no third solution

A commenter pointed out that I was wrong in my assertion (I think an erroneous citation) that the dollar fell 25% versus the Euro in the past 5 years. It’s worse. Continuing on that theme, an article in the Financial Times says that yesterday “[t]he dollar fell to $1.4750 against the euro.”

When I was backpacking in 1999, shortly after the Euro was introduced, I recall an exchange rate of something like $.8 = €1. This is an astounding 85% depreciation over 8 and a half years. In order to lose this much value, the Fed needs to be expanding the money supply at a rate of 8% annually. But that’s not all — because I’m sure the E.U. has also been inflating its currency, too (I have no idea how much they’ve been doing this, and I’m not inclined to look it up), we can safely assume that domestic inflation is much higher than a mere 8%. It’s 8% more per annum than our European counterparts.

A related article says that investors, wary of further dollar inflation among other fears, are running to commodities like oil and gold, both of which hit all-time highs yesterday.

Gold soared to $868.00 a troy ounce, setting a record for a second session after hitting $861.10 on Wednesday, as bullion powered beyond its previous high of $850 reached in January 1980.

Via Kitco, historical prices from 1999 forward suggests that the annual average price of gold (in terms of USD) has increased by an average of about 11 or 12% per year, although really it’s risen dramatically in the last 3 years and not so much in the earlier years.

This anachronism has historically been the safe-harbor investors seek during times of financial crises. Why? As long as people continue to value gold, this pattern will persist.

Some people say that gold doesn’t have any intrinsic value. I tend to agree with this position because value does not exist independent of man’s subjectivity, although gold comes pretty goddamned close. There are a number of reasons why this is so: It is relatively scarce. It is nearly universally desired. It is fungible, malleable, and ductile — which properties facilitate divisibility. It is a heavy metal, i.e., dense. It does not corrode. And it is generally not consumed or otherwise destroyed when put to non-monetary uses.

You can be 100 percent certain that when the price of gold (in terms of FRNs) is rising, it’s not because the quantity of gold in existence is diminishing.

People by and large, understand that gold is a damn good hedge against whatever the world’s central banks do to their respective currencies. They understand that others will continue to want gold, either for use or for exchange (because other people want or will want gold) and they will be willing to pay for it in-kind, in barter, or with a quantity of relatively worthless paper-notes sufficient to compensate for the ongoing and/or expected inflation.

As long as the Federal Reserve continues to print FRNs, the price of gold (in terms of FRNs) will continue to increase. This is elementary.

Possibly related posts:

1. New Hampshire Gold Bill
2. What’s Behind the High Price of Gold?

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This entry was posted by David Z on Thursday, January 3rd, 2008 at 3:10 pm and is filed under Economics Lessons, gold bugging. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.