Another Chinese central banker advises buying gold and oil instead of dollars


Gold: Good As A dollar?

By Robert Aronen
The Motley Fool (
Wednesday, May 31, 2006

Talk to serious investors about buying gold, and they will likely
look at you as though you're a bit of a nut case. Gold attracts
goofballs: shysters shilling shares of Peruvian mining operations,
people predicting worldwide economic collapse, and various voices on
the economic margins crying for a return to the gold standard.

The last group claims that gold is "real money" and that paper
dollars are nothing more than "fiat money" -- just paper with no
real backing. Consider the argument: Because paper money is
controlled by central bankers, who insist upon inflation, the value
of paper money is almost guaranteed to decline. And the declining
dollar is one of the major reasons for the dramatic rise in the
price of gold over the past four years. It is also one of the
reasons I own gold -- through two exchange-traded funds: iShares
COMEX Gold and Streettracks Gold.

... Paris on the cheap

In2002, my wife and I were in Paris. We stayed at a four-star hotel
room near the Latin Quarter, ate in wonderful restaurants, and
enjoyed the good life. Thinking back, I remember it being incredibly
cheap. The hotel was less than $80 a night, and dinner for two (avec
le bon vin, bien sur) was about $35.

In retrospect, I have created a rule: When Paris is cheap, your
currency is overvalued.

Four years ago, gold was selling for about $300 an ounce. Around
that time, the dollar-to-euro exchange rate hit a low near $0.85 per
euro. Since that time, the dollar has steadily declined compared to
the euro, to a current level near $1.28 per euro. Assuming the price
of gold held steady in euros, in dollars it would have risen to $450
an ounce, accounting for roughly half of the increase over the past
four years.

... A brief history

The connection between gold and the dollar has been playing out for
a long time. Newmont Mining can give you the long history, but
here's the short version. For the first hundred years or so of the
U.S. dollar's history, dollars were backed by gold and could be
exchanged for gold. The problem was that when the government needed
money to engage in construction, stimulate the economy, or fund a
war, the gold-backed currency supply was inflexible.

This led to the creation of the Federal Reserve in 1913, which was
the first step in removing the interchangeability between the dollar
and gold. For 20 years, the currency supply expanded more than the
supply of gold. In 1933, Franklin Roosevelt banned the export of
gold, halted the convertibility of dollars into gold, and ordered
U.S. citizens to hand over their gold. In 1934, he fixed the price
of gold at $35 an ounce, where it stayed for nearly 40 years.

After World War II, the nations of the world signed on to the
Bretton Woods system, which set currency exchange rates in relation
to gold and established the U.S. dollar as the world reserve
currency. U.S. government spending, inflation, and trade deficits
eventually undermined the fixed price of gold at $35 an ounce.
Foreign countries began to increasingly prefer gold to dollars, and
U.S. reserve gold coverage declined to 22%.

... The rise of gold

In 1973, Richard Nixon officially removed the dollar from the gold
standard. Prices were set by the market, and gold immediately shot
up to $120 an ounce. In 1974, the ban on American individual
ownership of gold was removed. During the bear market in stocks,
rising interest rates, inflation, oil shocks, and the general
political uncertainty of the 1970s, gold prices soared, hitting an
all-time high of $870 an ounce (intraday) on Jan. 21, 1980.

... The fall of gold

For the next 20 years, gold prices mostly declined. Gold as an
investment vehicle or store of economic value was disparaged. In
Stocks for the Long Run, Jeremy Siegel showed that the real,
inflation-adjusted return on gold from 1802 to 2001 was 0.0%!
Compare this with the real return per year on stocks for the same
period of 6.9%, and it should be obvious that only a lunatic would
own gold.

... The future for gold and the dollar

A major driver of where gold prices will head for Americans in the
next 10 years will be the value of the dollar. Obviously, if I knew
where currency exchange rates were headed, I'd be running a hedge
fund and taking 5% of assets and 20% of profits as a reward for my
genius. Undeterred by the evident folly of predicting something as
arcane as currency values, I will advance an opinion from my place
in the cheap seats.

When the world powers talk about "unsustainable imbalances" and
Chinese "currency manipulation," I interpret these code phrases to
mean that the U.S. has too much debt and the Chinese currency needs
to rise in value. Regarding the debt, the U.S. has a huge privilege
that comes with it -- it is denominated in U.S. dollars. An easy way
to reduce the debt burden is to allow the value of those dollars to
decline. Regarding currency manipulation, a stronger Chinese
currency and a devalued U.S. dollar will make American exports more
competitive. The hope would be that this would reduce our soaring
trade imbalance.

Does this mean the dollar will decline? No, but it sure points to a
couple of huge incentives for the big shots to let it happen.

... Conclusions

Obviously, the price of gold is driven by more than a simple
relationship to the number of dollars in circulation or foreign
exchange rates. In the future, I will take a look at some of the
items that were present when gold soared in the 1970s, such as
inflation. Leaving these aside for the moment, a declining dollar
bodes well for gold, as investors holding dollar-denominated assets
sell in search of another currency that will hold its value. Gold
has been viewed as currency for thousands of years, and in times of
uncertainty, people have preferred gold over paper.

Of course, there is no guarantee that the dollar will decline
compared with other world currencies or that gold will return to its
glory days of the 1970s. Bearing in mind the long-run returns on
gold compared with stocks (unless you are a total lunatic, of
course), an investment in gold should be considered only as a part
of a well-diversified portfolio.


Robert Aronen is only partially a lunatic. He owns shares of iShares
COMEX Gold and Streettracks Gold. He found that much more convenient
than burying the coins in his back yard.


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