Gold prices have been rising, and many experts cite demand from the growing economies of China and India as the reason.
But that's wrong. Gold is trading higher because of loose monetary policy and the purposeful devaluation of the US dollar.
Since gold generates no cash flows, and in fact ownership costs money (storage, and perhaps insurance), divining its value is really impossible. Gold, the "barbarous relic", as Keynes referred to it, is worth what others will pay for it, by definition a speculative non-investment.
Yet Gold has historically been a reliable store of value. An ounce of gold has been worth about 15 barrels of oil for decades. An ounce of gold at $1,500 in 2011 buys 15 barrels of oil at $100 each, much as a $500 ounce of gold bought 15 barrels of oil at $30 in 1981.
The changes in the nominal price of gold simply reflect the persistent weakness of the dollar, as the US has been pursuing policies that virtually guarantee a weaker currency. While gold's nominal price has been going up, as has almost everything else except housing, its real purchasing power has remained constant.
In that context, it is interesting that Treasury Secretary Tim Geithner and Fed Chairman Ben Bernanke warned Congress recently to raise the debt-ceiling, lest the federal government won't be able to pay its bills.
Rather than default, Treasury prefers to pay the interest due on the national debt with a gradually weakening currency, as a way to shed the onerous burden the country has accumulated.
Yet for all practical purposes this policy of devaluation is not much different from formal default. Recall that the dollar, a concept designed to measure real wealth, has lost more than 97% of its value over the past four decades, as an ounce of gold went from $35 in 1971 to $1,530 today.
Pursuing this course of weakening currency has certain pernicious side effects, not the least of which is mis-allocation of capital. Take the money now flowing into the commodity producers. The weak dollar led almost all commodities to trade at nominal highs, but this is an illusion. Commodity rich countries are enjoying prosperity, but this is part of a regular boom and bust cycle, and the bust never fails to arrive. Once the inevitable tightening comes, this chimera will all go away.
Or take the last financial crisis as another example. During the boom years, egged on by low interest rates, Americans borrowed incorrigibly, usually against higher home values. The percentage of income saved reached a low of 1% in 2005. When housing prices fell in 2008, so did consumer spending. The deleveraging of the American economy then ended the bubble, made credit sparse and severely curtailed buying habits.
This illusion of a plethora of money also gave us low treasury yields, indicating markets are not worried about inflation. But the treasuries' market has had massive intervention by the Federal Reserve, so that price level is artificial.
Lower interest rates and weak dollar distort the capital allocation process and gold is riding that wave. To me, the most interesting aspect of this diversion of capital is how involved the general public has been. Clearly gold ETF's have become a very popular investing tool. But when the notoriously perspicacious George Soros is selling gold (as he has been recently) and Mrs. Jones in Iowa is buying, you have to wonder who is going to end up regretting it.
Alan Schram is the Managing Partner of Wellcap Partners, a Los Angeles based investment firm. Email at firstname.lastname@example.org.