Tuesday, June 1, 2010

Gold: The Ultimate Fiat Currency?

In the financial weekly Barron's, Richard Wiggins makes the absurd claim that gold is the ultimate fiat currency. He reaches this conclusion by making every faulty argument ever made about gold. It pays to dissect this article to understand the errors that can be made when a fundamental understanding of gold is not to be found.

First, to attach the term "fiat" to gold can only be done with the most twisted use of the word "fiat". Every definition of fiat  revolves around the word meaning an an authoritative decree. The demand for gold is the exact opposite of an authoritative decree. In fact, it is a flight away from money that is used because of authoritative decree, e.g., the dollar. the euro. Gold became money in the Hayekian sense of spontaneous order and unintended consequences (BTW, the more sophisticated use of "unitended consequences" in which Hayek used the term)

Wiggins begins his attack by writing:
The gold bubble could continue to inflate. But it is much riskier now, and there are better ways to protect against inflation.
The truth of the matter is there is no better inflation hedge than gold. The reason gold is going up is because people, at a very basic level understand this. If countries are inflating their fiat currencies, then gold is a protection from this inflation because it can not be printed at will by the central bank of a country.

That said, I hasten to add that we are now in a period of zero money growth in the United States and Europe. The Federal Reserve and the ECB are simply not printing money at the present time. In other words, this is not a period of strong monetary inflation and thus gold may fall back in price short-term.

Wiggins then writes as a negative about gold that it:
... is a special commodity. Virtually every ounce ever mined -- whether for use in jewelry or anything else -- is still around. It doesn't rust or decay, and we keep mining more each year. It's not like oil, which we use up.
He seems to fail to understand that the fact that it doesn't rust or decay is a key to its becoming a money. Who would want a market where, say, bananas were the currency, i.e. a currency that would spoil after a few days?

As far as the actual supply of new gold mined each year, it is under 2%. Citizens of any country would be happy if  their central banks were limited to the printing of fiat currencies that was limited to under 2%.

Wiggins then goes from bad to worse:
Another part of the logic for gold-that whole flight-to-safety thing -- doesn't exist anymore. Maybe once upon a time, gold was a handy way to buy passage out of an oppressive country, but not anymore.
He writes this while at the same time telling us that:
Demand for physical gold is projected to rise to 52.3 million troy ounces, the highest in history; and sales of American Eagle gold coins have jumped 65% so far this year, according to the U.S. Mint.

Gold may be the "currency of last resort," but premiums on gold coins have soared to levels never before seen. One-ounce coins are now trading far above their bullion value, as people continue to chase them, and mints worldwide are unable to keep up with demand.
Sounds to me that a guard might accept a gold coin as a bribe. And remember what the Swiss have long said, "Gold has no smell." This applies now more than ever, when electronic tracking embedded in paper currency is just a matter of time, more and more will move to the use of gold as an anonymous form of transaction--, in the future, border guards may prefer gold coins as their form of bribe payment, since it has no smell or electronic tracking strip.

Wiggins then makes suggestions as to alternative inflation hedges. Among them the euro, which could be a good hedge if Wiggins is willing to guaranty any inflation losses if the Euro money supply expands by more than 2%. The strength of gold over the euro as an inflation hedge is that we know there won't ever be massive money printing of gold.

He also suggests that:
Investors afraid of 1970s-style inflation also should be buying Treasury inflation-protected securities.
Great idea, except for the fact that the inflation rate paid out by TIPS is based on government data as to what the inflation rate is. If you trust those numbers, let me know and I'll set up a personal money management consultation for you with Bernie Madoff.

Wiggins then manages to botch an observation of the Austrian school of economics. He writes:
A vital observation of the fun-starved Austrian school of economics is that investors err together, so unanimity of opinion is a danger sign.
The observation is in fact that central bank distortion of interest rates and the money supply cause investors to err in unison, a cluster of errors. The Austrian theory has nothing to say about unanimity of opinion. It is about distortions caused by central bank money printing, which, by the way, would be eliminated under a gold standard.

He then repeats the error of gold as a fiat currency. and then tells us that:
The only reason gold is valuable is that we believe it is valuable
This only means that Wiggins doesn't understand the Regression Theorem of Ludwig von Mises whereby Mises explains that although a commodity may now be used simply for its value as a medium of exchange, if we could historically regress in time we would find the point where the commodity was used for other purposes almost exclusively.

Bottom line: Gold may suffer from a short term decline here because of the lack of money printing by the Fed and the ECB, but this doesn't mean that gold is a "fiat currency". It doesn't mean that there are better inflation hedges than gold.

Wiggins knows just enough to be dangerous. He knows some of the lingo, and freely throws it around, but really doesn't know what the hell he is talking about. He uses the word "fiat" improperly. He absurdly claims that a TIPS bond is better protection against inflation then gold. He incorrectly disses gold as a method to bribe a border guard, and he completely misunderstands Austrian business cycle theory. In short, if you want to understand what a cluster of errors in analysis looks like, Wiggins article is what you need to read.

(Thanks to Nick)


  1. Fred Hickey, author of the High Tech Strategist newsletter, had a good discussion around Jan 2010 about gold and how it isn't a bubble. He compared it to the NASDAQ of late 90s/early 2000s and showed the difference between gold and a clear, obvious bubble.

    Maybe Higgins should be sent a copy.

  2. It isn't a "bubble" but it is likely to go down short term.

  3. Remember that the bolder the lie, the more people will believe it. So this guy went as bold as he possibly could with this subject.