valid common global medium
of exchange. We would like to propose that trade has been deteriorating
as a consequence of the erosion of confidence in the dollar as a sound
common medium of exchange.
If that is true then Bush's shift in trade
policy is reactionary, and the fall in the value of the dollar is just
around the corner.
Whatever happens in Japan, it's bullish
for gold. If the Yen and Nikkei fall apart, it is bullish for gold. If
the Yen and Nikkei go up, it is bullish for gold, because the dollar will
be going down. Only, investment demand for gold will grow in the US instead
of Japan.
The Australian dollar is still trending
up, but the RBA's decision to hold rates steady pressured it against the
greenback this week, which kept the US dollar's decline in check, generally.
Softness in the Aussie is bullish for gold demand. Still, the chart of
the Aussie, as well as those of most currencies, continues to build bullish
bias.
I think this week will be very bearish
for US/European stock markets, bearish for the US dollar, bullish for
gold (including equities), the yen, and maybe the Nikkei.
Anything can happen in the oil markets,
but we expect most surprises to happen on the upside, and stay generally
bullish on oil and other commodity markets. But this week, the focus should
be on Wall Street, the dollar, and Gold.
Ed Bugos
Editor - The GoldenBar Report
www.goldenbar.com
9 April 2002
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