Economy Watch: What if Stocks Were Priced in Gold?

"Everything has its limit -- iron ore cannot be educated into gold."

-- Mark Twain

Several charts have been floating around the Internet for some time, showing the historical Dow Jones Industrial Average, priced in terms of gold. The simplest explanation entails thinking of the Dow divided by one ounce of gold; if the Dow is at 5000, and gold is at 500, then Dow-to-gold is 10. But it's important to remember as you're considering this ratio that the Dow is calculated in terms of dollars. So essentially, when we determine the Dow-to-gold ratio, it's not just a simple ratio of gold to shares in the Dow, but rather it is a three-part ratio -- Dow, expressed in dollars, to an ounce of gold.

Wouldn't it just be easier to express gold in terms of dollars, or the Dow in terms of dollars? Well, those are certainly useful ratios -- and we use them all the time -- but what we're really going after when we look at a historical Dow-to-gold chart is how well the Dow has performed, relative to the dollar, and relative to gold. What have inflationary pressures done to the Dow, in terms of gold and the dollar, over the past century? How have the three components moved in the various historical boom-bust scenarios? The results are interesting.

Let's shift gears for a moment. Just off the top of your head, what would you expect stocks to do in periods of inflation? The dollar loses value rapidly, right? And that means prices of goods and services move higher, presumably with wages. So wouldn't it stand to reason, intuitively, if corporations were making more money as prices increased, profits would increase too? And if profits increase, shouldn't share prices go higher in response?

It turns out that inflationary price increases are bad for the stock market, and no period in history establishes this more concretely than the late 1970s and the early 1980s. Interest rates and prices soared, along with the price of gold, but stocks were flat. I want you to think about what I'm saying here: prices in general were going up, and yet the stock market was not. What this means is while stocks, in nominal terms, looked to be relatively stagnant, in real terms they were getting crushed. This is why the Dow-to-gold ratio is so significant as an indicator of relative value.

There is an elegant, simple truism that comprises every single transaction between buyers and sellers, and yet most people don't even think about it: whenever you buy something, you are selling something else. When you buy corn, you are selling dollars. When you buy a Ford, you are selling dollars. If you are in Mexico and you buy a chicken, you are selling pesos. Of course, if you came from the U.S., you first sold dollars, bought pesos, and then sold pesos to buy the chicken. I know most of you already understand this concept, but I'm trying to emphasize that even when currency is used, every transaction is merely a trade; that is to say, the transaction is nothing more than negotiation that results in the exchange of two things -- whether goods, services, or currency.

With that in mind, consider this: when prices rise because of inflation (printing of money), it isn't so much that goods and services are getting more valuable -- rather it's much more accurate to say the currency is simply getting less valuable relative to everything else. If the dollar collapses, for instance, and the cost of a loaf of bread goes from $1 to $20 at the same time a share of Microsoft (MSFT) goes from $20 to $30, then Microsoft is severely under-performing -- in inflation-adjusted dollars. A loaf of bread will cost you 20 times what it used to -- not because it is more valuable, but because the dollar is less valuable. Meanwhile Microsoft is worth only 50% more. Relative to the dollar, shares of Microsoft are actually losing money -- in a big way.

If you look at a chart of inflation from 1978 to 1982, you'll notice a huge spike. If you look at a chart of the Dow Jones Industrial average during the same period, you'll see that stocks traded sideways in a fairly well-defined range over the same period. But that doesn't tell the whole story; if you adjust for the meteoric rise in prices during that five-year period, the stock market actually performed much worse than the nominal dollar fluctuations presented in the historical chart. In other words, the price of just about everything was going up dramatically, but stocks were not. So if you adjust prices back to "normal" levels, and adjust stocks accordingly, the picture for equities would have been horrible.

Now for the pièce de résistance...

