What should be the price parity of dollars to gold? Why?
John Tamny, editor of RealClearMarkets and Forbes.com Opinion, and advisor to http://thegoldstandardnow.org, recently wrote with great lucidity about the repricing of the dollar when gold convertibility is restored. We advocate a market exploration period to determine the appropriate price. Tamny lays out the conceptual parameters well.
The definition of the amount of gold that defines a dollar represents a balancing act between debtor and creditor. If the dollar is defined at $800 an ounce that is far more beneficial to creditors. $3,000 an ounce is a definition far more beneficial to debtors. It is important to strike an equitable balance. It is crucial to resolve the price and thus fix the measure.
It can't be stressed enough that money isn't a commodity, rather money is a measure. Just as a foot is twelve inches, money should be a measure of something stable. Gold has defined money well for thousands of years precisely because it's the most stable measure of value known to mankind.
So with stable money in mind, gold should be the definer of the proverbial paper ticket. Unstable money values lead to chaotic pricing of investments and goods purchases in much the same way that an unstable minute would lead to a lot of burnt apple pies. Once this is understood it should be clear that stability of the measure of value is the goal, and if $1500 is the only way that it can be achieved, we should embrace that number.
To varying degrees the price of everything has changed during the floating money period, so to avoid a deflation that drives up the cost of debt in concert with falling prices that reduce nominal profits, it's believed that in returning to gold we shouldn't strengthen the dollar too much. England certainly did strengthen the pound in returning to gold after WWI, and the headline result (exacerbated by tax rates that remained at wartime levels) was a major recession that eventually forced it back off of the gold standard.
With an eye on stable dollar permanency, [Nathan] Lewis and others argue that returning to a dollar defined as 1/250th of a gold ounce (where the dollar stood as late as 2001), or one that buys 1/800th of an ounce (gold's ten-year average price) would discredit the idea altogether. Their valid argument is that $250 or $800 gold would constitute a wrenching recession, so the better answer is to accept the dollar's 10-year devaluation on the way to $1,500 gold.
Ever wonder it’s like inside the deepest gold mine on the planet? Or, who buys the gold bars produced by said mine? Speaking of which, where are gold bars actually stored? And, for that matter, have you ever wondered how gold is turned into bars? Or jewelry?
CNBC’s Bob Pisani did. He answered these questions and others in an half-hour television show simply titled, “Gold.” In a sweeping narrative, Pisani took viewers two miles below the earth’s surface in a South African gold mine, the Mponeng. Its name means “look at me” which seems appropriate considering that this it is one of the richest, most productive gold fields ever discovered.
When asked about the limitations of the gold supply, one of the mine executives replied that “the sky wasn’t the limit but the earth was.” According to employees in the mine, they are drilling deeper than ever before—12,600 feet deep. At this depth, miners face 100 degree heat coupled with 100% humidity. Plus, miners face seismic activity on a regular basis. To generate an ounce of gold, on average, 3.5 metric tons of earth are removed.
Sounds like hard work to find a measly ounce of gold, no? It is. Nevertheless, the 3,500 employees of the Mponeng mine produced 532,000 ounces of gold in 2010.
The costs—both labor and capital—required to produce an ounce of gold are real. The market for gold is constrained by the natural elements found in the earth’s crust. And, gold’s price is determined in the marketplace by its supply and demand.
Gold supplies are sufficient but not unending. The United States Geological Survey estimates that there are roughly 51,000 tons of gold left on land with another twenty million tons are undersea. And, deep sea mining is just beginning to hit its stride.
So, who is buying all this gold? That is, what does demand for gold look like? After being unearthed, gold is purified at refineries to meet general, agreed to standards of purity and weight. The resulting gold bars are then shipped to buyers all over the world. The two largest uses for gold are jewelry and investments: fifty percent of the world’s gold is made into jewelry while thirty percent is used for investments.
