May 11th, 2010
- Bretton Woods (see Wikipedia)
- Gold: The Next, Last Bubble
Money is anything that is generally accepted as payment for goods and services and repayment of debts. The main functions of money are distinguished as: a medium of exchange, a unit of account, a store of value, and occasionally, a standard of deferred payment. Fiat money is without intrinsic use and derives its value by being declared by its issuer (country, group of countries like the EU) to be legal tender. In other words, it must be accepted as a form of payment within the boundaries of the country, for all debts, public and private.
The financial crises in the EU and our own staggering and still escalating national debt underscores that the world’s spending and obligations has outgrown it’s ability to pay. Inflation is coming and there isn’t any way around it. The policies that pulled us out of the recent economic crash put trillions of new dollars into circulation. That makes all of our existing dollars worth less… but it increases the value gold and silver. In other words, currency is being devalued around the world-even in China.
The rise in the price of gold didn’t start last month or last year. It really started to run (see chart above) about the same time as the US deficit started to balloon due to the recession following the DotCom Bubble Crash and 9/11. Rather than slowing down, the worldwide financial crises and recessions could accelerate the rise. Consequently, gold now has characteristics similar to the objects of earlier bubbles with two exceptions: its demand is worldwide and governments could stop it by agreeing to fix currency exchange rates fixed to gold.
Until that happens (it may come at any time), the price of gold will probably act the same as did for beanie babies, tulips, tech stocks or stocks in companies that promise to develop mines on Mars and the moon (ala, South Seas Company stock).
Were you a Beanie Baby collector? People would search near and wide for their next Beanie Baby, they’d pay ridiculously high prices on Ebay for the most recently issued doll or the one they were missing in their collection. Websites sprung up listing “market prices” of different dolls; exchanges were even created. Was that fad much different than a kids’ versions of Tulipmania in 1635 or the South Seas Bubble of 1720 in England or the DotCom Bubble of the 1990’s and the Real Estate Bubble of the last decade?
Bubbles usually involve assets whose value is subjective and difficult to evaluate or measure. Often these are collectibles or other forms of assets don’t serve a productive societal purpose or generate any form of income. Buyers who, for reason known only to them, rationalize a value that’s exuberantly higher than the asset’s current market price. Since the asset generates no income on its own, these buyers bid up the price and acquire it in the hopes of selling it sometime in the future at a higher price, hence the term “greater fool theory”.
“These individuals will continue to purchase regardless of market levels, considering only the willingness of other individuals in the market to pay higher prices. At this point the bubble inflates itself, because a growing portion of the market is self-referencing, making decisions while looking inward…..euphoric levels of valuation are validated by the market, and intelligence is measured only by profits, not reasoning and judgment.” Financial Genius Before the Fall by Jacob Freifeld 1996
With World War II was still raging in 1944, all 44 of the Allied nations gathered in Bretton Woods, N.H. to establish a system of rules, institutions, and procedures to regulate the international monetary system (and create the IMF). The chief features of the Bretton Woods system were an obligation for each country to adopt a monetary policy that maintained the exchange rate of its currency within a fixed value—plus or minus one percent—in terms of gold; the IMF was to bridge temporary imbalances of payments.
As the costs of the Vietnam War and increased domestic spending accelerated inflation, the U.S. ran balance of payments deficit and trade deficits for the first time in the 20th century. In 1970, because of foreign governments’ redeeming their dollar holdings into gold, our gold coverages paper dollars declined 33 percentage points, from 55% to 22%. Fearing a devaluation, Germany left the Bretton Woods standard forcing the $US to a 7.5% devaluation relative to the Deutsche mark.
In an attempt to prevent further devaluations, President Nixon unilaterally ended the direct convertibility of the United States dollar to gold and thereby essentially ending the Bretton Woods system and resulting inflation and wage price controls here.
Since 1971, gold’s value in $US has increased from a low of $63 to today’s high of 1219.90 (from GoldPrice.org)
Note: Subscribers to Instant Alerts saw me starting to add precious metals stocks and ETFs to my portfolio back in April.