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May 25, 2009

Thoughts on the Gold Standard, Risk and Speculation
by Steve Saville

Below are excerpts from recent commentaries posted at www.speculative-investor.com.

Return to a Gold Standard?

The most commonly cited reason against returning to a gold standard is that there isn't enough gold in the world, but no one with a good understanding of money's role within an economy would argue against a gold standard on the basis of insufficient gold supply (for the uninitiated, Frank Shostak explains why in: How Much Money Should There Be?). There is, however, a good reason to argue against a gold standard.

Although a gold standard would undoubtedly be vastly superior to the current monetary system, any government-imposed monetary standard would be fatally flawed, even the gold variety, because governments cannot be trusted to monitor and control something as important as money. To get an idea of how the monetary system would evolve over time if we were to return to a gold standard, look at what has happened to money over the past 100 years. In a nutshell, returning to a gold standard would eventually lead us back to where we are today.

The optimum solution is not to return to a gold standard; it is, instead, to get the government out of the money business. Amongst other things, this would entail getting rid of the central bank, legal tender laws, and deposit insurance*. Once the government was out of the way the market could then select the medium of exchange. Given such a choice the market might decide to stick with paper dollars, euros, Yen, etc., but history tells us that it would more likely choose gold or a combination of gold and silver. As we explained back in the good old days of 2005 (the 12th October 2005 Interim Update):

"When the market has been free to choose it has, over thousands of years, invariably chosen gold (and silver) as money, and given the choice it will almost certainly do so in the future. However, the possibility also exists that a superior monetary system to one based on gold will be discovered at some point. It is, therefore, important for the market to have the freedom to opt for some form of money other than gold.

To further explain, gold never became money because some government decided that it should be money. Rather, during those times throughout history when governments have decreed gold to be money they have done so only because gold was already money in the eyes of the people. Unfortunately but not surprisingly, without exception these governments subsequently decided that gold should not be money because a gold standard places severe restrictions on the size and scope of government (you can't print gold in order to buy votes). A more 'flexible' monetary system -- one that places no limits on the amount of new money that can be borrowed into existence (created out of thin air) -- was thus phased-in over many decades. This, in turn, is why governments must never be allowed to become involved in the monetary system in the first place even if their initial involvement is to set-up and monitor a gold standard. The problem is that as soon as they do become involved in some way then the door will be open to eventual government abuse of the system. If history is any guide this abuse will begin as a temporary measure justified by some sort of emergency, but will later become entrenched."

The current monetary system can be likened to a legion of termites methodically gnawing away at the foundations of the economy. But very few people in the world understand this, so when the foundations eventually give way there's every chance that the diagnosed reason for the collapse will be completely off the mark. In fact, the way things are going the collapse could well be used to justify even greater government control of money, perhaps via a World Central Bank and a global fiat currency.

*Deposit insurance is a scam because the only way the government can ever make good on the losses suffered by some depositors is to steal the purchasing power of other depositors via additional taxation or inflation.

You can reduce risk, but you can't avoid speculation

Despite the strong rebounds of the past two months we are sensing general disinterest in the financial markets. Most people got burned during last year's panic, almost regardless of what they were invested in. As a result they have either withdrawn from the markets or become far more circumspect.

The desire to reduce financial risk is a rational response to today's economic reality and the policies being implemented/planned by most governments, but speculation cannot be avoided altogether. If you have some form of savings then you are a speculator whether you like it or not. For example, if you take what most people would consider to be the ultra-conservative approach of having your entire net worth in cash then you are, in effect, speculating that your government will fail in its efforts to substantially devalue your cash.

In our opinion, the lowest risk investment portfolio would comprise 50% US$ cash and 50% gold bullion. It is possible that both of these positions will do well over the years ahead, although it is more likely that one will do well while the other fares poorly (regular TSI readers know which one we expect to do well). We cannot, however, envisage a multi-year scenario under which both of these positions do poorly. The reason is that if the US$ were to collapse for any reason then the gold price would rocket upward by enough to more than offset the losses on the US$ part of the portfolio; and a large decline in the gold price would only become a realistic possibility if there were a rapid deflation of the US money supply leading to a rapid appreciation of the US$.

By adding equities, other commodities and other currencies into the mix it should be possible to do much better than the ultra-low-risk cash-bullion portfolio mentioned above, but giving oneself the potential to achieve greater returns invariably entails taking on additional risk.

We aren't offering a free trial subscription at this time, but free samples of our work (excerpts from our regular commentaries) can be viewed at: nhttp://www.speculative-investor.com/new/freesamples.html.

Steve Saville
Hong Kong

Regular financial market forecasts and analyses are provided at our web site: http://www.speculative-investor.com/new/index.html. One-month free trial available.