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Gold, bitcoin and the dollar

Connecting some scary dots in the undercurrent of market turmoil.

Are we seeing signs of a return to gold-backed currencies? It’s a valid question in the light of a deal now being implemented between China and Russia. China, the world’s biggest oil importer is de-dollarising its oil bill with its biggest supplier, Russia, by paying in yuan that can be converted into gold. That, in effect, means gold backing for a major currency in a highly significant international transaction and which will be extended to cover the total $116 billion per annum Chinese oil bill.

China is expected to buy 1 000 tons of gold this year, India a further 900 tons, and Russia has been consistently topping up its gold reserves from an average 715 tons to more than 1 700 tons in the last quarter. Together, these three countries have been absorbing gold nearly equal to annual newly mined gold. In addition, China has launched yuan-denominated gold contracts in exchanges in Shanghai and Hong Kong.

These developments have hardly featured in explaining gold’s 11-month high in past weeks, focusing rather on geopolitical tensions. It’s another reflection of the short-term perspective of derivatives and paper trading which now set a global gold price totally removed from physical supply and demand. This graphic by the London Bullion Market Association published by Zero Hedge and the Bullion Star shows that 15 000 times more unallocated gold is traded than there are reserves.

 

Following derivative short-term thinking, gold seems for the most part to be viewed as a palliative for paranoia, ignoring its significant monetary potential as an alternative to paper currencies, especially the United States dollar. Yet, how strong is the mighty greenback? And can deliberate de-dollarisation by large countries be ignored?

Recent market trends reflect again a simple link between dollar strength and the performance of the American economy. GDP growth is the ultimate rainmaker and statistical indicators move markets in short-term bursts. Largely ignored is the most important ultimate health of an economy and strength of its currency – the national debt. In the wake of hurricane havoc, $15 billion in victim relief gave good cause to waive the United States government $20 trillion debt ceiling until December. The fact that US Federal government debt has nearly tripled in about ten years, with little prospect of a slowing down in the next five, must pose a threat to the country’s long-term health.

Debt creation is contained by raising interest rates. But that means a substantial proportion of government revenue has to go to debt servicing. (A 1% increase in rates adds $200 billion to interest payment.) It also curtails consumer demand and therefore economic growth. Until recently the Federal Reserve board has been acting completely counter-intuitively to that but when you approach zero interest rates and keep on adding more debt, you have clearly reached a cross road. The hesitant and modest Fed rate hikes reflect the difficulty in reversing that trajectory.

And then there’s the diminutive bitcoin, now in its third bubble deflation/burst/correction in as many years and punching way above its weight in terms of public attention. It’s a bit sad, really, because it detracts from its still promising potential of revolutionising money. Paul Donovan of UBS Wealth Management believes that it never had and never will have that potential (See Moneyweb article here). Others, such as JP Morgan’s Jamie Dimon and our own Mike Schussler, have weighed in on its alleged fraudulent nature. 

Howard Marks, The Oaktree Capital co-chairman shared that view until a few days ago when he wrote: “Bitcoin fans argue that it qualifies as a currency under these criteria: most importantly, it’s something that parties can agree to accept as legal tender and a store of value. That actually seems right.”

But then he comes to the crunch: “… I found myself admitting that much of the criticism I had levelled at bitcoin is applicable to the dollar as well.”

The two main functions of money, a stable means of exchange and store of value are flawed even in existing fiat currencies, and crypto has already shown that an alternative is possible. The current rush reflects, at least in part, growing distrust in alternatives. People confuse “store of value” with “appreciating investment”. Store of value simply means being able to store and preserve the value of your cow, chicken, or labour in a safe way. Only then does it live comfortably with means of exchange. When it is subjected to speculative investment its means of exchange status is disturbed, but not necessarily lost.

Crypto is such a new, complicated phenomenon that any speculation about transaction costs, booms and busts, bubbles and bursts, usage, security, ultimate winners and losers, regulatory framework, taxation and indeed the real value of the crypto itself is premature, albeit valuable to its development. With its widely trusted blockchain technology, bitcoin may well morph into something different, or even be replaced. But it will be difficult to replace the decentralised nature of bitcoin. Control of money through central banks, banks and governments is simply no longer trusted. Likewise, central control of a crypto currency will suffer the same fate.

Despite extreme volatility, bitcoin’s price has clearly shown explosive demand. Until one can clearly determine where that demand is coming from, how long it will be sustained and at what price, can one start predicting and charting its course. The same goes for the plethora of other cryptos, some good and some absolutely rotten, that enter this space and dilute the offering.