Here is a series of charts of historical nominal gold prices (not adjusted for inflation), in several different currencies -- the first of which is U.S. dollars. Take a look at the spike in the price of gold from 1977 to 1981. Now, if we go back to our original chart above, showing the Dow Jones Industrial Average, in direct relation to an ounce of gold (Dow-to-gold), you can see that the ratio went roughly 1:1 in 1980 -- at the peak of the inflationary price surges. To clarify, the Dow was at about 750, as was gold.

But didn't we say that, relative to rising prices, the Dow actually underperformed dramatically? So if you bought gold in the mid-1970s, not only was your investment skyrocketing, but the stock market -- which was flat in nominal dollars -- was actually doing very poorly relative to rising prices. Bear in mind that both the Dow and gold were priced in terms of nominal dollars at the time; they essentially "cancel out" -- that is to say, relative to rising prices, gold also failed to perform as well as the nominal dollar-price. Still, it did offer an excellent hedge against rising prices, and even outperformed during the period.

What does all this mean? Well, for starters the average Dow-to-gold ratio over the last century has been about 9.5, and we are currently at about 8.5. So you're probably thinking we're oversold and due for a correction. In other words, the Dow-to-gold ratio is probably going higher, right? Well that was my first conclusion too, but actually on closer examination it turns out that's probably not right at all.

For much of the last century the dollar was tied to gold, and while the relationship was never perfect -- and the U.S. government betrayed the union many times, in many different ways -- there was at least some relationship, which helped pull the ratio down. Eventually, excessive inflationary printing caught up with the government in the 1960s, and it became clear it wouldn't be able to honor redemptions against the dollar at the price it had fixed. Nixon essentially defaulted on the U.S. promise to redeem dollars for gold by taking the U.S. off the standard in the 1970s -- and this, more than anything else, allowed inflationary pressure to drive general prices into the stratosphere. This was the moment the Dow-to-gold ratio approached 1:1. To fight rising prices, Paul Volcker, the Fed Chairman at the time, pushed the Fed's target interest rate past 20% and barely saved the U.S. economy from collapse.

For most of the next 20 years, gold fell and stock prices rose. Meanwhile, the U.S. government capitalized on the lie it had created and printed more and more money. Who really cared? Everyone was making money in the stock market, and prices remained relatively stable. In fact, every time prices failed to act "correctly," the Fed simply changed the rate at which it would lend to banks. But the illusion of the monetary policy game couldn't last forever; people used easy money printed by the government to buy assets they couldn't afford throughout the economy -- especially houses. Finally the pressure was just too much, and everything started unraveling in 2007. But the gold market seemed to understand the game couldn't last, and around 2000 it started a slow, steady rise.

Relative to everything, the number of dollars in the system in early 2009 is almost incomprehensible. Once de-leveraging reaches its nadir -- and it's coming soon -- those dollars are going to hit the economy and drive prices much higher.

What have we learned about stocks in such periods of rising prices? Not only do they fail to perform, but adjusted for inflationary price pressures, they actually under perform. General prices and unemployment will continue to rise. The consumer will continue to be unable to consume. Corporate earnings and dividends will continue to collapse as a result. Stocks are going lower -- probably much lower.

And what about the price of gold? It will almost certainly continue to increase -- not only because people will flock to its long historical stability and consistency, but also because there are simply so many more dollars (and yen, and rubles, and euros) in the world. Remember, the U.S. isn't the only country printing innumerable sheets of currency. And in that context, remember also that inflationary price increases have almost nothing to do with increased demand, but rather they are the result of currency devaluation and destruction -- through printing.

I just want to share two more charts with you. The first should give you a little perspective -- it is a historical chart of gold, in both nominal and real dollars. Notice the real price of gold in 1980 (in 2007 dollars) was $2272 per ounce. If I'm correct about inflation and the fate of the dollar -- and I'm confident I am -- then we are nowhere near the historical high in gold. But I don't think we're merely going to re-test that high -- I think we're going to blow through it as the dollar loses value.

