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Looking for a gold bubble but not finding one

With the price of gold climbing, we are once again starting to hear the clarion cries warning us of a gold bubble.  But how does one objectively evaluate that claim?  The first step is to understand what a bubble means.  A bubble occurs when there is a large disconnect between something’s price and its worth. Determining the price of gold is a straightforward proposition, but how do you calculate its worth?

Gold’s primary use is money. We can evaluate gold in the same manner we would an exchange rate between two currencies. Supply and demand are the usual starting points.  Intuitively we understand why the demand for a currency can change. For example, when the viability of the European Union is called into question, demand for dollars increases as less people are comfortable storing their wealth in Euros.  Understanding demand is one thing, quantifying it is a bit more difficult.

Supply is easier to measure. Once you remove demand from the equation, an exchange rate simply becomes a ratio. If you compare the base money supply to the amount of gold held in the US reserves, you come out with a ratio of just over $10,000 for every ounce of gold.

Adjusted Monetary Base


Historically, if we take a look at the ratio of the value of the US gold reserves to the base money supply, we can start to quantify demand.  In 1980, when the fear for the future of the dollar last peaked, the value of the US gold reserves went to over 130% of the base money supply. If you apply the same demand to the current supply you arrive at a price exceeding $13,000/oz.

US Monetary Base


But here’s the catch, as bad as the graph of the base money supply growth looks, it represents only what was necessary to keep the current status quo afloat for the time being.  Nothing has been fixed.  We still have a banking system that is largely insolvent, a federal debt that can never be paid in terms of today’s dollars, and a black box of OTC derivatives overhanging everything that is measured in the quadrillions of dollars.  It certainly doesn’t appear that the experience of the seventies will be able to hold a candle to the coming global financial crisis.

A rational analysis of the situation would indicate that it is not gold that is a bubble, but rather the system of infinitely expanding paper and credit built on top of it.


3 Responses to “Looking for a gold bubble but not finding one”

  1. netcents

    As a fellow Engineer, I appreciate data driven analysis. This is an excellent article. The second chart “US Monetary Base Per Capita vs. gold” might look very different had various government interventions not taken place. It could be the subject for another great article. For example: Notice the period of relative stability at the beginning (1920-1933). Gold price (gold line) and The blue line representing 40% of the monetary base overlay each other while the black line (100% of the monetary base) roughly parallels at an offset. It could be argued that the difference (100%-40% = 60%) represents tolerable excess monetary base as determined by the majority in times of stability. This 60% offset probably extends back much further than 1920. The abrupt jump in the gold line in 1933 was caused by FDR, after he issued Executive order 6102, stole the Americans’ gold, and then devalued the paper he ordered they be given in exchange for their gold, relative to the price of gold, by about 40%. Further analysis of the chart then shows gold price being very stable till about1970. Remember this is the period when it was still illegal for Americans to own gold in any significant quantity. Government intervention artificially suppressed demand for this period of time. Notice that monetary base begins to increase again in about 1963. It is this increase that leads to inflation experienced in the 1970’s. Had it not been for Volker arresting inflation by increasing interest rates above real inflation rates by about 3-5%, thereby creating an opportunity cost for holding gold, the dollar would likely have been destroyed through hyperinflation in the 1980’s decade. In other words, the peak in the gold line that occurs in about 1980 would extend upward approaching infinity. Today, it appears to me that gold demand as compared to monetary base per capita is barely if at all greater than during the period of time when gold was illegal for Americans to own and demand was artificially reduced through government intervention. We are very likely very early in the gold bull-run. Predicted and justifiable future price will make todays’ price look paltry.

  2. DAle A. Thome


    Subject: Your Economic Rights:

