Gyroscopic Investing

First-time poster here. I just recently learned about the Permanent Portfolio, and am still on the sidelines lurking and learning. I came across an article today from last year that got me wondering....

http://www.moneynews.com/StreetTalk/for ... /id/409369

Apparently Steve Forbes thinks the US will go back to the gold standard after the 2012 elections. I know it seems pretty far-fetched, but let's just say this actually were to happen. Presumably, gold would plummet big time, and with 25% of one's portfolio in physical gold, it seems like a legitimate question to ask if the PP could be expected to weather such a turn of events. Thoughts anyone?

It depends on the gold standard.  If the dollar is 0.001% backed by gold, it probably won't make much difference.  If the dollar is 100.00% backed by gold, that would make gold and cash somewhat synonymous, at least until the Fed and/or the government decides to change their minds.

The U.S. will not go back on a gold standard.

Politicians and central bankers have more power when not constrained by a gold standard, and once a politician gets additional power he almost never voluntarily gives it up.

If it were to happen, the effects would all depend on the exchange rate.

hoost wrote: If it were to happen, the effects would all depend on the exchange rate.

And once the exchange rate was established the speculators would start hammering away at its weak spots.

MediumTex wrote: The U.S. will not go back on a gold standard.

Politicians and central bankers have more power when not constrained by a gold standard, and once a politician gets additional power he almost never voluntarily gives it up.

I concur though for more pragmatic reasons. When the world abandoned the last real gold standard in the 1930's the global population was estimated at around 2 billion and change. Today it's more than 3x that. The global economy is completely interconnected with global currency markets trading 24/7. The number of nations with their own sovereign currencies has increased by a factor. And the volume of money in the world has increased by a factor so large I would have to use scientific notation to type it out. But the global supply of gold has increased by a relatively low percentage. Indeed the entire above ground supply of gold is believed to be somewhere in the neighborhood of 160,000 tonnes. Most experts doubt that there are more than another 50,000 tonnes remaining below ground that could be mined without prohibitive costs. Even if the US Government had every ounce of existing above ground stocks, there is no way we could establish a workable standard on which to base the world's principle reserve currency. It is simply not possible and to even attempt it would throw the world economy into complete chaos.

The unhappy truth is that the gold standard sucked. It was obsolete even during its supposed heyday in the pre-World War I years. There was a chronic shortage of specie and hard cash practically everywhere west of the Mississippi. That's why the hottest political issue in Gilded Age American politics was bi-metalism (free silver). To try and recreate one today would require one of two courses of action. Either a currency reset where basically you would trade in a $100 bill for a $1.00 bill (or coin) which would again throw the world into chaos, or setting the value of the dollar so low vs gold that it would make convertibility impossible. And a "gold standard" sans convertibility is not a gold standard. It's "trust us, would your government lie to you?" Even setting aside the lack of credibility you still would not have enough specie. And what to do with the paper money used by the rest of the world? How does one value paper next to our supposedly gold backed dollars? What happens when they trade their paper for our dollars and then try to redeem said dollars for specie and cart our gold reserves off to some foreign capital? How do you pay off our fiat based bonds with a gold backed currency?

I could go on but I think the broader point has been made. People who dream of going back to the gold standard are living in a fantasy world. It is simply not possible. And I don't mean it would be difficult or inconvenient. Nor am I saying it could be done with some minor dislocations. It is NOT POSSIBLE. You cannot create a viable currency for a country as large as the United States in the modern world based on gold. Period.

I have said this on several different threads but it's worth repeating. The days of hard metal based currencies are over. The world has gotten too big and far too complicated. The only metal that one MIGHT be able to find in sufficient quantity to back a major currency is silver.  Oddly no one seems very interested in silver these days. Which to my mind is probably just as well.

[Edit: Typo]

Ad Orientem,

That's a great post, and I mostly agree.

What is interesting, though, is that we have always been (and may always be) on sort of a pseudo-gold standard in that gold is used as a barometer of the dollar's and other currencies' health, and of course when a currency collapses gold is a great way of transitioning into the currency that replaces it.