In the 1930s, as corporate earnings and dividends disintegrated, the Dow lost nearly 90% of its value from peak to trough. The U.S. was a creditor nation with a huge manufacturing base. The dollar was tied closely to gold. Since its peak in October 2007, the Dow has lost less than 50% of its value. The U.S. is a debtor nation with a relatively small manufacturing base. I can't say it enough: we borrow profusely, we manufacture very little, and we consume gluttonously. Nonetheless, the consumer has now lost almost all his purchasing power, and corporate earnings and dividends are going to suffer massively as a result.

In 2007, the Dow peaked at about 14,150. To give you some perspective, an 85% drop in the Dow from peak to trough would put it at about 2100.

I know it's easy to imagine the Fed has magical powers. I've fantasized about such things myself at times of extreme weakness -- that maybe the Fed will "somehow" figure out a way to fight and defeat the unprecedented evil specter of inflation it is foisting on its unsuspecting children. Sometimes I do believe that our Lord and Savior Barack Obama will wave his charmed "unicorn horn of change" and all will be well again. Likewise, at times I feel like I could let Uncle Ben Bernanke take me just about anywhere in his helicopter of prosperity. My faith in the reverend John Maynard Keynes runs deep, as I hope, and hope, and hope. I find myself gleefully clicking my heels together and repeating, "the dollar is almighty, and the Stars and Stripes will prevail." And when I am in this wonderful place, I have confidence that someday soon, we'll all be buying houses with no money down, and with no jobs. Our driveways and backyards will once again overflow with boats, motorcycles, and sports cars.

Then I think about the 1930s. And suddenly I am wide-awake.

Let me ask you a simple question, and I want you to actually think about it. Do you really think we can't get to the 1930s again? Do you really think that we're going to return to the exuberant excess of the past few decades? If so, let me disabuse you of the notion: the United States was in much better shape, economically, going into the Great Depression than it is now. Prosperity is not coming back to the U.S. as we know it. We are in a lot of trouble.

Is a Dow-to-gold ratio of 1:1 so incomprehensible? Again, it has happened before -- several times. But I'll even take it a step further: what about a Dow-to-gold ratio of .5? Or less? I promise you, if the Fed fails to soak up all the dollars it's putting in the system, that's exactly where we're going. And what, you may ask, does the Fed use to "soak up dollars?"

I'll be glad to tell you that too. When the Fed needs to take dollars out of the system, it sells Treasuries (which means it buys dollars). The problem is, the U.S. debt-load is astronomical. Who, exactly, is going to buy that debt from the Fed? And at what interest rate? Remember, if the Fed is desperately trying to take dollars out of the system, there can be only one reason: it is scared of rising prices caused by inflation. But if the Fed floods the market with Treasuries, it will achieve exactly the opposite effect it's looking for -- it will cause rates to rise, probably dramatically. Do you really think the Chinese and the Japanese are going to buy Treasuries at a 2% yield if the Fed is panicking and trying to buy dollars to stop an inflationary price explosion? If so, you're delusional. Chinese and Japanese people are smart. They're not going to fund an inflationary dollar at 2%. Ever.

In the past it might have worked. Of course, in the past, the U.S. money supply was much smaller, and our ability to borrow was much stronger. But those days are gone.

As if I haven't terrified you enough, the last thing I'm going to leave you with is really scary. It is a link to an excellent article by Mark J. Lundeen, whose insight into this economic catastrophe has been stupefying since long before all of this even started. Embedded in the article is a chart that shows historical dollars-in-circulation, relative to U.S. gold.

With that, I think I'll let you do the rest of the math. Sleep well.

Disclosures: Paco is long gold.

Copyright 2009, Paco Ahlgren. All Rights Reserved.

Comments

[bick2:]

All of this presumes a high inflation rate. Japan had an asset bubble far worse than this in the '80s, and managed to avoid inflation.