But it’s a huge playground, as shown in this table of investment and speculative deployment of money. It was extrapolated from a graphic worth looking at here, and published by the Visual Capitalist. The figures are not fully comparable with each other because I updated some of them.

Instrument

Value

Bitcoin

$70 billion*

All crypto

$150 billion*

Gold

$7.8 trillion

Stock markets

$70 trillion

Broad money

$80 trillion

Global debt

$200 trillion

Derivatives

$630 trillion to $1.2 quadrillion

 

(*latest. Other 2015)

*GLOBAL GDP (PPP)

$130 trillion

 

Source: Visual Capitalist

One simply cannot begin to calculate cryptocurrencies’ share or potential share of the total and much of the criticism levelled at cryptocurrencies can be levelled at many of the instruments shown. But connecting some less apparent dots creates a much more disturbing picture: the overwhelming weight of finance over the real economy, which is GDP and key influencing factors such as debt. Clearly finance is no longer being informed and driven by GDP, but is driving it! And in the worst possible way of trying to extract maximum short-term, speculative gains! It reverses an old and wise economic law – enterprise leads and capital follows.

It explains a lot about what is wrong with the world.

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COMMENTS   19

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Hey Jerry

Glad you have become a money scientist truth seeker and I am happy to have helped you along the route in my small way.

Just a couple of points that need to be laboured. Rising interest rates are not necessarily bad for the US regime as it reduces the burden (retirement value) of existing debt. Also do not forget that interest rates are a market phenomenon. The market leads and the Fed follows. The Fed influences rates not by decree (setting rates) but by bond purchases. The reason for the ZIRP (zero interest rate policy) was do destroy interest rates by mass bond purchases to stave off a deflationary debt collapse where all the money in the system is sucked into feeding the rabid debt monster. This, as you know, is simply the result of using irredeemable debt as money. The issue (irredeemable debt money) that caused the GFC are still very much alive. The Fed is merely kicking the can down the road.

When society recognises that they have been conned and the medium of exchange is a form of debt enslavement, things will have to change. Gold is the form of money that is nobody’s debt hence gold back currencies are redeemable and one can expand the money supply without a concomitant increase in debt. This will not mean the end of a central bank or fractional reserve banking but will mean the end of the free lunch for the financial sector, the end of bond (interest rate) speculation and of course the welfare state. RIP- I shed not a tear.

China, I believe, will lead in this regard with gold backed currency and if the US does not follow they will lose their super power status.

There are some problems with gold. The total amount is barely more than 5% of the world’s GDP and far less than the total wealth in the world. Unless the value of gold increases drastically there is simply not enough of it to replace currencies. How would you buy a house? You talk about debt enslavement, would you be required to save the full price of the house, in gold, before you could buy it? Carry a bag of gold with you all the time? What about multibillion dollar deals? How would they do it if currencies are not acceptable? Also gold can be regarded as one more product like bread. During and after WWII some people were prepared to exchange their wedding ring for a loaf of bread. Does it mean that the value of bred increased so much or the value of gold dropped? My father was in a Russian prisoner of war camp and he could exchange a single cigarette for a day’s food ration. In the camp cigarettes were far more valuable than gold because the prison guards simply confiscated any gold if they noticed it.

Your arguments are not really thought through here. You must remember your comparing a physical asset with an over indebted financial sector. Also econ 101 a currency is as valuable as the demand for it. If gold starts to be used to back currencies its value with skyrocket so you should solve that issue and dollar value will drop.
Does you company pay you with a wad of bills? No. That would be stupid. Were talking about gold backed currency. Salt was a currency back in the dark ages, but I dont see you trading cigarettes for salt. Currency should just be a means of wealth trade and storage. As long as both parties see it as valuable then the trade can commence.
This issue is as the article says; the financial sector has hijacked and is driving everything including GDP and it shouldn’t be like that. We need a better way to determine value and hopefully gold or a decentralized currency will be a start.

Negative, Hun. The concept of a gold backed currency is simple. All a gold standard involves is a promise to pay x$ (or rand, pound etc) for yOz or vice versa. The currency is as “good as gold” because it can be exchanged at a fixed rate. Simple. That’s it.

Nowhere does it state that each currency unit must have a equivalent amount of gold stashed somewhere in a vault. The demand for the currency is controlled by interest rates of gold bonds (bonds that are as good as gold).

