Brett Arends, writing in the Wall Street Journal Why I Don’t Trust Gold explains the rise of gold in the following way:
If the price rises you’d think there must be a shortage. But data provided by the World Gold Council, an industry body, tell a remarkable story.
Over that period the world has produced—or, more accurately, recovered—far more gold than anyone actually wanted to use. Since 2002, for example, total demand for gold from goldsmiths and jewelers, and dentists, and general industry, has come to about 22,500 tonnes.
But during the same period, more than 29,000 tonnes has come on to the market.
The surplus alone is enough to produce about 220 million one-ounce gold American Buffalo coins. That’s in eight years.
Most of the new supply has come from mine production. Some, though a dwindling amount, has come from central banks. And a growing amount has come from recycling—old jewelry and the like being melted down for scrap. (This is a perennial issue with gold. I never understand why the fans think gold’s incredible durability—it doesn’t waste or corrode—is bullish for the market. It’s bearish.) So if supply has consistently exceeded user demand, how come the price of gold has still been rising?
In a word, hoarding.
Gold investors, or hoarders, have made up all the difference. They are the only reason total “demand” has exceeded supply.
Arends’ explanation is based entirely on a series of misconceptions about how the gold price is formed. He looks at it as if it were a commodity that is produced and then used up. But this is not the case. Gold is produced primarily to be held in the form of bars, coins, or jewelry.
We all agree that prices are the mechanism by which supply and demand come into balance. Arends is working from the assumption that the price of gold must balance annual mine production against the annual use of gold for fabrication and dentistry. That is not the case at all. This could only be true under the following two (false) assumptions: if all of the gold that already exists – about 100 times annual mine production — were destroyed or otherwise permanently removed from the market, and if potential gold buyers could only purchase gold that was mined in the last year.
The market for gold does not consist only of gold that was mined in the past year. In the gold market, newly mined gold and existing gold form a single market. As I have written on this site, the supply of gold that participates in the price mechanism is all of the gold that exists.. Gold mining has very little impact on price. If mining were halted entirely that would not affect the price by much.
The demand for gold does include fabricators, gold smiths, jewelers and dentists, but these sources of demand constitute a tiny fraction of the total demand. The largest component of gold demand is reservation demand, or demand-to-hold gold by people who own it – also known as hoarding. By not selling their gold at or below the current price, gold hoarders ensure that the price stays at or above that level. By not bidding at or above the current price, dollar (and other money) hoarders ensure that the prices stays at or below the current level.
Trying to understand the gold price on an annual basis leads to the conclusion that there is a phony surplus (or deficit according to others).
Arends writes that more gold was mined than anyone wants to use, as if that has some kind of bearish implications. The mined surplus, according to Arends, has not yet depressing the gold price due to investors dramatically stepping up their hoarding. He implies that this big bump in hoarding is sure to be temporary, and then, gold will crash.
But there is nothing new, or special as Arends seems to think, about hoarding. Hoarding, or demand-to-hold, is the mechanism by which the price of any stockpiled good is set. Arends makes the quantitative increase in hoarding during the last few years seem about 100 times more important than it is by looking only at annual supply. In fact, the demand-to-hoard only needs to increase by about 1% per year in order to keep the market in balance because that is the rate of growth of supply. As long as investors, collectively, are willing to add to their hoards by 1% per year, the price of gold could stay at the same level.
The overwhelming majority of the world’s gold supply is hoarded by someone. The annual demand for destructive uses of gold, e.g. dentistry or irrecoverable industrial use is minuscule and can be met out of annual mine production. The importance of hoarding applies as well to money or any other financial asset as to gold. Take, for example shares of equity of a corporation. Like gold, financial assets are not “used” as in “used up”, they are hoarded. The price of any asset is set by the competition between asset hoarders and dollar hoarders as they balance the sizes of their hoards (otherwise known as accounts or portfolios). The question is, what price will existing gold hoarders choose to increase their stockpiles of money, and at what price will existing money hoarders choose to increase their stockpiles of gold?
Suppose that you read a research report from a brokerage like this:
Corporation XYZ plans to issue 1 million shares in an upcoming equity offering. Last year’s trading volume in this stock was 0.5 million shares. This new share issuance represents two times annual consumption of XYZ shares. Unless there is a 100% increase in the demand for XYZ shares this year as compared to last year, then the stock price of XYZ will clearly fall. Last year’s demand of 500,000 shares of XYZ was based on investor “hoarding” of XYZ shares. This hoarding demand is clearly temporary, speculative, and irrational; as such, it cannot be relied on to carry into the current year. Therefore the price outlook for XYZ is bearish.
What are the problems with this analysis? The analyst fails to look at how many shares of XYZ are outstanding and then to compare the size of the new offering to the total share count. Suppose that XYZ has already issued 100 million shares, then the new shares only dilute XYZ’s equity by 1%. If the equity offering is priced at fair value, then an equal asset is added to the firms’ balance sheet and existing equity holders are not diluted at all.
The analyst fails to understand that all shares of any equity are “hoarded”, that is, held in a stockpile by an investor somewhere; it is the nature of an asset to be “hoarded”. The analyst confuses trading volume with demand: the 500,000 shares of XYZ that traded last year is not a measure of the total demand for shares, only of the turnover. The trading volume tells you nothing about the price – a stock can trade either up or down on rising or falling volume. The analyst fails to take into account that it is existing bids for the shares that are responsible for maintaining the price where it is. All demand to hoard is speculative in nature though not necessarily irrational. And so it goes with gold.
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Maybe calling gold a commodity is misleading. Arends seems to be comparing it to pork bellies or corn.
@Mark. In terms of how it is produced, gold is similar to other metals. Maybe that is why people group it together. However, it is different than everything else that comes out of the ground (or is farmed or harvested) in two respects: 1) the ratio of above-ground stocks in relation to annual production is about 100:1 – nothing else is close to this and 2) it is never “used up”, it is accumulated. Nearly all of the gold ever mined in human history still exists somewhere. Because of these two facts, the gold market is dominated by people trading existing stockpiles. Miners, who trade newly produced stockpiles, are really small players compared to the holders of existing stocks. Miners tend to sell “at the market”, which means, they are price takers. The price makers are people who hold stockpiles of gold and the people who hold stockpiles of money.
