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Is Gold Just Another Fiat Currency?

Below is a clip from Sky News which demonstrates that a Gold Rush is developing in China, with many now distrustful of fiat currencies. China is now the number one consumer of gold. But all across the world, we are witnessing the same currency revulsion and distrust of central banks, which has buoyed the price of gold.

Nevertheless, the video does point to a certain mania amongst investors that sounds more like speculation and risk seeking than investing and risk aversion. Witness the Chinese man quoted saying, "I think investing in gold bullion is very good. Recently, the price of gold has been increasing all the time and I think it will rise even more." That is exactly the psychology we witnessed in Emerging Markets shares in the mid-1990s, in Internet stocks in the late 1990s and in housing in the 2000s.

In this week’s Barron’s, Richard Wiggins, chief investment strategist for First Michigan Bank, says that gold is just another fiat currency.

He says:

A vital observation of the fun-starved Austrian school of economics is that investors err together, so unanimity of opinion is a danger sign. In past decades there has always an overvalued sector-a steaming corner of the market where money was converging — and outperformance has come from getting out ahead of the crowd.

- In the 1950s, avoid electronics.

- In the 1960s, avoid franchise restaurants.

- In the 1970s, avoid the Nifty Fifty and fixed income.

- In the 1980s, avoid energy and biotech.

- In the 1990s, avoid Japan and the Internet.

- In the 2000s, avoid real estate and home-building.

All bubbles have nearly identical characteristics. The second half of the 1970s witnessed the outperformance of energy issues. At $30 barrel, oil companies were clearly in fat city. But the gonzo run-up in oil prices that propelled this sector in 1982 contained the seeds for an eventual glut that eventually sent it right back down.

Similarly, gold, which was outside the pale of serious discussion in the 1970s at $35 an ounce, entered the investment mainstream at $600 and $700 an ounce between 1978 and 1980, when it was quadrupling.

Only 15% of gold is used as a monetary metal; the rest of it is used as a commercial metal, and that use, particularly as a corrosion-resistant electrical conductor for semiconductors, is declining. Regrettably, it is a soft, semi-useless metal with very few industrial applications.

Gold is just another fiat currency. The only reason gold is valuable is that we believe it is valuable. Ultimately, this gold bubble ends in tears. When and how far gold’s price will decline is anyone’s guess, but a smart bet is "sooner rather than later."

Is gold just another fiat currency? Is Wiggins right that this is a bubble forming?  George Soros seems to think a bubble has formed.  But for now, the price of gold is rising. And as central banks turn to the printing presses to fight deflationary forces, I believe it will rise much further still.

Source

Gold: The Ultimate Fiat Currency – Barron’s

About 

Edward Harrison is the founder of Credit Writedowns and a former career diplomat, investment banker and technology executive with over twenty years of business experience. He is also a regular economic and financial commentator on BBC World News, CNBC Television, Business News Network, CBC, Fox Television and RT Television. He speaks six languages and reads another five, skills he uses to provide a more global perspective. Edward holds an MBA in Finance from Columbia University and a BA in Economics from Dartmouth College. Edward also writes a premium financial newsletter. Sign up here for a free trial.

36 Comments

  1. Vangel says:

    As someone who has been buying gold since 2000 I have to admit to having a bias. But that bias was developed by research and fundamental analysis.

    I can’t see how Soros can call China’s attempt to diversify its reserves by purchasing gold instead of T-bonds a bubble. China has very little gold in its reserves and will need to get a great deal more to reach Western levels. (It is also hard to believe him when he attacks gold at the same time as he was buying the gold ETF.) That said, we could see a pullback that could take prices down a few hundred bucks but that has been common during this bull market run. While they won’t ring a bell to signal the true bottom, it is likely to occur when an ounce or two of gold will be enough to buy the Dow.