Feb 01 04:31 PM

[bc818:]

Your point on gold is spot on and so is everything relative to gold. However, will i really be buying groceries with gold and silver coins once the dollar collapses? Isnt every currency tanking relative to gold? At what point does the old joke come into play: I don't have to outrun the inflationary bear to survive, but i do have to outrun my buddies next to me. In that case, the dollar wins big as its holding up much stronger than the euro, ruple, and everything else save the Yen. Also, who are the two of the biggest owners of gold...that would be the USA and Japan. I like TIPS better for protection.

Feb 01 04:41 PM

[Rick Krementz:]

@bc818

Your bear analogy is slightly wrong. If you and your neighbor are trying to out run a Yen bear, a dollar bear, a Euro bear, a yuan bear, a kroner bear, a baht bear, etc, just being faster than your neighbor isn't good enough. One of the other bears will get you (unless you have a golden rifle).

Feb 01 05:03 PM

[Gold Barron:]

That is a very sobering article. When will the value of the dollar begin to depreciate? What currency besides the dollar will be king? I think it is fair to say that we all wont be trading gold and silver coins for bread anytime soon. There would be blood in the streets if that were to happen.

Am I the only person that has the feeling that this whole crisis is not real? I have this feeling that something very major is about to happen but when I watch our leaders speak they seem to be pretty calm. Are they clueless or what?

Feb 01 05:30 PM

[random guy:]

You say, "If you look at a chart of inflation from 1978 to 1982, you'll notice a huge spike. If you look at a chart of the Dow Jones Industrial average during the same period, you'll see that stocks traded sideways in a fairly well-defined range over the same period."

But looking that DJIA chart, from the trough in 1978 to the peak in 1981, the DJIA gained 273 points for a 36.5% increase in under 3 years. That's hardly sideways trading (an IRR of nearly 17%, which outstrips the 10-15% inflation rate).

Feb 01 05:52 PM

[ROLEX18K:]

Whatever DJIA will do, the price of gold can't rise much further, yes, gold is a bubble same as stocks were a bubble last years.
But there is one crucial difference, stocks even when overvalued serve some good to society, to investors who bought/sold them, to employees who work, to consumers...I think you all can imagine that stocks are not some ticker symbols on exchange, there is much more about stocks than gold.
The normal ratio for DJIA/Gold would be 20-40 historical average 30.
Today's gold price is very close to collapse as there is no even money to pay back credit card debt, morgage.
How something can rise when even very rich people cut spending like crazy, I ask who then buys gold.
Maybe you?

Feb 01 06:09 PM

[derryl:]

I just read the Lundeen article and agree that floating currencies in a global trading world is insanity. Really, it's like trying to trade oil in a market where the amount of oil in a barrel depends on which country you are selling from and which country you are buying from, and the actual volume of oil in any country's barrel changes daily, up or down, sometimes by a little, sometimes by a lot. You are trading "floating volumes".

So to protect yourself against this insanity you collectively buy hundreds of trillions of dollars of 'hedges' against any conceivable, but always unpredictable, changes in the amount of oil that will be in the 'barrel' you are buying or selling. Nobody know how much oil is in any barrel. It's always a 'surprise'.

You put in 40 gallons in March and when you sell it in November there might be 30 gallons or 45 gallons in the barrel, depending on whether your currency went up relative to the buyer's currency, or down. This is not a healthy environment for production and trade.

I'm not sure if going back to a gold standard is the solution. I do think we need some kind of more fixed currency exchange system, but I'm not convinced it needs to be based on the amount of physical gold any country possesses. That just seems really arbitrary to me, notwithstanding goldbugs objections that gold is the world's "natural" money. If I had no 'mark of the beast' fears I would say a single global currency is the best solution, but i do have those fears so I wouldn't advocate a global currency. Maybe the 'globalization' of our economy is itself the problem, and we should pull back to a more self-sufficient national or regional economy under some kind of loose (or tight) common currency zone. Really, if the global economy has grown beyond human ability to control or even predict, do we have an economy or does the economy have us?