The bigger use of gold is as a store of wealth than as a commodity, so I think that’s the confusing point for many. Calling gold a commodity focuses on that minor aspect of its use, but calling it money or savings would focus on the much more significant use you point out. I’m sure Arends has a savings account where he stores money for later use, but I doubt he would say he hoards dollars.
It’s amazing that the same people who disparage gold’s value as arbitrary seem to be the same people who feel that fiat currency is absolutely okay. Has no one in our society except for a few Austrian theorists figured out yet that value is subjective? Silly Arends.
i guess because capm uses “risk-free” treasury bond to model portfolios.
One does not imply the other. Gold is only as valuable as people value it. If gold had some magical value outside of human valuation and works counter to the dollar then a graph of gold prices of the past decades would show a flat line. Instead such a graph shows gold’s value fluctuates depending on the peoples’ whim of that time period.
@Michael Powell – You make a point that I was going to address but decided that my post was too long already. All monetary systems start out with something that has use value, but as a commodity becomes money, most of the demand for the commodity is monetary demand, aka “hoarding” or demand-to-hold for exchange purposes. So Arends is correct in pointing out that demand to hold is the biggest component of gold demand and he is also correct in pointing out that gold has relatively few uses at this point (however that is a function of the price – if gold were selling for $4/ounce we would find lots of uses for it). But this again is nothing new. The demand for fiat money consists entirely of demand to hold because it has no use value whatever, other than maybe as fish wrap or wallpaper.
but why is gold specifically chosen to be “hoarded” for monetary demand? Why is the price of gold so stable and in ‘high’ demand just for ‘hoarding’ when other things can be ‘hoarded’ for monetary demand and be cheaper than gold? Also, are you predicting higher gold prices in the years to come?
Because gold is currency, currency that is even more secure than the U.S. Dollar. Why do people flock to the USD in times of economic crisis?
@Diogenes – We can to some extent only guess why gold has emerged as a monetary commodity. And this state of affairs is not necessarily permanent. Probable reasons are that is has the properties of the ideal money: scarce enough to have a high purchasing power per unit but common enough to emerge into general use. Recognizable. Durable. Divisible. Difficult to produce more of it. It was in use for other purposes prior to its emergence as money so people knew what it was.
If gold was only $4 an ounce, we would probably use platinum or some other rare earth metal as currency.
The reason for this is money is not a good, nor a commodity but only a function.
A commodity usually has “good function” and if it is marketable enough it may begin to gain “money function”. Once a commodity starts gaining “money function” it starts feeding on itself, and while increasing its money function, it starts losing its relative “good function”.
Money function requires hoarding, and good function requires consumption. That is one of the reason why hoardable things tend to gain money function.
Silvio Gesell version 2.1
Arends does not seem to comprehend that gold is currency with intrinsic value. It is inaccurate to categorize gold purely as a commodity. If you guys have ever watched the movie Waterworld, pure dirt was their form of gold. Why? Because it was so rare and the entire world was under water, so it became an excellent form of currency that no government power could inflate. In our world, it is the same with gold.
The less people trust government issued currency and flock to gold, the more valuable gold is. This should be something so simple that an elementary school kid could comprehend.
Nothing has intrinsic value.
Billions in this world disagree with you.
“In commodity money, intrinsic value can be partially or entirely due to the desirable features of the object as a medium of exchange and a store of value. Examples of such features include divisibility; easily and securely storable and transportable; scarcity; and hard to counterfeit.”
ryan’s right. for “intrinsic”, substitute “non-monetary”.
If gold was plentiful it would be a pretty yellow metal that wouldn’t rust but it wouldn’t be valuable.
You confuse objective use value (also known as power/capacity in terms of degree) and exchange value, which is itself contingent on marginal utility.
“Billions in this world disagree with you.”
Yay, logical fallacies!
At last, smeoeon comes up with the “right” answer!
” Billions in this world disagree with you. ”
Yeah! As though that makes the billions right. Incidentally, at one point in time, most of the world’s population believed that the Earth is flat. At another point in time, most of the world thought that the Sun revolves around the Earth. Many more examples abound to show that your appeal to the preponderance of an opinion as proof of its validity is rather pathetic. Reason shows that the argument of “intrinsic” value of anything is flawed because “value” per se is subjective in nature and is appraised by each individual in terms of the extent to which something serves his/her life.
Most people held (or, shall we say hoarded? ) their tech stocks, but that didn’t stop them from becoming overvalued. Most people live in (hoard?) their residential real estate, but there was a housing bubble nonetheless.
If you want to identify the bubble, look at what they’re flogging on Drudge or during O’Reilly: 1998 – Janus Funds! 2007 – Refinance with Ditech! 2010 – Gold!
If gold was going to $5000, why would Eric Sprott be so anxious to sell his ‘hoard’ to the rubes?
Just askin’.
it’s hard to imagine gold being a bubble when the mother of all bubbles, the us bond market is still intact. a running yield of four something percent for a thirty year bit of paper? treasuries, not gold have been the go-go asset class of recent times.
@Thad – Sprott is not selling his personal stockpile of gold. He is a financial intermediary. His fund buys gold and then issues shares that represent fractional ownership of the fund’s assets. He is issuing more shares of this fund because of investor demand for a vehicle to own through an ETF. Some issues that have been raised about the custody structure of the other gold ETFs so there is market demand for an ETF with a more transparent custody structure. Whatever is your opinion of this investor demand, the fund’s new offering is not the same thing as Sprott selling his personal assets.
I understand how Sprott’s ETF works and why investor demand for it is so high. I’ve followed the debate over a possible decoupling of the price of physical gold from that of ‘paper’ gold. I would ask how you can be so confident about what he’s doing with his personal holdings – are you his portfolio manager? Do you direct his hedge funds? The VCs who took Doorknobs.com public didn’t sell their personal holdings either, at least not until the lock-up period was over and the rubes had driven the share price to the heavens.
