Gold Prices and Panic

By: Douglas_French

With gold selling for around $1,400 per ounce, it seems like everyone has jumped on the yellow-metal bandwagon. Resource-investment guru Rick Rule said about gold investing recently, "we're no longer lonely in the gold trade. You couldn't describe this as a contrarian activity, and you couldn't describe this as a low-risk activity."

But while Rule and the likes of David Einhorn aren't alone keeping some, or a lot of, money in gold, the Wall Street Journal ran a profile of a more typical investment guide who claims, "There's no utility of gold." Investment advisor Tim Medley says people only trade their dollars for gold when they're afraid, and they won't be afraid much longer.

Medley is old enough to remember overflow crowds at financial conferences in the early 1980s listening to presentations about gold, only to have the metal's price plunge and go nowhere for two decades. He's figuring the same will happen again. "Given a choice between first-rate common stocks and gold over the next five to ten years, I feel strongly that stocks will do much better," says Medley.

Unless his clients specifically tell him to buy some gold or gold stocks for their accounts, Medley won't touch the stuff. "There's no organic growth" in gold, he says.

For sure, gold coins and bars silently gather dust. Gold has no staff, makes no product, earns no profit, and incurs no loss. The yellow metal owes no one, but at the same time it collects no interest either.

However, to say gold has no utility? Time and history would say otherwise. Murray Rothbard listed seven necessary qualities for money during a History of Economic Thought lecture at UNLV back in the fall of 1990. For a substance to be used as money it must be (1) generally marketable, (2) divisible, (3) durable, (4) recognizable, (5) homogeneous, and have a (6) high value per unit weight and (7) fairly stable supply.

Gold happens to meet the test of all seven attributes. However, investment advisor Medley seems to be equating the macroeconomic landscape today with that of 1980, when gold hit $850 per ounce, thinking that it's all downhill from here for the price of the yellow metal, just as it was 30 years ago.

But he turns a blind eye to the fact that M2 was just short of $1.5 trillion in January 1980, while this past October it was $8.7 trillion. Gross debt in 1980 was $909 billion, on November 2 of this year, $13.7 trillion. As a percentage of GDP, the debt was 33.4 percent in 1980; today it's 93.2 percent.

On February 15, 1980, the discount rate was goosed up to 13 percent and federal funds were yielding 14.5 percent to 15 percent (on the way to 20 percent a year later) Today, the discount rate is all of 75 basis points and federal funds fetch a yield of zero to a quarter percent.

And while Volcker's policies spurred widespread protests due to the effects of the high interest rates on the construction and farming sectors, causing irate, bankrupt farmers to drive their tractors onto C Street NW, blockading the Eccles Building, Ben Bernanke invited 60 Minutes into the Fed's chambers to go on camera assuring people he will keep rates near zero for as long as it takes.

Bernanke assured the national audience that the Fed was not printing money; however, he didn't explain where the Fed was going to get the funds to buy $600 billion worth of treasuries.

Rick Rule already knows the answer; and it's not just the Fed that's creating money out of nowhere to buy government bonds. "The decision by the European Central Bank to emulate their American peers to print money to buy existent European bonds is tantamount to government counterfeiting," says Rule.

And while central-bank bureaucrats come up with fancy names for this counterfeiting, like "quantitative easing," the owner of Global Resource Investments differs with that characterization. He says, "I disagree; I think it's a form of fraud. I think they are printing money to buy bonds that they couldn't otherwise sell."

Tim Medley believes stocks are selling at good prices and have the potential to reward investors with significant gains, while he believes the gains in gold prices are likely short-lived. Rule also remembers the late 1970s gold bull market, and he contends this market hasn't yet become the "echo market" that that one was:

In an echo market, the market might be kicked off by fear buying like we're seeing in gold now, and the momentum established by the fear buyers attracts the greed buyers. The momentum associated with the greed buyers sparks more fear buying and backwards and forwards.

Based on what Bernanke said on 60 Minutes, it is hard to imagine that it's really too late to be afraid.

Douglas French is president of the Mises Institute and author of Early Speculative Bubbles & Increases in the Money Supply. He received his masters degree in economics from the University of Nevada, Las Vegas, under Murray Rothbard with Professor Hans-Hermann Hoppe serving on his thesis committee. See his tribute to Murray Rothbard. Send him mail. See Doug French's article archives. Comment on the blog.

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