The value of the dollar

2012-DEC-09

I very rarely criticise the work of others, but I am going to make an exception in the case of Paul van Eeden, of Cranberry Capital. Mr van Eeden, in an interview with The Gold Report stated that “the value of gold is about $900 per oz. Expectations of monetary inflation are keeping gold prices high.” He states that quantitative easing is not producing the inflation expected. The purpose of this article is to point out some of the fallacies behind his approach, and in this respect, Mr van Eeden is far from alone. And this is where a number of basic errors are committed.

We start with the definition of value. According to the glossary of von Mises’ Human Action, value is “always relative, subjective and human, never absolute, objective or divine”. It is reflected in human conduct, placing value in the same subjective category as fairness and morality. So all Mr van Eeden is basically doing is expressing a personal subjective opinion when he talks about the value of gold. He justifies his belief with a monetary statistic of his own invention, and compares its growth rate with the rate of increase in the price of gold. The basic error Mr van Eeden makes here is to believe there is a physical link between changes in the supply of money and the gold price. For a start, there is no convertibility between the two, and fiat dollars are intrinsically worthless, so cannot realistically form the basis of a valid monetary equation.

The dollar only has value because the foreign exchange markets and the people that use it assume it has value, vaguely based on the standing of the issuer. This can change suddenly and substantially, irrespective of changes of the quantity in circulation: ask anyone who possessed Icelandic kroner a few years ago. Likewise, gold has a value that measured in paper money can change suddenly, without a sudden jump in mine supply, if people simply shift their preferences between gold and money.

If Mr van Eeden’s view of value was fundamentally justified, one would expect foreigners, particularly central banks and over three billion Asians, to cash in their gold for dollars. Instead they are keen gold buyers, and we get no explanation why, other than the implication that they are all wrong and Mr van Eeden is right. Asians are not interested in his views, or mine for that matter: they know that gold is a better store of wealth in the long term than any invention of government or the financial markets; and they know this through experience.

I would also question his statistics. He constructs something he calls actual money supply, which is merely the sum of cash and deposits. Inexplicably, he excludes checking accounts.

All you need to know is that Austrian, or true money supply in dollars, for which there is a sound theoretical basis, is 23 times the value of gold said to be held by the US Treasury. Based on this relationship, my admittedly subjective view is that at a time of escalating global systemic risk, the dollar is wildly over-valued relative to gold, and not the other way round.