Look, I’ve seen Sprott’s interviews on Zero Hedge and elsewhere, and he seems like a straight-up guy. You’re probably right. The gold bull market probably still has some legs. Probably. The sovereign debt crisis is real and will stay in the headlines for awhile, and politico-economic uncertainty is always good for gold.
In my experience, however, the smart money doesn’t share its investment strategies with the rubes until it’s time to look for an exit. Raising a bunch of capital for a gold ETF would make excellent cover for liquidating one’s own position.
Otherwise, you have to believe that the smart money is at home at 4:00 pm watching all the ads for gold dealers on Glen Beck or during Law & Order reruns.
Someone should tell Arends to stop hoarding souvenir knick-knacks from his trips abroad, old photographs, all those golf shirts in his bottom drawer, and the fishing poles sitting in his garage that he never uses. Because if someone buys something that is (according to me) not really very useful, and hangs on to it longer than (I think) is strictly necessary for utilitarian purposes, it drives up the price unnecessarily (in my opinion). That’s why I don’t trust the price of knick-knacks, photographs, casual shirts or fishing poles. And it’s a bad for society that so many people hoard these things.
Most Austrians don’t seem to want to consider what Arends supposes – what if the gold price did plummet to the $500 – $600 per ounce range? If it did then what? Many people who bought gold on the notion that it can only go up will be mortified. Will the same people get comfort when hearing they may get their money back when gold starts rising in 15 or 20 years time?
In the history of gold there are very few “spikes” during which if you had bought gold during that time, you would have had to wait many years for it to regain its value (in paper money). Actually there is only one such spike that I am aware of. But there have been several episodes in the last 100 years alone during which if you had bought the average stock, you would have had to wait many years for it to regain its former (nominal) share price. If ever – the stock indexes usually recover because they are deliberately composed of winners, but many individual companies never come back because they go out of business during the dip or they are taken over for a song. Non-gold commodities like oil, copper, etc. also have periodic spikes and dips during which quite a lot of shareholder or speculator value is lost for long periods of time. Ditto real estate.
On this basis, considering the likelihood of losing the value of your investment and not being able to recoup its value again before you need the money, gold appears to be by far the most sound investment.
Besides, it’s easy to tell when to dump your gold – when your friends and relatives who were never interested in it start to tell you what a wonderful investment it is, and when traditional media suddenly begin pushing it.
Gee, it must be starting to get close to the day when the gold price is going to plummet.
@Gil – I know of Austrians who have a range of views on the gold price from bullish to bearish. The purpose of my post was not to to make a price forecast for gold. Rather it was to point out that the WSJ writer was not reasoning about the gold price in a logical way. The writer suggests that the gold price is where it is in spite of a surplus of gold because of investor hoarding. What I was trying to show is that there is no gold surplus or deficit and that all gold is and always has been hoarded, so hoarding tells us nothing about the gold price. The balance between gold hoarding and dollar hoarding could settle at any price.
In order to come up with a forecast for the gold price, you need to look at other things. Most of the Austrians I know consider it a quasi-currency and look at things like money supply growth rates, the build up of debt in different countries, the degree of risk and rates of return in other financial assets.
About things having “intrinsic” value – How are you defining intrinsic value? Are you making a play at the somantics that if a person doesn’t value it, it doesn’t have value? Absent of use, a rock still has mass, copper has conductivity, grain stores energy. In a world with humans, the rock can be used to hold down paper, or as a weapon, the copper can be refined, drawn, and used to conduct electricity, and the grain can be eaten or used for fuel. People value the characteristics of things. The attributes of the things exist in the absence of use, but the value comes from use. So if you are attempting to state that things don’t have intrinsic value, because things only have value in man’s use, I would respond – “So what? Man exists, he recognizes the usefulness of various things, so it is functional shorthand to say that things have the value man generally attributes to them.”There were people who thought that the tie of US dollars to gold was what gave gold value. They anticipated that the price of gold would fall from $35 dollars per ounce to $7 dollars per ounce (their estimate of its industrial use value) when Nixon demonitized gold in ’71 or so. Obviously, history has shown them to be wrong.Also, the article doesn’t discuss the current nature of the formation of the “gold price”. Most people believe that the “gold price” is based on a transaction for physical gold. It is not. Generally, the “gold price” is formed in the COMEX futures market, for gold futures. The LBMA then picks a morning and afternoon fix at which to conduct trades, based on the COMEX market. The various markets for physical gold generally follow the COMEX – just look around at your favorite local coin shop your favorite internet vendor. There is an increasing volume of “fringe” reporters that discuss the backwardation of COMEX settlements, and the massive shortage of gold for physical delivery that the COMEX and LBMA have if physical delivery were demanded for settlement (as was originally allowed) by those markets. Backwardation is the payment of a premium in cash (USD) for the allowance to settle a futures contract in cash (USD), rather than in the commodity traded. The ETF’s also have substantially less gold than their NAV. My point is that the “price” of gold is still being based on paper transactions with no firm basis in physical gold. I believe that the fraudulant nature of the COMEX and the LBMA, where they claim to trade in physical gold, but can not fulfill their contracts, will become better known. I believe that the true price of gold, meaning that demanded for immediate physical delivery of gold, will diverge from the COMEX and LBMA “prices”, and that this event will lead to a dramatic increase in the gold price in all fiat paper currencies.
hear, hear. i’m sympathetic to the work by gata to expose the rot in the gold market.
Question: Might monetary inflation also have something to do with the increasing price of gold? It is my understanding that, for example, the same amount of gold will buy a gallon of milk today as it was able to buy in 1900, more or less.
