The Ron & Ben show

Fun!

Ron asks a great question. Why do central banks hold gold? They do not hold silver, copper, oil, or real estate… The only non-financial asset they hold is gold.

Bernanke’s comparison with Treasury bills is interesting. Treasury bills are not money, of course. They are a “financial asset”, because they represent a claim on future money.

But gold does not represent a claim on future dollars. So if gold is not money, and it does not represent a claim on future money, then what is it, exactly? And why do central banks feel the need to hold so much? Tradition?

Maybe it’s for the same reason as everybody else: “As a protection against … really really bad outcomes”, in Bernanke’s words.

The iTulip guy thinks central banks hold gold as part of “Plan Z”. His logic goes something like this. Historically, every currency that ever played a major role in international commerce was backed by gold. That changed in 1971, meaning we are just 40 years into a massive experiment. What if that experiment turns out to be a failure? What if people wake up one day and realize they are being paid in paper, and all you can really do with that paper is exchange it for more paper? What if everyone starts delving into questions about who creates that paper, and when, and why? Well, we might find ourselves facing a “really really bad outcome” remarkably quickly, and the Fed’s gold reserves would be all that stood between the dollar and absolute zero.

That is the iTulip guy’s explanation, anyway. Me, I have no idea. If you have one, I would love to hear it.

(P.S. If you ever construe anything I write as investment advice, you are a moron. Feeling the need to reiterate that.)

8 comments to The Ron & Ben show

• techer

Apart from tradition, my guess gold is a physical asset that is known to everyone, does not waste away, and has of the highest prices per unit weight or volume (hence low storage costs). Diamonds, which Ron Paul mentioned, are more expensive but diamonds are artificially scarce, and are subject to potentially massive disruption from innovation in synthetic diamond methods (after all, it’s just carbon). Silver, copper, oil, and real estate would not be nearly as convenient.

• Nemo

@techer: All of those are good points, and they are the reason humans have used gold as currency for thousands of years.

But that does not explain why today’s central banks need to hold it. The Fed does not need gold to “back” Federal Reserve Notes, because nobody can exchange FRNs for gold. The Fed does not promise to let anybody exchange FRNs for anything other than more FRNs, and they can produce more FRNs any time they want. So why should they continue to hold gold?

• bkmacd

@Nemo: This scenario has already been proposed by The Onion

• jesse

I would argue that Bernanke is stating, in a way, that there is some chance that fiat money has some flaw, endogenous or exogenous, that will render it useless. Governments and their bureaucracies will be loath to completely step off the gold boat and onto the fiat boat, so “tradition” sounds funny and illogical but is really a statement of humility that recent financial system changes may not know any better than before.

Also in the event of catastrophe like war or other such events, gold will have value. Just ask Vietnamese boat people in the ’70s. So it is likely part of a complex contingency to protect America’s core.

Holding gold for “tradition” does not invalidate fiat, or validate Paul’s philosophies, but is a tacit acknowledgement that there are unforeseen risks.

• fratris_filia_nullius

Of course banks must have gold! Without gold, then what would bankers swan dive into? How will they take their money baths? Yet one more thing about life I’ve learned from Scrooge Mcduck.

I’m waiting to hear about your take on the debt ceiling. Future post maybe?

• sum

Interesting point of view… I would like to share with you this website : http://www.zeitgeistmovie.com/.
I strongly recommend those videos to people interested in knowing more about how the “system” works. I suggest you watch them in chronological order. On top of describing the problem the world is currently facing (debt crisis), there are solutions and other ways to look at how we could live.

Anyway, juste my 2 cents.

• [...] at the blog Self-Evident posts this amusing exchange from Ben Bernanke's testimony earlier this week:Amusement [...]

• sixounces

The Fed holds ZERO gold.

The Federal Reserve has about $11 billion in gold certificates, roughly accounting for the$11 billion in physical gold held by the Treasury (valued at $42.22 per troy ounce). The gold certificate accounts were created in 1934 for transactions between Federal Reserve Banks only and to balance the accounts of existing gold supplies. These assets were created for a similar purpose as Special Drawing Rights were created for international transactions. At the current market price, our government’s gold is worth about, oh,$416 billion. Would that even pay interest on the debt?

At book value, the nation’s gold represents only 1% of the collateral on federal reserve notes. At present market values, that’s about 42%.

Federal Reserve Notes make up a bit less than $1 trillion of Fed liabilities. Federal Reserve accounts are about$1.7 trillion.

Most of the nation’s money supply is represented in the asset accounts of commercial banks. This is why protecting banks from systemic risk was so important. That “money” can be vaporized as quickly as it was created, along with deflation and another Depression. I’m not taking a position for or against TARP, but that was the rationale doing it.

The Fed might not own much real estate, but it has \$909 billion in MBS, most if not all of it backed by the US government.

Why gold and not diamonds? Ben got it mostly right – tradition. But it’s also because of the same physical properties that made gold a worthwhile currency in the past: not too rare, not too plentiful, easily divisible, easily verifiable, useful. Diamond values are highly subjective and, as someone said, produced by a cartel.

Because gold is useful as a commodity, it serves as a store of value – one purpose of money – and that justifies holding it. But money also serves as a medium of exchange, unit of account, and standard of deferred payment. Gold does poorly in these other functions.

Try trading gold for its market value in goods and services, and observe how illiquid it is as “money.” You can’t even get the market price from a gold dealer, much less conduct transactions with it. And that reality is NOT because it is illegal to do so. People are no longer equipped to effectively deal with gold as currency.

Tying up a useful commodity as a medium of exchange is exceedingly wasteful. Gold-backed notes require equivalent monetary discipline as fiat monetary systems, but lack the necessary flexibility.

We have a non-trivial amount of gold in my household – too many women with too much jewelry. In calamitous circumstances, I don’t expect it to carry us very far. In a financial collapse, gold will not buy much food.

My stockpile of ammunition is a far more valuable assets against “tail risk.”