I'm also not sure gold prices will actually rise as the economics of money supply inflation predicts. Central bankers are reaching into a whole new bag of tricks that could sideswipe any historical relationships between gold and fiat money. I think gold will hold its own pretty well and probably rise some more and maybe enjoy some spikes, but I seriously doubt that gold will become a general alternative to fiat money unless the world economy utterly collapses, in which case what will you buy with your gold?

Feb 01 06:15 PM

[E.D. Hart:]

The Japanese citizens were much better savers than their US counterparts, and the comparison with the Japanese is somewhat different as this time the global deleveraging is massive, global, and unprecedented. All countries are deleveraging at the same time and devalauing their currencies simultaneously. What are the floods of currencies being devalued against, if they are all moving down together (over the long term) ?

Commodities in general, and of course gold as a subset of commodities in particular.

Feb 01 06:19 PM

[E.D. Hart:]

Stock bugs point to the "stocks for the long run" arguments and others of those who point out that, on average, stocks are the best investment asset class based on historical relationships.

They are mostly right. I certainly have most of my wealth in stocks.

But there are a few things to consider:

(1) Armageddon and civil war doesn't have to break out for gold and commodities to do well, better than equities in fact over long periods of time, all it takes is for inflation to tick up, or the expectation of inflation. The gold market is very small, relative to other asset classes. Just a 1% shift from other asset classes into gold can double the price of gold according to Rob McEwan (spelling?) CEO of US Gold and former CEO of Goldcorp. Look at the current Treasury bubble for evidence that bonds are going to be losing investment for the foreseeable future. If a fraction of a percent of this money went into gold, look out

(2) Much financial analysis has the potential to go astray by looking backwards, and finding historically relevant periods to compare today to.
Perhaps however, the world has undergone a seismic change where the worlds financial tectonic plates are permanently shifting beneath our feet, and we just experienced a few earthquakes. Then, what would it all mean? It would mean that looking backward would be fairly useless for predicting the future. Things happen every day that have NEVER happened before. In endeavors of state and economics, the experts make the same mistakes--by "fighting the last war". By looking backward, you can be annihilated going forward.

(3) I certainly don't know the future, and perhaps the author is correct, and perhaps the author is wrong, but it is smart money management to hedge your bets. What if I'm wrong and gold declines? No problem, my stocks and bonds do well. What if gold and commodities do well, and stocks tank? No problem, my gold investments will make up some of the difference. So, you see it is not an either or argument that you only need gold if there is a war outside your window, and by then it is too late because, after all, then it would be useless.
Tiny changes in sentiment towards gold by the worlds middle classes world result in very large changes in the price.

(4) The CPI as constructed has been periodically revised in methodology. Therefore comparisons of the gold to the inflation rate are very misleading. In fact, by my calculations, using the methodology that was in place for calculating inflation in 1980 were that in place today--inflation would be averaging 6 to 8% over the last. (see Shadowstats.com) if I use the lower figure of 6% for the actual non-reajusted figure for CPI, the true (i.e. apples to apples comparison) for the inflation adjusted price of gold from 1980 would be roughly $4200 in today's dollars, not 2272.

(5) Summary: The gold to Dow ratio is not a useful timing technique, for the same reason that p/e ratios are not good timing techniques, they fail to account for the fact that averages are very poor indicators in a random and dynamic market. (proof of that is clear if you look at the huge valleys and troughs of the Dow to Gold ratio). However it is a useful picture of what is possible in the future. It is possible that the ratio goes back to 2:1 or 1 to 1 Dow to gold. With gold at $4200 and the DOW at 8400 in five to ten years, that a real possibility, and a 2:1 ratio. A 1;1 ratio could mean DOW 4000, gold 4000, or Dow 5000 gold 5000, or a nearly infinite series of possibilities. Why not hedge a little in case you are wrong?

Long: AUY, UXG, GG, SLW.