    • Lildynamite209 says:

      Those who find fault in gold / silver are actually afraid of real, accountable money. As long as paper is accepted as “money” they will continue to manipulate the system. They go as far as manipulating gold and silver with ETF’s ( more paper ) but if there were NO ETF’s and NO fiat currency and banks/central banks or should I say the federal reserve were made accountable for each oz. of gold / silver….. ( since they can’t print gold / silver ) they would have REAL, ACCOUNTABLE MONEY and paper manipulation would be the BARBARIC RELICS and every note that does not have any gold or silver backing it should be burned !!! Those who call gold / silver barbaric relics of the past or label real money ( Au. / Ag. )as the next bubble are afraid of accountability………..

  2. Sir James says:

    I would like someone to explain why/how gold is not fiat when so much paper gold exists without backing?

    Jim

    • Lildynamite209 says:

      Dear Sir James,
      There are so many paper contracts or ETF’s in gold and silver which means ETF’s (gold or silver) are empty contracts or pieces of paper telling someone they own gold or silver but in reality they only own the piece of paper ( you don’t own gold or silver unless it’s in your hands, personal control; ETF’s ? MOST of THE TIME almost always, are manipulation, ponzi schemes or just plain old criminal acts allowed… ALLOWED BY WHOM???? My suggestion would be to ask Gensler of the CFTC. I’d bet he would have a colorful explanation……..

  3. Mtbomb says:

    The problem with gold is that it is difficult to fundamentally value. There isn’t a clear PE ratio. The best one could do is see how the price of gold compares to the price of other commodities especially oil. If there is a lot of divergence, then gold is likely in a bubble. Of course bubbles can last for a long time.

    • Lildynamite209 says:

      Oh, I see, it’s much easier to fundamentally place value on a piece of paper…… Next president/world leader….. “Mtbomb”

  4. JustinS says:

    Gold has value because it is the ‘original’ currency. alchemists cannot create it / governments cannot print it and supply is now genuinely limited as the most economic deposits have been exhausted.

    Gold has value that is relative to the supply of money. The more money that central banks create, the closer we edge to serious inflation, the higher the value of gold…RELATIVELY. it is not that gold has gone up, but that dollars and other fiat currencies have gone / are going down.

    I am a value investor who generally tries to follow the wisdom of one Mr Buffett and until the last few years would have agreed that gold has no utility and that people watching from mars would be scratching their heads. However, as governments continue to believe that they can solve long term problems with short term solutions, gold will be forming a larger and larger percentage of my portfolio.

    To anyone wanting to read more, i suggest you find some recent material written by Eric Sprott, David Einhorn and Dylan Grice. I would back their intelligence over Mr Wiggins any day of the week.

  5. Hawks Fan says:

    I do not see gold in the bubble territory just yet but I would not get religion on it just the same.

    I would say that what I do not understand is the inflation theory in general. Where or what is the exact mechanism by which all this inflation is going to be generated. (I can see some plant closers leading to some production cutbacks) But I do not see any governments giving money to the average citizen (they are giving it hand over fist to banks and they put it in the vault). I see austerity coming to the average citizen not a surplus supply of money. So what is the exact mechanism by which all this inflation is going to be generated?????

  6. Stevie b. says:

    “(When and how far gold’s price will decline is anyone’s guess,)… but a smart bet is “sooner rather than later.”

    What a ridiculous non-sequitur conclusion to “prove” his point!

    The point should be that no-one knows what comes next – that’s what real uncharted territory is. The point should be that anyone with any monetary assets should have let’s say 10% of those assets is gold and hope like hell that gold goes to zero in terms of the particular currency of the other 90%.

  7. Tth says:

    Not a fiat currency, but it IS the quintessential “greater fool” investment.

    • Lildynamite209 says:

      Greater Fool ????? Thanks.
      Sincerely,
      The greatest fool on earth

  8. Ross Thomas says:

    Um. Of course gold isn’t a “fiat” currency. Does Wiggins even know the definition of the word?

    Fiat: An authoritative command or order to do something; an effectual decree.

