10 November 2009

Willem Buiter Apparently Does Not LIke Gold, and Why Remains a Mystery

Dr. Willem Buiter of the London School of Economics, and advisor to the Bank of England, has written a somewhat astonishing broadsheet attacking of all things, gold.

I have enjoyed his writing in the past. And although he does tend to cultivate and relish the aura of eccentric maverick, it is generally appealing, and his writing has been pertinent and reasoned, if unconventional. That is what makes this latest piece so unusual. It is a diatribe, more emotional than factual, with gaping holes in theoretical underpinnings and historical example.

I suspect that commodities such as oil and gold are giving many western economists with official ties to government monetary committees a stomach ache these days. Perhaps this is just another manifestation of statists and financial engineers facing the music, as illustrated by the second piece of news from Mr. Buiter on the US dollar, from earlier this year.

Here are relevant excerpts from his essay, with my own reactions in italics.

Financial Times
Gold - a six thousand year-old bubble

By Willem Buiter
November 8, 2009 6:02pm

"Gold is unlike any other commodity. It is costly to extract from the earth and to refine to a reasonable degree of purity. It is costly to store."

This is inherent to its rarity. It is desirable because it is scarce and useful, and this requires greater protection against theft or accident. Euro notes are far more costly to store than the paper and ink which is used to make them, at least for now.
"It has no remaining uses as a producer good - equivalent or superior alternatives exist for all its industrial uses."
This is an absolute howler to anyone who cares to look into industrial metallurgy. Gold is one of the most malleable and ductile of metals, with excellent conductive properties, slightly less than silver and copper, but is remarkably resistant to oxidation; that is, it does not tarnish. It is widely used in electronic and medical applications for example. What limits its use is that it is scarce, it is expensive, and that there are other competing uses, not that superior solutions have been discovered based on their fundamental merits.
"It may have some value as a consumer good - somewhat surprisingly people like to attach it to their earlobes or nostrils or to hang it around their necks. I have always considered it a rather vulgar metal, made for the Saturday Night Fever crowd, all shiny and in-your-face, as opposed to the much classier silver, but de gustibus…"

Silver is indeed an attractive metal, and had been used for jewelry and coinage throughout history for its unique characteristics. Silver was the metal of the common man, and gold was the metal of kings because of its greater beauty and scarcity.

The garishness and lower class status of gold is of course reflected throughout history, in the funereal artifacts of the Pharoahs, the Ark of the Covenant, the mask of Agamemnon and the adornments of Helen of Troy, the exquisite beauty of the Emperors of China, and the treasure of the Aztecs. Perhaps Willem is merely used to the cheap 'bling' being sold in market stalls, and should occasionally shop on High Street for better goods.

"Because to a reasonable first approximation gold has no intrinsic value as a consumption good or a producer good, it is an example of what I call a fiat (physical) commodity. You will be familiar with fiat currency. Unlike what Wikipedia says on the subject, the essence of fiat money is not that it is money declared by a government to be legal tender.

It need not derive its value from the government demanding it in payment of taxes or insisting it should be accepted within the national jurisdiction in settlement of debt. Instead the defining property of fiat money is that it has no intrinsic value and derives any value it has only from the shared belief by a sufficient number of economic actors that it has that value.

The “let it be done” literal meaning of the Latin ‘fiat’ should be taken in the third sense given by the Online Dictionary: 1. official sanction; authoritative permission; 2. an arbitrary order or decree; 3. Chiefly literary any command, decision, or act of will that brings something about."

This is where Willem's tortured reasoning reaches a crescendo of nonsense. Firstly, we have already shown that gold has many industrial and decorative uses contrary to his misstatements, and has been valued throughout recorded history in its own right in diverse societies and cultures.

By his definition anything that is priced by the market is fiat. It is a broadening of the definition so as to make it completely useless, or a narrowing of the definition to a few 'essentials' by some unstated arbitrary measure so again to make it useless.

The definition of fiat with regard to an instrument of the state is perfectly well known, despite his attempt to distort it. The ruling authority makes a decree, and so let it be done based on that power. Willem seems to confuse a fiat currency with barter, or some traditional custom of value. What is customary is not 'fiat' but a popular convention ordinarily for fundamental reasons.

If a valuation is highly peculiar to a region and time it might be an eccentricity, like tulipmania or ladies fashions. But calling a mania a "fiat" degrades the language in an Orwellian manner, because one comes from the people and is popular, and the other from the authorities and is often embodied in the laws.

If something has universality, the likelihood is that it is well-founded on an essential reasonableness, satisfying some basic need and utility. People desire a store of value that is stable and reliable everywhere and anytime, and not subject to the vagaries of the local ruling elite. And the judgement of the history is that nothing fulfills that desire better than gold, or gold in combination with silver.

If a price is established by law without regard to the market, it is 'fiat.' That is the difference between a decision of the marketplace and a regulation from a ruling authority. No wonder English banking is in such a mess, if this is their conception of valuation. They can no longer see any substantial difference between the will of the people and the diktat of the state.

The best way to explain this perhaps is by example. Let us imagine that tomorrow young Tim of the US Treasury announces that the US government will no accept Federal Reserve notes in payment of legal debts, public or private, and that further the US was issuing a new currency called the amero for which Federal Reserve notes would be redeemed at 100 to 1, that is 100 FRNs for one

What would the market price of Federal Reserve Notes around the world do in response to this? Is this outlandish? No it is remarkably common in the history of paper currencies. I witnessed this personally while in Moscow during the collapse of the Russian rouble in the 1990s, and it made a distinct impression.

