Many people are screaming at the top of their lungs that the European Central Bank (ECB) should print up wheelbarrows full of Euros to give out to desperate Eurozone nations in order to cover their over-spent public budgets. Some of these people are even in the camp who are calling for a "gold standard".
The problem is a misunderstanding of what the ECB and the Euro are. The Euro is a sort of synthetic gold. A "gold-lite".
The "problem" with a gold standard (a fixed, convertible price against gold for any given currency) is that it forces fiscal responsibility on those least able to deal with it: politicians and their electorate!
Politicians love nothing more than to be in power. That is their whole modus operandi summed up in a single sentence. They will do whatever they can to stay in power by winning as many votes as possible -- and the surest way to win a person's vote is to promise to put them on the payroll in some way, or to promise them free money or a tax break. That is all they have to offer you.
The electorate love nothing more than to live at the expense of everyone else. You want to tax other people and give me some of the money? Perhaps you're going to offer me a public sector job or offer my private company public sector contracts? Or perhaps you want to offer me some kind of tax credit to keep me sweet? Perhaps all of the above? Great! Where do I put the cross?
Within a paper money system under the control of the local politicians, such as the US Dollar, the UK Pound, the Yen, etc, anything is politically possible. They will just magic up some extra "money" and add it to their local monetary system, in order to balance the budgets and pay all the bills. They will call it "Quantitative Easing" because this sounds fancy and the man on the street will take no notice since it's obviously very complicated. The currency unit will be devalued by doing this, but hey -- nobody takes any notice of that, right? It's all good. We'll increase the money supply by, what? 30%? 50%? Hell, this year let's go with 100% why not! (It went down OK in 2008 after all, few people seemed to really notice eh?) And to make up for this, people will get, what do you think? Perhaps we go to town and give them 3% pay rises, what do you say? We can make the CPI and RPI numbers say whatever we want, so let's just pick a number and the pay rises will follow it pretty closely.
The difference with the ECB's Euro currency? Like gold, it is not under the direct control of any nation's politicians. You cannot just have as many new Euros as you want, to paper over your inconvenient political realities. Realities like, say, a massively over-extended bank credit boom that has gone pop and tipped into credit deflation. Or perhaps you have 50%+ of your population either sucking on the public welfare teat or working in/for the public sector. Mentioning no names, but there are a good few countries actually trying to cope with both of these example realities right now.
The good news is that, unlike gold, the Euro can be produced at will. Just not at the will of your nation's local politicians, but only by consensus of the ECB. The ECB are interested in one thing, and one thing only: price stability within the Eurozone area. They are only concerned with maintaining very close to 2% inflation, as measured by Eurozone-wide CPI. So far, for the last 12 years or so since the birth of the Euro currency, they have achieved this feat -- yes, even in the last couple of economically-challenging years. They achieve this objective by strictly controlling the Euro money supply. They don't achieve this by printing up more Euros willy-nilly like the Bank of England or the US Federal Reserve. They are able to negotiate temporary liquidity-enhancing programs, which are in line with their aforementioned price-stability objective. It is a breed apart from other currencies.
A classic gold standard carries the problem that it is rigidly restrictive. When a crisis appears, you cannot bend it to your will no matter how much you attempt it. You will just end up having to devalue, which will be a permanent thing since who ever heard of anyone getting away with revaluing their currency UPWARD before now?
A locally-controlled paper fiat currency carries the problem that politicians cannot be trusted to show restraint in the issuance of the currency. They will devalue it any time they get an excuse to do so, and their electorate will provide them with plenty of excuses because they are simple folk who know not what they request.
So that leaves the Euro, in between the two monetary extremes. The externally-enforced responsibility of a gold standard, but with the temporary flexibility of paper currency during times of crisis like today.
The problem today for nations who have opted to join the Eurozone, is that they didn't understand what it was they signed up to. They are going to have to get used to the idea that they will have to devalue themselves internally against the Euro. Everyone's getting a pay cut.
Tuesday, 23 November 2010
Thursday, 18 November 2010
Is gold a bubble about to burst?
In the immortal words of Tommy Cooper: I wanna tell you a story...
From 1971, when President Nixon closed "the gold window" at the US Treasury, the Dollar was no longer exchangeable for anything but another Dollar. It was a piece of paper and a smile, in other words. Prior to this event, you could walk up to the Treasury and they would swap every $35 you presented to them, for 1 ounce of gold.
This was an acceptable deal -- everyone could measure, objectively, what a Dollar in their possession represented in terms of real value. Just about the whole world agreed to fix their currencies to the Dollar, rather than gold. All currencies became paper derivatives of the Dollar. What it could be expected to be exchangeable for in the real world, in terms of goods and services they might require at that time or sometime in the future, was a known measure of value and everyone found it acceptable.
