Is a return to the gold standard on the horizon?

I’m not trying to scare you. But here are a few popularized quotes from Jon Maynard Keynes that you should pay attention to:

Keynes on fiat currency:

“There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.”

Keynes on the gold standard:

“In truth, the gold standard is already a barbarous relic.”

Keynes admits that a paper money system will only serve to hollow out the middle class and eventually destroy an economy. He also seems to suggest that a gold standard can never succeed as a monetary system.

He is right. And it is because of …

Government Interference

Policy of uninhibited money and credit creation funneled into limitless spending simply serves to undermine the wealth of the private sector. But it is done under the guise of softening business cycle downturns, thereby precipitating a cloud of complacency over the private citizens.

Somewhat contradictory, Keynes is well-known for his theory that suggests stimulating demand in order to mitigate the severity of business cycle downturns. In his book The General Theory of Employment Interest and Money, Keynes wrote:

“To dig holes in the ground, paid for out of savings, will increase, not only employment, but the real national dividend of useful goods and services. It is not reasonable, however, that a sensible community should be content to remain dependent on such fortuitous and often wasteful mitigations when once we understand the influences upon which effective demand depends.”

Sounds ridiculous, I know. But to his credit, I don’t think he intended government to implement crisis-thwarting measures to augment the business cycle boom. This is what breeds the malinvestment that contributes to “overturning the existing basis of society.” But then again, Keynes’ stuff is full of contradictions.

It is also because of government interference that Keynes recognized the gold standard as a barbarous relic. Such a hard-money system tied the hands of government’s spending power. That is, of course, until the government untied its own hands by breaking the rules. The gold standard really never stood a chance for reasons that can be chocked up to government power and, to a somewhat lesser extent, market forces.

Alan Greenspan wrote many years ago:

“In the absence of a gold standard, there is no way to protect savings from confiscation through inflation …

“… This is the shabbiest secret of the welfare statists’ tirades against gold. Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding statists’ antagonism toward the gold standard.”

So What’s Pushing
Gold Higher?

Over the last several months, the rising price of gold has been explained by saying investors are simply fed up with governments and their policies dictating the direction of fiat currency values.

It’s hard not to agree here. But an article from a few months back suggested rising gold prices should be mostly attributed to growing demand from China. The point of the article was to show that the Chinese are being encouraged to invest in gold and gold-related assets.

China, the world’s largest gold producer, imported 260 tons of gold in 2010; and their imports have increased mightily in 2011. And in the first quarter of this year, China passed India to become the world’s largest market for gold bars and coins.

But why are Chinese policymakers encouraging Chinese to invest in gold?

I’m sure many will tell you, as The Economic Times recently quoted an analyst saying, “The view that gold is an enduring store of value is firmly rooted in Chinese cultural traditions.”

Many will also tell you it is a means to reduce the risks of rising inflation in China as well as those risks in underperforming assets of the West.

Take a look at the two charts below. See the resemblance?

That is some compelling fundamental evidence, but much of the demand still revolves around negative market sentiment. Back in August a Gallup poll summed it up quite well: More Americans believed gold is better investment than anything else right now.

Another Keynes quote:

“Americans are apt to be unduly interested in discovering what average opinion believes average opinion to be; and this national weakness finds its nemesis in the stock market.”

Much of what’s enabled the process of printing money and bailing out banks, the process that engages all the hidden forces of economic law on the side of destruction, has been the focus on the financial economy. Unfortunately, the financial economy can no longer be the scapegoat if Americans lose interest in discovering what average opinion believes average opinion to be.

It is starting to look that way, ever so slightly!

Does That Mean a Return to the
Gold Standard Is on the Horizon?

Not a chance …

The power interests have too much to lose and too much power to lose it. It will likely take a near collapse of the current system before the market forces a change. Or, a major reform brought on by a rogue president elected to office by a public growing increasingly distrusting of the establishment could do the trick. But that, too, is unlikely.

Still, the market may actually bring about a mild transformation despite public sector and financial sector interference. That transformation would likely mean gravitation towards infrastructure and real-economy investments.

In order for this to happen, the public would need to openly reject the trajectory of credit creation and managed interest rates; the public would look to first protect capital and then aim to increase savings; this increased savings will be what drives investment in the real economy.

The hard part is finding the incentive to save when interest rates are kept so low. That’s why so many are more than happy to park their money in gold until the environment changes. A week and a half ago the Federal Reserve and ECB were both active in quelling market fears. The Fed only resorted to the usual “it’s there if we need it, and it looks like we might need it” rhetoric; but the ECB cut interest rates by 25 basis points. The kneejerk reaction from the market was “Hooray! A global QE3!” But this week the hangover has set in.

As investors sober up, risk appetite looks vulnerable. Are investors tired of being fooled by a monetary and fiscal mirage?

As long as the U.S. dollar index stays above that lower trend channel, a move up through 81 is very possible.

Best wishes,

Jack

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