And what if young Tim decreed tomorrow that the US would no longer accept gold for taxes or provide as payment for its debts? Oops, too late. Nixon did that in 1971. And gold is now at $1,100 per ounce versus about $45 then.

A fiat currency is an instrument of debt, a bond of zero maturity, an IOU. It has a counterparty risk, and is not sufficient in itself.

That, Willem, is what is meant by fiat, the contingency of value upon some official source. If it were possible let Willem and I go back in time to ancient China, or even Victorian England, he with his pockets filled with euros, and mine with Austrian gold philharmonics, and we will see whose definition of value stands the better.

Governments can effect the price of any commodity negatively, by force of law, but its value is not contingent on government backing per se, except in instance of subsidy, but based on the utilitarian decision of the marketplace. Governments do not force people to buy gold, except indirectly through reckless management of the national economy. They do often compel a people to perform their economic transactions in the official currency however, so that it may be taxed, directly by percent, or indirectly through inflation.

Or as George Bernard Shaw put the proposition, "You have a choice between the natural stability of gold and the honesty and intelligence of the members of government. And with all due respect for those gentlemen, I advise you, as long as the capitalist system lasts, vote for gold."

I don’t want to argue with a 6000-year old bubble. It may well be good for another 6000 years. Its value may go from $1,100 per fine ounce to $1,500 or $5,000 for all I know. But I would not invest more than a sliver of my wealth into something without intrinsic value, something whose positive value is based on nothing more than a set of self-confirming beliefs.
It is fortunate indeed that Willem does not wish to argue this point, because his proposition on this score smacks of mere petulance. In the words of financier Bernard Baruch, "Gold has worked down from Alexander's time... When something holds good for two thousand years I do not believe it can be so because of prejudice or mistaken theory." And he is right, unless you are looking at history with very selective contortions.

There are also historical benchmarks for the value of gold, that being one ounce of gold for a man's suit of fine clothing that holds remarkably well. How then could anyone say that gold is in 'a six thousand year bubble?'

But why such an odd, almost hysterical essay now, with such an outlandish title unsupported by any data?

It is probably simply the rankling irritation that all statists and financial engineers feel when confronted by something that resists their control and manipulation. Or it may be related to some unfortunate decisions made by the Bank of England, or the Bundesbank, to enter into trades with the people's gold on the well-intentioned advice of their economists, a decision which is now coming back to haunt them, causing them to peer into an abyss of public anger.

Who can say. But there is a time of uncertainly in stores of wealth and currency coming. Below is a news article from earlier this year about a European economist named Buiter, who is predicting that the US dollar will collapse. That is because the US dollar is contingent on the actions of the Obama Administration, the Congress, and the Federal Reserve.

And gold is not, unless the US begins to emulate Herr Hitler. "Gold is not necessary. I have no interest in gold. We will build a solid state, without an ounce of gold behind it. Anyone who sells above the set prices, let him be marched off to a concentration camp. That's the bastion of money."

And Willem, if you do not understand that, the principle of the contingency of fiat money, you understand nothing of economics. But I think you do understand it. Perhaps you are merely grumpy and out of sorts today, having eaten a bad sausage, with a case of dyspepsia. It does happen, off days and intemperate remarks, but not to eminent Financial Times columnists and distinguished professors when they wish to be heard on important matters.

It seems as though Mr. Buiter just doesn't like what gold is doing right now, rising in price, and the real story may lie in why he and the brotherhood of western central bankers are so concerned about it.
"We looked into the abyss if the gold price rose further. A further rise would have taken down one or several trading houses, which might have taken down all the rest in their wake. Therefore, at any price, at any cost, the central banks had to quell the gold price, manage it. It was very difficult to get the gold price under control but we have now succeeded. The U.S. Fed was very active in getting the gold price down. So was the U.K." Eddie George, Governor Bank of England, in a conversation with CEO of Lonmin, September 1999
Financial Times
Willem Buiter warns of massive dollar collapse

By Edmund Conway
5:34PM GMT 05 Jan 2009

Americans must prepare themselves for a massive collapse in the dollar as investors around the world dump their US assets, a former Bank of England policymaker has warned.

"...Writing on his blog , Prof Buiter said: "There will, before long (my best guess is between two and five years from now) be a global dumping of US dollar assets, including US government assets. Old habits die hard. The US dollar and US Treasury bills and bonds are still viewed as a safe haven by many. But learning takes place."

He said that the dollar had been kept elevated in recent years by what some called dark matter" or "American alpha" - an assumption that the US could earn more on its overseas investments than foreign investors could make on their American assets. (I think it is related to a subsidy, a kind of droit de seigneur, granted to the dollar by the central banks as their reserve currency in lieu of a gold standard. And that is the regime that is collapsing with the overhang characteristic of a Ponzi scheme. - Jesse) However, this notion had been gradually dismantled in recent years, before being dealt a fatal blow by the current financial crisis, he said.

"The past eight years of imperial overstretch, hubris and domestic and international abuse of power on the part of the Bush administration has left the US materially weakened financially, economically, politically and morally," he said. "Even the most hard-nosed, Guantanamo Bay-indifferent potential foreign investor in the US must recognise that its financial system has collapsed."

He said investors would, rightly, suspect that the US would have to generate major inflation to whittle away its debt and this dollar collapse means that the US has less leeway for major spending plans than politicians realise..."