Feb 01 07:02 PM

[Paco Ahlgren:]

Japan avoided high inflation because of the yen/dollar carry trade. The U.S. can't count on strong external economic conditions.

On Feb 01 04:31 PM bick2 wrote:

> All of this presumes a high inflation rate. Japan had an asset bubble
> far worse than this in the '80s, and managed to avoid inflation.
>
>

Feb 01 07:22 PM

[Paco Ahlgren:]

That's a very cogent argument. Thank you for contributing so substantively.


On Feb 01 06:58 PM walleke wrote:

> Paco, Please go back to flipping burgers. If that's not where you
> are its where you belong.

Feb 01 07:27 PM

[billyboy54:]

This is one of the best articles I've read on this site lately. Very articulate, comprehensively explained, and very credible.

Many Goldbugs really can get carried away with hyperbole, but you've given me a reasoned and credible explanation, for their predictions about the upcoming explosion in the gold price.

Thanks very much.

Feb 01 07:38 PM

[James G:]

Does it really matter if the dollar drops against gold if the yen and euro also drop? All foreign exchange eventually have to trade against each other, not commodities or metals. Rising gold will only bring about equalibrium of currencies.Look for the dollar, yen, and euro to equal after the gold dust settles James E Gambrell

Feb 01 10:44 PM

[Marcap:]

"Does it really matter if the dollar drops against gold if the yen and euro also drop?"

No it doesn't. If the dollar, euro and yen all fall (or rise) at the same rate relative to gold, it does not matter what the value of gold is unless of course one has a position in gold (long or short).

Feb 02 12:09 AM

[oldgoldbug:]

As far as I know, gold has traded at a 1:1 ratio to the Dow twice - when the Dow collapsed 90% during the Great Depression and gold was increased by about 75% to $35 from (I believe) $20.67 and when gold peaked around $875 in the 80's and the Dow traded about the same.
After the massive move up in the stock market during the 1990's gold sold (roughly) as low as .025. So gold dropped over 97% versus the Dow. The sword cuts both ways.
The concern about the liquidity of gold or any other investment is well taken. Wasn't the Russian stock market closed on and off for weeks at a time fairly recently? I would imagine selling stocks over there to eat would indeed have been a problem. Gold, silver, stocks, bonds etc are not money, they are investments and all have their risks including illiquidity. (Real estate anyone?) I have personally never had any problem liquidating physical gold or silver to get dollars but that doesn't mean it can't happen.
I believe the author makes a good case for thinking outside the box and considering how far "up" or "down" might actually be. If gold goes to $5000, most likely under highly inflationary conditions, which is only about 5.5 times the current price, is it not possible for the Dow Industrials under those same conditions, to drop to 2500? If so, owning some gold might be a great hedge against a mega black swan event and give the holder the opportunity to buy back into the stock market at a great price, much like the sellers of gold at $875 were able to do back in the early 80's. After all, 875 to 14100 surely beats $875 to $300.
It seems to me highly unlikely that gold or stocks or real estate or any other single investment will be profitable under all potential future investment scenarios. We all want to be 100% invested in the next big winner, but it will happen for only a very few. Better to invest across investment categories with the goal that the winners will more than offset the losers. After all, a portfolio that simply kept its dollar value since the end of 2006 or 2007 would have standout relative performance versus most strategies.

Feb 02 12:44 AM

[gdog:]

Gold...

Imagine a martian looking down, it see's us digging yellow stuff up from the ground, and then digging wholes again to put it back in for storage; he thinks to himself..."these guys are frickn crazy!"

Gold has no productive value (actually very very little productive value).

Productive ideas, innovation, intellectual capital, these are the things the are important in a knowledge economy, in any economy. This is where uninhibited scare resources always flow.

Investment in the US is all that matters. New technologies, new energy, wonderfully productive things yet thought of that will change and shape our lives. This is what the US does. It is what we are very good at.

Do I think the price of gold will rise? yes probably, is it a signal of the horrific future you imply, absolutely not.

Come on people. Believe in this country!

