| All That Glitters: Part 2 |
Dateline: 11/18/97
Last week I looked at the gold bug’s theory of money. It argues that gold is, or ought to be money, based on its historical role as a store of value and medium of exchange. Modern fiat currency is, in fact, counterfeit, say the gold bugs. Essentially worthless. This week, I argue a different view.
Just as the horse and buggy was supplanted by the automobile and the post office is being supplanted by email, so too has gold been supplanted as money by fiat currency. For many, many years I held the hard money view that this was a bad thing.
During the seventies, inflation raged. Hard money pundits such as Jerome Smith and Harry Browne predicted a hyper-inflationary blowout. And it looked like they might be right. Inflation, Browne explained, feeds on itself. To avert recession and keep interest rates down, the government must inflate at an ever greater rate just to stand still.
In January 1980, after gold had jumped from $218 to $684 in a year, most of the increase in the preceding six months, Smith published an article in his World Market Perspective called "Hyperinflation Now". "With a trebling of the dollar price of gold and a six-fold increase in the price of silver," wrote Smith, " hyperinflation began in 1979."
On January 21, 1980, gold peaked at $850 an ounce. But then something unexpected happened. The price of silver and gold began to moderate. And by mid-1982, gold had dropped to just $304 an ounce and silver was down to $5.10 (which, ironically, is almost exactly where the metals are today!)
The conservatives, Reagan in America and Mulroney in Canada, started on programs of deregulating the economy and privatizing government operations. But while they were expected to slay the twin dragons of inflation and deficit spending, instead the national debt of both countries rose to staggering proportions during their tenure. A new monster was rearing its ugly head - insolvency. Some smaller governments (the City of Cleveland if I’m not mistaken and Orange County, California, among others) went bankrupt. Everywhere governments were being forced to the wall by their huge debts.
Then a socialist government in New Zealand did the unthinkable (unthinkable for a socialist, not for a philosophical arch-capitalist like myself). It adopted a hard stance on the problem, privatizing, deregulating and freeing up their economy and tackling the national debt head on. Their finance minister Roger Douglas was knighted and became a conservative folk hero.
Clinton in the U.S. and Chretien in Canada followed up on the deregulation and privatization begun by their conservative predecessors and also began to attack their deficit problem, though not with as much zeal as the Zealanders. Now it looks like the debt monster is on the verge of being slain.
These topsy turvy fifteen years from 1980 - 1995 have made me rethink my ideas on money. Although the hard money advocates were undoubtedly correct in their analyses in the seventies, their predictions of doom and gloom (hyper-inflation and/or a major depression) failed to materialize for a number of reasons. The main reason is that they underestimated the intelligence of their opponents. They predicted that politicians would continue to be seduced by the lure of inflation and deficit spending.
What they didn’t count on was a major paradigm shift in public opinion. Here in Canada, for example, the Vancouver Board of Trade originated its debt clock. This huge, constantly clicking counter, lodged in a prominent window in the Bank of Hong Kong downtown, galvanized public opinion against profligate government. BCTV’s Newshour, the most watched local newscast in Canada, installed the debt clock in its studios and broadcast it every night on the news for over a year. Similar attacks on wastrel governments in other Canadian cities produced a grass roots groundswell of public support for fiscal responsibility.
In Alberta, Ralph Klein became the province’s most popular politician by wrestling the provincial debt to the ground. In Ontario, after several years of NDP socialism, the people elected Tory Mike Harris on his promise to emulate the Klein revolution. And federally, Paul Martin has been able to effect a concerted attack on the deficit and is being touted as the likely successor to Chretien as leader of the Liberal Party.
Politicians in democratic countries don’t have the power to run roughshod over the people. They answer to the people. If the people want fiscal responsibility, they will get it because they control the coin of the political realm, their votes.
Another major change over the last two decades has been the communications revolution. Today money traders in all the major centers of the world can respond to changes in the world instantly. Currencies float freely against each other in an international money market. We truly live in a world where money is a commodity, responding to the market influences of supply and demand. Governments, in fact, are in the "business" of supplying money. Because there are many such "businesses", they compete to provide stable and reliable currency. Competing governments, once thought of as a contradiction in terms, are now a reality.