    Gold’s innate attractiveness to the human mind may puzzle the poor paperbug banker, but it most certainly is not a fiat currency. It is and always has been money — the only form of money you can keep outside of Wiggins’ beloved financial system and therefore the only form without counterparty risk. And given Wiggins doesn’t seem to understand simple economics concepts, I’m inclined to keep as much of my money out of his hands as possible.

    • Lildynamite209 says:

      Oh Wiggins knows the definition of “fiat currency” and not unlike most kings of deception, they all hope the masses never understand what real money is. They have convinced many that money is a piece of paper with a picture of a dead president along with official looking serial numbers that lead to their own demise. Ultimately the masses decide what money is with China and India setting the tone. Mexico is currently working on bringing SILVER back into the picture with their Libertads and if I was a betting man I’d say this makes the kings of waterlines and pics of dead presidents real nervous.

  9. Rick_Hunter says:

    Gold is a hedge against political stupidity. As long as Governments around the world continue to bailout banks, countries, monopolies that are ‘too big to fail’, gold will continue to perform well. The day when we completely lose confidence in our Governments (i.e. Bond market collapse), where do you believe capital will flow into? Hard assets, and gold will play a major role by then.

  10. Here’s the (simple) current “order” of world economics. US gets to print as much money as it wants or needs. Gets the goods n services of the rest of the world the first time it spends the money and a second time when the rest of the world buys our treasuries. Looks like a “Dollar Standard” to me except it’s called Currency Reserve. How long could this go on? Well since Nixon took us off the gold standard and to the “unforseeable” future because the US manipulates the price of gold through the IMF. EXCEPT now China and India are buying all the gold the IMF “dumps.” They’re also making the necessary moves as an alternative currency reserve to the dollar. BRIC, Brazil, Russia, India, China… through the IMF with SDR’s (special drawing rights). You ain’t seen nothing yet. By the way gold isn’t going up, it’s the fiat currencies that are going down, therefore it takes more dollars to buy gold. The good news is that there isn’t enough gold in the world to monetize all of the worlds economy.

  11. Vangel says:

    “I would like someone to explain why/how gold is not fiat when so much paper gold exists without backing?”

    Gold and paper gold are not the same thing. If you think that the ETF is fully backed by physical you may be in for a shock but most people who believe in a gold standard would not use the ETF for anything other than trading on the margin. Their core position would be made up of physical metal or something like the Central Fund of Canada, which has actual gold to back its paper.

  12. Vangel says:

    “The problem with gold is that it is difficult to fundamentally value. There isn’t a clear PE ratio. The best one could do is see how the price of gold compares to the price of other commodities especially oil. If there is a lot of divergence, then gold is likely in a bubble. Of course bubbles can last for a long time.”

    You are confused. Gold is money. You will not be able to ‘value’ it as a stock so it is pointless trying.

  13. Vangel says:

    “I am a value investor who generally tries to follow the wisdom of one Mr Buffett and until the last few years would have agreed that gold has no utility and that people watching from mars would be scratching their heads…”

    On the topic of gold Howard Buffett makes a much better read than his son. That said, Warren seems to have paid attention and has taken steps to increase his exposure to real assets as he reduces his exposure to treasuries.

  14. Clearly, Gold is not a fiat currency because the definition of fiat is a currency whose value is unrelated to the value of any physical quantity ie something that can be produced by government fiat in unlimited quantities. So I reject Mr Wiggins’ fiat argument out of hand.

    My argument in favor of gold and any other hard asset is that governments will look to inflate their debts away by printing money since they can do so with a few clicks of a mouse via their electronic printing press.

    The right question is the one that Wiggins asks: is gold in a bubble. My answer is yes, bubble psychology is forming. But gold has a lot further to run as long – especially because the EU has joined the other central bankers in printing money. You knew we had a fiat problem when the Swiss went QE and are now attempting to manipulate their currency downwards.