According to one of the largest jewelry makers in the world, Stuller of Lafayette, Louisiana, “gold demand is indestructible.” The Stuller vaults hold 100,000 items that are shipped to more than 40,000 clients, making the world’s largest jewelry maker one of the largest express customers of both FedEx and UPS.
Finally, in a rare insider’s look, Pisani gained access to the world’s largest private gold vault—containing 1,200 metric tons of gold—where viewers caught a fleeting glimpse of stacks of gold bars. Vault employees described the process by which gold bars are identified—each with a unique serial number—and catalogued with respect to its physical location. Auditors regularly visit the vault to insure the accuracy of both sets of information about each gold bar.
Fascinating, right? Just for fun let’s briefly contrast labor- and capital-intensive gold production with the creation of fictional dollars.
Let’s start with the obvious. There is no so-called “sweat” equity backing newly created Federal Reserve credit or notes—just the full faith and credit of the United States government (which, just in case anyone forgot, our credit rating was downgraded last year). Production of new credit and notes is inkless and paperless—it occurs electronically via computer.
Dollars—unlike gold—cannot be permanently recycled. In fact, the Chicago Fed has a massive operation to destroy dollars and coins that are unfit for circulation. Want to make $364? Anyone can visit the Chicago Fed and pick up a (free) bag of shredded bills—some assembly required. Interestingly, the Fed does not give out (free) tokens of recycled coins—apparently, some value is retained in the metal.
There are no new private sector jobs created when new dollars are produced. This contrasts sharply with the creation of jobs in a variety of industries related to gold mining—for example, the miners, jewelers, traders, vault keepers, delivery men, and auditors who made an appearance in the first half of this post.
The irony, of course, is that Fed Chairman Bernanke and Treasury Secretary Geithner—the two policymakers largely responsible for making and carrying out our country’s monetary affairs—are employed by those in the private sector.
As inflation rises—which is bound to occur when dollars are produced without corresponding demand—the very miners, jewelers, traders, vault keepers, delivery men, and auditors who are most harmed by (and who can least afford) today’s easy money foot the bill.
The virtues of gold are profound as are the vices of paper money. Gold retains its value over time since its quantity is limited and its price is determined by the market. Paper money loses its value over time since its quantity is limitless and its price is determined outside the market.
Over the long run, a monetary standard based on gold will maintain stable prices while a paper standard will lead inevitably to inflation. The choice for a sound monetary standard is clear.
The "world has changed," Fed Chairman Ben Bernanke recently told George Washington University undergraduates. He was putting down the gold standard, as is the former Princeton professor’s habit.
The gold standard, he apparently feels, is not worth the effort. Professor Bernanke may have been a bit young to have seen the original 1953 version of "A Wonderful Town," but he certainly might have seen the 2003 Broadway revival. In it, one of the transplanted girls from Ohio sings of the New York dreams and experience of many fellow of her transplants to the Big Apple:
Apparently, that is Bernanke's attitude toward the mining of gold. Bernanke said the GWU students: "To have a gold standard, you have to go to South Africa or someplace and dig up tons of gold and move it to New York and put it in the basement of the Federal Reserve Bank of New York and that's a lot of effort and work."
Well, the Fed Chairman needs to update his data on world gold production. China, not South Africa, has been the leading producer for several years – with 345 tons mined in 2010. Australia was second with 255 tons. Even the United States produces more gold than South Africa. And these days, gold exploration and production has been springing up around the world.
And apparently, the production of gold needs little incentive from Washington – or perhaps it gets a lot of incentive – since world production has hovered around 2500 tons for more than the past decade.
The world may have changed, but perhaps the world may need to change again. Because the price of gold in recent years suggests that people aren’t happy with the changes that central bankers like Bernanke have been making.
The BBC reports:
Venezuela has received its first shipment of gold bars, after President Hugo Chavez ordered the repatriation of 85% of the country's bullion reserves.
The gold was unloaded from a plane and taken under heavy guard to the Central Bank in the capital, Caracas.
President Chavez has explained the move as an act of sovereignty that will protect Venezuela's reserves from global economic turbulence.