Certainly governments have the power to run amok, to inflate the currency willy nilly, but they cannot do it without consequence. They are held in check by market forces. And in the end, since gold, silver and other precious metals are freely available for purchase by citizens, they are measured in those terms as well.
One need only look at the remarkable story of Brazil to see how a determined government with visionary leadership can do a complete about-face on bad policy, driven by necessity and the market. Brazil was running as high as 5000% annual inflation until 1994. Then, in July of 1994, Finance Minister Fernando Henrique Cardoso put together a team of foreign-trained economists to reform Brazil’s monetary system. He did. Inflation slid to 23% the next year and has since declined to 4.5% today. Cardoso is now President of Brazil and working on cutting government spending. Problems still persist, but they are steadily being eradicated. Brazil did not introduce gold backed currency to accomplish this change.
Another influence on my thinking about gold and money has been economist Julian Simon, author of The Ultimate Resource. Simon set out to challenge the predominant doom and gloomers of the last two decades, the environmentalists. Amid almost daily cries that the world was overpopulated, that our air and water was deteriorating, that food would become scarce and expensive as a result, that the world was on the threshold of ever increasing scarcity, Simon pulled out his tables of facts and figures to prove that food production per capita has been steadily increasing, that air and water are cleaner than before and improving, that the price of resources was declining and so on.
Simon challenged his detractors to a bet "that the cost of non-government controlled raw materials (including grain and oil) will not rise in the long run". In 1980 Paul Ehrlich, the fear-monger about over-population, took up the challenge. Simon let Ehrlich choose five commodities. Simon’s bet was that the commodities would be cheaper after ten years. The commodities chosen were chromium, copper, nickel, tin, and tungsten. They bought, on paper, $200 of each, then waited ten years. In 1990, Simon collected a check for $576.07, the amount by which the aggregate price of the commodities had dropped. Tin, for example, had dropped from $8.72 a pound in 1980 to $3.88 in 1990.
Well, I asked myself, if Simon’s thesis is correct, and it appears to be, why should this not also apply to gold? Shouldn’t the price of gold drop over the long run? And in fact, since the U.S. government unpegged the price of gold from $35 in the early seventies and allowed it to float, the price found a level, surged briefly (very briefly) to $850 an ounce) and has continuously dropped since then. (With short term fluctuations, of course. Simon’s thesis is for the long term.) In real terms, it has dropped considerably.
In the end, the market, as it always does, determines what is money. It’s all well and good for the gold bugs to assert that gold ought to be money. Or for governments to assert that dollars, francs, lira or pesos are money. Whether they are money or not depends on what the consumer mandates. In a country with questionable money, the former Soviet Union for example, the local money runs in tandem with a market established money. The ruble appeared to be money on the surface. The American dollar was used as money in a thriving black market. The ruble market encountered shortages and scarcity. Anything was available in the black market.
Until a black market economy establishes itself using gold as money, fiat currencies will continue to be effective money. The cyberspace company, e-gold, is in fact, trying to establish a cyber-market operating on gold. Personally, I don’t bet on them succeeding. Their market will be limited to die hard gold bugs. As long as governments maintain some semblance of fiscal responsibility, people will retain their confidence in its marketability and fiat currency will be king.
Gold and other precious metals are commodities, like copper, tin, wheat or pork bellies. They are not "money" in any practical sense at all. I cannot buy my groceries with gold. I cannot pay my phone bill with gold. I do not get paid by my employer in gold. But I do carry out all these transactions in Canadian dollars. Now if that ain’t money, what is?
Missed Part 1 of this article? Click here! All That Glitters Part 1
Agree? Disagree? Send me your comments. I may publish them in a future article!
Next week I'll be doing my Monthly Mutuals Analysis. Part 3 of All That Glitters, which will look at gold as an investment, will appear here in two weeks. From this week's analysis you might expect me to be down on gold. In fact, I am rather ambivalent. There's still a bit of "gold bug" in my blood, in spite of losing big time on my precious metals investments the past year.
All That
Glitters: Part 1
All
That Glitters: Part 3
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