Black Gold and 21st Century Monetarism
New York Peak Oil Conference April 27-29, 2006
Late 20th and early 21st century monetarism played gold-averse for quite a while: from about 1985-2005 almost any finance minister of the International Community, those hands-on former business chiefs or party hack politicians who have become their nation's Mr Money, would go out of their way to say that gold was fading away. It was no longer needed, it really was a barbarous relic, it interfered with the public's appreciation, respect and adoration of the national money - and behind all that, their adoration of the US dollar. High gold prices in New Economy newspeak were destabilizing and inquieting, harbingers of inflation, messed around with trade growth and transparent markets, and gold is not only produced by dependable and well-managed South Africa, but also by some pretty barbarous countries that Nice People don't like dealing with.
Gold prices are also linked with oil prices. In the early 1980s when really vintage monetarism came back out of the mists of time to rule for a 20-year eye blink in human history, the world was coming down and out of the 1979-1981 frenzy. In that time of fear and loathing, as Khomenei's mobs chanted anti-Western slogans in Tehran, gold prices had racked their way up with oil prices to exotic, scary highs. In 2006 dollars, the gold price achieved about 1400 USD-per-ounce in that time, when oil cost well above 110 USD-per-barrel. Of course inflation was high: any hands-on businessperson could profit from the ambient hysteria, rack up their own prices, borrow at negative real interest, speculate on anything, and make a killing. This was bad economics. Speculation is only for the nices and best speculative instruments, like home purchase and rental prices, or mobile phone operating licences, and other socially-approved inflation, which somehow don't appear in the official inflation numbers. Beating inflation is a bugaboo that goes back a long, long way.
The monetarist creed goes back so far in history that explaining its fascination for modern, hands-on finance ministers whose personal business experience can extend to running pizza franchises or football teams, is more than difficult. The story goes back to the 1560s, and the grave threats to monetary stability posed by massive inflows of cheap gold into Elizabethan England, and elsewhere in royal Europe. The coins of Elizabeth's realm, some of them gold, just couldn't compete. Gold from the Caribbean, Central America and South America, brought by Spanish, Portuguese, English, Dutch, French and Italian sailor heroes, and also by international pirates, flowed all over Europe. People quickly started minting their own coins, official moneys wilted, and prices went haywire, that is down, up and sideways.
Most of all, the assured profit from producing official money, which at the time was only coins (paper money appeared for the first time in the early 1700s) was seriously threatened. When other players bust the cosy monopoly of official money they reduced, sometimes eliminated the mark-up on the coin value against what it cost to buy the metals and make coins from them. This was bad news to the elites, who ran on what they got from controlling official money production. Their rake-off on national - that is royal - coin producing came from buying the raw material metals, including gold and silver at a cheap price, and selling the output manufactured products dear, that is coins with nice pictures of the Queen, King or other fine persons on it. Whenever times were tough and the raw material metals were in short supply, older and heavier coins would be called-in, scraped, and new lighter ones produced from the scrapings - with the same money number stamped on them. This is monetary inflation.
Called seignorage in England, the royal rake-off from the monopoly on producing money financed the Royal Treasury, and the entire system of noble privileges, paying the royal retenue of soothsayers, priests, soldiers, thugs and other bodyguards that any self-respecting royal has to have. By 1571 the situation was grave enough in Elizabethan England for the Royal Mint to be set up, its total monopoly secured, in theory, by draconian laws punishing any person minting their own coins and undercutting the official money. The gold kept on flooding in. One estimate of total inflows of New World gold and silver to Europe through 1550-1600, by the cycle economist Nikolai Kondratiev, was of 50 000 tons of gold and 400 000 tons of silver. No national bank in Europe, today, has more than about 1000 tons of so-called 'fiduciary' gold in its vaults.