However critics say it is expensive and unnecessary.
Much speculation has swirled around what Mr. Chavez is up to. The shrewdest assessment may be that of investigative journalist Richard Miniter, in Forbes.com who observed last September:
The mystery only deepens the more one thinks about the costs and risks. An insurer, if one can be found, could easily charge 4% of the market value of the stockpile, plus security and shipping charges. All told, that could be almost $100 million. And moving the gold will almost certainly lower Venezuela’s credit rating, which Moody’s Investors Service puts at B2—well into junk-bond status. Standard & Poor’s also rates the nation’s creditworthiness as junk. Making Venezuela’s government assets more opaque will only lower their value. So shipping bullion makes matters worse and means Venezuela will pay even more in borrowing costs.
Don’t forget the risks. A bold pirate could seize tons of gold in a single brazen raid. Or a storm could take it to the muddy bottom of the Atlantic.
So why is Chavez moving his gold? What’s the strongman’s real reason?
Foreign investors are harassed and work under the ever present threat of expropriation. Coca-Cola, PepsiCo, McDonald’s, Wendy’s, ExxonMobil, ConocoPhilips and more than a dozen other publicly-traded American companies have seen their assets seized. The total value seized tops $23.3 billion, according to Ecoanalítica, a Caracas-based research firm. Since 2007, the rate of nationalizations has climbed 924%, according to Coindustria, the equivalent of Venezuela’s chamber of commerce. The World Bank, in its 2011 Doing Business Report, finds that Afghanistan is a better place to do business than Venezuela.
Meanwhile, a Spanish judge has found that Chavez’s regime is linked to two terrorist groups, ETA in Spain and the FARC in Colombia. When Walid Makled, a drug lord with family roots in the Palestinian territories, was arrested in Colombia, he admitted to paying some $40 million to the Chavistas. He is also suspected of financing terror plots.
Finally, at the World Bank’s International Center for Settlement of Investment Disputes (ICSID), American and European companies have filed at least 18 claims against Venezuela for illegally seizing their properties. Those claims total more than $14 billion.
The value of Venezuela’s overseas gold reserves? Roughly $12.3 billion.
So let’s connect the dots and solve the mystery of the moving gold.
The Financial Times reported Tuesday that European bankers are thinking of using their gold assets to back their new eurobonds. "In order to 'enhance' the guarantees on the eurobonds, the draft says, governments could provide collateral, including 'gold reserves which are largely in excess of needs in most EU countries.'"
This is, of course, just another step away from the true solution of the monetary crisis gripping Europe. In a desperate search to tinker with an essentially broken system, Europe’s central bankers are trying to use gold to prop up the machine that prints Europe's money and debt instruments. Anything is possible...and preferable...it seems to getting serious about a true gold standard.
It is always amazing to contemplate the lengths to which central bankers will go to avoid a true diagnosis of the patient’s problems. One is reminded of the kind of barbaric medical practices like blood letting – the kind that helped kill America's first president in December 1799. George Washington, at least, was serious about money. Paper money ills particularly afflicted Rhode Island in the period after the Revolutionary War. In 1787, Washington wrote a Rhode Island correspondent: “I am sanguine in the belief of the possibility that we may one day become a great commercial and flourishing nation. But if in the pursuit of the means we should unfortunately stumble again on unfunded paper money or any similar species of fraud, we shall assuredly give a fatal stab to our national credit in its infancy. Paper money will invariably operate in the body of politics as spirit liquors on the human body. They prey on the vitals and ultimately destroy them."
The sixteenth American president was also serious about money. "Fluctuations in the value of currency are always injurious," wrote President Abraham Lincoln in 1863, "and, to reduce these fluctuations to the lowest possible point will always be a leading purpose in wise legislation. Convertibility – prompt and certain convertibility into coin – is generally acknowledged to be the best and surest safeguard against them."
It's time for Europe to get serious about money – and to stop the blood-letting that is killing the body politic.