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Belief

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Laurie's response in the debate between fiat money and hard (read: gold) money is full of great observations about the structural differences between gold and fiat forms of money. And those structural differences are very important for understanding why gold will eventually be (in my very humble opinion) the single most important asset class to own.

But I want to clarify a bit one of his statements as it is an important element in understanding the non-linearity of markets. Laurie stated:

"But the paper you and I hand over is only worth what the government tells us it is and is backed only by a promise."

Actually, that's incorrect. The 'worth' of fiat currencies like the U.S. dollar, the Euro, the Yuan are not determined at all by what the governments say they are. They are only worth what all the participants in the economy think they are worth. Economic actors exchange goods and services via these currencies and from that exchange, taken billions of times per day, we can infer a 'value' for the USD. The government doesn't decide what the USD is worth; you and I do.

Why is this distinction important? Because human beings largely make irrational decisions; they are not in fact rational in their economic decision-making. Economists Amos Tversky and Daniel Kahnemann (Kahnemann won the Nobel) have already proven that the rational choice paradigm within economics is wrong.

So if human beings make irrational decisions and these same human beings are the ones that are now 'telling us' what the value of the dollar is (or the Euro, or the Yuan, etc.) then the 'value' of the dollar will (and obviously does) vary widely over time as a function of - more or less - what people believe the USD is worth.

For some people that trade dollars (or any other fiat currency regime) issues like the current account deficit (approaching 6% of U.S. GDP), the federal budget deficit, the looming $40+ trillion in U.S. liabilities (social security, medicare, etc.), and the unsustainable consumer debt/savings levels are hugely important. For others - for the vast majority of others - such concerns are secondary, tertiary or perhaps not even on the radar screen. For these players fiat currencies remain "valuable" vis-à-vis gold simply because they believe it to be so. Maybe habit, maybe ignorance, whatever: as Kahnemann already proved, most people do not think rationally when it comes to economic decisions.

All of the above holds true for gold as well: the "crowd" determines what the 'worth' of hard monies like gold, silver, etc. is. Yes, it is as Laurie says, the only real money for all the reasons he spoke of. But its value, just like the value of that USD, that Euro or that Yuan, changes according to the fancies, whims, and sentiments of the crowd.

This is one of the reasons why U.S. M3 has increased more than 600% since 1980 while the price of gold has declined. Rational choice theory - equilibrium economics - would suggest this would be impossible. Gold should have a direct relationship to inflation. It does not.

And the reason is that the crowd - not macroeconomic principles - are determining what gold is worth in terms of dollars and Euros. Our job should be to understand the macroeconomic principles at work, appreciate the fact that Gold is the only 'real' money on the planet, and search for the time when the irrational crowd has fully embraced the idea that Minyan Mark so succinctly put: that fiat currencies are safe, sound, and a perfectly reasonable long term replacements for real money. When they have fully embraced that trend, that is when it will end. And that is when gold becomes a monetary replacement and the single best asset to own on the planet.

That time, according to my analysis, isn't now, but we're sure a lot closer to it than we were 10 years ago.

No positions in stocks mentioned.

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