    Do you know your economic rights or that you even have any? Under the U. S. Constitution you are guaranteed a regulated currency with it’s own intrinsic value. The problem we now face is our government hasn’t been following the Constitution on the monetary system for some time. If we followed the Constitution we wouldn’t have inflation or deflation.
    The main reason for the constitutional convention was our country was having a problem with runaway inflation. People were no longer honoring their contracts because by the time they completed their contract the money they contracted for was virtually worthless compared to the work they had preformed. Commerce was grinding to a halt because of this.  There were other problems they needed to fix but the monetary system is what brought every thing to a head. We all need to pay attention to what is going on because we are headed towards the same problem they had. We have worthless paper money that has no fixed value and at the rate they are dumping it into circulation, run away or hyper inflation can’t be far off. It’s not just our government but most of the world is operating with the same type of funny money. They think they can stimulate the economy by putting more money into circulation, but that will not work in the long run.
    Rodger Sherman was the founder who perfected the design of our country’s monetary system and spent most of his life struggling with – and publicly condemning a fluctuating medium of exchange. He said with a fixed medium of exchange the people could be free. Karl Marx said with a central bank empowered to emit paper money and compel the people to use it was essential to government control of individual property. I suggest you try and get a copy of Rodger Sherman’s book ( a chavet on injustice or the inquiry into the evils of a fluctuating medium of exchange). Chavet is a French word meaning warning. Rodger Sherman was a delegate from Connecticut who on August 28, 1787, proposed that the states sacrifice the power to participate in paper money schemes. When it was counter – proposed that the states be allowed by congress to make other things than gold and silver coin a tender in payment of debts, we’re told by James Madison that Sherman exclaimed, (“We are making these measures absolute. This is a favorable crisis for crushing paper money. If the consent of the legislature could authorize emissions of it, the friends of paper money would
    make every exertion to get in to the legislature in order to license it”.)
    The founders knew that for your money to never become worthless you needed money that had it’s own intrinsic value built into it. So they researched history and found that gold and silver were valued as a medium of exchange above anything else. They made gold and silver as money of account of the United States and nothing else. Then in article 1 section 8 of the U. S. Constitution they gave gave congress the power to coin money, and regulate the value thereof, and of foreign coin. We no longer have gold and silver coin in circulation or a regulated currency to buy it with.  In article 1 section 10 they prohibited the states from making anything but gold and silver coin a Tender in payment of debts. Now congress was suppose to issue the money into circulation at plus or minus 3 percent of the gross national product. They realized they couldn’t hit it right on the nose so with the 3 percent error factor they could adjust from time to time. If you have a one on one ratio of money to goods and services produced you can’t have inflation or deflation.
    Silver was considered the people’s money because of it’s unique properties. It resonates at a certain frequency that kills bad bacteria and viruses. What passes through society more anything else? It’s your money. Silver coins have the ability to kill the germs and viruses as it is passes from one person to the next. The pioneers put solver coins in the bottom of their water barrels as they traveled west to keep their water fresh because it killed the germs and bacteria. Have you heard the saying “he was born with a silver spoon in his mouth “? Do you know where that came from? In Europe during the bubonic plague the well to do people gave their children silver spoons to suck on to help keep them from getting the plague. They are starting To go back to silver in the medical field because the bacteria are mutating faster than they can come up with new antibiotics. Silver kills the bacteria and viruses by breaking up their cell structure so they can’t reproduce. They now make a silver solution with ionic charged silver particles that are small enough to penetrate the red blood cells.
    The founders said that true wealth is the ability to produce goods and services, and that the people were the wealth of the nation because only people produce goods and services. If that is so your best investments are knowledge, tools, machinery, land, a business, or anything that helps you produce goods and services.
    Now you monetary system is suppose to be a means of measuring and storing wealth. The term dollar is only a unit of measurement like an inch, foot, yard, pint, quart, and gallon. Congress no longer regulates the value of the U. S. dollar. The federal reserve notes that we use for money is just like a promissory note promising to pay you however many units the denomination is. Nothing tells you what those units consist of or what the measurement of that unit is. How would you like to go to the gas pump and buy a unit of gasoline when nothing tells you what that unit is and it changed from time to time without notice to anyone? What is worse is you are paying for it with a unit of measurement that has  no fixed value if it has any value at all. At least at the gas pump with no fixed measurement you at least knew you were getting gasoline. How can you measure or store wealth with something that has no measurement or at best fluctuating value. It’s like trying to build a house with an elastic measuring tape. You would be hard pressed to even get the foundation laid out. The gold backing was taken off of the dollar for the U. S. citizens in 1933, the silver backing in 1965, and the gold backing for foreign countries in 1971. Congress no longer does it’s job regulating the dollar or even   making any. What we are using for money are federal reserve notes, or what the founders would call debt money. The are borrowed into existence. The government says they are worth whatever confidence the people have in them. How much confidence are we suppose to have in them when they are dumping 80 billion of these units into the economy every month, created out of thin air. If this is a sound policy why do they need our tax money? Why don’t they just print up what they need and leave us alone? This makes no sense, and it makes no sense to try and store wealth with something that has no set value and no one has any idea what it is. Not only that but the confidence people have in it keeps shrinking. It’s like trying to store ice cubes without refrigeration.