Specifically, the Saudis found it an acceptable trade to supply their oil to the world in exchange for Dollars, at an exchange rate of $1.80/barrel. So, in effect (and reality) what they were prepared to do was to give you 19.44 barrels of oil in exchange for 1 ounce of gold. They simply took the $1.80/barrel that they were paid in exchange, used some of it to pay their bills to the rest of the world, and the remainder (a significant proportion, being desert nomads they were a people of simple needs) they simply used to purchase more gold, building up their signicant store of wealth for future use. Everyone will give you something for some amount of your gold, no matter when you want that thing and whatever happens in the world. They didn't think they could say the same thing about keeping stacks of paper Dollars; they could easily become worthless at some point in time. It wasn't worth that risk to them. They exchanged the paper for gold.
In 1971 this simple and cosy relationship broke down. When Nixon broke the exchange of Dollars for gold at the Treasury, this presented a problem for the Saudis (in particular, but not exclusively) and that is what caused the 70's oil crisis (among other things). The price of oil had to be ramped up, as the exchangeable value of the Dollar sank (in terms of gold, which is what they really wanted for their oil, after 5000 years or so of history demonstrating it was the only money they could put any degree of long term faith in). Very quickly, the oil price in Dollars spiked, keeping up with the newly-free price of gold on the open market.
This is a very short summation of a long and interesting story, but the main point I wanted to bring to your attention at this moment is the historical price relationship of oil and gold (through the exchange medium of the Dollar price). When the Dollar was "as good as gold" at $35/oz, you could get 19.44 barrels of oil for the prevailing price for 1oz of gold. Today the oil price is around $80/barrel, and the price of gold is around $1300-$1400.
19.44 x $80 = $1552.20
This is not very far from the current price for 1oz of physical gold, the kind of gold you can touch rather than the kind of gold you can see on an account statement from some bank or metals exchange. Gold is underpriced still today, and the Dollar is (as are its international paper equivalents) still being debased through Quantitative Easing. The stated intent of governments the world around, is to devalue their currencies to increase their export competitiveness. What are all these people devaluing their currencies against? Not the Dollar, because the US wants to see that devalued against everyone else too!
Unless you think the world is going to stop using this much oil, or the Saudis are going to stop thinking gold is the best kind of money the world has to offer, I think you know what is going to continue to happen to the price of gold when measured in terms of your local currency, wherever you are in the world.
From 1971, when President Nixon closed "the gold window" at the US Treasury, the Dollar was no longer exchangeable for anything but another Dollar. It was a piece of paper and a smile, in other words. Prior to this event, you could walk up to the Treasury and they would swap every $35 you presented to them, for 1 ounce of gold.
This was an acceptable deal -- everyone could measure, objectively, what a Dollar in their possession represented in terms of real value. Just about the whole world agreed to fix their currencies to the Dollar, rather than gold. All currencies became paper derivatives of the Dollar. What it could be expected to be exchangeable for in the real world, in terms of goods and services they might require at that time or sometime in the future, was a known measure of value and everyone found it acceptable.
Specifically, the Saudis found it an acceptable trade to supply their oil to the world in exchange for Dollars, at an exchange rate of $1.80/barrel. So, in effect (and reality) what they were prepared to do was to give you 19.44 barrels of oil in exchange for 1 ounce of gold. They simply took the $1.80/barrel that they were paid in exchange, used some of it to pay their bills to the rest of the world, and the remainder (a significant proportion, being desert nomads they were a people of simple needs) they simply used to purchase more gold, building up their signicant store of wealth for future use. Everyone will give you something for some amount of your gold, no matter when you want that thing and whatever happens in the world. They didn't think they could say the same thing about keeping stacks of paper Dollars; they could easily become worthless at some point in time. It wasn't worth that risk to them. They exchanged the paper for gold.
In 1971 this simple and cosy relationship broke down. When Nixon broke the exchange of Dollars for gold at the Treasury, this presented a problem for the Saudis (in particular, but not exclusively) and that is what caused the 70's oil crisis (among other things). The price of oil had to be ramped up, as the exchangeable value of the Dollar sank (in terms of gold, which is what they really wanted for their oil, after 5000 years or so of history demonstrating it was the only money they could put any degree of long term faith in). Very quickly, the oil price in Dollars spiked, keeping up with the newly-free price of gold on the open market.
This is a very short summation of a long and interesting story, but the main point I wanted to bring to your attention at this moment is the historical price relationship of oil and gold (through the exchange medium of the Dollar price). When the Dollar was "as good as gold" at $35/oz, you could get 19.44 barrels of oil for the prevailing price for 1oz of gold. Today the oil price is around $80/barrel, and the price of gold is around $1300-$1400.
19.44 x $80 = $1552.20
This is not very far from the current price for 1oz of physical gold, the kind of gold you can touch rather than the kind of gold you can see on an account statement from some bank or metals exchange. Gold is underpriced still today, and the Dollar is (as are its international paper equivalents) still being debased through Quantitative Easing. The stated intent of governments the world around, is to devalue their currencies to increase their export competitiveness. What are all these people devaluing their currencies against? Not the Dollar, because the US wants to see that devalued against everyone else too!
Unless you think the world is going to stop using this much oil, or the Saudis are going to stop thinking gold is the best kind of money the world has to offer, I think you know what is going to continue to happen to the price of gold when measured in terms of your local currency, wherever you are in the world.
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