Posts Tagged ‘gold’

These are troubled times. The stock market gyrates wildly every day; major industries are teetering on the verge of extinction; and banks are paying a pathetic 1% interest on savings accounts. So what should you do with your money? Should you just put it in a piggy bank or under your mattress? How about burying it in the backyard? The truth is that burying it is the worst thing you could do with your money. Well OK, I suppose you could just burn it – that would definitely be worse.  The thing that is invisible to most people who want to preserve their wealth is that the U.S. dollar is a really bad way to preserve wealth. Why? Because inflation eats up the value of your dollar every minute that you hang onto it. Here’s an example: suppose you buried a $1,000 in your backyard in 1970 and you dug it up today. How much do you think it would be worth? Would you believe $177.06? That’s right. You can have a lot of fun with inflation calculators, like Tom’s Inflation Calculator.  You can calculate forward and backward in time and really see why it doesn’t pay to squirrel your money away.

But wait! You can have even more fun.  Try the compound interest calculator at moneychimp. Then try both calculators together like this: let’s suppose you had $1,000 in 1970 and that you put it in the bank at 5% annual compound interest. What would your investment be worth in 2008? It would be worth $6,385.48. So you ask what would the inflated value of the original $1,000 investment be after those same 38 years? The answer from Tom is $5647.59.  If you subtract the inflated value of your investment from the total value you have a net profit (before taxes of course) of $737.89. How’s that for a 38 year investment of $1,000? It gets to be a lot more fun if you change the interest rates on the compound interest calculation. For example, if you only get 4% interest on your original investment it only accumulates to $4560.68, for a net loss in buying power of $1,086.91. You should have spent the money while you had it!

You can have hours of fun with these calculators. Here’s another fun thing to do: pretend you are a credit card company and you loan some poor, bad-credit-history, sucker $5,000 at 33% interest. Just for fun let’s assume the poor guy only  makes minimum payments. So how much does he have to pay the credit card company? $15,628.61!!! And it takes him 23 years and 5 months to pay off the card! You can do your own calculations at this website.

Getting back to your $1,000, what can you do to preserve your buying power? Put it in the stock market? Hmmm….maybe not.  Bonds at 3% interest? I don’t think so.  How about buying gold? Well, let’s see. In 1970 gold was selling for about $35 an ounce. Today it is at $765.50 an ounce.  So $1,000 in gold in 1970 would have the buying power of $ 21,871. 43 today.  Just for fun, let’s check on oil. In 1970 oil was selling for about $3 a barrel.  Today it’s about $44 a barrel, so $1000 worth of oil in 1970 would be worth about $14,666.67 today. Let’s see how that compares with inflation…Hmmm, oh yes, I remember – according to Tom’s inflation calculator $1000 dollars, buried in a tin can in your back yard in 1970, would have the buying power of $177.06 today.

So what does this all mean? First, it means that whatever money you make from your job begins to decline in value the moment you receive it (sort of like when you drive your brand new car off the dealer’s lot). The worst thing you can do with your money is to hoard it. It’s value will evaporate.  Your money can lose value even if it is gaining interest in a bank!! It all depends on the interest rate you are receiving.  We all know stocks can be risky investments – boy, am I glad I didn’t by stock in American Motors in 1970!  Commodities can be risky too, especially in the short term.  On the other hand, they don’t tend to go out of business and vanish like U.S. companies do.  So, should you go out and buy commodities? Maybe. I have no idea if commodity prices will continue to go up.

I only know the worst thing you can do: whatever you do, don’t bury your money in the backyard!

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Five months ago, the price of oil was over $147 a barrel. Today it is about $47 a barrel. How can that be? Did the intrinsic value of oil just evaporate?  Is oil just not as useful as it used to be? Or is it that the U.S. dollar is now worth a lot more than it used to be? How could that happen?  Did we just strike oil or something? No, we didn’t, and yes, oil is just as useful as it used to be. So what is going on here?

How about Las Vegas. In June of 2007 the median price of a home in Las Vegas was $305,000; in June of 2008 the median price of a Las Vegas home was $225, 000 – a loss of 26% of its value. So, what happened to its value? How can the intrinsic value of a house just disappear? Or did the U.S. dollar suddenly increase in value so you don’t need so many of them to buy a house? The problem we are facing today when we try to establish the value of commodities, whether they are barrels of oil, ounces of gold, or three bedroom homes is that not only does the value of each commodity change over time, but so does the value of the U.S. dollar.  It’s like trying to drive a car at a constant 50mph while you have to keep adjusting your pressure on the gas pedal because your fuel flow keeps changing while at the same time your speedometer is fluctuating randomly.  Sooner or later you are going to get a speeding ticket.

The value of commodities is more or less based upon the work needed to create them and the amount of demand for them. Sometimes, breakthroughs are made in production methods and prices can fall drastically; sometimes the price can skyrocket because all of a sudden everyone decides they need a particular thing – like maybe a hula hoop.  This is understandable and it is something that most of us can learn to live with, but the problem becomes much more difficult when our currency is also wildly fluctuating.  The time has come for us to reassess how our currency obtains is value.

For thousands of years, money in many civilizations consisted of gold or something related to gold. Even the U.S. valued it currency in relation to gold, until 1971 when President Nixon decided to decouple the dollar entirely from gold. Its value is now somewhat arbitrary and it is traded on the world markets by speculators.  Gold, although long used as a monetary standard, is not necessarily the best way to determine the value of a dollar. In fact, because there is a limited supply of gold in the world, having a gold standard places a limit on how much money can be created and therefore a limit on how much wealth can exist.

It appears that Nixon’s decision to eliminate the gold standard for the U.S. dollar worked for a while, but now we are beginning to see an unintended effect: the rapid and enhanced fluctuation in prices of “commodities” because the value of the dollar and the value of commodities priced in dollars are changing independently and simultaneously.

A partial solution to this problem can be borrowed from the way science defines the meter. The meter, which really could be any arbitrary length, is defined as “the length of the path traveled by light in vacuum during a time interval of 1/299792458 of a second”. Pretty exact, isn’t it?  With this agreed upon definition of the meter, scientists and engineers all over the world can design products and devices, knowing that they will fit perfectly together with each other today, tomorrow, and ten years from now.  Even though the value of your house may increase or decrease by 50% or more next year, you can be sure than the boundary markers of your house lot, that was surveyed by people using laser devices, won’t change by a millionth of an inch in a hundred years.

So why can’t we also come up with a solid definition of the dollar? We can, the problem is that our government likes having an arbitrary value for the dollar. That way our government has the ability to print its way out of debt.  That Dick Nixon was a genius, wasn’t he? Wouldn’t it be great if we could all do that?

Perhaps it is time to create a new currency – a world dollar – that does derive a fixed value from something that can be easily defined, but not limited in extent, like gold. Then all world currencies would be valued against this, and, I suppose, eventually the entire world would use this single, solid, unchanging currency.

Maybe then we would even be able to say what a barrel of oil is really worth.

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