The pirates had their anarchic fun by paying trivial purchases by banging down solid lumps of gold - enough to make gold coins paying a dozen times the purchased article. Today's equivalent is new wealth sheep and camel herdsmen from the Saudi deserts banging down fistfuls of petrodollars to build a plastic-and-concrete instant city using the nicest possible Western expertise. Back in Elizabethan times, scheming nobles set up their own back-country mints, organized local money systems, recruited private armies and waited for their chance. Wannabe rivals of European royal heads increased in number, threatening the heads of incumbents. In the official money system things went from bad to worse. More and more nobles became disloyal. The church complained, loyal nobles complained. Trade and guild leaders also complained because the 'false money' based on stolen gold and silver from the New World was everywhere, and thicker, and better than the official. Whether in fact this was what we call inflationist today, or deflationist, is a good question but what counts is the official reaction.
Reasonable-priced Gold and Reasonable-priced Oil
In the period of about 1600-1650 the grave threat to established, royal money systems in Europe was countered by what we call vigorous and robust action, that is military. Pirates were hunted down, and muscular monetarism set a strategy of rapid reaction overseas. Colonial implantations of soldiers-plus-miners were set up in gold producing regions, and the hunt for gold in 'new' regions like Africa started in earnest. This was therefore a supply-side strategy: get to the gold before the others, grab the resource, and prevent the others from getting their hands on it. Controlling the resource assured supplies to royal mints, and also deprived the rivals of gold for their mints, weakening their money. Not only was this good for loyal traders and nobles, but it was also bad for the other side, who could not recruit and pay mercenary soldiers for rebellious projects.
The 1991 Gulf War was very close to that spirit: get to the source of black gold, ensure a free flow of reasonable-priced oil to the home side and its allies, and deprive the bad guys of both oil and money. Also, we can note, the leader clans of today's globalizing economy, recycled from running pizza parlours to becoming great men of state, are brought up to believe that the 1979-1981 shakeout and meltdown of the economy, with gold and oil prices reaching terrifying heights, was caused by the vertical upward movement of oil and gold prices. Their PhD toting soothsayers told them what they wanted to hear: verily, oil and gold price rises were the sole, root cause of inflation at that time. The idea that base or high street bank interest rates at 25% or 30%-per-year can or could be inflationary was irrational to them, and simply did not figure on soothsayer radar screens. Interest rates are hiked, by monetarists, with the firm belief they counter inflation and come after inflation. They in fact come before, cause and intensify inflation, but no amount of Nobel economics prize rhetoric will work. Monetarism is an age-old dogma, and needs no facts and figures.
Thus it was that gold prices were cranked down, inch by inch and dollar by dollar through the 1980s and 1990s. To help the process, finance ministers who were always proud to say their experience of running a football team immensely aided their deft running of the economy, would periodically sell big slabs of fiduciary gold. The word 'fiduciary' is itself a relic from the 17 th century, but means the stock of dead gold held in national bank vaults 'just in case'. That is, just in case The Enemy starts trying to undermine our good and nice money, these days with printed paper notes and bills carrying cute pictures of Kings, Queens, presidents, prime ministers and great war heroes. National bank gold stocks can be used to prevent that, it is believed. But if you want gold prices to fall, to bolster the value of the paper stuff, or for some other reason (and monetarists have them), then you sell the national gold. This was done regularly through the 1980s and 1990s. Buying it back from the free market after about 2003 is not proving too easy - that is it works out very expensive, using those taxpayer funds the ex-football team heroes love to spend.