If interest rates are too low then people junk overpriced bonds and invest in physical gold which pays no interest. This is a signal to raise interest rates. If interest rates are too high then people would rather hold the gold bond which pays interest in gold and junk the metal.

I would imagine purchasing a house would be no different than today. You would apply for a loan in the currency of your residence and repay this over time. The difference would be the loan value would not be debased by inflation and consequently interest rates would be low.

When shopping you can use your plastic card or cash as you do now. The difference is that the value of the currency is not being stolen on an ongoing basis by debasement and remains convertible to gold at a fixed rate. Prices tend to be stable but price fixing is absolutely not the purpose of the gold standard.

The best two things about a gold standard are the stabilisation of interest rates and thus bond values as well as the fact that you will no longer use irredeemable debt as a means of exchange. When money is created it is created as an interest bearing debt which grows exponentially and is what gives fiat its value- it is owed by someone. Every cent. There is no way to pay the debt as the money in circulation is always less than the debt. The current approach is to debase the currency by a few per cent annually but eventually the debt gets out of control leading to crashes, QE and more debasement i.e. robbing you of the value of your money. Under a gold standard there is an ultimate extinguisher of debt. Gold. Money that is nobody’s liability.

The Hun, take a look at this series on what money is, and the role of gold on youtube: Hidden Secrets Of Money Ep 1-5 by Mike Maloney.

Also, everything you wanted to know about Gold as money, and then some: http://fofoa.blogspot.co.za/

I forgot to add one other problem with gold. At the moment the value of it is close to the cost of production. There are millions of tons of gold in the soil and even in the seawater (just google it), what would happen if somebody invents a method of robotic extraction of this extremely minute percentage at the cost of say 100$/oz? What if they discover a meteor with large gold content and successfully mine it? Would the entire economy collapse due to the fact that the increased availability of gold would introduce an incredibly high inflation (in gold)? What would happen to the value of the gold backed currencies? I think an arbitrary element like gold was ok to base the economy on in the middle ages but in the 21st century it is anachronistic. There are several far more rare and more expensive metals, why not one of them (not that I actually advocating it)? Also, unless payments are made in physical gold, who would hold it for me, the banks? They could fake their gold holdings just like the Greeks faked their balance of payment precipitating their economic troubles.

Negative. The average concentration of gold in soil is about 0.8ppb i.e. about 800mg per 1000 tonnes. This will never be mined. The seawater story is just that. A dream.

I think you mean meteorite not meteor. Mining something entering the atmosphere at ~30km/s might be tricky. You are correct in that a lot of gold suddenly introduced into the equation could spark off inflation as happened when the conquistadors returned home from South America. The purpose of the gold standard is not to stabilise prices but interest rates as well as have a debt extinguisher.

Given what we know about the geochemistry of the earth, gold is a rare metal for a reason. When the earth accreted (came together) and melted, it differentiated. Almost all the gold, platinum group elements, nickel, cobalt and iron went to the core leaving very little in the crust. That is why platinum is more abundant than tin in the earth overall but the tin is overwhelmingly in the crust and the platinum in the core and also why gold is very scarce. This is establsihed science.

The choice of gold as a monetary metal is not mine. One must differentiate between monetary metals and scarce metals. Scarce metals (platinum, palladium) follow the usual supply – demand fundamentals. Monetary metals (gold, silver) on the other hand have a very low declining marginal utility. There is 120 years of gold production sitting on the surface yet the price keeps increasing. Can you imagine what would happen to the price of copper if 120 years of copper production suddenly materialised? Very low declining marginal utility means that the demand is almost insatiable unlike scarce metals. Simply because mankind has chosen gold as the ultimate currency.

You ask how someone will be able to buy a house under the gold standard. The answer to this question is the biggest motivation for being on the gold standard. The price of a house in ounces of gold is relatively the same as what a similar size house would have cost a 100 years ago. House prices did not rise, it is the purchasing power of the fiat currency that declined. The effect of inflation does not cause the inflation-adjusted price of property to rise, but does in fact cause the affordability of the house to crash along with the declining purchasing power of your salary.

The current value of gold does not begin to reflect the monetary value because gold is a mere commodity during the times when there is a fiat currency system, the same way a fiat currency is worthless during the times when there is a gold standard. Under the gold standard, with full backing, not fractional reserve banking, the value of gold will reflect the need for currency. You don’t need more ounces of gold because the value of the ounces in circulation will be sufficient to fund all viable projects that can repay the loan.