    As far as hard assets go, gold is not the only game in town. It is not even the only precious metal. Marc Faber talks about farmland. Platinum, silver and palladium all have good industrial uses as well and are alternatives. However, I am wary of paper gold via ETFs because I anticipate those funds without enough physical backing will run into problems.

    And remember, even in a deflationary environment, hard assets are a good hedge. That was certainly the case in the 1930s.

  15. Also, for anyone interested in the macro picture, Felix Zulauf gives a great perspective in an interview with King World News. It puts the issue of gold in perspective:

    http://kingworldnews.com/kingworldnews/Broadcast/Entries/2010/5/28_Felix_Zulauf.html

    I may write this up in a later post. I also intend to write up something based on a Marc Faber talk I ran across recently.

  16. Jdavis says:

    The fool at Barron’s does not understand the definition of “fiat.”

    A fiat currency holds its value because its issuer uses the power of law to make it so. Even if the people distrust the currency, they still must obtain it in order to pay taxes and transact with authority, or under color of authority.

    Gold’s value is purely a mechanism of the market. Gold’s value comes through the aggregation of the will of the billions who desire it. This makes gold an asset, not a legal unit of account.

    The only way to devalue gold is to convince billions otherwise; hence, it is inherently valuable.

    Fiats are routinely devalued when their issuer removes its backing from a specific quantity of units (monetization), or removes its backing altogether (devaluation). Thus, fiats remain valuable only within a constantly enforced framework of law. They are inherently valueless in the market, but situationally valuable as long as their issuer demands such.

  17. Vangel says:

    “The right question is the one that Wiggins asks: is gold in a bubble. My answer is yes, bubble psychology is forming. But gold has a lot further to run as long – especially because the EU has joined the other central bankers in printing money. You knew we had a fiat problem when the Swiss went QE and are now attempting to manipulate their currency downwards.”

    How many people do you know who are buying physical gold or have much exposure to physical gold or the shares? From what I can see, the retail investor is as likely to sell jewelry and scrap gold and silver as he is to buy it. That is not the sign of a bubble.

    I do not mean to suggest that we could not have a few hundred dollar decline in the price, particularly when we get near options and futures expiration. That has been quite common during this bull market move. But the bottom line still comes to protecting oneself from the printing presses. Prudent individuals, institutions, and governments will try to limit their exposure to the printing presses by moving away from fiat money and government debt as they gain exposure to real assets that cannot be created out of thin air.

  18. gnk says:

    Ed, I brought this up before a while back, and I think you agreed. It was about Soros’s use of the word “ultimate.” But I think you left out the second inference that can be made. Assuming he used the word “ultimate” correctly, and I think he did, he made two predictions: 1) gold is in a bubble, and 2) gold will be the last and biggest bubble.

    If gold is the last bubble – what happens to the world that discourages or prevents more bubbles? That’s the question. I foresee, for many reasons – economic, national security, and others – gold becoming once again the global reserve currency. SDRs will either be limited in its role, a failure, or just a distraction.

    Just my two cents.

  19. Edward,

    Clearly, gold is not fiat. There’s no government backing or mandate to use it, although Ron Paul is quick to point out (correctly, I might add) that The Constitution requires gold or silver to back our currency. But we’ve moved to on to fiat, and the backing question is for another day, another time.

    With respect to counterparty risk, there’s no counterparty risk when there’s no credit. If you accept/extend credit – regardless of payment mechanism (that includes gold as a means of settlement) – counterparty risk exists. So to say that risk doesn’t exist with gold is foolhardy.

    The printing press hasn’t been turned on, but we’re rolling credit cards every 6 months (looking for a better analogy), overborrowing & hoping to consume our way out of this. We can’t. Debt has to be repaid, and so does the interest. We can’t find assets that will earn enough to repay the debt continuously in our current backdrop. This is ultimately a deflationary set-up.

    I agree gold can perform well, but so can currency. And with the world wired the way it is to paper, paper doesn’t have the liquidity risk that gold has.