It is difficult to get a man to understand something, when his salary depends on his not understanding it.
The mainstream economic landscape has been predictable in its denouncement of the Swiss Referendum on gold which will take place on November 30. By far, the most spirited denouncement comes from Willem Buiter of Citi, who penned a ten page note dedicated to reducing gold to merely a 6,000 year bubble (and being equally unkind to Bitcoin). Financial Times writer Izabella Kaminska alerted me to this note in one of her recent posts. Kaminska and Buiter both sing from the same hymn sheet, and while the music written on that sheet is closer to Rebecca Black – Friday than Verdi’s La Donna e Mobile, it is treated with the reverence normally reserved for works on the level of the latter. I will delve into why that is, but before that I would like to briefly look at Kaminska’s post, in which she lays out the ‘compelling’ points Buiter makes, along with her supplementary comments. Buiter’s points fall under three, tired critiques of gold – Gold is a Barbarous Relic, Gold has No Intrinsic Value, and Gold is too volatile to Function as Money. I will address each critique in turn.
Gold Is a Barbarous Relic
…Which neatly takes us to his key point, that both gold and bitcoin draw their value from the Thorstein Veblen logic that the more time you have spare to waste on idle and trivial things, the more your base needs must be satisfied. An economy that can afford to spend a lot of its spare time mining bitcoins or digging up gold — and wasting its natural resources in the process — must indeed be wealthy. Or at least some concentrated aspects of it.
“John Maynard Keynes once described the Gold Standard as a “barbarous relic”. From a social perspective, gold held by central banks as part of their foreign exchange reserves merits the same label, in our view. The same holds for gold held idle in private vaults as a store of value. The cost and waste involved in getting the gold out of the ground only to but it back under ground in secure vaults is considerable. Mining the ore is environmentally damaging, especially if it involves open pit mining. Refining the gold causes further environmental risks. Historically, gold was extracted from its ores by using mercury, a toxic heavy metal, much of which was released into the atmosphere. Today, cyanide is used instead. While cyanide, another toxic substance, is broken down in the environment, cyanide spills (which occur regularly) can wipe out life in the affected bodies of water. Runoff from the mine or tailing piles can occur long after mining has ceased.”
Gold must be extracted from the earth, requiring resources and labor, while paper currency requires only the effort needed to build and maintain a printing press. The idea Buiter, Kaminska and the rest of the mainstream present is that because the printing press makes it possible to produce the same good (money) while using a comparatively insignificant amount of resources, that method is inherently superior. The preference for the old good (gold) is thus tantamount to renouncing progress, and thus barbaric.
This would be correct, if the two goods were of the same quality. That is, if gold and paper money performed the task of serving as money equally well. To confirm that, it is important to note the characteristics which make for good money. From the Federal Reserve Bank of St. Louis:
There have been many forms of money in history, but some forms have worked better than others because they have characteristics that make them more useful. The characteristics of money are durability, portability, divisibility, uniformity, limited supply, and acceptability.
These characteristics are important because they are conducive to achieving the goals of money, which are mainly to serve as a medium of exchange, unit of account and store of value. Gold and paper money both share all of the characteristics of good money, except for one – limited supply. A limited supply is a requirement of good money because without it, the goal of serving as a store of value is compromised. Anything which is readily available and easily obtained does not work well as store of value.
For example oxygen is all around us, and easy to obtain. Even though it is vital to our ability to survive, the fact that it is so abundant makes us take it for granted. Storing oxygen with a view to exchanging it at a later date for something tangible is a foolish idea, because the other party in this exchange can obtain the same air on offer at no cost. Thus there is no reason to incur one. This is clear to the vast majority of the global population, such that it may seem absurd that I have to spell this out. But alas, mainstream economists exist. The ease at which paper money can be produced in comparison to gold is exactly what makes it inferior in the context of the monetary characteristic of limited supply, and thus inferior in the context of what is good money.
Gold Has No Intrinsic Value
Related to the barbarous relic point is the idea that gold has no intrinsic value:
“Gold should not be analyzed as one of a set of intrinsically valuable commodities (silver, iron, lead, zinc, platinum, aluminum, titanium etc. etc.) but as part of a set of intrinsically useless and valueless fiat currencies – the US dollar, the yen, the Yuan, the euro, sterling, the rupee, the rouble, Bitcoin etc. etc.). It is therefore in times that market participants are nervous about the future value of most other fiat currencies that gold will be most attractive.”
