Video: Mark Thornton on How Silver Money Kept Inflation in Check

From the Mises Blog

Much of the history of Philippine money has been in commodity: gold/silver. This is until the US Congress enacted the Philippine Coinage Act.

Sanctions Against Iran Spurs Burgeoning Use of Gold as Money in the Middle East

US sanctions against Iraq has been promoting the use of gold as medium of exchange in the Middle East, particularly the Iran-Turkey-Dubai corridor.

From Reuters:

Couriers carrying millions of dollars worth of gold bullion in their luggage have been flying from Istanbul to Dubai, where the gold is shipped on to Iran, according to industry sources with knowledge of the business.

The sums involved are enormous. Official Turkish trade data suggests nearly $2 billion worth of gold was sent to Dubai on behalf of Iranian buyers in August. The shipments help Tehran manage its finances in the face of Western financial sanctions.

The sanctions, imposed over Iran's disputed nuclear program, have largely frozen it out of the global banking system, making it hard for it to conduct international money transfers. By using physical gold, Iran can continue to move its wealth across borders.

"Every currency in the world has an identity, but gold means value without identity. The value is absolute wherever you go," said a trader in Dubai with knowledge of the gold trade between Turkey and Iran.

The identity of the ultimate destination of the gold in Iran is not known. But the scale of the operation through Dubai and its sudden growth suggest the Iranian government plays a role.

The Dubai trader and other sources familiar with the business spoke to Reuters on condition of anonymity, because of the political and commercial sensitivity of the matter.

Iran sells oil and gas to Turkey, with payments made to state Iranian institutions. U.S. and European banking sanctions ban payments in U.S. dollars or euros so Iran gets paid in Turkish lira. Lira are of limited value for buying goods on international markets but ideal for a gold buying spree in Turkey.

ROUTING VIA DUBAI

In March this year, as the banking sanctions began to bite, Tehran sharply increased its purchases of gold bullion from Turkey, according to the Turkish government's trade data.

Direct gold exports to Iran from Turkey, long a major consumer and stockpiler of gold, hit $1.8 billion in July - equivalent to over a fifth of Turkey's entire trade deficit in that month.

In August, however, a sudden plunge in Turkey's direct gold exports to Iran coincided with a leap in its sales of the precious metal to the UAE.

Turkey exported a total $2.3 billion worth of gold in August, of which $2.1 billion was gold bullion. Just over $1.9 billion, about 36 metric tons, was sent to the UAE, latest available data from Turkey's Statistics Office shows. In July Turkey exported only $7 million of gold to the UAE.

At the same time Turkey's direct gold exports to Iran, which had been fluctuating between $1.2 billion and about $1.8 billion each month since April, slumped to just $180 million in August.

The Dubai-based trader said that from August, direct shipments to Iran were largely replaced by indirect ones through Dubai, apparently because Tehran wanted to avoid publicity.

Perhaps US imperialist policies will backfire in the context of the degeneration of the US dollar as the world’s foreign currency reserve.

Doug Kass On Gold As ‘The Emperor's New Clothes’

Investment manager Doug Kass predicts that gold will plummet in 2011 by $250 or about 17-20% from current levels.

He writes,

Surprise No. 9: The price of gold plummets by more than $250 an ounce in a four-week period in 2011 and is among the worst asset classes of the new year…

My surprise is that next year the price of gold has the potential to become the modern-day equivalent of Hans Christian Andersen's "The Emperor's New Clothes," a short tale about two weavers who promise an emperor a new suit of clothes that are invisible to those unfit for their positions, stupid or incompetent. When the emperor parades before his subjects in his new clothes, a child cries out, "But he isn't wearing anything at all!"

With a finite supply, gold has historically been viewed as a tangible asset that increases in value during uncertain (and inflationary) times. No wonder it has become such a desirable asset class following the Great Decession and credit crisis of 2008-09. Gold bugs remind the nonbelievers that for thousands of years, gold has been a store of value and, given the current state of the world's financial system, gold is the best house in a bad neighborhood of asset classes.

But gold, which may be the most crowded trade around, is viewed now as a commodity for all seasons -- during inflation, deflation, low or high economic growth.

There is a body of thought that maintains gold holds little intrinsic value, that it is only a shiny metal with limited industrial value that throws off no income or cash flow (and, as such, its value cannot be determined or analyzed with any precision based on interest rates or any other measure).

Mr. Kass argues that gold has been rising out of misplaced faith or equivalent to a “religion” (with reference to gold bugs), which apparently has been spreading like wildfire.

When we say people adapt a faith or religion based outlook, this extrapolates to fundamental evidences being discarded in favor of a desired outlook or outcome. In short, a form of rational ignorance or deliberately sidelining information that opposes on one’s belief.

Here Mr. Kass parrots the mainstream view that gold has little intrinsic value (commercial value) even while citing the role of gold as money for thousands of years which of course is a self-contradiction.

Mr. Kass does not mention how and why gold, among many other commodities and the paper money system as competition, emerged as money for thousands of years. And this would be similar to abandoning evidence or yet represents as another form of rational ignorance.

It is important to remember that one of the most essential functions of the emergence of commodity money is its marketability. And what is seen as marketable is likewise seen as having high commercial value. Of course the other important qualities of commodity money would be its being divisible, durable, recognizable, homogenous, high value per unit and scarcity.

Well I don’t deny that gold may correct given its recent steep rise as no price trends goes in straight line even as gold prices seem to be consolidating at the moment.

But I wouldn’t depend on the dismal track record of Mr. Kass’ predictions, since he also predicted gold prices to fall back to $900 levels for this year, which palpably went to the opposite direction.

