The End of the Paper-Money Experiment
By Tom Dyson
October 22, 2008
Over the last few weeks, three people have told me they refuse to buy gold.
My dad told me gold is only worth what someone else is willing to pay for it. That it only has theoretical value. That he'd much rather own something useful, like copper.
Then the Thai politician I met in Bangkok told us he couldn't own gold because he didn't understand it or know how to value it.
Then one of my friends in England told me gold is a fraud and if it ever lost its appeal as jewelry, its price would plummet.
I've heard all these arguments many times. They almost always come from people who've worked in the financial industry. The truth is, gold is an incredibly useful commodity. Like any other commodity, supply and demand determine its price.
First off, gold has applications in technology and communication. Gold is the most malleable and ductile material known to man. Second, gold is eye-catching. Humans use gold for jewelry. That's never going to change.
But the third reason is by far the most important. This reason is the one that's going to send gold prices to the moon.
Money is essential to humans. We need it to trade. The material you make money out of must be portable, divisible, homogeneous, durable, and valuable. Without each of these five qualities, it's useless.
Gold and paper are the only two basic materials on Earth that can serve as money. (Silver and platinum might be good complements to a gold system.)
Right now, we're using a paper-money system. So gold isn't really important to anyone (except a few fringe investors on the Internet). It's why so many people don't understand gold, especially those who work in finance.
The flaw with paper money is, it's portable, durable, homogeneous, and divisible... but it's not valuable. It's only paper. So there's always a temptation to print money out of thin air. And that's what always happens. Paper-money systems always end up collapsing.
That's what's happening now. We're coming to the end of the largest paper-money experiment the world has ever seen. It may take a few years, but when it ends, whoever is in charge will implement a gold standard. Gold is the perfect foundation of a currency system. It's the only material we have that meets all five essential characteristics of money. It's the only available alternative.
But how high would you have to price gold to use it as a foundation of the world's monetary system? The money supplies of Japan, China, the United States, and Europe add up to around $50 trillion. There are 5 billion aboveground ounces of gold. You'd need to value each ounce of gold at $10,000 to back these four currencies in gold.
According to consulting firm McKinsey, the value of all the world's financial assets – stocks, bonds, and bank accounts – is $167 trillion. These assets are also denominated in paper currency. To back them with gold as well, gold would have to rise over $40,000 an ounce.
I'm not suggesting gold will ever trade at $40,000 an ounce. But it shows you how, unlike paper money, gold is a useful commodity and has intrinsic value. I do think gold is easily worth over $2,113 per ounce. That's the level gold set in January 1980 – $850 per ounce – stated in today's money.
To invest in gold, I recommend you buy physical gold and keep it hidden on your property. Pick up the yellow pages and look for gold brokers or coin dealers. Ask them what price they charge on gold bullion coins. Buy from the broker with the lowest price and the longest history of doing business in your town. If you don't have a coin dealer, call the guys we know: David Hall Rare Coins, Camino Coin, or Asset Strategies International.
One more thing, don't buy it right now. Physical gold is in short supply and prices are at rip-off levels. I called two dealers yesterday and both said they were out of stock. They told me they could get gold bullion for me, but I'd have to pay a large premium over the gold price to buy it... as much as 13%.
I recommend you wait for the panic to die down in the market and start accumulating gold when there's more gold bullion in the market.
Good investing,
Tom
Editor's note: Tom Dyson is a regular contributor to DailyWealth, a free investment newsletter focused on the world's best contrarian opportunities. We write with a simple belief in mind: You don't have to take big risks to make big money with your investments.
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IT'S TIME TO BOOK THAT TRIP TO AUSTRALIA
Today's column offers a rare "travel tip" to our readers... pack your bags for Australia!
Our "tip" comes down to purchasing power. You see, for much of the past six years, the Australian dollar was one of the world's strongest currencies. Australia's economy is dependent on commodity exports... so soaring gold, copper, oil, and uranium prices gave a huge boost to the country's prosperity, profits, and real estate. The Aussie dollar followed suit and almost doubled in value against other currencies from 2002 to 2008.
The strong Aussie dollar was fantastic for natives. Their dollars simply grew and grew in value for years. On the other hand, it was awful for Americans who wanted to go see kangaroos... The strengthening Aussie dollar vastly increased the U.S. dollar cost of a vacation.
But the past few months have been a classic "live by the sword, die by the sword" story for Australia. Commodities have had one of their worst quarters in history. The Aussie dollar has plummeted 30%... a colossal move for a developed country's currency. As you can see from today's chart, the Aussie dollar hasn't been this cheap since 2003... and "all things Australian" are on sale. Make sure to have a Vic Bitter and think of us.
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Currencies including the South African rand, the Mexican peso and Australia's dollar are undervalued by more than 20 percent based on inflation, productivity and terms of trade, Goldman Sachs Group Inc. said.
The three have been the worst performers of the 16 most-active currencies against the greenback over the past month, falling 21 percent, 18 percent and 16 percent respectively as equity markets and commodity prices tumbled amid a global credit crisis.
The currencies "offer considerable value from a medium-term perspective," Jens Nordvig, a Goldman strategist in New York, wrote in a research note dated [Monday].
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The worsening economic outlook is sustaining a high level of risk aversion on the part of lenders and investors.
Of course, this creates a self-fulfilling outcome as frozen credit markets and falling equity prices directly undermine the economy. The authorities fully understand that they must break this vicious cycle. For its part, the Fed has begun to rapidly expand its balance sheet, and it is under pressure to cut interest rates again soon.
The recently released Beige Book provided further confirmation that economic activity is weakening across the country, and there is little doubt that a deep rather than mild recession is unfolding.
A zero funds rate within the next few months is possible if financial conditions do not soon improve.
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