Yeah I think that it has a lot to do with the price of gold. I wrote an article addressing the question Is Gold Money?. My answer was that it is not, exactly, but it is near-money or something close to money. As it acts like a currency in financial markets you would expect it to maintain a relatively stable purchasing power, maybe appreciating a little bit because economic growth has averaged around 3% per year while gold supply has grown more slowly than that. If you buy my argument, then you might expect it to appreciate in purchasing power terms by about 1-2% per year over time.
I see the price swings of the US$ price as partly due to swings in the exchange rates between US$ and other currencies and partly due to the perceived stability of the global monetary system as a whole. Remember, gold is a global commodity. The dollar price of gold is not the only price of gold. Gold is purchased with every currency. As one currency moves against another, the price of gold in both currencies will change. During periods of dollar strength against other currencies, the dollar price of gold will tend to be lower, while the gold price in other currencies will be higher. The dollar price declined between 1980 and 1998 but it did not do badly in other currencies during that period. The last ten years has been a time in which the perceived attractiveness of financial assets has moved from a peak during the bubble to a relatively low point, making gold relatively more attractive.
Gold is money sadly – to the point that in addition to a number of other abuses – they have substituted worthless paper for it. There is not close to enough bullion to cover demand, so they print paper out of thin air – several kinds in fact. Unlike reserve banking for which there is some insurance, if you end up with a piece of paper or your gold pooled, you have nothing, nada. Yet it is this paper gold that is used to balance supply and demand artificially, keeping the true value down. When the EU and Japan were going crazy for bullion last week, the spot price never moved. It should have doubled on any commodity or asset of limited availability. Take paper out of the equation – it should be illegal – take out the other scams – and gold/silver would go through the roof. I cannot believe that everyone is not demanding bullion now!
Even going back before Bretton-Woods was cancelled, 1 oz of gold was worth about 10 barrels of oil. The exact range fluctuates. Currency is just a temporary media that can be used to exchange other products. So when the WSJ says that the price of gold is volatile, all it is really saying is that the dollar is volatile. This why Peter Schiff regularly quotes the Stock Market Index Prices in ounces of gold
“Gold Buying” Commercials are everywhere on All Major TV networks ..You see the street signs “We Buy Gold”..This is not a coincidence. The people behind this move to own gold know whats coming.. the business cycle is rearing its ugly head again… We are heading for a MAJOR BUST.. Neither the Euro nor the USD is a safe haven in this economic climate… Gold, Silver and other precious metals will do very well… Dont ask questions… Just Buy Buy Buy
Aaaah, A place founded by the heirs of the marginal revolution but, when it comes to “supply” marginal analysis is left out.
The supply of gold is not the same thing as all the gold in existence.
Supply, in economics, is the amount that is traded at the margin.
If 90% of the gold in existence is hoarded, and left out of the trading, that 90% doesn’t not constitute a part of the supply hence it has no effect on the prices.
That is why gold prices increase even in a deflation. Even though the supply of dollars decrease in a deflation, the supply of gold decreases even more because many people hoard the gold and remove it from the previous supply. They do this because of panick of course.
The marginal supply analysis also applies to fiat money. That is why even though there is close to 1 trillion dollars in excess reserves, there is not rise in general prices. Because all of that fiat money is hoarded, and left out of the supply that effects prices. It doesn’t matter what M1, M2 or MZM says, that amount is no part of the money supply.
Of course the reason gold is hoarded in the first place is because gold is money. At least a quasi money as of now.
Also it is time that Austrians to quit this monetarist obsession regarding measuring the supply of money. It is not possible.
It is not even essential to Austrian economics or monetary theory, since no Austrian claims money can be managed. Why would you want to measure something when you know you can not do anything with it. At least monetarist have a desire to manage money, thus their futile attempt (at measuring the money supply and its increase) is understandable, but Austrians obsessed with measuring the money supply is not
@Kerem you are quite wrong about this.
At any point in time, 100% of gold is hoarded. This is true for fiat money and any other asset. 100% of the shares of XYZ corporation are hoarded.
You are correct that price is set at the margin. But all of the hoarders of gold and all of the hoarders of dollars must be taken into account in order to identify where the margin is. Every ounce of gold is at some level part of the market because every ounce of gold is offered at some price. The
market price of gold in dollar terms is where it is because all of the gold hoarders will not accept less than that amount for any of their gold. On the dollar side, the dollar price of gold is where it is because all of the dollar hoarders will not part with more dollars than that in order to obtain an ounce of gold. By hoarding their gold and their dollars — that is, by refusing to part with their hoard for less than a particular price — hoarders determine where the market price is.
All of the supply and all of the demand participate in the price formation. Your example of fiat money is also incorrect. You describe a situation where the supply of money increases while at the same time the demand for money increases by a corresponding amount, so the purchasing power of money does not change much.
According to your criteria, money that is held is not part of the money supply. But at any time all money is held, as is all gold. This is not a helpful distinction. There is no way to differentiate between money that is held and money that participates in price formation. By not buying at a higher price, holders of money ensure that the price of a good is where it is and no higher. By not hoarding their money at a lower price, holders of money ensure that the price of a good is no lower.
I explain this in more detail in my article.
Robert,
I am afraid you are wrong regarding this. You seem to accept marginal analysis but only treat it as a trivial fact and do not apply it in your analysis regarding money.
Money held and money hoarded are different things. Money held is a part of the money supply because it effects the valuations and the actions of individuals who trade money for goods and services. You act differently if you hold 100 dollars in cash than if you held 1000 dollars in cash. But also holding 100 dollars in cash and hoarding 900 dollars are not the same thing as holding 1000 dollars in cash. Imagine there is only two ways of keeping money. One in your pocket and the other in safe at home. Keeping 1000 dollars in your pocket is not the same thing as keeping 100 dollars in you pocket and 900 in your safe. In both situations the money supply is different and that is why it is futile to try to measure the money supply.
Money hoarding decreases the money supply and consequently it increases the purchasing power of money remaining in the economy that is held. You can also see this in Walter Blocks “In defense of the Miser” article, recently posted on the blog. That is why hoarding money is not a bad thing for the economy, or savings can not leak as the Keynesians claim, since price of money adjust to the new supply after the hoarding. You are falling into the Keynesian trap with your analysis.