In short, it’s a least ugly contest between all these non-intrinsically valuable currencies, with the winner usually determined by the system of social values surrounding the fiat currency that drives the most wealth.
Buiter describes what he means by ‘fiat currency.’
You will be familiar with fiat currency. Unlike what Wikipedia says on the subject, we argue that the essence of fiat money is not that it is money declared by a government to be legal tender. It need not derive its value from the government demanding it in payment of taxes or insisting it should be accepted within the national jurisdiction in settlement of debt. Instead the defining property of fiat money is that it has no intrinsic value; it derives any value it has only from the shared belief by a sufficient number of economic actors that it has that value.
The word ‘intrinsic’ is an adjective defined by Webster to mean ‘belonging to the essential nature of a thing.’ ‘Intrinsic value’ then, is just the value such a thing offers strictly because of its essential nature. This value can be derived from what the object is or what the object does or can be fashioned to do. Wood and iron ore have intrinsic value because the properties belonging to them are of use in construction and manufacturing, thus providing value. If humans had no need to build things or manufacture things, wood and iron ore would have no value, and no effort would be made to collect them.
The properties belonging to the essential nature of gold (durability, portability, divisibility, uniformity, limited supply, etc) are the same properties which comprise a high quality form of money. As long as humans have a need for something to serve as money, gold has value because it is capable of performing this task. The fact that this is down to its inherent properties means it has intrinsic value.
Buiter is correct in writing that fiat money has no intrinsic value, and that it only derives value ‘from the shared belief by a sufficient number of economic actors that it has value.’ As discussed above, the fact that paper money fails to meet the ‘limited supply’ characteristic of good money means it fails as a candidate for good money. In other words, the properties inherent in paper (intrinsic) render it unsuitable to provide value as a high quality form of money. Without this intrinsic value, paper money must be ascribed its value externally, which as Buiter remarks can be done with or without government decree.
Where Buiter and Kaminska err is in the classification of gold as just another intrinsically valueless fiat currency. As such, they claim, the fact that gold is valued at all rests on the external validation from society, which indeed can fluctuate based on the state of other currencies such as the US dollar or Japanese Yen. The difference between gold and the US dollar is that, as discussed, gold has the full set of ‘good money’ characteristics inherent in its constitution, while the US dollar does not. Similarly, wood has the full set of ‘good building material’ characteristics inherent in its constitution. Whether one believes this or not makes no difference to that truth. Gold does not need a ‘shared belief by a sufficient number of actors that it has value,’ the same way that wood does not need a ‘shared belief by a sufficient number of actors that it has value.’ If for some reason the entire planet decided that trees were never to be cut down again and their wood banned from use, it would not change the fact that wood is a high quality building material. Similarly, the mere assertions of the economic establishment that gold is useless as money does not render it so, because mere assertions cannot change the properties of an object, meaning its value will not change in the context of the goal required of it.
The correct comparison to make between gold and paper currencies such as the US dollar is the comparison of its quality in operating as money. Gold is higher quality money than paper currency, which is exactly why it is valued, and exactly why men have undertaken great pains to extract more of it from the earth. On a basic level, money is a representation of value creation. In order to obtain it, one had to provide value to someone else first. The value in extracting gold from the ground is to provide humanity with a higher form of money, a form which is better than any other at representing the value that one produces and preserving it until it is ready to be exchanged for something else. Gold production is not a ‘wasteful’ endeavor any more than wood or concrete production is. The logic Buiter and Kaminska put forth, when applied to wood and concrete, would suggest that since straw is widely abundant and can obtained with a fraction of the effort, it is a superior alternative to wood and concrete for the construction of buildings, and any efforts made to harm the planet in producing wood and concrete would be barbaric. This is obviously silly, yet such analysis has been woven into the dominant economic thought over the last 80 years.
The Value of Gold Fluctuates Too Much to Be Considered Reliable
The final critique I’ll look at is the idea that gold is too volatile to be of any use. Buiter writes:
“In a classic paper, Kareken and Wallace (1984) have shown that even in the other (nice) fundamental equilibrium, in which each of these fiat currencies has a constant positive value, those constant positive values can be anything – there is exchange rate indeterminacy between the various fiat currencies. This holds for paper or electronic fiat money, gold and Bitcoin.
So if gold has positive, albeit wildly fluctuating value, it is because we are in a benign bubble for gold. Likewise, Bitcoin’s positive value represents a benign Bitcoin bubble. The gold bubble is, of course, pretty impressive. Intrinsically useless gold has positive value. It has had positive value for nigh-on 6,000 years. That must make it the longest-lasting bubble in human history.