The reasoning path of latter-day monetarists is a baroque thing: high gold and oil prices are inflationary, so if gold price can be levered down then oil prices could or should follow, and inflation will be low forever. Amen. Another cut on this is the monetarist belief that high gold prices undermine confidence in money of the paper variety. Money of the paper sort is a vital thing. For a whole lot of reasons we can't go back to gold, silver, copper, aluminium and iron coins, so we have to keep the paper stuff. Ergo monetarists defend their paper money with the same gung-ho fervour their ancestors defended the value of gold and silver coins - of the right type, from the right manufacturing centre, that is. Trifling details such as the energy cost of gold, which is nowadays often mined from 4500 metres underground, followed by sifting through a ton of ore to grub out 3 grams of gold, takes rather a lot of energy. In the case of reworking tailings from old gold mines the process needs huge quantities of cyanide, grapple a few grams of the yellow stuff here and there. This all costs a lot of energy, a lot of it oil. So if the oil prices rises, then gold prices rise. The other way round, which is official monetarist logic, is not so sure.
Waiting For It
A quick check through US national economic and financial accounts shows the vast need to maintain confidence in paper dollars. In normal logic the US dollar should be completely worthless, but the same also applies to the Euro, the Yen or most any other money you care to name. Oil exporters have to accept these paper moneys, like you and me. Every so often, and Kondratiev claimed that 'every so often' is cyclic and relatively predictable, and is not purely stochastic, confidence melts down and paper money, along with even more papery share actions and derived financial instruments has a very rough ride. This is what happened in 1979-1981. No amount of gold selling by national banks, today, will or can halt the upward rush of gold prices - or oil prices.
Back in 2004 or 2003 it was not so sure. Brave, respected and stout-minded defenders of the New Economy and strong money of the paper sort could get up their hind feet and proclaim that 'quite soon' the world would come back to its senses. Being monetarist minded and sharp enough to run a pizza parlour, even two pizza parlours, they had numbers to go with their sure and certain pronouncements. The London-based L M Rothschild private bank, with its age-old seat on the London bullion price fixing committee - dating from the 1770s - pulled out of the gold price fixing arena in 2003 in a fanfare of financial media attention. It anounced that gold could never exceed 270 USD-per-ounce, or oil 35 USD-per-barrel. Of course the Rothschild spokespeople added that these ideal, reasonable prices were 'in the long-term'. Just for the short-term, therefore, we can and will have 600 and 700 USD for gold, and 75 or 90 USD for oil, but don't worry folks, that isnt long-term reality. In any case the L M Rothschild bank makes nice dosh on shuffling paper stuff like swaps and derivatives so what the worry for them?
We can have an awful lot more than 700 USD-per-ounce for gold, and 90 USD-per-barrel for oil. All kinds of experts, that is former dotcom analysts with hands-on experience of good financial management, are falling over themselves to forecast 125-dollar oil: with that price for oil, gold should easily crash through the 1000-dollar ceiling.
This will very surely lead to classic knee-jerk response from the monetarist guardians of what they call economic orthodoxy: that is massive interest rate hikes, further raising inflationary pressure - this of course being denied as even possible in monetarist newspeak. To them, hiking interest rates into the stratosphere only causes other people to lose their businesses and lose their jobs, not the Nice People. Strong money must come back, and that needs cheap oil and cheap gold, in half-baked monetarist logic. So getting back to the happy state of money stability needs a heavy dose of misery, but course for other people and not the government and bureaucratic elite, nor the financial and economic elite.
We can almost count down to this coming struggle. Surely, our great democratic and economic leaders will reason that all they have to do is repeat the 1980-1983 recession through cranking interest rates ever higher, showing immense courage as they watch the economy fall apart as a result. But this time around the strong money medicine is going to be harder to sell than 25 years ago - and is aso not going to work because of Peak Oil and the end of cheap energy. Back in the 1980s it was still possible for Saudi Arabia's anxious-to-please rulers to hike their oil output by 25% in a pumping frenzy that more than covered depletion losses elsewhere. Today Saudi Arabia cannot hike its oil production by even 10% - in fact its likely at flat out peak right now. Oil prices will be hard to swat back down to 'reasonable' levels, and will bounce back any time the economy starts growing. So unless our monetarist rulers decree and organize a permanent, that is really permanent economic recession their crawling desire for 'strong money' will not be assuaged.