Friday, June 3, 2011
"...increasing the supply of money, without an underlying asset of equal value, leads to inflation."
That headline is a direct quote from J.P. Morgan.
He was and is right. When you hold a twenty dollar note in your hand, it isn’t money. As it says right at the top of the face of the bill, it’s a Federal Reserve Note. It’s simply a note from the Federal Reserve that promises a value of $20 to whomever you give the note to. It has no inherent value.
A gold coin, or gold bar, however, does have an inherent value. It isn’t the promise of money, it’s the real thing.
If you think that distinction is just semantics, let’s look at a very real and tangible reason why gold will always hold significant value.
There is only a very limited supply of gold.
The total amount of above-ground gold is somewhere between 108,000 to 140,000 tonnes. About 30,000 tonnes are held by central banks, about 70,000 to 80,000 tonnes are in the form of jewelry, and about 20,000 tonnes are held as coin and bullion.
That’s it. In spite of the alchemists’ best efforts, you can’t conjure up more gold. You have to dig it out of the ground, at significant cost.
However…and this is where the other boot drops…you can print more Federal Reserve Notes. In fact, you can print as many of them as you like. Billions of them if you want.
That’s what QE1 and QE2 were all about…printing more notes. More promises.
Well, we are coming to the end of QE2 about now. How are things looking for the U.S. economy? Not so good. Jobless claims are up, house prices are down and most other economic indicators are equally dismal.
So maybe we’ll be looking at QE3 before too long.
The trouble is, printing more money puts downward pressure on the value of the money, or notes, already out there. And that’s just another way to say that increasing the supply of money, without an underlying asset of equal value, leads to inflation.
The long-term value of gold is preserved by its scarcity. There’s not much of it.
The long term value of cash money is undermined by its endless abundance. You can print as much of it as you like.
The issue of scarcity is central to why gold prices will keep rising.
I’ll be writing another post soon about the scarcity of gold, and how it can have a multiplying effect on gold prices. And why you should be buying more gold now, while you still can.