Global Investors Losing Faith in Faith-Based Paper Currencies

In today's Daily Global Commentary, Paul Kasriel explains why the price of gold is soaring [pdf]:

"Gold is a sterile asset. … Gold's appeal as an investment comes into play when central banks no longer provide for a positive inflation-adjusted return on short-term investments – that is when the yield on the central bank's policy interest rate (or some related money market rate) is below the inflation rate. …gold becomes a better store of value than short-term money market instruments dominated in fiat currencies. … global investors are losing faith in, as Jim Grant calls them, faith-based paper currencies as a store of value."

Is the explanation much more complex when we are dealing with multiple central bankers, playing geopolitical games one with another? I think not. US central bankers ought to have expected this. The question remains open as to what they will now do with it.

Toni Straka, The Prudent Investor, adds insightful comments to Jim Hamilton's recent Econbrowser post that downplays any importance attached to recent rises in gold prices. Hamilton says, "[T]oday's Fed looks to me even more committed than Volcker was to preventing even the smallest whiff of inflation." Straka says,

Gold beats the Dow since the closing of the gold window comfortably. It beats all equity indexes since 2000. And when I think of the strong correlaton of gold and inflation I find another reason to own physical gold. In his last testimonial to Congress Greenspan also said that in times of extreme crises gold remains as the only accepted form of international payments. It has been the universally accepted currency of 6000 years, the last 35 and a few coming years will be seen as a blip in history. So far every fiat currency has come back to its intrinsic value within a human's lifespan.

Add in the context that the 2 coming superpowers are India (importing 600+ tons of gold p.a.) and China (strong indivdual demand) and compare this with the US debt, backed by nothing than a diminishing belief that it can be repaid without being inflated and I will stick to gold. This year's recovery of the dollar was just a bear market rally.
Posted by: The Prudent Investor at December 4, 2005 09:53 AM

{12/10 Update}

Robert Samuelson concludes his Dec 7 Gold Still Glitters for Some:

"Whatever happens, the fears that give gold its speculative appeal could intensify or dissipate. Gold is an unending mystery - its value lies less in what it does for us (unlike sugar or oil) and more in what it symbolizes. It is almost as unfathomable as the human drama itself."

Peter Bernstein was interviewed on Gold and more early 2001. Bernstein suggested then to put 4-5% of funds into Gold as a hedge, as it was then priced just barely beyond production costs.[pdf]

Yesterday Bernstein reiterated his view on NPR's All Things Considered. [link to audio feed] Bernstein said that if the world's geopolitical environment is perceived by investors as stable, then Gold will not perform well going forward, but if it is perceived as unstable, then "pick a number" as to where it might go. Bernstein's numbers went as high as $4,000 or $5000 an ounce.

So there we have it. Typically, in today's dollars Gold has seldom stayed about $500 for any length of time. But who knows what tomorrow may bring in this increasingly "interesting" world.