In any case, if you don't then consider:

The us has a lot of dollar denominated debt, it also has the gold market close to cornered, if gold rises as the dollar devalues, than the US balance sheet gets better and better, and ultimately nothing changes. (So if you got excess dollars you sure better let the US buy them back).

There is still a lot of undiscovered gold, it just happens to reside in some of the least explored regions of the globe. So there is a ceiling on gold, were just not quite there yet, partly because it has no productive value.

Feb 02 12:59 AM

[Moon Kil Woong:]

One of the reasons gold didn't work in the years leading to the great depression is the same reason we are having a meltdown today. Simply put, no one can trust financial institutions. How does this relate to gold. Well in those days, banks and other institutions that issued paper based on other currencies and paper that was suppose to be based on gold simply didn't have them and the currencies that were backed in gold also probably were lying and didn't have enough. Thus you had a complete crash not just because there wasn't enough of the metal but because people found out the financial industry was filled with crooks and liars.

How similar that seems to today.

Feb 02 02:03 AM

[japan20000:]

how has the ratio of industrial use of gold to overall god changes over that period of time? If it grew, this analysis doesn't hold, because all of a sudden a lot of gold will not be in demand.
In 1981, how many tons were consumed by electronics industry compared to 2008? If we have a recession, that gold will not be bought and will be up for buys, as it probably is now

Feb 02 02:21 AM

[kelm:]

A good article.

What many fail to understand is that America will still be here and will remain an important nation - but that does not preclude our going through some truly awful financial realignments. The blind spot most people have is the US dollar's role in the world. That blind spot is so endemic that it is the likely place that a serious break will come. When that break comes - this year, next year, whenever - the world will be at a point where paper currencies are distrusted in general and precious metal buying as well as other physical assets will soar. It may only last a brief period but for those willing to lie in wait it will be profitable. If you don't believe that is possible look at the planned increases in sovereign debt this year globally and ask yourselves who is really going to buy that much debt at rock bottom yields, why you would trust entities that are already so encumbered by debt and are becoming more encumbered?

The FT had an article last week on a Bermuda hedge fund that was offering a share class priced in gold to avoid paper currencies.

www.ft.com/cms/s/efe1a...

Feb 02 11:37 AM

[JohnAl:]

Mr. Ahlgren, another well thought out and well written article. Thanks.

Your reasoning is sound. Like you, I've lost confidence in the dollar, but it appears that we're either wrong or early. I'm in gold, but I'm still hedging my bets. They may be able to patch this thing up one more time. People want to believe in the dollar, which comes down to belief in the US government. Obama popularity polls may be the best indicator out there. The expectations are high that he's going to be able to fix things. To the degree his popularity wanes that's an indication that "hope and change" are on the decline. That's an indication that it's time to buy more gold.

Gdog, your's was a very interesting comment. Especially this:

"Productive ideas, innovation, intellectual capital, these are the things the are important in a knowledge economy, in any economy. This is where uninhibited scare resources always flow.

Investment in the US is all that matters. New technologies, new energy, wonderfully productive things yet thought of that will change and shape our lives. This is what the US does. It is what we are very good at.

... Come on people. Believe in this country!"

I agree, but for the life of me I don't see how sound money, based on gold or something else, is incompatible with this. I don't see how sound money doesn't help this country.

Why do you think fiat currency is good for the US or any country?

Feb 02 07:12 PM

[Ray Winter:]

Does anybody know how much Gold is owned by each country as I have never read of a verified stock audit being undertaken. I have read of many dfferent stockpile values being attributed to each country but none of them seem to have been based on facts.

If the true value of Gold is the amount of cash consumed to mine and smelt it, then any increase in value caused by a nervous population causing the price to rise would be justification for the Central Bank to print money, up to the net present value of its stockpile.

As the popluation's nervousness recedes and the gold price falls it would be relatively easy for the Central Bank to pull back those previously printed dollars, to the base level value of its Gold stockpile.

