Stimulus Money Creation Makes Gold More Attractive

The U.S. government sells debt in dollars. It also prints dollars. That means it can print new dollars to pay off its debt. It needn’t default, i.e. be unable to find currency to pay its creditors. If it were issuing debt in a foreign currency, say Yuan, then it would have to pay debt off in that currency and COULD default.

But perhaps we are quibbling over details. An inability to service its debt or pay off its long-term obligations, or just a willingness to do so by printing more money, is effectively a devaluation of the U.S. dollar. That’s what the currency markets have been telling us all year. (And that’s one reason why the yield curve is starting to look like an Olympic ski jump.)

This fear of the sustainability of the U.S. deficits is another reason investors and people who use their brain own at least some gold. And on that subject, we copped it a bit from a friend last night for our comments yesterday. He also trotted out a famous quote about gold from Warren Buffett.

“Don’t you think you were a bit self indulgent yesterday going after Pascoe?”


“Well, it is a fair point.”

“What is?”

“If the world goes to hell like you say, you can’t eat gold. You can’t sleep on it, although you could sleep with it I suppose. How useful is it really going to be as a medium of exchange or a store of value if economic activity grinds to a halt?”

“I don’t know. I’m not Nostradamus. But I’m not recommending people convert all their equity holdings into precious metals either. I AM recommending they own some bullion and, for leverage purposes, some gold shares. That doesn’t seem so radical. Why would anyone find the idea of hedging your bets against monetary policy so kooky?”

“Because monetary and fiscal policy have basically worked, at least here in Australia.”

“Are you drunk?”

“I’m serious. The stimulus worked. It kept Australia out of recession. What more do you want?”

“Less. Less is more, mate. The stimulus increased the debt and maintained the appearance of growth. But the economy didn’t need growth. It needed to reduce personal debt levels and consumption and get a less leveraged balance sheet. The government encouraged the exact opposite.”

“Blah blah blah. Even Buffett thinks you’re wrong about gold. What’s that quote of his… ‘Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.’ What do you say to that?”

“Buffet is a better investor than I’ll ever be. And obviously he’s a smart guy. But surely he’s heard of Gresham’s Law.”

“Gresham’s Law. Bad money drives out good. Or to quote the late, great Harry Browne, ‘If an individual holds two types of money of unequal value, he will spend the bad money and save the good money.'”

“I’m afraid I’m not following you.”

“That’s because you’re a moron. But it’s the argument between owning all paper and at least some gold. You don’t convert all of your wealth to gold because right now, that’s not useful. You need cash to conduct transactions in the real economy. And when the government is inflating away systematically, it makes absolute sense to get rid of cash before its purchasing power diminishes. Trade it for tangible goods that DO have value or utility like whiskey, cigars, and bullets.”

“How about something less revolutionary like houses?”

“Maybe not a bad idea if you’re using cash and not debt. And it would be a good idea if the price of the asset wasn’t going to collapse imminently. You don’t want to convert your cash into a capital asset that rapidly depreciates in value, which is possible with house prices.”

“But isn’t that possible with gold too? You convert your cash into a tangible asset whose value fluctuates? And it doesn’t even pay a yield! And you can’t exactly live in it either.”

“Of course that’s all true. But the reason central banks and households own gold, and the reason people have hoarded it for thousands of years, is that they KNOW intuitively that gold is good money, sound money, and that paper money is generally not good money – especially when it’s being actively destroyed by bad fiscal and monetary policy. Generally it’s not something you have to consciously think about. Most of the time the money in your pocket is exchangeable for the things you want.”

“So what’s the problem?”

“The problem now is that people are beginning to understand that monetary inflation is theft. If you trade your labor for wages paid in the form of cash, and the government devalues that cash, it’s stealing your productivity. It’s trading its paper product for the fruits of your labor at a discount. It’s cheating you. Gold doesn’t cheat you. It doesn’t love you either. It doesn’t do anything. That’s why people prefer to hold some of their wealth in that form, for those times when they are being cheated by government.”

“Well, that’s pretty much all the time isn’t it?”

“You know what H.L. Mencken said about elections in democracies? He said they are an advanced auction of stolen goods. There’s a whole lot of stealing going on these days. A fiat money system is systematic theft because it’s based on unsound money. That’s what’s being exposed by this financial crisis. The entire funding model of the fiscal welfare state is collapsing because it’s based on debt and fraudulent, counterfeit money.”

“Hey, do you want to go see Avatar?”


We’re not saying people who don’t understand gold’s role as money are stupid – although maybe a few of them definitely ARE stupid. What we are saying is that it’s not rational to hedge against what you don’t know is coming. Most people have no experience with a currency collapse. So they don’t prepare for it. It seems so unlikely that it’s not worth hedging against.

Incidentally, until we start hearing this conversation in barbershops, we won’t be convinced gold is in a bubble. But in the meantime, if you are less dogmatic, a strategy for converting your equity holdings to something more tangible is just as practical.

Unfortunately for Ben Bernanke, the Fed can only make more dollars, not more gold. There are not many ready substitutes for precious metals. That’s part of what gives them their inherent value: their scarcity. Gold is not exactly unobtainable, like the “unobtanium” in Cameron’s Avatar. But it’s certainly getting a lot more desirable the more sovereign states go into debt they can never repay.

Dan Denning
The Daily Reckoning Australia

December 21, 2009

Editor’s Note: This article first appeared as “Sustainability of U.S. Deficits Reason Why Investors Own Some Gold” in The Daily Reckoning Australia. To view the original article, please click here.