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The Week of Taking Gold Seriously
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(November 15, 2010) Gold last week hit another new record price against the quantitatively eased dollar, and then managed to fall more than 4% at week's end. More noteworthy is the new and widespread talk about the nature and function of gold itself, its future as a peg in the monetary puzzle, and its function as a currency today.
Another notable week in the gold markets, with new highs reached on Tuesday 11/9/10, immediately followed by a three-day freefall which chopped some $50 off the gold spot price. Silver, which traded over $29 for about fifteen minutes on that Tuesday, proceeded to shed over 10% of that brief-held value, and traded below $26 before the week was over.

But holders of precious metals shouldn't feel too bad about that - at least they weren't invested in sugar. Pity those who were long the sweet stuff on Tuesday, only to see sugar prices slide some 26% over the next 72 hours. That is called taking a licking.

This week saw the G20 Summit come to no real conclusion, except to point out just how angry much of the world feels for the Fed’s decision to try to pump us the US economy via what is known as QEII (Quantitative Easing, Part Two) or in plain language, printing more dollars.

At the conference in Seoul, there was definite evidence of a global backlash against QEII, with central bankers from China, Germany, and Russia publicly criticizing the move. Brazil’s newly-elected president Dilma Rousseff went so far as to say:

“The last time there was a competitive devaluation of currencies it ended up where it did, in the Second World War.”

President Obama’s defense of QEII pretty much came down to this statement:

"The Fed's mandate, my mandate, is to grow our economy. And that's not just good for the United States, that's good for the world as a whole."

Mr. Obama’s outlook on the strength of the dollar was not directly stated. But he did say,

“From everything I can see, this decision was not one designed to have an impact on the currency, on the dollar. It was designed to grow the economy.”

With this scant non-defense of the dollar, it’s no wonder the Wall Street Journal pointed out in its November 13/14th editorial “Embarrassment in Seoul:”

“And the U.S. solution is to have the Fed print enough money to devalue the dollar so America can grown by stealing demand from the rest of the world.”

Weakness, perceived and actual, in the US dollar, began this whole round of talk about gold as a currency, or at least as a factor to reckon with when considering the stability of a basket of currencies. In a Financial Times editorial last week penned by Robert Zoellick, head of the World Bank, Zoellick discussed ways to encourage economic growth and reduce the current disorder in world currency markets. In essence, Mr. Zoellick proposed a brand new global monetary plan:

“The new system is likely to need to involve the dollar, the euro, the yen, the pound and a renminbi that moves toward internalization and then an open capital account.” Wrote Zoellick, ”The system should also consider employing gold an as international reference point of market expectations about inflation, deflation, and future currency values. Although textbooks may view gold as the old money, markets are using gold as an alternative monetary asset today."

James Grant, publisher of Grant’s Interest Rate Observer, penned an article for the Sunday New York Times entitled “In Gold We Trust – How to make the dollar sound again.” He begins:

“By disclosing a plan to conjure $600 billion to support the sagging economy, the Federal Reserve affirmed the interesting fact that dollars can be conjured. In the digital age, you don’t even need a printing press.”

“That was on November 3. A general uproar ensued, with the dollar exchange rate weakening, and the price of gold surging. And when, last Monday, the president of the World Bank suggested, almost diffidently, that there might be a place for gold in today’s international monetary arrangements, you could hear a pin drop. “

“Let the economists gasp: The classical gold standard, the one that was in place from 1880 to 1914, is what the world needs now. In its utility, economy, and elegance, there has never been a monetary system like it.”

“It was simplicity itself. National currencies were backed by gold. If you didn’t’ like the currency you could exchange it for shiny coins (money was ‘sound’ if it rang when dropped on a counter). Borders were open and money was footloose. It went where it was treated well. In gold-standard countries, government budgets were mainly balanced. Central banks had the single public function of exchanging gold for paper or paper for gold. The public decided what it wanted.”

Mr. Grant’s article offers a brief history of money (hint: gold works best, other kinds of money fail) and brings up the fact that hundreds of Ph.D economists are employed at the Fed, cranking out such treatises as “The Two-Period Rational Inattention Model: Accelerations and Analysis” and "Continuous Time Extraction of a Nonstationary Signal with Illustrations in Continuous Low-pass and Band-pass Filtering.”

You can’t help but like Grant’s vision of the future at the Federal Reserve under a ‘true-blue’ gold standard. He suggests that it would usher in an era of a more gainful employment for Fed workers: “Rather than writing monologues for each other, they would be standing behind a counter exchanging paper for gold and vice versa.”

The November 13/14th edition of the Financial Times nearly echoed the same title, “in Gold They Rush,” with the subtitle: “Bullion’s sharp rise in price is prompting a rethink for the first time in four decades about whether the metal should have a monetary role.”

The FT article by Robin Harding, Javier Blas, and Alan Beattie, explores gold’s role today, and tried to parse out what is behind gold’s rise from $250 back at the turn of the present century to nearly $1400 today. They quote David Einhorn of Greenlight Capital, who pretty much nails the big picture thusly:

“The size of the Fed’s balance sheet is exploding and the currency is being debased. Our guess is that if the chairman of the Fed is determined to debase the currency, he will succeed. Our instinct is that gold will do well either way: deflation will lead to further steps to debase the currency, while inflation speaks for itself.”

Gold, the article contends, is popular today as an investment option because most of the world’s currencies are destined to sink in value, except the Chinese renminbi. But international trading is not allowed under restrictions that China has in place to control its currency. Therefore, gold is a substitute for that currency. As Mr. Zoellick wrote,

“Investors have become increasingly concerned about sovereign default and they think that most currencies should fall against the renminbi. But since non-convertibility means they can’t buy the renminbi, they buy gold instead, which can’t be debased.”

All in all, this was an auspicious week for the recognition of gold as a currency. When the likes of Jim Grant and Robert Zoellick both talk up gold, people tend to listen. Long ignored, but never obsolete, gold today is being recognized for being more than just simply the canary in the currency coal mine – it actually is a monetary standard unto itself.

 

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