Money hoarding is not the same thing as holding the money and making different amounts of supply available at different price points. Money is not a good that is exchanged for eventual consumption. Hoarded money is not the supply of some speculators waiting for the price to rise so they can sell. It is done usually in situations where future is less certain and there is panic.
Right now, most of the gold is hoarded and not available as a part of the gold supply. The only thing that determines the price of gold is traders, that trade on the margin with maybe less than 1% of the whole gold amount that exists. The reason for this is gold as of now is not real cash but quasi cash. It is used as a hedge against fiat money risk.
If gold becomes real money in the future, the hoarding would decline dramatically (this would increase the supply dramatically) but this time the demand to hold also would increase more relative to the decrease in hoarding. This of course would raise the price of gold.
Also regarding the fiat money and the excess reserves of the banks, you are again mistaken.
Banks do not hold money. That is not their business and that is why these reserves are called “excess” reserves. That money is hoarded by the banks and not traded or used in anyway. That is why those reserves are not a part of the money supply and that is also the reason they have not effect on money prices of goods and services.
If that hoarded money, stops being hoarded and becomes a part of the money supply then we would see the long awaited hyper inflation regarding prices.
if the money is owned either in a safe or in a pocket how is the money supply different??
hasnt it been accounted for somewhere??
from ore (miner gets paid) – to metal (refiner gets paid) – to smelter (smelter gets paid) -to mint (minter gets paid) – to a safe or pocket (for spending, saving or emergencies)…
isnt it the same money but a different decision on where to put the money
If you hoard, or save the money as money and not lend it to anyone, that money is removed from the money supply. Because money is a medium of exchange and if something is not a medium of exchange, on the margin, it is not money. It doesn’t matter if it is viewed generally as money.
Today because of the inflation usually fiat money is not hoarded, because it loses its purchasing power. The fiat money is either hold as cash or lent as an investment. Of course we are in exceptional times and fiat money is also being hoarded by the banks as excess reserves, but that is an exceptional case.
When gold was money it could be hoarded, or saved as money without lending it, because it kept its purchasing power, when it was brought about to be added to the total money supply it retained its value. But this didn’t cause a leak in savings because since the hoarded money is removed from the money supply, the prices adjusted accordingly.
Hoarding money or keeping cash is a subjective individual decision that takes place in instances. That is why money supply can not be measured in any meaningful way. Money is subjective function and decision regarding hoarding and making it available for trade is instantaneous and individual.
Also even if there was only gold being used as money, total money supply is not the weight of all the gold that is in existence. Mises and Rothbard was wrong on this point. There are two reasons. One is the one I mentioned regarding hoarding money. And the other is commodity money like gold still has good functions, besides its money function.
Lets say there is 100 tonnes of gold and no hoarding. How can we say that all of it is regarded as money by holders of it? What if some of it is viewed as jewelry which is good and valued by its direct use instead of being valued as a medium of exchange? And since this is a decision made by individuals, you can not even find out which amount of gold is regarded as jewelry and which amount is money. It can change instantly. One second one person might view her necklace as jewelry the next second she can use it as money and trade it away. This all changes the money supply.
Of course in usual times, these changes don’t effect the money prices that much, since the amount of total gold hence a part of the money supply can not be manipulated and increased that easily. But still it is what it is.
Why would gold being hoarded allow the remaining gold to “retain its purchasing power”, K. Tibuk? If some decide to hoard gold then the gold’s purchasing power has improved. If hoarders decide to reintroduce their gold into the system then the price of gold would go down. If a gold mine opens up and pours new gold into the system the purchasing power of gold goes down. If a ship carrying gold bullion sinks into the deepest parts of the ocean and the gold bullion can’t be retrieved then the purchasing power of gold goes up. Therefore the purchasing power of gold would fluctuate over time depending on the situation.
Gil,
“Why would gold being hoarded allow the remaining gold to “retain its purchasing power”, K. Tibuk?”
Gold being hoarded doesn’t allow the remaining gold to retain its value. As you said, the act of hoarding would decrease the supply hence increase the value of the remaining.
My point is, the reason gold is hoarded is because gold retains its value, because the chances of its supply being arbitrarily increased is slim.
Gold doesn’t retain its value per se. Its value depends on the economics of the day. If society collapsed to the population of the year 1000 as well as the economy, technology and productivity with no likelihood of things improving until the year 3000 yet all the gold that has been mined is still with us and becomes the new currency such that most of world’s hoarded gold enters the economy (and even gold jewellery melted into ingots and coins) then the purchasing power of gold would a small fraction of what it was in the year 1000.
Banks do not hold money. That is not their business and that is why these reserves are called “excess” reserves.
do they hold money in safe deposit boxes??
do banks hold something other than money??? a currency??? if a bank currently gives a laon check to someone and the someone put the check in a another bank and then withdrawls some paper currency from the deposited check what was the bank holding???
“do they hold money in safe deposit boxes??”
That is not the point. The issue is excess reserves, in todays monetary system. Of course banks should hold 100% of the checking accounts but that is simply not the case and a reason for inflation.
@Kerem:You are quite wrong about this, still.There is no meaningful distinction between holding money and hoarding money. The money supply consists of all money. All money is held. There is no such thing as money in circulation. At any point in time all money is in someone’s cash balance.
You have the cause and effect backwards. Money is held because of the valuation of the person holding it. The reason that people hold/hoard cash balances is that the reservation price of their money (in terms of goods) is higher than the prices currently offered (in terms of goods) for their money. Each money holder has a different reservation price for each unit of their money.
