Many investors argue that Gold has no intrinsic value. I disagree with this assessment as it does not consider the nature of the financial system.
Let’s compare Gold to the US Dollar.
Every asset in the financial system trades based on relative value. Ultimately, this value is denominated in US Dollars because the Dollar is the reserve currency of the world.
However, even the US Dollar itself trades based on relative value. Remember the Dollar is merely a sheet of linen and cotton that is printed by the Fed and is backed by the full faith and credit of the Unites States.
In this sense, the Dollar’s value is derived from the confidence investors that the US will honor its debts.
A second item to consider is the fact that the Dollar’s value today also derived from the Fed’s money printing. Indeed, a Dollar today, is worth only 5% of a Dollar’s value from the early 20th century because the Fed has debased the currency.
As a result of this the world has adjusted to this change in relative “value” resulting in a Dollar buying less today than it did 100 years ago.
In this sense, Gold’s value is derived from investors’ faith in the Financial System (ultimately backstopped by the Dollar) and the Fed’s actions.
Gold also moves based on investors’ confidence in the system. If investors’ are afraid that the system is under duress (meaning that they have little confidence in the Dollar-based financial system) then they perceive Gold has having a higher value.
Similarly, if the Fed prints Dollars by the billions, Gold is perceived as having a higher value relative to the Dollar.
Thus, Gold does not have any less intrinsic value than the US Dollar does. In that regard we can price it relative to the Fed’s actions and to the fear of systemic risk to get an assessment of its true value.
As noted a moment ago, every asset in the financial system trades relative to investors’ confidence in that system. With the US Dollar as the reserve currency of the world, that confidence is ultimately based on the idea the US will pay you if it owes you money.
If you remove this confidence, then the entire system collapses as the reserve currency is no longer perceived has having value.
The problem with this setup however is that the US, like almost every other country in the world (I’m including China which is sporting a Debt to GDP ratio north of 200% if you account for its Shadow Banking liabilities), has made promises that it cannot possibly keep.
The US “officially” owes nearly $17 trillion in debt. However, if you include unfunded liabilities this amount surges to at least over $80 trillion and likely north of $100 trillion.
These are promises the US has made. And the US Dollar’s value is based on the belief that the US will honor these promises.
The US is not isolated in this regard. Indeed, the problem of unfunded liabilities exists throughout the world.
In the case of Europe, the situation is so bad that the average EU country would need to have an amount equal to over 400% of its GDP sitting in the bank, earning interest at the government’s borrowing rate, in order to fund its unfunded liabilities.
The same goes for Japan and even China where the shadow banking system has liabilities north of 200% of China’s GDP.
These are promises that cannot be kept. And when these promises are broken confidence in the system will be broken. This will inevitably lead to a period of currency collapse. After this, ultimately there will be a need to restore confidence in the system.
The only way to do this will be by backing currencies with Gold again (or a basket of items that includes Gold).
Given the limited amount of Gold in the world, (a little over 171,000 tons) and the enormous amount of US Dollars in the world, this would require a revaluation of Gold to north of $10,000. Dylan Grice formerly of Societe General lays this out beautifully in the below chart.
I cannot possibly predict when all of this would happen. All I can state with 100% certainty is that ALL fiat currencies throughout history have failed.
This failure has been based on a loss of confidence. And the only way to restore confidence is to limit the ability of Central Banks to print money.
This will inevitably lead to some form of a Gold backed currency. Gold has been used as currency for over 5,000 years. It will be considered currency again in the future. When it does, the price of Gold will be much higher (remember, Gold has risen over 34 fold in the last 40 years).
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