Saturday, July 3, 2010

Is the Queen of England Sleeping with the King of Saudi Arabia?

Please forgive the absurd question in the title of this post. It serves only to point out the fact that not all kings and queens rule the same fiefdom, or, in fact, necessarily interact with each other.

This must be clear in mind to understand the fatal flaw in a recent post by Bob Murphy.

Murphy declares in response to a post of mine, where I declare "Cash (the dollar) is King," that Cash is Queen and Gold is King. He then points out that gold was up 10.8% in the second quarter while the dollar index was up only 6.19%. He is thus implying that cash and gold are of the same royal family. I vomit at the thought.

Yes, there may be times when gold and the dollar may both be up in price against other goods, but for the most part gold and the dollar are in battle to be the supreme money of the land.

At present, the dollar is the currency of the land, and getting stronger. Gold, on the other hand, is not the currency of the land, and may in fact begin to weaken in price against the dollar.

I am not arguing that this will always be the case, nor am I arguing that it should be thus. I am simply stating the facts the way they are.

Money is defined as a broad-based medium of exchange. If I walk into a snack shop and buy a $1.00 pack of gum, and attempt to pay for the pack of gum with a one dollar bill, a ten dollar bill or a twenty dollar bill, the clerk will have no problem accepting my payment. If on the other hand, I attempt to pay for the pack of gum with a one/tenth ounce gold coin, the clerk may,or may not, accept the coin, even though the coin is worth over $100 and I tell her she can keep the change.

It should, thus,be obvious that  the dollar is king. Gold is not as much Queen, as a King-in-exile., Will gold ever return to the throne? That depends upon the Fed and how much they run the printing presses. At present, they are not running them (as measured by M2). If the Fed continues this policy (unlikely), the dollar will remain the medium of exchange. However, if the Fed starts to print money, then the chatter will increase about  gold returning from exile to become King.

Whenever possible, I try to  talk to people who have lived through a hyper-inflation. Their respect for gold and how it was used in countries dealing with hyper-inflation is different than the theoretical understanding that American gold buyers generally have.They have real life stories of attempting to immediately get rid of any paper currency of the hyper-inflation country, and they have respect  for those who had gold during the hyper-inflation. In those countries a clerk would know the value of a one-tenth ounce gold coin and she certainly would take it instead of the hyper-inflation currency (if only to keep it for herself and pay for the gum out of her own pocket with the hyper-inflation currency).During such a period, no one  would view the paper currency as a Queen to gold as the King.

My reference to the dollar as king is reference to the fact that the dollar is the medium of exchange, and also reference to the fact that there is a huge demand to hold cash balances ( hold dollars) at present.

The falling prices in the capital goods market,and the general "lack of spending" is evidence of the demand to hold cash balances (i.e.dollars), in addition to the restructuring going on between the capital goods sector and the consumer goods sector. This is why I declared cash as king--not because of any specific movement between gold price and the dollar price.

The recent climb in the gold price can be attributed, as I have pointed out before, to the panic flight out of the euro (especially from Germany) and a climb in the desire by many in the states to own gold. But, as I have also pointed, there is a limit to this buying when there is no money printing by such central banks as the Fed and the ECB. The buying is finite, not like during a hyper-inflation when it is printed and printed.

Thus, at present, cash is king, a shaky reign though it may be.

One other point that must be tackled, that Murphy raises, is my use of M2 as my money measure of the money supply. Murphy links to the monetary base, which was skyrocketing. Murphy calls this "Bernanke writing checks to himself". Murphy does this since he knows this money is sitting as excess reserves that are not in the system, and thus not driving up prices, anywhere. 

If these funds start  to enter the system, it will be inflationary.It will weaken the dollar and strengthen gold, but none of this has happened to date.

In the real world, in order to make business and investment decisions,you need to know what is going on and what could go on, but they are two different things. M2 is the money that is in the system. It is not growing. The excess reserves are funds that could enter the system, but haven't as of yet. This difference must be made crystal clear to understand trends.

This means with the current trend, the stock market will remain weak, the dollar will remain strong and gold, most likely,will start to weaken. In other words, cash is king, for now


  1. Why even point out that the dow and other stocks went down and the dollar went up in the 2nd qt. if you can't include gold in the discussion. It is true that you can't use the gold to buy goods and services with gold, but you would have done better in the 2nd qt. holding gold over dollars. So as far as investments gold was king in the 2nd qt. over dollars.

  2. I love Bob Murphy, but he and the first responder are confusing the issue. Gold, today, isn't currency. It IS money. 5 years from now gold will be worth far more than equivalent dollars are today.

    If you are looking to buy assets, dollars/cash IS king. Gold, though, may suffer short term as assets such as gold are sold to cover current liquid cash/dollar needs.

    This squabble seems pointless. You're BOTH pretty, and I love both of you!

  3. Nice article. "The square root of 9" is grammatically incorrect, because 9 has two square roots.