From the point of view of marginal utility theory, there is no distinction between holding/hoarding 100 dollars and 1,000 dollars. Those are only different quantities while marginal utility theory is valid for any quantity. The difference in human action that you are describing between someone who holds 100 or 1000 is based on the lower marginal utility of each dollars from 1000….101 than of each dollar from 101…0.The marginal utility of each dollar is greater as you work you way down through the hoard/cash balance. But there is no point in the process where you transition from dollars held to dollars hoarded. Where would it be? Is #167 held and #168 hoarded? The only thing you can say is that as you work your way down from dollar #1000 down to dollar #1, that each dollar has a higher marginal utility as a dollar held, meaning, it would require a lower dollar price in the goods market to induce the holder/hoarder to part with that dollar.
Money hoarding, which is the same thing as money holding, or holding a cash balance determines the purchasing power of money through marginal utility. Each money hoarder/holder balances the size of their money hoards against consumption opportunities for different goods at different prices. There are not two separate economic processes at work – money “holding” and money “hoarding” – there is only one economic process: everyone adjusts their cash balances at all times in line with the utility of the marginal unit of money compared to the marginal utility of the highest-ranking good that they could purchase with money.
I looked up the Walter Block piece and it can be read as supporting your incorrect view. If that is indeed what Block meant, then he is wrong. I will write Dr. Block and ask him if that is what he meant.
Let’s look at Rothbard. First let’s look at Man, Economy, and State, Chapter 2, Section 5, Determination of the Equilibrium Price. Rothbard works through an example showing the determination of the exchange rate (price) between apples and horses. While those are both consumption goods, for the purpose of understanding hoards/stockpiles/balances, it does not matter. The point is that each unit of a hoard of goods has a lower marginal utility than the previous unit. But all units that a person owns form his hoard, or stock.
Now let’s go to Chapter 11, Money and its Purchasing Power. Here Rothbard explains that there is no division of the money supply:
and here, that hoarding and adding money to the cash balance is the same:
Kerem, if you read all of Chapter 11, Rothbard uses “hoard” synonymously with “to increase your cash balance”.
Robert,
The reason you and Rothbard are mistaken on this point is, you think money is a good. Any analysis regarding goods do no apply to money because money is a function different than a good function. This function, like the good function is embedded in commodities but one shouldn’t confuse these.
Good function is the direct satisfaction function. When it comes to good function, the more is better. And the amount or intensity of the good function represents wealth.
Money function is a liquidity function, in other words it is a medium of exchange. The more of it isnt better, and money doesn’t represent wealth. Also its supply is not directly tied to the physical amount of the commodity it is inherent in. Thus its supply fluctuates independent of the physical commoditity.
A commodity may contain both good functions and money functions at the same time, and the ratios, although impossible to measure, fluctuates. If gold is used as money, gold isnt only money. It also contains good functions, and as we know money function can not arise from something without a good function. If you look at the gold as a good, as commodity used in jewelry, electronics, etx the more gold the better. But as money its quantity is irrelevant, although the change of the quantity and how it comes about is relevant.
Also think about it. If hoarding is the same as holding, this means unless you destroy the money you can not decrease its supply. This means the Keynesian leakage of savings is really possible, if money is only saved but not invested, because the prices can not adjust. Are in agreement with Keynes regarding this. If not how do you think Keynes is wrong on this.
@Kerem, I’m glad that you are conceding that the Austrian view is what it is. Your view on this is different than the Austrian view.
Is money a good? Let’s go back to Menger, Principles of Economics, Chapter 12, The General Theory of the Good An (economic) good is a thing that these properties: it meets a human need, humans have knowledge of how to use it to meet their need, and humans have command of the good. Also see Chapter 6 and Chapter 8 which deal with use value, exchange value, and money.
Menger’s entire theory of money is based on the fact that money is a good. Money meets the need of people to participate in a wider variety of exchanges more conveniently than they could in a non-monetary economy.
As far as the distinction between monetary and non-monetary uses of gold, I see this as more of a spectrum of uses rather than a hard boundary. In some parts of the world consumers prefer coins and bars for monetary gold and jewelry is mostly ornamental. In other parts of the world monetary jewelry is preferred. Even ornamental jewelry has some monetary value – people do every day sell jewelry for its melt value. The monetary use of the jewelry is the opportunity cost of holding it as jewelry. Even metals use in industry can be reclaimed as scrap. There are examples (or you could think of an example) where it would pay off to scrap an entire finished product and replace it with a different version of the product in order for the scrap value of its retained metal.
Because the monetary value of its gold is so high, the monetary use of gold figures into all calculations of its non-monetary use.
1. Concerning holding and hoarding, see my quote from Walter Block below.
“unless you destroy money you cannot decrease its supply” => true. However, by increasing or decreasing cash balances, the money-demand side of the price system can change. Prices will generally rise or fall as the population adjusts its demand for money.
“if money is only saved but not invested” ==> People can increase their money demand by abstaining from purchasing at a higher price. If enough people do this, then the price level will fall. There are two problems with Keynes here. One is that he was inconsistent in his usage of the term saving do mean either not spending on consumption or not spending at all. Not spending on consumption means either holding cash and/or spending on capital goods (investing).
Not spending at all means increasing your cash balance. Because at any point in time all cash is held by someone, everyone cannot increase their cash balance at once. However, everyone can increase their real cash balance by not spending at current prices. The price level will adjust downwards (purchasing power of money rises) until enough people are satisfied with their real cash balances (current prices) to buy at those prices.
The problem with Keynes on this point is he did not believe that the price system worked at all. Possibly you agree with him because you say that prices can not adjust (or maybe you are presenting Keynes’ view in that sentence). This is covered in Chapter 11 of Rothbard, which I cited yesterday.
For Austrians there is no general macro-economic problem caused by an increase in monetary demand. If consumption goods or investment goods become cheaper, then people with more cash will get better deals.
Robert,
Menger and then Mises and Rothbard was wrong when defined money as as good.
“Is money a good? Let’s go back to Menger, Principles of Economics, Chapter 12, The General Theory of the Good An (economic) good is a thing that these properties: it meets a human need, humans have knowledge of how to use it to meet their need, and humans have command of the good. Also see Chapter 6 and Chapter 8 which deal with use value, exchange value, and money.”
This definition maybe true but not sufficient.
