## Sunday, October 26, 2008

### Why gold?

I have seen this being discussed in several newspaper articles: In view of the financial crisis people withdraw their money from the bank and buy gold. They do this to such an extend that Germany's main internet gold coin dealer has stopped accepting orders. Amazing. What do they think they are doing?

Ok, you don't trust your local bank XY anymore and, depending where you are, you either have so much money that you are beyond the limit or you even don't trust the banking guarantee system anymore. Therefore, you don't want to leave your money in your account. Fine, you are a pessimist.

But why on earth are you buying gold? Obviously you are so afraid that you are willing to renounce the interest you could be getting for your money. But why don't you keep your money in coins and bills and put it in a save place (safe, mattress, cookie jar).

But that's not good enough for you. You don't even trust your (or any other) currency anymore and want to avoid the risk of inflation. That is you don't trust that somebody is willing to give you enough real stuff for your bills. That is, you mistrust your complete local economy.

You really want to make sure. Therefore you buy gold. Because that keeps its value. That you know.

But why on earth do you believe that? Why do you think that the value of gold is in any way less symbolic or just based on common agreement than the agreement of many people that you will give you food if you provide them with enough pieces of paper on which somebody printed the portrait of some former president in green color?

I have bad news for you: You cannot eat the gold, at least it has zero nutrition value (see wiki article linked above). You can use it for electric contacts that will not corrode. And yes, you can make jewelery from it (as it is done with a third of the gold that is mined). But again, the value of the jewelery is just that "everbody knows gold is precious". And this is only the case as long as everybody believes that. But there ist not much you can actually do with gold that you cannot for example to with copper or palladium (which is an excellent catalyst for many reactions involving hydrogen by the way). The value of gold is only high because everybody believes that. But that's the same for dollar bills or any other currency (leaving out the Icelandic crone for the moment).

And it is not beyond historical example that people stopped believing that gold has high value: As pointed out buy my history teacher in high school this was the main strategic mistake of the Spanish crown: not realising that you can destroy the marked if you suddenly have a lot of it. The Spanish kept importing huge amounts of gold that they had found in the Americas without noticing early enough that the others lost their interest in gold as soon as the Spanish suddenly had so much. At the same time, others found that it's a much better to invest into the real economy.

It took some more years to understand that the value of a currency is not so much based on all the gold that the central bank holds but much more on the economy that backs it.

And of course the telephone desinfactants that stranded on the earth in our past as told by the hitchhiker's guide to the galaxy also had the great idea to use leaves as bills. Which lead them to burn down all their woods.

Mark Herpel said...

The US money supply is growing now at +16% a year. That means if you keep your bills under the bed, next year you will only have the value of $84 for every bennie you have hidden. Inflation eats up the value of currency, that is why people own gold, you cannot create or print gold from thin air, its limited to what you can pull from the ground, IT IS RARE, fiat currency is NOT. If you don't understand this because you have used USD or plastic cards your whole life and can't envision the loss of purchasing power due to inflation, take a quick trip down to Zimbabwe. Inflation is so high, the price of currency, goods and 'money' changes each hour. There is no food on the store shelves, no cars on the road, no jobs and the population is dying. If you are a wealthy person and your budget for food each month is just .5% of your monthly income, you don't notice inflation. If you are poor and have just$200 each month to spend on food or medicine and the cost of those products gets inflated by 16% you can't afford the food or medicine. This is what is occurring now in the US. The poor get hurt much more from inflation than a wealthy person. Gold...not fiat paper currency offers a solid future and protection for all.
Mark
editor@dgcmagazine.com

Robert said...

Mark,

I agree that inflation is a real thing although I doubt that it is 16% per anum in the US. Note well that actually it does not matter how many bills the central bank prints (although of course that has some infuluence especially if done excessively) but what counts is how much they give you for your bill when you actually go shopping (in supermarkets, buy a car or a house).

Of course the central bank has a lot of power to change the value of the currency. But devaluating at a significant rate would completely ruin the real economy and therefore they will not do it (that might be different for countries where there is not much real economy to lose).

However, that is not my point. My point is that basically the same is true for gold: It does not have a value in itself it just has a value by agreement. And actually, it's not that rare.

In fact, the US still has significant gold reserves. What do you think what would happen to the gold price if they suddenly decided to sell a significant part of it? Since only a very few people actually need gold the price would fall just as much as the value of any currency during an inflation.

In short, the value of any currency exists just by agreement but so does the value of gold.

It works as people still believe that others will give them something for their gold in the future. Those will do that if they believe that still others...

Michael said...

I'm not an expert but many people say that the volume of open derivate trades exceeds the physical availability of gold and many short sellers in gold are on the street.
You can look at the VW chart what will happen to gold if the other side will call "deliver!"
But, honestly, if you buy gold on this expectation, you do it not for safety but for speculation...

Venkateshan said...

I think there are 2 principal reasons why people like to save money in the form of gold . One, as pointed out in other comments is to protect the savings from potential inflation.The idea is that the possibility of significant inflation in a volatile period like this is more than the the likelihood of the price of gold NOT following the inflation trend.
The other has to do more with centuries of exchanging gold for goods and services. For most of trading history, gold has been used as a real money (initally) or representative currency (later on) . Up until 1970, currencies from several nations could be exchanged (at least in principle) for gold at any time, as was pledged by the US Government when setting up the Bretton-Woods system. So, I guess this history gives some notion of absoluteness to the money.