Under these circumstances, printing dollars in times of market difficulties could be viewed as not to be inflationary. However, printing money without a gold stockpile would be viewed as highly inflationary.

Perhaps it is for the above reason that countries do not publish any information on their Gold stockpile and perhaps we should all ask for them to do so, so we can see in advance whether they are creating an inflationary situation which could seriously affect our net worth.

Feb 03 07:21 AM

[gdog:]

Thank you John, I'm glad you find my comment interesting.

Your questions, I believe, are striking at the heart of a long debate in economics over the government's ability to influence output through fiscal and monetary policy, and a general economies ability to maintain or achieve equilibrium.

The basic theory goes that in times of reduced output, governments should spend in deficit to spur growth, this is difficult when sticking to a commodity currency like gold, once the government is out, its out.

The opposition to this view seems to believe that government influence is not needed and a economy will achieve natural balance in a short amount of time. This classical view of human economic behavior is ridiculous in it's reliance on human rationality, which is required to be at an equilibrium.

Humans are not rational, and their behavior cannot be modeled through physical mathematical models alone. Imagine an alcoholic, and his preference for alcohol. Before having any drinks, he would prefer to have none, once having a single drink he would prefer to have 10, once having 10 he wishes he had not had any at all. This preference chain presents serious problems for a mathematical model because of it's inherent irrationality, but this analogy can be extended to Citi, and Morgan Stanley's preference for high leveraged finance; and hence things become very complicated.

Fiat currencies allow for a government to adjust to market conditions to achieve a "more favorable" result for an economy when market participants fail to act in rational manners.

Oftentimes its not even a question of rationality, a simple "economy" with three participants two goods, and two time periods, requires a 12x12 (12 dimensional) system of equations to "solve" for equilibrium conditions. This is very difficult to do. Add in irrational behavior by participants on top of this, and equilibrium becomes nearly impossible to compute, and thus adjustments to observations become necessary, and it is the hope, in our real economy, that these adjustments can be made quickly, and fiat money makes this possible.

(As a side note, the addition of "non-replicable" assets, or assets that cannot be expressed as a combination of other assets, credit derivatives are such an example, means that an equilibrium calculation becomes truly impossible as a n-1 system (with n-1 equations and n unknowns) has been formed, which is solvable only down to a single, likely bounded, vector (prices and general consensus can take on many different values bounded by reason, which is what we are currently observing globally with asset prices in general). The other time we have seen this in recent history was with enron and the manipulation of CA energy prices, now like then, corruption and lax regulation were key to the problems.

I don't think that quite answers your question, but I tried.




On Feb 02 07:12 PM JohnAl wrote:

> Mr. Ahlgren, another well thought out and well written article.
> Thanks.
>
> Your reasoning is sound. Like you, I've lost confidence in the
> dollar, but it appears that we're either wrong or early. I'm in
> gold, but I'm still hedging my bets. They may be able to patch this
> thing up one more time. People want to believe in the dollar, which
> comes down to belief in the US government. Obama popularity polls
> may be the best indicator out there. The expectations are high that
> he's going to be able to fix things. To the degree his popularity
> wanes that's an indication that "hope and change" are on the decline.
> That's an indication that it's time to buy more gold.
>
> Gdog, your's was a very interesting comment. Especially this:<br/>
>
> "Productive ideas, innovation, intellectual capital, these are the
> things the are important in a knowledge economy, in any economy.
> This is where uninhibited scare resources always flow.
>
> Investment in the US is all that matters. New technologies, new energy,
> wonderfully productive things yet thought of that will change and
> shape our lives. This is what the US does. It is what we are very
> good at.
>
> ... Come on people. Believe in this country!"
>
> I agree, but for the life of me I don't see how sound money, based
> on gold or something else, is incompatible with this. I don't see
> how sound money doesn't help this country.
>
> Why do you think fiat currency is good for the US or any country?

Feb 04 12:50 AM