Gold is always as Money $$$ not investment

Bullish Gold PriceMasks Problem With Paper Money

Michael Trifunovic

April 13, 2011

It helps to consider gold as cash rather than an investment only, writes Michael Trifunovic.

The debate rages as to whether gold will continue its bull run or whether its bubble is about to burst.

Over the past decade gold has risen against every currency every year as well as outperforming most other asset classes.

Assertions of a bubble are flimsy. According to the CPM Gold Yearbook 2010, despite 10 years of rises, gold constitutes only 0.7 per cent of the world's financial assets. Indeed, in the late 1960s gold comprised 5 per cent of assets, and in 2000 it was 0.2 per cent. A bubble cannot exist if something is so sparsely held.

The bull market case makes a stronger argument due to continued investment appetite, debasement of the US dollar and relative value.

Gold is being viewed through the prism of it being an "investment", and "cash" as the base measure.

A more appropriate way to look at gold may be not as an investment but as what it has always been, money.

Gold has functioned as money for thousands of years, going back to the Egyptians and Mesopotamians. It has been the cornerstone of the monetary order for most cultures and empires throughout history.

It is imbedded in the human psyche and belief structure. Gold is in our vernacular pertaining to concepts of value and wealth as well as a descriptor of high worth, merit and standards.

At the very least it has the qualities of scarcity, durability and integrity, fitting characteristics of money.

Gold has always been money, the ultimate means of payment and store of value.

But if gold is money and thus a currency, it is not an investment.

We can argue definitions, but consider our present currency medium, cash - one cannot invest in cash per se but instead we use cash as a starting point to invest for the purposes of value creation and return. The success or failure of that investment is then judged according to how much cash the "investment" will revert into.

The whole investment industry operates around this principle.

Indeed, even an "investment" into a bank account or term deposit is not a "cash investment". Instead it is a creation of a "loan" to the bank, which compensates you via an interest payment and return of original capital.

But cash money derives its value from gold.

Cash arguably began in the middle ages with the Knights Templar, who ran a basic form of bank that held gold and silver but issued coded "chits" that could be redeemed for gold and silver coin.

Goldsmiths took this a step further by developing what we know today as fractional reserve banking. They figured that not everyone who deposited their gold would come and claim it, and therefore they could extend credit via pieces of "paper", creating money many times the value of the gold stored.

It was a confidence trick and worked because people believed in the "paper" they issued. Indeed, financial alchemy was achieved in creating money out of nothing via faith. But it only worked as long as the goldsmith was not audited and dependent on a certain ratio of gold being held. If either of these were violated the house of cards would crash. This is modern banking.

With the cessation of the "gold standard" in 1971 and Federal Reserve Notes (aka US dollars) becoming the reserve currency, financial alchemy was achieved via a declaration or "fiat" and the subsequent acceptance of this faith in the value of these notes. Money created out of nothing and backed by nothing.

Its value only exists in our minds and to the extent that we are prepared to accept it for real goods and services. It is a mammoth confidence game.

Rather than arguing that gold is rising and in a bull market, a more appropriate argument is that it is not rising at all, but that the fiat cash currencies are collapsing versus gold. Cash is no longer functioning as a store of value.

This has big implications in terms of the value of our financial system.

When we price goods, commodities and stockmarkets in terms of gold, we do not observe inflation.

In a speech at the Council on Foreign Relations last September, the former Federal Reserve chairman Alan Greenspan argued that currencies move in relation to gold and that currencies are themselves a zero sum proposition as they net out. He then went on to argue that if gold was rising it points to a "problem with respect to currency markets globally". He goes on to describe gold as a canary in a coalmine.

He is not the only one who seems to recognise the trouble ahead.

Last month the state of Utah passed a bill to allow gold and silver back into circulation and to be recognised as legal tender. Other US states are looking to follow. Mexico is debating the reintroduction of silver money.

In a 1966 essay, Gold and Economic Freedom, Greenspan, argued that gold stood in the way of welfare statists using the banking system for an unlimited expansion of credit and the resultant wealth confiscation via the associated inflation. Gold stands as the protector of property rights.

It appears gold is reasserting this function.

Alchemy is the word often used to describe the art of transforming something of value from nothing, a practice of mind over matter. In the realm of money, it essentially is a confidence trick, where one gets others to believe something is

of value.

The confidence trick around our currencies is unravelling.

In contrast, gold seems to be standing the test of time.

Michael Trifunovic is a portfolio manager and writer.

Source: http://www.smh.com.au/business/world-business/bullish-gold-price-masks-problem-with-paper-money-20110412-1dcmz.html