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December 05, 2008

Twelve Tonnes of Jelly (Or, the Trouble with Gold, Part II)
by Adrian Ash

"...'What is economics?' an economics professor asks. 'Scarcity' comes the school-children's answer..."

SO WE'RE LIVING through the end of something. Something important and ugly. Everyone seems agreed on that.

But what is it...this big, slippery something, harder to nail down than twelve tonnes of jelly?

"It's the end of an era in the global capitalist economy," says antediluvian historian Eric Hobsbawm. Or the end of "the prevailing economic model" according to London's left-leaning Guardian. Or rather, the end of "American capitalism" in the Washington Post's words.

Just call it "the end of Wall Street" says Michael Lewis, author of Liar's Poker. Better still, let's call it the end of "US domination" chips in Russia's puppet-president, Dmitri Medvedev. Either way, the 50 states are to blame - and with half-a-million Americans losing their job in one month, it's "the end of the world as we know it" wails German weekly Spiegel.

So many nails, so much jelly! But seeing how what's really at stake - first through its surfeit, now through its absence - is money and all that flows from it, we can't resist pitching in our ha'penneth here at BullionVault. Not because we believe we might have the answer, but because we should at least bore you with our opinion. We are, after all, now caring for 12 tonnes of gold on behalf of private investors worldwide, all seeking to defend their wealth. That's as much as the central banks of Canada, Mexico and Ireland combined.

And yes, the last 18 months do indeed mark the end of an era; the op-ed columnists have got that much right, living through their own end-of-times in the fast-fading newspaper business. But the next year-and-a-half will only mark it still further, we think. And given how government the world over is trying to revive the patient with fresh gobfuls of money, his death may yet be made worse by stuffing cash into his throat as he struggles for breath.

First, though, the story so far.

"What is economics?" asks a professor priming first-year university students. "Scarcity" comes his own answer. "Resources are scarce, but human wants are unlimited," a school-children's textbook goes on, clipping their dreams before they're out of short trousers.

If only we could all have everything we all wished for! But there's never enough time, stuff or effort for that. And money was supposed to make vivid this problem.

Above all other things, money is a claim on resources. My Dollar, your Euro...in law they can't be refused when we use them to buy things. But just like the resources cash buys, money also needs to be tightly supplied. Too much of the stuff would force the price of things higher, as those limitless claims crashed into still-limited nature. Either that, or the flood of unlimited claims would imply we'd all got way more resources to use. And that would skew the picture so badly, we'd risk using tomorrow's resources today...burning our way through our children's fair share and smacking their legs with text-books bought for a penny from the stacks of unsold, unwanted remainders.

Hence the trouble with gold - both when it really was money (c.3,000 B.C. to A.D. 1933) and also today (scarcely one life-time later). Gold makes real that scarcity the world faces each day. Limited in its supply, and useless for pretty much everything else, gold-as-money works wonderfully well. Provided, of course, that the fact of scarce resources is politically possible.

For those who owned the resources gold bought and sold, the metal's power reached its zenith with the late-19th century Gold Standard - "the rule of law applied to money" as James Grant of Grant's Interest Rate Observer once noted. Under this law (both natural and legal), scarcity always won over demand, ownership always beat credit. "The civilized world had a single money - gold - of which the paper moneys of individual states represented fixed and timeless sums," relays James Buchan in his history of money, resources and wants, Frozen Desire. "Its chief effect was a slight but continuous depression in the price of goods in money, thus accelerating the use of technique in manufacturing, ruining farmers and other debtors and entrenching the lending class, the rentiers. Gold became, in Keynes' phrase, 'part of the apparatus of conservatism'."

So lightly supplied, however, gold capped humanity's aims, foiling ambition and curbing expansion to the limits of progress. If science, agricultural or mineral yields and factory efficiency couldn't deliver fresh growth, then neither would money. But what of the opposite problem? What if humanity's unlimited wants ever got ahead of themselves, supplying tomorrow's desires with production today?

"Even as a child, Ben Bernanke was intrigued by the Depression," wrote Greg Ip, the Fed's inside man (or so rumor had it) at the Wall Street Journal back in 2007. "His maternal grandmother described life as a young mother during the 1930s...[when] many neighborhood children had to go to school in tattered shoes or barefoot."

"Why didn't their parents just buy them new shoes?" the young Maestro asked. "Because their fathers had lost their jobs when the shoe factories closed," answered his nan. "Why did the factories close down?" asked the enquiring young mind. "Because nobody had any money to buy shoes."

"The circularity of her logic bothered him yet illustrated a key puzzle of the Depression," Ip says of the prodigal wonk. "Why was there so much idle capacity when there were so many unmet needs?" Hence the childish solution today, conceived when "Young Ben [was only] six or seven years old"...

More money for more shoes than more people could ever have wished for!

"My government's overriding priority is to ensure the stability of the British economy during the global economic downturn," said HM Queen Elizabeth II this week at the state opening of Britain's parliament. To that end, "My government is committed to helping families and businesses through difficult times," she went on, reading her government's script. The help, like the aim, is simply to steal from tomorrow to refinance yesterday's errors. And where theft or debt can't be managed, government will simply print new money instead. Because everyone else running competing economies with competing currencies also stands ready to throw fresh claims at the world...claims in cash-form to keep families in housing, workers in jobs, shoppers out shopping, bankers in banking.

The alternative course just can't be allowed. Even if it can't now be avoided.

Third and final part (promise!) to follow...

Adrian Ash
BullionVault.com

Head of research at BullionVault.com, the fastest growing gold bullion service online, Adrian Ash is also City correspondent for The Daily Reckoning in London, and a regular contributor to MoneyWeek magazine.

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Please Note: This article is to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events and should be verified elsewhere if you choose to include it in your own analysis.

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