It is under a system of fiat currencies that interest rates are so low that projects that are not viable, are able to attract funding, only to go bankrupt when interest rates rise. Think of the fracking industry. If you take into consideration the effect of QE on the price of money it is similar to interest rates being a negative 27%. This is how fiat currencies implode to be replaced by the gold standard. The world experienced this cycle in the development of money for more than 2000 years. Don’t expect this cycle to end merely because some people call the current monetary system “modern”.

@Richard
I did not mean meteorite, I meant the stuff flying around in space, meteors, space junk, comets, planets and mainly asteroids, or in other word, mining in space.
I am prepared to bet that in my lifetime no major country will return to the gold standard. It would be simply totally impractical. However much people complain about fiat currencies and fractional banking and however much gold bugs hope that it will happen gold standard is over. I think there is more chance for the total collapse of civilisation than gold standard.

Thanks, Hun. The feasibility of mining asteroids/comets (the distinction can be blurred) does not currently stack up. The amount of energy to get a spacecraft to escape velocity ~7km/s is about 30 to 100kg/kg. For a ten tonne space craft this would require 300 to 1000 tonnes of fuel. Iron-nickel rich asteroids are rich in platinum group elements as they presumably formed the core of the planet that broke up to form them. These things move around at insane velocities (10s km/sec) relative to earth so the spacecraft would have to move into this orbit (mass fuel use), dock, mine, refine and send a pod back to earth’s orbit with the precious metal product (mass fuel use). The gold in a the average iron asteroid is only a few ppm, similar to the average mine although platinum group elements can be high up to 50ppm (10x a Bushveld mine) so the economics don’t remotely stack up.

As for returning to the gold standard (honest money), the obstacles are vested interests not impracticality. Bond speculation, currency manipulation, the welfare state, bloated government are the main recipients of the largess of fiat. Irredeemable money is the most effective device
ever devised for defrauding the innocent of their wealth.

China and Russia are stockpiling gold. Why?

No country has ever declared in history that they will categorically not return to a gold standard. Why?

Thank you Richard. I’ll never stop learning and deeply value teachers wherever I find them! I suppose the real question to be asked is whether we can trust any price anymore.

Hi Jerry,

Thanks for the great article. Please excuse my ignorance but could you tell me what would happen if there were a run on Bitcoin today please? Where are the funds and what is it’s NAV? Is this info availabe and accessible to give a potential investor some form of comfort?

Gold is all well and good, but the reasons that countries went off the gold standard in the past still remains. We’re just flipping from the failure of fiat to a failure of gold (by failure I mean countries keep abandoning it)?

Excellent article. Cryptos have barely been born. Until recently, this was the preserve of nerds and propeller heads. Only now is the commercial use starting to be explored but still barely understood. Debate around intrisic value is therefore meaningless and will be so for some time. In time, the use case will become clearer, adoption as a medium of exchange will grow which will lead to more trust, a better understanding, less volatility and ultimately a fully accepted modern-day currency. The rest is just noise.

Excellent article. At least some people are seeing the potential. So maybe the 1st guy that makes the invention fails. (bitcoin) Here’s looking at you Microsoft tablet and google glass, but it opens the way for better and improved developments.
The whole idea isnt to destroy any of the current paper currencies. Countries will ALWAYS have a local currency. The idea is to create a counter weight, something to measure your “dollar” against. Unless there is an actual production efficiency or increase in cost the cost of things dont really go up or down much. However the value of your dollar does go down. Inflation is a hidden tax meant to make debt cheaper over time. And who holds the largest debt you guessed it… governments.
For me the biggest thing about decentralized currencies is to keep government more honest. How the hell China and Russia are heading this up is beyond me tho.

Jerry, thank you for your regular articles. Luckily it is published on a Friday because I need the whole weekend to contemplate it…..and then Richard the Great adds another layer of thought-provoking ideas.

After the Nixon Shock of 1971 the USA needed an alternative backing for gold. They fraudulently broke the Bretton Woods agreement by writing more cheques (dollars) than they had gold reserves “in the bank”. They made the brilliant deal with Saudi Arabia to trade oil in Us Dollars, thereby in fact backing the dollar with oil.

So, even if your currency is backed by gold, the currency can still be devalued because of the fractional reserve banking system. The only way we can ever have “honest” money that will be a store of value and trusted means of exchange, is if the world is on a gold, silver, platinum (even rhino horn will do) standard, without a fractional reserve banking system and without Central Banks.