Is there a possibility that, out of the blue, the market could produce a zero value for central bank-issued fiat paper and electronic money (base money)? Yes, if the prices of goods and services in terms of base money are freely flexible. Fortunately they are not. The world is Keynesian. Nobody understands the mysteries of the unit of account or numéraire, but for some reason in most societies and most of the time, central-bank issued fiat money or base money has been the unit of account for most contracts, and prices of goods and services in terms of this numéraire, are sticky – empirically and for reasons we don’t understand, but they undoubtedly involve limited computational capacity and other manifestations of bounded rationality. Nominal wage and price rigidities therefore rule out the zero price of base money equilibrium (notwithstanding the fundamental equilibrium at the end of a hyperinflation).”
In any case, while it’s true there is a logical equilibrium where the value of central-bank issued fiat currency retains positive value and gold and bitcoin don’t, in the case of gold anyway, Buiter says it’s redundant to argue with a 6,000 year bubble. Indeed this is probably the core problem with gold as a store of value; the inherent subjectivity associated with gold makes its value impossible to predict. Furthermore, while investing a vast amount of money in something whose value is based on nothing more than a set of self-confirming beliefs may make for an exciting ride, that’s hardly worthwhile enough a quality to impose it as a requirement on one’s central bank.
The primary role of money in general is as a facilitator of exchange. To the extent any form of money can play this role, there have to be goods and services which can be exchanged. If there are no goods at all, or if there are infinite goods, exchange is not necessary and thus neither is money. Since we are neither here nor there, money is necessary and will have a value which fluctuates based on its abundance compared with the abundance of other goods and services. The ‘impossibility’ of predicting gold’s value also applies to fiat currencies in this respect.
The difference is that the inherent scarcity of gold renders it a relatively stable figure in terms of output. The supply of gold increases a constant rate of roughly 2-3% annually. Compare this with coffee production for example, which in the last two crop years increased by 0.7% and 7.4%. This sort of disparity in output is down to the ever changing, uncontrollable conditions involved in coffee production, as is the case with many other lines of production. What this means is that in the first crop year, gold became relatively more abundant than coffee, which is reflected in the gold price of coffee rising over that time. In the second year, the increased abundance of coffee in comparison to gold is going to be reflected as an increase in the value of gold for that crop year, or a decline in the gold price of coffee.
What experiences the wild fluctuations is output, and this is reflected when viewed through the prism of gold. Gold itself does not change, it is inherently stable and its limited output increases render it stable in comparison to everything else. This is why it serves well as a reference point, and as a store of value. The ability for fiat currency to be increased at will in unlimited qualities introduces another variable in the calculation of monetary value. An increase in the dollar price of coffee for example, tells us nothing about the abundance of coffee. The price could have risen because of a relative dearth of coffee, but it also could have risen thanks to an increase in the money supply. In fact, coffee production could have actually risen by record totals, but an explosion of the money supply could have caused the price to rise anyway. This phenomenon is much harder to achieve with gold thanks to its relatively stable production rate.
As mentioned before, gold does not derive its value from a widely held ‘set of self-confirming beliefs,’ but rather its objective properties, which mirror the properties that make for high quality money. Subjectivity only enters the fray when elevating intrinsically valueless fiat currency to the same level as gold in the monetary sphere. To do this requires a widely held set of self-confirming beliefs. That most societies have been successful in instilling those beliefs, and elevating fiat currency to practical supremacy over gold does not render the former a superior form of money to the latter, just as a self-confirming belief that straw is superior to wood does not render the former a superior building material.
On larger level, the fact that Buiter needed to pen this note is interesting. His point of view has been the dominant view in economics for well over 50 years. John Maynard Keynes gave the academic cover for politicians to worldwide to systematically reduce the standing of gold in the global monetary system. Being an advocate of gold in today’s environment instantly brands you a lunatic in the eyes of most. So why have there been so many words written in recent weeks in opposition of the Swiss Referendum? If the anti-gold position was really as obvious of a truth as the fact that the world is not flat, it would not have to be pounded over the heads of the economic readership with such vehemence.
The reality is that the elevation of fiat currency over gold as money is generally borne of political expediency, rather than the genuine quest for a higher quality form of money. Gold, by virtue of its scarcity, is a limiting factor to the control seeking ambitions of politicians and central bankers. This is a key reason behind a lot of the opposition to the Swiss Referendum. The Referendum would require the Swiss National Bank to hold 20% of its reserves as gold while being forbidden to sell any of its existing gold, or gold it accumulates in the future. Buiter says this renders Swiss gold worthless, and in a sense he is right. That provision of the Referendum is flawed, but the reason is because the inability for the SNB to sell its gold is an inability for individual holders of Swiss Francs to have access to it.