How come a good, that doesn’t include money, represents wealth but money itself doesn’t? How come we can say “the more of the good there is better it is” but we can not say the same thing for money? Mises knew about this paradox and he had to invent another category of good to get around this, beside producer goods and consumer goods, but categorizing money as a category of good is not useful because money and good are very different things.
The problem with Menger’s definition is, ironically, that it doesn’t treat the issue marginally. A “general” human need is not sufficient to define a good. Any function fulfills a need. But “good function” and “money function” are very different things. The good function represents a direct satisfaction upon consumption thus wealth. But money functions only job is to be a medium of exchange and facilitate indirect exchange.
You quote Rothbard regarding the circulation of money. And then you quote Block regarding the velocity of money. Don’t you think this is paradoxical.
Yes Rothbard was right when it comes to the velocity, though mistaken when it comes to the money supply. Velocity is a cop put concept you have use when you can not define money as a function.
Money function is subjective function that depends on individuals subjective valuations. It is not an objective, detached physical thing. You can not physically measure a commodity that has money function and declare the money supply. Unless you can read the minds of everyone that is holding, or hoarding the said commodity. If some part of the populace that is holding the commodity view the said commodity as a good then it is not a part of the money supply.
Also holding and hoarding is a state of mind on an individual level. If some people think the future is more uncertain and remove the money they are holding both physically and mentally from their cash holding, money supply decreases. This can not be explained by a change of demand, since this is about the change in the mental state of one individual that already owns the money. If I own 1000 dollars I already own it. If I decide to hoard 900 dollars of it, bury it somewhere and forget about it, how is this anyway related to demand to hold money? My mental state regarding that money is not a change in demand but only a change in money supply.
M is not M and it can not be measured, and inventing a concept called velocity is counter productive and useless.
Gold has been increasing in dollar prices in spite of a dollar deflation. Dollar supply is deflating but gold supply is deflating even more.
Also this money being a subjective function, the same problem exists when you try to define money as one of the M’s.
Do savinn accounts consitute a part of the money supply?
You can not give a general answer. Some people might think they can have access to the amount so for them it adds to the money supply. Some do not think they have any claim on the amount until the end of the contract term. Same is true for credits. In many countries the credit agreements between banks and companies are not strict time contracts. They are like general guidelines. The bank can call of the loan anytime it wants, despite the loan being a 5 year loan or a 10 year loan. And on this if the banks think they can call the loans anytime they want this adds to the money supply. Of course in this way every written off bad loan deflates the money supply as well as banks going bankrupt.
@Kerem, I’m afraid that this reply is going to show up in the wrong place since there is no reply button on the specific post that I want to reply to. This is a continuation of the discussion of a good.
“Menger and Rothbard were wrong…” There are differences between different types of goods. Menger saw it was to understand human choice under the conditions of scarcity. The purpose of Menger’s definition was to identify those things in the world that are the that are the objects of human action.
There are different kinds of goods. Goods that are valued for their use value – final goods, or consumption goods – are the only goods that directly satisfy human needs. Other goods – producer goods and money – are classified as goods because they are indirectly useful toward the end of attaining final goods. Because they are scarce they are the object of economizing behavior.
Given our finite time and resources, you have to make choices between actions to obtain more final goods, more producer goods or more money, but you must choose between the three. All goods therefore are subject to economizing behavior. This is why it makes sense to look at the entire realm of goods.
re: Dr. Block, my purpose in quoting him was to clarify that Dr, Block did not adhere to any distinction between holding money and hoarding money. I agree with Dr. Block on that point. the quote I gave in its entirety because he granted me permission to use that quote on this blog. If you are making the point that velocity is not a valid concept within the Austrian framework then I accept that point and agree. What I think that Block was saying is that in mainstream macro, they would use the term velocity if they were having this conversation, which is true.
re: “holding and hoarding is a state of mind”… What I am not clear on at this point is whether you mean by hoarding any non-monetary use of gold?
I agree that there is such a thing as non-monetary use of gold. See my discussion above about ornamental versus monetary jewelry. Ornamental jewelry, wedding rings, dental fillings, and tiny amounts of gold used on circuit boards constitute non-monetary use of gold. Also agreed that a non-monetary use of gold decreases the money supply. However, even non-monetary use of gold must take into account its monetary value because gold can and does move back and forth between monetary and non-monetary value. If its monetary value becomes high enough people will sell their non-monetary gold for its melt value and return it to the money supply.
What I am not clear about from your last paragraph if you mean by “hoarding” any non-monetary use of gold. If so then that would be in my opinion a curious definition for several reasons. Hoarding usually implies accumulating something or holding on to something, while non-monetary use of gold are for their use, not to accumulate as the object of accumulation. See dictionary.com for example hoard=”a supply or accumulation that is hidden or carefully guarded for preservation, future use, etc.:”, “to accumulate for preservation, future use, etc., in a hidden or carefully guarded place:”. So if you are going to define non-monetary (i.e. consumption) uses of gold as hoarding that is contrary to common use of that term.
Now if you mean by hoarding, holding gold but in a different mental category, that is not an analytically significant difference in the economic sense. See my earlier posts on this. Everyone’s gold holding is ranked from the lowest valued ounce to the highest valued ounce. The lowest-valued ounces are lower valued because of the holding of the higher-valued ounces — without the higher-valued ounces in reserve the lower-valued ounces would be higher-valued. Every ounce has its place in the person’s value scale. There is no transition where you cross the boundary from ounces held to ounces hoarded.
The way that the total money supply is relevant to the PPM is because the aim of human action in relation to money is to maintain some level of purchasing power or real cash balance. If the total money supply increases, then at least someone or a few people will find their cash balances have increased. If they want to maintain them same real cash balance as before the M increased they will spend some of their cash by hitting the offer price of previously unsold goods. These transactions occur at higher prices than before…and so on until the price system has adjusted to the point where everyone has their desired real cash balances but at a generally higher level of prices.
Also your marginal analysis has shortcomings.