And given that most of what he predicted didn’t emerge in 2010: strong US dollar, falling treasury yields, war in the Middle East, retirement of Warren Buffett, Central bank tightening and etc…, most which I rightly argued against, this only goes to show how fatal wrong predictions from a “faith” based analysis can be.

To give credit to Mr. Kass, he had been right that the stockmarket would correct by 10% during the first half of the year. But his overall predictions went the opposite way.

If gold bugs have been blindly bullish, as Mr. Kass alleges, so has Mr. Kass been perfervidly bearish and apparently in staunch denial, which after all, just shows that gold “atheism” can also signify a form of rational ignorance that is likewise cut from the same cloth as with gold bug zealots-dogmatism.

Financialization of Commodities: Boon Or Bane?

A Wall Street report recently highlighted on the "financialization of commodities" or the increasing role of commodities being used as investment assets.

They cite a study from Ke Tang at Renmin University in China and Wei Xiong at Princeton University which showed of the growing correlation between prices of commodities with stocks and the US dollar. Mr. Tang and Mr. Xiong writes,

``We find that concurrent with the growth of index investment, commodity prices have become increasingly correlated with the world equity index and US dollar exchange rate, and with oil. In particular, this trend is more pronounced for commodities in the two popular commodity indices, the GSCI 25 and DJ-UBS indices. As a result of the financialization process, the spillover effects of the recent financial crisis contributed to a substantial part of the large increase of commodity price volatility in 2008."

In addition, this has been used by some to cast a bearish light on commodities price trends.

Analyst Simon Hunt is bearish on copper, ``This economic scenario is not conducive to a strong trend growth in world copper consumption let alone to its declining intensity of use, a result of high and volatile copper prices. Moreover, copper’s end users, together with their fabricators, are fully aware that prices have not been driven by real fundamentals, but by the growing intrusion of the financial sector into treating copper, as for other base metals, as an alternative investment." (bold highlight mine)

Well in my view, financialization of commodities isn't a reason to be bearish.

This reflects on the deepening of capital markets in search of higher yield from relative returns, it also signifies the market process of discovering alternative havens or 'store of value' from inflationism and even possibly 'commodity as assets' could also function as sanctuary from numerous regulations.


Besides, commodities plays a minor role (.47%) in the $615 trillion derivatives [from the Bank of International Settlements] market largely dominated by interest rates (73.17%) and followed by foreign exchange (8%) and credit default swaps (5.32%). To consider that even weather plays a role in the derivatives market today as part of the growing sophistication of financial risk management.

Importantly, one mustn't forget that commodities once played the role of money, as Murray Rothbard wrote in Man, Economy and the State,

``Money is a commodity that serves as a general medium of exchange; its exchanges therefore permeate the economic system. Like all commodities, it has a market demand and a market sup­ply, although its special situation lends it many unique features. We saw in chapter 4 that its “price” has no unique expression on the market. Other commodities are all expressible in terms of units of money and therefore have uniquely identifiable prices. The money commodity, however, can be expressed only by an array of all the other commodities, i.e., all the goods and services that money can buy on the market. This array has no uniquely expressible unit, and, as we shall see, changes in the array cannot be measured."

Therefore, in today's environment where inflationism is the dominant path of policymaking, commodities can partly play the role of alternative store of value.

This means that the demand for money which consist of exchange demand (by sellers of all other goods that wish to purchase money) and reservation demand (the demand for money to hold by those who already hold it), would translate to what the mainstream sees as "speculation" or "hoarding".

In short, commodities are not just meant to be consumed (real fundamentals) but also meant to be stored (reservation demand) if the public sees the need for a monetary safehaven.

Moreover, when developments reveal heightened concerns over the accelerating loss of purchasing power in a currency, the role of commodities as money could be reinforced.

As Mr. Ludwig von Mises wrote,

``He who believes that the prices of the goods in which he takes an interest will rise, buys more of them than he would have bought in the absence of this belief: accordingly he restricts his cash holding. He who believes that prices will drop, restricts his purchases and thus enlarges his cash holding. As long as such speculative anticipations are limited to some commodities, they do not bring about a general tendency toward changes in cash holding. But it is different if people [p. 427] believe that they are on the eve of big cash-induced changes in purchasing power. When they expect that the money prices of all goods will rise or fall, they expand or restrict their purchases. These attitudes strengthen and accelerate the expected tendencies considerably. This goes on until the point is reached beyond which no further changes in the purchasing power of money are expected. Only then does this inclination to buy or to sell stop and do people begin again to increase or to decrease their cash holdings.

``But if once public opinion is convinced that the increase in the quantity of money will continue and never come to an end, and that consequently the prices of all commodities and services will not cease to rise, everybody becomes eager to buy as much as possible and to restrict his cash holding to a minimum size. For under these circumstances the regular costs incurred by holding cash are increased by the losses caused by the progressive fall in purchasing power. The advantages of holding cash must be paid for by sacrifices which are deemed unreasonably burdensome. This phenomenon was, in the great European inflations of the 'twenties, called flight into real goods (Flucht in die Sachwerte) or crack-up boom (Katastrophenhausse). The mathematical economists are at a loss to comprehend the causal relation between the increase in the quantity of money and what they call "velocity of circulation."

So in my opinion, where commodities serve as insurance against a crack-up boom, financialization of commodities is just one additional way to obtain access to such insurance. Not bad for as long as the counterparty in these contracts produces the 'real goods', when claims are presented.

Lastly, in competition with other asset classes, the financialization of commodities should likewise add to the pricing efficiency of the marketplace.