The likes of Buiter would prefer to see central bankers and politicians remain in complete control of their economies, and reducing the presence of gold is paramount in that endeavor. The problem for those who favor this aim is that it is not based on a foundation of strength. Over 800 years ago, the Chinese proved that paper currency was inherently weak and vulnerable to the short term delusions which afflict all politicians. From the politicians’ vantage point, the lure of a possible Get Out Of Jail Free card has always been too tempting, rather than face the distressing situation head on and risk political demise.
The latest such experiment with paper began in earnest just over 40 years ago when President Nixon closed the gold window, ending the Bretton Woods construct. He did this not because of it would represent a brighter economic future, but rather because the United States had embarked in a printing frenzy, and now being called to task via increasing gold redemptions, understood it could not meet them, and abruptly changed the rules of the game. In other words, the United States defaulted on its obligations to exchange dollars for gold.
Given that the US dollar was the only currency redeemable for gold, this move effectively put the entire planet on a fiat standard, where it has been ever since. Perhaps, for the first time in 6000 years, human trade is taking place without even the indirect involvement of gold. As fiat currency is inherently a weaker form of money than gold, this shift has represented a shift to a weaker foundation of the global monetary system.
The cracks in that foundation have been clear, mostly in the shape of a 40 year debt binge which has taken the global economy to the precipice at least two times in the last 15 years. The response from the politicians and central bankers – all of whom employ the dogma which Buiter and Kaminska are partial to – has only been to keep doing more of the same and hoping that the results will change.
In A First Rate Madness, Nassir Ghaemi argues that in times of extreme difficulty, leaders who are sane (where sanity refers to normality and ‘by the book’ behavior rather than a mental disorder) are not properly equipped to deal with the issues at hand. He cites the examples of George Bush and Tony Blair in the context of Iraq, and more prominently Neville Chamberlain in the context of Hitler.
Applied to economics in 2014, the Keynesians are ‘sane.’ The Keynesian playbook had dominated economic thought and policy in some form for half a century at least, and when tough times come, all that is needed is to refer to the playbook and act accordingly. The problem, at least in the monetary realm, is that the playbook is built on a false narrative, akin to the idea that there were weapons of mass destruction or that Hitler merely wanted the Sudetenland and would have stopped there. Rivaling those falsehoods is the idea that politicians and central bankers will resist the temptation to drastically increase the money supply at will, realizing the weakness of fiat currency vis-a-vis gold in the process.
That there has been no major currency collapse in the 40 plus years since the end of Bretton Woods, despite the explosions in the money supply of major currency potentially lends credence to the anti-gold position. Quite frankly it doesn’t, for the simple fact that the 40 year ‘global fiat era’ is not of statistical significance in the course of 6000 years of commerce, most of it dominated by gold. Paper currency is not a new invention; the same experiments have been tried unsuccessfully countless times over the centuries. That Buiter and Kamistka arrogantly dismiss 6000 years as a ‘bubble’ in favor of the last 40 is telling.
To accept that in fact gold is a superior form of money to paper is to on some level accept that the dogma on which their academic and professional training has been based is flawed. As per the Upton Sinclair quote, this is very difficult to do. But Buiter and Kaminska are hardly alone. As I’ve repeated, the entire political and economic establishment from the government to Wall Street has a stake in the views of Buiter being correct. In truth they are fighting an uphill battle against reality. But through their ability to craft the dominant narrative, they are able to shield themselves from that truth for the time being.
Unfortunately for them (all of us really), the ‘Fiat era’ has overseen crises just like any other era, with the distinguishing feature being that each crisis has been larger and more encompassing than the last. The ability for economic downturns to be ‘papered over’ always leads to declarations of success, including most recently with the general proclamations of success of the recently ended Quantitative Easing program. What has resulted from these papering campaigns has not been the resolution of problems, but rather the creations of new ones to replace them. All the while, the value storing capacity of the money continues to come under fire, which means the individual wage earner finds it increasingly difficult to get by. This leads to more and more questions being asked of the story they’ve been told, which in turn leads to events such as this Swiss Referendum.
Having written all of that, I doubt it will pass, but the scrambling the establishment has done to oppose it will have to be repeated in the coming years, as more and more begin to wake up to the failures inherent in basing a monetary system on an intrinsically worthless item.