Gold has reached its fair value

Gold is a store of money and so is paper money. The one exception is that gold has a limited supply while money can be created at will. Many people still think that money is somehow pegged to gold and that Government must have some gold to back up their currency. No the gold peg was removed decades ago and money can now be created almost at will. The key to the possibility of gold reaching US$2000 per ounce is dependent on how much money has been created.

On March 23, 2006, the US Government stopped publishing the M3 money supply data. A reason for doing so is that it wants to hide the amount of money it is creating . The rate at which this M3 money supply increases annually could raneg from a low of 6% to a high of 9%. This means the value of money will decrease. Using the rule of 72, this means the value of the US dollar will drop by half in 12 years using a 6% increase in money supply or just 8 years if we use the higher 9% figure. Thus when gold hits the US$2000 level, it is not that gold prices have risen but that dollar has devalued.

The well known US trade deficit has hit the US$800 billion level which means they buy more than what they exported. We do not know how this trade deficit is computed and whether services are excluded or not. A printer may be made by Hewlett Packard in China and exported back to the USA creating a deficit . But profits made by Hewlett Packard worldwide will be used to pay for the cost of its staff in the US and so this sort of offset the trade deficit. Assuming that somehow three quarters of the trade deficit somehow returns to the US, it leaves an annual deficit of US$200 billion.

But this is part of the overall debt. The Federal , State and Cities in the USA has substantial debts as well. The Federal Debt at at 25 July 2008 is US$9,528 billion dollars. At a 4% interest rate, it has to pay $240 billion just in interest alone each year! This Federal Debt is growing at the rate of $1 million a minute. Scary though it sounds, the pciture can get worse.According to the Institute of Truth in Accounting, the true federal debt is $55,146 billion of off balnce sheet items are included such as Social Security and Medicare. These are "promises" that have to be fulfil in the coming years!

All the increase in money supply goes to fund these debts. When someone incurs a debt, it also mean the other party has money to spend. When the US Government incurs a debt, its employees would be paid and hence have money to spend. When the US Government spends on buying military hardware, defence contractors make a pile and this money goes to its employees and shareholders. So as the US Government goes on a borrowing spree, everyone is happy and the party continues. The question is when will this party end?

Amazingly even more debt is created by the past housing boom fueled by easy credit .These housing mortages are the no questions asked, 100% loans called subprime mortgages. The two institutions that provide mortgage guarantees , Freddie Mac and Fannie Mae, have provided $4.8 trillion worth of mortage guarantees. They owned half the housing mortgage which puts the total US housing mortgage at $10 trillion. The loans benefited housing contractors, real estate agents, interior decorators, furniture and appliance suppliers and a whole gamut of businesses that benefitted from a housing boom! Now all these money spent and earned have to be repaid, somehow.

US Government may step in to bail out Freddie Mac and Fannie Mae but where does it gets the funds from? It is already in deficit which means it either prints more money, borrow more or do both. The end result is the same, an increase in money supply which will cause the US dollar to devalue over time and increases the price of gold! The price of gold in US dollars is meaningless and perhaps more meaningful to compare it with say a house.

In 1970, a terrace house in Singapore can be bought for S$70,000 and gold prices was US$35 per ounce . Based on an exchange rate of $1.8, the terrace house would cost 1,111 ounces of gold. Today the same terrace house cost $1.2 million and gold is at US$930 an ounce with an exchange rate of 1.36. The cost of the same house in gold is 945 ounces. Thus we see that based on gold prices, the cost of the house has indeed dropped rather than increase! Based on this analogy, we see that gold at US$930 per ounce has reached its fair value based on current exchange rate and property prices in Singapore.