Is Gold in a 6000 Year Bubble?

Posted by Patrick Ceresna on Dec 8, 2014 7:13:24 AM

The other week Willem Buiter, Citigroup’s chief economist, grabbed the news headlines stating that gold bullion is in a 6,000 year bubble. The statement is based on his belief that gold has no intrinsic value. Mr. Buiter went on to exclaim that, “Gold has become a fiat commodity or a fiat commodity currency, just as the U.S. dollar, the euro and the yen.” He continued, “The main differences between them [fiat currencies] are that gold is very costly to produce, while the production of additional paper money has an extremely low marginal cost.”

Is this for real?  Gold bullion is no different from fiat currencies?

First off, the statement is a complete discredit of Mr. Buiter. Fiat, by Latin definition means “let it be done”.  This implies that a fiat currency comes to existence from government regulation or law. There is no law or regulation that decrees gold to have value or to be used in trade. Humans have simply used gold as a currency because it was portable, divisible, extremely rare and relatively indestructible. How can that be a bubble or be a fiat commodity?

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Now I want to differentiate myself from many traditional gold bugs. I am first and foremost a trader seeking the next profitable opportunity. While there is a very emotional divide between gold bugs and gold haters, I try to take a more neutral stance of trying to see things for what they really are.  I don’t yearn for a return to a gold standard currency nor do I stash hordes of gold prepping for the day of reckoning.  But, at the same time I do feel that there is and always will be a place for gold in the world. 

Through human history gold has played an incredibly important monetary roll and while most individuals look at it as a store of personal wealth, there is a much more important role of gold in the wealth of a nation.  Why?  Because in world dominated by global trade, there needs to be a median of exchange to settle trade. If a country is running a trade surplus, it would mean that they would need to own an ever increasing hoard of foreign currencies or risk having their own currency strengthen.

Since the Bretton Woods accords in 1944, the U.S. Dollar has supplanted gold, and even in its current fiat form played the key role and the international currency of trade. This has given the U.S. incredible power to dictate its economic will upon the world.  I am not really for or against this, just simply observing the reality of the modern world. 

So, what if you are a country like China, India or Russia and you see legitimate sovereignty risks in the U.S. being so dominant? A perfect testament is the current economic sanctions that have been levered onto Russia. It is no surprise that over the last few years the three countries have been hoarding almost all physical inventories of gold available around the world. The gold in their central bank reserves gives them an asset that is still, country to country a median of exchange to settle imbalances.

In order for one to believe that gold is meaningless, one would have to believe that the fiat U.S. dollar will remain the de facto international median of exchange for all trade for all time.  Can it stay this way for 10 more years, 50 more years, 100 more years? If given enough time, the U.S. Dollar will eventually lose its place as the world reserve currency. When this occurs, what will countries use to trade internationally? If you are an emerging market country and you trade with Russia, would you take rubles in return for your goods if there was a trade imbalance? If the country did, would another developed country accept those Russian rubles that the country now holds in reserve?  This is where through history gold has always played a role as a currency that is globally accepted. The current massive accumulation of gold by China, India and Russia indicates that these countries are looking out into the future and see the value that Mr. Buiter chooses to ignore.      

So what do I believe? 

Gold will always have a role in the world and will continue to be accumulated.  The current gold prices are likely to not drop below $1000-$1100 levels for any sustainable time as that would halt the mining of the precious metal.  Eventually, a period of time will come where confidence in the existing debt based fiat system will rise and the need to diversify risk will return. During periods like that, gold will regain its luster.  If my perspective has any merit, then gold represents a compelling risk/reward proposition where the downside risk of loss is a small fraction of the upside potential. This alone has the metal on my radar for potential bullish technical breakouts.

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