The Hindu Business Line : Gold: Cheap at $1000 an ounce!

Considering the total reserves of gold bullion, the volume of which is about two billion ounces, a price of $1000/ounce just accounts for $2 trillion of paper currency. The real circulation of money, even within the US, is many times this number and so gold prices have to go up substantially higher.

Shanmuganathan N.

“An almost hysterical antagonism toward the gold standard is one issue which unites statists of all persuasions. They seem to sense — perhaps more clearly and subtly than many consistent defenders of laissez-faire — that gold and economic freedom are inseparable, that the gold standard is an instrument of laissez-faire and that each implies and requires the other. In order to understand the source of their antagonism, it is necessary first to understand the specific role of gold in a free society.

“Under a gold standard, the amount of credit that an economy can support is determined by the economy’s tangible assets, since every credit instrument is ultimately a claim on some tangible asset…

The abandonment of the gold standard made it possible for the welfare statists to use the banking system as a means to an unlimited expansion of credit.

“They have created paper reserves in the form of government bonds which, through a complex series of steps, banks accept in place of tangible assets and treat as if they were an actual deposit, i.e., as the equivalent of what was formerly a deposit of gold.

“The holder of a government bond or of a bank deposit created by paper reserves believes that he has a valid claim on a real asset. But the fact is that there are now more claims outstanding than real assets.

“In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. If there were, the government would have to make its holding illegal, as was done in the case of gold.

“If everyone decided, for example, to convert all his bank deposits to silver or copper or any other good, and thereafter declined to accept checks as payment for goods, bank deposits would lose their purchasing power and government-created bank credit would be worthless as a claim on goods.

“The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves. This is the shabby secret of the welfare statists’ tirades against gold.

“Deficit spending is simply a scheme for the ‘hidden’ confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists’ antagonism towards the gold standard.”

Thus wrote Alan Greenspan as part of “Gold and Economic Freedom” in The Objectivist (1966), reprinted in Ayn Rand’s Capitalism: The Unknown Ideal.

Unparalleled statist

Given what this writer has written in previous articles about the very concept of central banking, in general, and Mr Greenspan, in particular, it is perhaps rather ironic that this article begins with a Greenspan quote.

But this is the quote of the young Greenspan (a stage so early in his life where he might have been contemplating choosing between a career on the clarinet/sax vs monetary economics) who initially started as an Austrian economist till he became the central banker by which time he had morphed himself into an unparalleled statist i.e. money-printer (now, of course, Bernanke is giving it his best shot to crown himself with the title).

As this article will explain, the US and the world would have been a better place had Greenspan focused his efforts on earning the “maestro” title on the clarinet.

There is only one reason why gold prices go up i.e. a lack of confidence in fiat currencies. A study of history would show that every currency other than gold, without exception, gets debased into oblivion.

Whether that debasement happens through chicanery of erstwhile rulers or in modern times through the sophisticated operations of central banking, the end result is and will always be the same i.e. the eventual death of fiat currencies and a return to the market currency of gold.

Despite the rather tall claims of central bankers these days, it will be no different this time as well.

Diminishing currency value

The attractiveness of gold is because of its scarcity and unlike the supply of paper money, central bankers cannot increase the supply of gold at will. What is popularly referred to in conventional media as “global liquidity” is an euphemism for “global inflation” i.e. the expansion of credit.

Of the top 20 central banks, 18 of them are expanding their local money supply in double digits (UK 12 per cent, Euro 14 per cent, the US 16 per cent, China 17 per cent, India 23 per cent, and Russia 44 per cent) and the inevitable consequence of this increase is a loss in the purchasing power of every unit of the currency.

It is this fear of an ever expanding supply of paper money that pushes investors to purchase gold as a means of protecting their purchasing power.

So, while almost all fiat currencies are appreciating against the US dollar (refer “The Collapsing Dollar”, Business Line, July 27, 2007), it should be noted that they all continue to depreciate against the market currency of gold.

This just confirms the fact that all paper currencies are getting debased, but just that, some are getting debased much faster than others.

So while Mr Greenspan might have been responsible for the greatest increase in money supply the world has ever witnessed, the other central bankers have been more than mere bystanders to the near two-decade monetary debasement exercise.

What Price for Gold?

History has repeatedly shown that the only way to prevent currency debasement by the ruling class is the adoption of the gold standard. Gold, therefore, derives its intrinsic worth from its property as an alternative to paper currencies.

Thus, a good starting point to define the intrinsic value of gold would be the total supply of currency in circulation divided by the total stock of gold bullion reserves.

Starting from this, we could refine the calculation to account for other factors such as the future expected inflation, off-balance sheet liabilities of the US Government that could total up to $65 trillion, currency circulation outside the US and the undervalued nature of these currencies vis-À-vis the dollar.

But all these refinements would not be necessary to determine the fact that gold at $1000/ounce is cheap. Considering the total reserves of the yellow metal is about two billion ounces of bullion, a price of $1,000/ounce just accounts for $2 trillion of paper currency. The real circulation of money, even within the US, is many times this number and so gold prices have to go up substantially higher.

This calculation does not even take into account the additional factors mentioned above, and these would substantially add to the upward pressure on prices of the precious metal. Given all these factors, a five-digit price of gold over the next decade is a certainty.

(The author is a Director at Benchmark Advisory Services and can be contacted at shan.sundaram@benchmarkconsulting.in)

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