    After congress took the gold backing off of the dollar for the foreign countries in 1971 gold went from 35 dollars an ounce to over 800 an ounce and settled back to around 400 for a while and is now over 1700. In 1970 I could sell gasoline for 25 cents a gallon during a gas war off of a tank wagon. Today if you had an old 1964 or older 90 percent silver quarter you can buy a gallon of gas and get change back. That quarter is worth around 6 federal reserve units and changing.
    We can save ourselves from inflation like the founders did just by going back to the U. S. Constitution. Germany stopped their inflation by going on the gold standard before world war 2. But the government is going to have to stop giving a representation of wealth to some one who isn’t producing wealth. Only those who produce wealth can give it to someone who isn’t producing it without inserting a lie into the monetary system or stealing it from someone who earned it. So we are going to have to wean people off of welfare, subsidies, and any other handout that isn’t earned.
    If we don’t what is going to happen to these people when we go into runaway or even hyper inflation and their worthless paper money won’t buy them anything. The government hasn’t been promoting the general welfare, but the welfare of a select group of individuals. Benjamin Franklin said there are two things you can do about poverty, lead them out or force them out, if you subsidize it you encourage it to grow. The founders said socialism was nonsense.
    One of the first things we need to do is tie the income tax brackets to inflation, so as our money becomes more worthless we are not thrown into a higher tax bracket paying a higher rate of tax on something that has less value than before. The Supreme Court got themselves a raise years back because they said the Constitution said their salaries were not to be diminished while they were in office. They said because of inflation their salaries were reduced. I say what is good for them is good for us, after all they are our public servants. We need to go back to when they got their raise and adjust the income tax brackets for inflation like they had their salaries adjusted from that time forward. With inflation the government gets an automatic tax hike without passing any laws. Also as your money inflates the money In the stock market tends to increase as the purchasing power decreases, and you have to pay income tax on a gain that may be worth less in purchasing power than it was the year before.
    We are not the only country in this mess. Most of the world is playing the same money games. The gross domestic product of the whole world is around 60 trillion and the world debt is around 600 trillion and growing fast. Can you do business like that? When this collapses the whole world is going to be in bad shape.
    We need to educate people on how wealth is created and to get a honest representation of that wealth. We need to get rid of the federal reserve and go back to honest money. It can be done. Jefferson got rid of the first central bank because he said it was unconstitutional. He also bought the Louisiana Purchase, doubling the size of the country. And it was paid off before he got out of office. Andrew Jackson got rid of the second one I believe for the same reason. I don’t know much about the third one but John Tyler vetoed national bank bills, and James Polk established an independent treasury. Woodrow Wilson helped get us the federal reserve and income tax. When the federal reserve was brought into being there was a provision that at any time the government could buy them out for 1 million dollars. If we did that we would get all of their assets. We could take all of those bonds they are holding and burn them and get rid of a lot of our debt. Then get the government back operating within the framework of the Constitution operating on import, and export fees, tariffs, and excise taxes. The founders said they never intended for us to pay tax on the fruit of our labour because it would ruin the incentive of the individual to do something for himself. We need to get rid of the lie that we are a democracy, because the founders said democracies always fail as soon as the majority find they can vote themselves an increase at the expense of the minority. That is why they made us a republic, guaranteeing the individual his god given rights. Jefferson said it was the duty of the legislature to determine and declare our rights and responsibilities and see that they take none of them from us. It protects the few from the many, and the week from the strong. We are democratic republic, democratically choosing our representatives. The Constitution also requires the states to have a republic form of government at the state level. We also need to get back to the state legislature choosing the senators we send to Washington so we can protect our states rights.
    One more thing, the founders almost didn’t give the federal government the power to borrow money on the credit of the United States. But they decided they needed to so if we were invaded we could raise money fast enough to defend ourselves. They said that if they did borrow money they needed to make provisions to pay it back within the average life span of the citizens living in the country at that time. They said if they didn’t it was like borrowing money and expecting your children and grandchildren to pay for it and that was immoral.
                                                     Thank     You

                                                      Dale A. Thome


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