MediumTex wrote: Ad Orientem,

That's a great post, and I mostly agree.

What is interesting, though, is that we have always been (and may always be) on sort of a pseudo-gold standard in that gold is used as a barometer of the dollar's and other currencies' health, and of course when a currency collapses gold is a great way of transitioning into the currency that replaces it.

MT
Thanks for the compliment. I should clarify that I am not arguing against gold as part of the PP. Nor am I suggesting that gold isn't money. It is money. It is the world's only incorruptible money and it is probably the reserve currency of choice after the dollar and maybe the euro. But gold's greatest attributes, it can't be printed or created with the push of button on the Federal Reserve's computer, also makes it singularly unsuitable as a major currency tied to a national government or country. As I already noted there isn't enough and it is terribly illiquid. But gold has in many respects finally fund its true roll in world finance. It is an extra-national currency and store of value not controlled by any government or pegged to any currency. As such it functions perfectly as a barometer for the health of sovereign currencies, and especially the world's principal reserve currency.

If your government is behaving responsibly and or there is no risk to the health or survival of the nation then your currency will rise against the dollar and/or gold. And if there is a problem and people are getting nervous then investors can hedge their exposure to a risky currency by diversifying into the world's only currency that can't be manipulated or debased. In the current world economy people have the freedom to choose which currency they trust knowing that gold is now at least mostly free of government control.

While I agree that a return to the gold standard is unlikely, I think that commodity-based currencies served the United States fairly well in days gone by.  I think we've learned, though, that governments can't be trusted to properly manage a gold standard or stick to even the most basic promises that such a standard requires (such as valuations and convertibility.)  Furthermore, a nice thing about being off of a gold standard is that the government takes much less interest in how much gold "we the people" might have squirreled away.

Having said that, I'm skeptical of some of the practical objections to the gold standard that I see here.

Ad Orientem wrote: When the world abandoned the last real gold standard in the 1930's the global population was estimated at around 2 billion and change. Today it's more than 3x that. The global economy is completely interconnected with global currency markets trading 24/7. The number of nations with their own sovereign currencies has increased by a factor. And the volume of money in the world has increased by a factor so large I would have to use scientific notation to type it out. But the global supply of gold has increased by a relatively low percentage.

Isn't this all just relative, though?  If you have a new world, wouldn't you simply have a new valuation of the dollar?

More concretely: in the early 30s, they used a valuation of $20.67 (a bit over $300.)  Today they would use some much higher value.  Let's imagine that the US government announced that they would return to a convertibility of $5000 for one ounce of gold.  From what I remember, the classic gold standard required gold holdings of 40% of the value of the Central Bank's liabilities.

The United States holds 8,133.5 metric tons of gold.  Google says that's 286,900,770 ounces.  At $5000 per ounce, that would be $1.4T.  With M0 at about $2.8T, that's more than enough to maintain the 40% coverage ratio that the gold standard required.  If you established a gold standard at $10,000, you could cover all of M0!

Also, remember that M0 was something like $800B before the financial crisis.  To cover that, you could set gold at $2800 per ounce.  To cover that at 40% you'd need a convertibility of merely $1100-$1150!

So I see no serious nuts and bolts obstacle to a gold standard.

Ad Orientem wrote:Either a currency reset where basically you would trade in a $100 bill for a $1.00 bill (or coin) which would again throw the world into chaos, or setting the value of the dollar so low vs gold that it would make convertibility impossible.

I'm not sure that I understand the part in bold.  Doesn't setting the dollar very low vs gold make convertibility extremely easy rather than impossible?  For example, a gold standard where you announced that you would convert $1 billion into one ounce of gold is trivial to support.

Ad Orientem wrote: The unhappy truth is that the gold standard sucked. It was obsolete even during its supposed heyday in the pre-World War I years.

The United States used commodity-based currencies of some form throughout the vast majority of its early history and was more or less on a "gold standard" since the 1830s.  While under these commodity-based currencies, the US experienced a combination of incredible prosperity and gently falling prices.  For a system that "sucked", it has an impressive record of performance.