The Fundamentals are...Fundamental

Atop the Stoa today, I'm pondering "Collective Fiction". Some might think of it as, "commonality of belief" or a "shared belief system".

For two thousand years, the Western world thought the Earth was flat. Obviously a collective fiction. Just because everyone believed it did not make it reality. For all of recorded history, gold has been the standard by which currencies are measured (no, I'm not including the wacky stuff from Sparta or Micronesia).

When sums demanded an unwieldy amount of gold to be transferred, bonds or certificates were issued that were redeemable in the amount of gold specified on the bond. Over time, this evolved into the paper currency of today. The problem was, our scale of operations was outstripping the amount of gold available to governments, so they began the time honored practice of debasing the gold or silver with copper, tin, and aluminum. Up until 1965, you could at least find a silver dime...but no longer.

Somewhere along the line, the idea of paper as a gold certificate became confused with the paper actually having the value of gold (non-redeemable). This blossomed into the "collective fiction" that a Federal Reserve Note was real money. It is just a piece of paper that is "redeemable" for...NOTHING. Just because it says that it is legal tender does not mean that it holds any real value.

The Fundamentals of anything are called "the fundamentals" because they are graspable truths from which more complex models can be evolved. If changes are made to the complex model without adjusting for the fundamentals (the 'givens') then the model will be flawed and fail over time. Gold is the fundamental unit of currency because there is a relatively stable supply of it in the world. EVERYONE wants it, therefore it IS valuable. It is money. The Federal Reserve Note, or FRN, is just a piece of paper-Fundamentally. Since 1933, FDR, and LBJ, the United States started to live with the fiction that the FRN WAS money. The rest of the world went along with it.

Since WWII and the massive economic dislocations of the post-war global economies, the FRN sure seemed like real money. The US printed it, said it was backed by gold reserves (which it collected as payment for various war debts), and people spent it. Life was good. Over time, the US got more ambitious with its spending and felt constrained by limiting the number of dollars as a function of gold holdings and in 1971 finally threw off the restraints. We told the world that we would never print more dollars than gold holdings, at least not too much more.

Go ahead and look up the total number of dollars in circulation starting in 1900 and ending in 2011. Economists will call it the "Money Supply". No, that is not a ski ramp on the right hand side, that is the number of dollars being printed and sloshing around in the world today. Grim.

Now, on to the boring stuff. Included below is a simply constructed chart of what the gold holdings in the world are and a simple comparison to debt:

Holdings (T) Oz. Value, as of 8/3/2011 Notes:
US 8,139 260,448,000 $434,531,443,200 1 short ton = 32,000oz
Germany 3,469 111,008,000 $185,205,747,200 32,000
IMF 3,217 102,944,000 $171,751,769,600
France 3,025 96,800,000 $161,501,120,000 Reserves accurate as to FY2007
Switzerland 2,590 82,880,000 $138,276,992,000
Italy 2,452 78,464,000 $130,909,337,600 AU value: 1668.4
Rest of World 30,000 960,000,000 $1,601,664,000,000
Totals: 52,892 $2,823,840,409,600 $2.8 Trillion in gold in govt. holdings.
Total amount of gold ever mined above ground: Slightly smaller than a tennis court.
140,000 4,480,000,000 $7,474,432,000,000 (19m x19m x19m)
Quantity of AU inflates by 2%/annual.
Current US debt, as of 8/3/2011: $14,348,765,058,280
All the gold in the world compared to US debt: 48%

This is quite interesting, given that the entire world has bought into the collective fiction that paper is money. Countries like Italy are running $1.7 Trillion dollar national debts, yet only hold $131 Billion in gold. All the western economies live on debt that they borrow and swap from one another. Where is the rationale, where are the fundamentals? Remember, you can ignore reality but reality will not go away. You may make it wait, but you will only make things harder on yourself in the end.

All the gold ever mined, all the gold ever ripped from Mother Earth, melted down and cubed would be about 3 feet shy of a Tennis Court. Yep, all the gold above ground since Man first noticed the interesting yellow metal. Every watch, wedding ring, gold tooth, you name it, fits into that cube. Roll out King Tut's bones on the floor and pitch his coffin in the smelter, his wife's ear rings too. Into the smelter. All the treasure of Philip II of Macedon...in the smelter. All coins, bars, and Alaskan prospecting...in the smelter. There you go.

All of it together, priced as of lunch time on August 3, 2011 comes out to about $7.5 Trillion dollars. The current US national debt, snapshot, of course, since it grows so fast, is $14.35 Trillion dollars, give or take. We are looking at all the gold in the world only equalling 48% of our current debt. Our current gold holdings are only valued at $435 Billion. Richest holdings in the world by far, but well below the $3.8 Trillion dollar spending binge Obama is on.

The dollar is falling and the price of gold is going up. The dollar has lost 20% of its value since Obama took office, yet the amount of gold in the world has only gone up by about 2%. This means that people are waking up and realizing that the FRN in their pocket really is no different then the shopping list wadded up with it. Gold is not getting more expensive, since it is no more and no less scarce than it was two years ago. The difference is that there is less confidence in the dollar.

The Fundamentals are fundamental. Gold is still valuable. It is still scarce. Dollars are rolling off the printing press as fast as they can feed a new roll of paper into the machine. The laws of Supply and Demand of immutable. The dead hand of Adam Smith guides us all. There are vastly more dollars in relation to the amount of gold in the world, so, therefore, the dollar will become less valuable the more you print.

It is a fiction that we have all lived with and going back to gold will be a difficult transition, but it is one we will likely be forced into, sooner or later. It is all just a matter of scale. Remember when you could buy a 1,500 square foot home for $18,000 and a Ford Mustang for $5,000? Remember when the price of gas was 20 cents per gallon? There is more gas in the world today, despite the increased number of cars on the road in relation to 50 years ago, yet gas is still near $4.00 gallon. Even taking out taxes, the cost of gas is about $2.50. Inflation is a real wealth killer.

For more than 5,000 years, gold has been the unit of value in the world. 60-70 years ago a bunch of government-types thought they could do better. Well, they didn't. The Federal Reserve is a JOKE; paper money has to REPRESENT more than just colored paper.

Ponder these items I have discussed. Test on Tuesday.

Live well.

--Zavost