Politicians desperately need the monopoly on the creation of money to keep on bribing their voters with socialist projects. This means that no country will abandon the fractional reserve and Reserve Bank system. Further, the USA won’t sit idly and watch the competition (Russia and China) pull the rug from under the dollar by destroying the petro-dollar backing for the dollar, by transacting in alternative currencies. Because the Dollar is an international, reserve fiat currency, it only has value because the US military stands ready to enforce it’s use, in international transactions.

This gets us to the point – we should see America’s perpetual wars, the sanctions against Russia and the tension and turmoil in North Korea against this background.

Great comments but let me explain what is currently taking place. We are in the early days of a new economic model, the crypto economy. Away from the slavery mankind has been exposed to for centuries, thanks to distributed ledger technology aka blockchain.

Depending on the blockchain referenced and in Bitcoin’s case moving from an inflationary monetary system to that of a deflationary one. In effect bringing power to the people and not to the elite. The banks ala JP Morgan et al. is so shit scared that they are using the MSM to their utmost best to discredit Bitcoin, why because they cannot control it. For those that are saying Bitcoin is a farce and backed by nothing, I say the biggest farce is the USD, printed into oblivion by the FED. It is only governments and our own believe system that gives the USD value. Paper money is coming to an end, and is already happening throughout the world.

Will Bitcoin be the new “currency” taking the USD’s place, probably not. For that there is a multitude of others coming to the fore. In all probability, we will have many digital currencies that are transferable between each other like we have today with the USD/ZAR/AUD etc.

Bitcoin experienced a hard fork end July into what in knows as Bitcoin Cash (BCC), which is the “eastern owned” i.e. Chinese version of Bitcoin. The Chinese whom is sitting on US treasury notes will be selling this into BCC over time to rid themselves of the USD. The USA will within the next year or two experience hyper-inflation. In November, the original Bitcoin will be forked again into what will be known as Bitcoin Segwit 2X, effectively rewriting the rules (code) of the original Bitcoin in so be able to manipulate and control Bitcoin even further by the very institutions we as normal slaves trying to free ourselves from.

Platforms are being built to make all of this possible, with Ethereum (created by Vitalik Buterin) in the lead and “western owned” and NEO the Chinese version of Ethereum. On top of the platforms is where the new world awaits, through the creation of dApps, distributed applications and each underpinned by its own “currency” or alt coins (alternatives to Bitcoin). Think of any sector today, all of them will be replaced by the crypto economy. From derivatives, to banks, to power grids. There are hundreds of these solutions already in the making. Go have a look at https://lbry.io the new decentralised YouTube or https://steem.it the new (old) FaceBook. Peer-to-peer power such as https://powerledger.io

As a type, this the whole crypto market is going through severe stresses with losses of 30%+, trying to unsettle early adopters and the “weak hands”. China “banning” Bitcoin and crypto exchanges is all efforts by governments to slow down the process and find ways to play the same game – only to realise their time is running out.

By June next year EOS will launch, https://eos.io – Who is EOS – some say the Ethereum killer – go check it out. The creator thereof Dan Larimar a mathematical genius and also the creator of Steem.it and Bitshares (a decentralised crypto currency exchange).

To end of those that think we are going to see a stock market crash soon is wrong. What in fact is taking place is business buying back its own stock and who all have joined the https://entethalliance.org. The same stock being replaced by “tokens” on the Ethereum platform and by doing so transition into the new crypto economy.

My prediction for Bitcoin is USD 7K by year end and USD 12K or thereabout by March 2018. Less than 2% of the world is in crypto today, by January next year it will be 3%. Once we hit this number nothing is going to stop it.

Thanks LouisBotha

On the button !!

And what I have been saying all along.

In addition, to all those naysayers of crypto, I say : ” It might not be perfect, but its the BEST we got right now.

Period

Thanks LouisBotha, ek kon dit nie beter verduidelik nie. Wie nie wil verstaan wat aangaan nie het Satoshi gese as jy nie verstaan nie het ek nie tyd om the verduidelik nie. Wat sad is, is teen die tyd dat ons arme mense wat mislei word deur die mense wat hier nog steeds goud en geld verkondig wakker word is bitcoin klaar in die hande van die res van die volke en on ons bly arm en kan net Sathosi’s bekostig wat in die toekoms self $1mil elk kan wees. Dis as mens dit met fiat as dit nog bestaan kan koop. Arbeid is al wat dit sal kan koop en dan is die wat nie nou verstaan nie se kinders slawe in die toekoms.

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