Relevant quantity of a good that is part of the supply is the good brought to the market. If a good is hoarded this means that good is left out of the market, thus is not a part of the supply. This leaving out of the market doesn’t even have to be the result of hoarding. For example the wheat production of Crusoe on his island doesn’t add to the wheat supply in England, thus can not effect wheat prices. You can not say all the wheat in existence comprises the supply. That is clearly wrong.
Of course goods and money are different especially when it comes to hoarding. Goods usually aren’t hoarded because they are produced to be consumed. Why would anyone hoard something that is made to be used. Only under very exceptional conditions this can happen. Money on the other hand is different.
@Kerem, you are making the same bogus distinction between in circulation and hoarded money, but in different words. This time it is “that part of the supply that is brought to the market” and that part of the supply that is hoarded. “Brought to market” is another version of “in circulation”.
All money is at all times in someone’s cash balance. There is no praxeological division into money that is “brought to the market” and money that is not. The market for money consists of the entire market of goods offered for sale in money terms and all cash balances.
The purchasing power of money is determined by all of the holders of cash balances, who, by holding their cash instead of selling their cash at a lower price, ensure that the purchasing power of money is where it is, instead of lower. Individuals who hold their money rather than selling who influence the purchasing power of money as much as those who spend.
Individuals have cash balances. For each unit of money in their cash balance, there is a reservation price. The least valued unit of money has the lowest reservation price, and so on, each successive unit of money having a higher reservation price. The money that you have on your person at any time is the money with the lowest reservation price. You carry this money with you in case you find a good that is offered at a higher reservation price (here we are talking the price of money in terms of goods) than the lowest valued money unit in your pocket. If that happens then you buy the good. The money is transferred from your cash balance to the cash balance of the person that sold you the good.
You cited Walter Block’s article as supporting your view. I wrote Professor Block, asking him whether he meant in this article that there is a distinction between holding cash and hoarding. He wrote back to me the following: ” M is M. It is always owned by someone. Hoarding, praxeologically speaking, is merely the concept of holding it for a longer period rather than a shorter period. An increase in hoarding is equivalent, in mainstream macroeconomic terms, to a decrease in velocity.”
re: what in England example, this comes under the theory of international trade.
For goods such as wheat, there is an international market. This is true for all commodities and many manufactured goods. There is a tendency for the same good in different places to sell at the same price plus transportation costs between two locations. Entrepreneurs every day buy a commodity or a good in one place in order to sell it at a better price in another place. Depending on the commodity and transportation costs, many goods form a single unified market.
re: “why would anyone hoard anything that is made to be used”. Many reasons. A store has an inventory of consumption goods. The fact that they have an inventory shows that they are hoarding. They could mark everything down to a price that would clear their shelves today, if they wanted to. Have you ever been to a movie where there were empty seats? The theater is hoarding seats. They could slash their prices to the level where the theater is always full. A miner might hoard mined metal in a warehouse waiting for a better price.
@Kerem, “Do savings accounts constitute part of the money supply”
I am not an expert on money supply components. The components of what is and is not the money supply are very much debated among even Austrians. There is a general agreement that non-bank credit instruments are not part of the money supply.
The two writers who have written the most about this are Dr. Frank Shostak and Michael Pollaro. You can find Shostak’s articles about the money supply and other topics here and Pollaro’s articles here.
Having read some of these articles the type of questions that you raise about what is or is not part of the money supply are the same types of questions that get debated among Austrian money supply researchers.
Gold is not only money, it is the only money that thieves (viz., governments) are unable to counterfeit, which clearly adds to its subjective value in the minds of money consumers. This is an attribute that no government’s currency possesses. In fact it could be argued that all of those government currencies are counterfeit, that gold is the only real or good money. As governments ramp up their counterfeiting to finance vote-buying social-welfare schemes and bailouts of government entities and government-favored businesses, gold’s subjective value will continue to increase in the eyes of all those who do not wear blinkers. The numbers of those who are not fooled by counterfeit money and see the wisdom of holding gold will similarly increase. And as government-spending schemes, mandates and entitlements compound, as compound they must, so too will the price of gold–real money–as measured by those government wannabee monies.
are you saying that due to the inflation of the money supply from all the spending, the value of the currency is going down and that will automatically and inevitably increase the price of gold in that currency down the road? Do you believe that the gold price is only going to go higher from here on?
are you saying that due to the inflation of the money supply from all the spending,…
spending of what??
the spending of dollars to pay for the treasury/fed to print more dollars (inflation)???
is all of the spending going into to making more dollars or making other stuff??
cret, increased spending leads to the government printing more money to be able to pay for them since there is a deficit. By spending I mean of all government programs
Gold is not only money, it is the only money that thieves (viz., governments) are unable to counterfeit, which clearly adds to its subjective value in the minds of money consumers
do you use gold or silver as money now?? if so, how???
“people do every day sell jewelry for its melt value. ”
if gold were money what would the get in return?? a gold coin of less weight that the gold in their jewelery???
What happens now is that you get less $ for your scrap than the gold weight of the item. The difference between the melt value and the price would be due to the cost of melting and forming into bars. If the jewelry item has other metals mixed in, I don’t know the metallurgy of that but I would guess it ads some complexity to the melting process. If gold were money then I think it would work the way that you describe. You could sell a worked gold item for less than its gold weight.
cret and Diogenes, sorry I didn’t see your several replies to my comment until just now.
In response to Diogenes questions: Yes, I do think that nations inflating the supply of their fiat currency will, certeris paribus, cause the price of gold to increase in terms of their currency. And, Yes, I do believe gold’s price is going to continue increasing in terms of the various fiat currencies of the world, because as certain as either the Celtics or the Lakers, one or the other, will win the NBA championship this y ear, nations with fiat currencies will inflate those currencies–no ifs, ands or buts about it.
cret: I would recommend you check out Franklin Sander’s website, download and read his recent article (in pdf) entitled “Prudence, Managing Dollar Risk with Silver and Gold,” which addresses your questions of me more fully than I could do so personally here.
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