Restoring Trust in the US Dollar with Gold
Similar to credit as the lifeblood of the financial market, trust is everything about money. Otherwise paper is just a paper, only with trust, a piece of paper suddenly has value, so we can preserve it or pass to someone else for goods and services. Trust becomes a bridge between two trading parties, just like credit as the critical link between two trades in the financial markets.
When a Brazilian model and Taj Mahal tour guide refused to accept US $, for some contrarians, it is a sign of the end of US $ decline, since how would a model and tour guide know anything about the complicated financial market? Is this the same story as shoe shine boy or taxi driver talk about hot stock tips at the peak of the bubble? To me, this is a misguided use of contrarian approach. My view is totally the opposite. It shows the deterioration of the trust on US $ by the world which US $ is depending on for its support. The only reason US $ becomes the world reserve currency is because people trust it. With this trust, US can issue all its papers to the world and pay for all the cheap oil, raw material, finished goods around the World, with foreign central banks holding these papers to finance the US high living standards.
However, as Warren Buffett said at his popular annual letter published on Friday, this kind of imbalance is unsustainable, the $2B daily force-fed to the rest of the world produces unpleasant indigestion. He pointed out, the current sovereign wealth funds investing in US is actually our own doing, the weakening US $ is not the fault of OPEC and China but our own. This is why he has been bearish on US $ for a while. In my view, the problem is worse than unpleasant indigestion, it is the loss of trust which might end US $ as the world reserve currency. Why gold is going faster last 2 years than previously? Maybe higher inflation expectation is part of it, but probably more due to the reason that gold provides an alternative vehicle and safe-haven for this potential trust crisis if US $ loses its reserve status. The current credit crisis is obviously not helping, when people lose trust on financial markets and their products, and they can't even dump paper assets due to lack of liquidity in the fixed income market with no buyers, what would they want to hold on to? What would make them feel safe? Commodities, especially gold. I feel this is at least part of the reason behind the current commodity boom cycle. it is a era of asset rotation by dumping questionable paper assets and buying into real physical assets which people can see, feel, know and trust for certain their true values.
Why gold? I think it is more a world tradition by our human being's own selection. Aristotle indicated "Gold is durable, not like wheat, divisible, not like diamonds, convenient, not like lead, constant, not like real estate, and best of all, as jewelry, it has intrinsic value". Why not other metals such as copper with the same properties? I don't know, maybe gold just looks and feels better. You never see a jewelry made of copper, do you? Magically all major nations and civilizations in separation without talking to each other and without consensus had uniformly picked gold (to some extent, silver too). Gold is precious and lasts forever. We can not create new gold through alchemy out of thin air, not like all the financial alchemy by creating various tranches from subprime mortgages in modern days. Milton Friedman mentioned that there is a tribe in the pacific that uses rocks as their currency. Why don't we use rocks instead of gold? Obviously rocks are lack of such properties mentioned by Aristotle, otherwise the world would be flooded with cheap money (rocks) like the US $ today. Why does the tribe use rocks? Because there is no gold or any other metal in this isolated pacific island, and rocks are the closest to the properties of durable, divisible, convenient and constant currency, not sure about intrinsic value though. Outside the island, rocks are worthless. I think it is the same thing on gold, outside the mother earth, gold means nothing to aliens either if they exist.
Even I am bearish on US $, bullish on gold, have big concern on inflation, especially monetary inflation represented by M3 which government conveniently stopped reporting, I am not a strict gold standard advocate. I do not necessarily advocate the return of that 1 oz of gold guarantees and exchanges so much US $ as the only option, and use gold as money instead of all paper currencies. I have some serious questions and doubts about the feasibility and implementation of such strict exchange scheme in current complex global trading environment and financial market. But sometimes in the future, I see some linkage (even a loose one) before US $ and gold, when gold rises to a much higher level than today. But I have not yet formalized a solid and practical mechanism at this point, and also want to see more market action on gold first, and other people's view as well.
I don't agree with many things Mr. Alan Greenspan had done as a Fed Chairman, but in the 1966, he published a little known essay about gold standard which I find interesting. He never mentioned this essay after joining the Fed and betrayed his early views in this essay with all his decisions at Fed. He neither mention nor include any of his views in this essay in his 2007 memoir "The Age of Turbulence". In this essay titled "Gold and Economic Freedom" in 1966, he observed "under a gold standard, a free banking system stands as the protector of any economy's stability and balanced growth". He also thought that gold standard could avoid rapid price inflation as a plague to the whole economic system. He pointed out that the abandonment of gold standard permitted chronic deficit spending effectively financed by the unlimited expansion of credit. Why hasn't he mentioned this again? Because his own essay discredits almost all his lifetime's work and his whole career as a Fed Chairman. As a matter of fact, gold standard even puts the very existence of Fed into question.
Gold is not an enemy of US dollar, but a friend. Some kind of loose linkage between the two will restore faith, value, credibility, popularity and honesty back into US dollar. It reinforces and restores trust in the US dollar for it to continue as the reserve currency in the world.