Many gold bugs make an implicit assumption. Gold is good, therefore it will go up. This is tempting but wrong (ignoring that gold does not go anywhere, it’s the dollar that goes down). One error is in thinking that now you have discovered a truth, everyone else will see it quickly. And there is a subtler error. The error is to think good things must go up. Sometimes they do, but why?
First, we think it’s a cop-out to say, “well it’s all subjective.” If it were all subjective, then there would be no way to say that gold is good, and no way to say that it “should” go up. It would be sufficient to say, “gold is $1,276.” Indeed that is all that one could say, if everything were subjective.
Why is gold trading at that price? Subjective preference, nothing more. Will it trade at $12,760? Maybe. If subjective preference changes. One might as well say “if God wills it.”
But it is not all subjective. There is something objectively wrong with the dollar and all of its derivatives such as euro, pound, yuan, etc. They are all slowly failing. Gold is the alternative to holding the dollar.
It is important to keep in mind that most people do not like to buy on speculation. This may be particularly difficult to understand if you are someone who bought gold as a bet on its price. Most people buy, not because they expect a discontinuous change, but simply because they have goals to achieve.
For example, a consumer buys food because he needs to eat. A business buys copper because it manufactures wire, or circuit boards, or chemicals to pressure-treat wood. That’s what businesses do—buy inputs, combine them into a product, and sell it for a profit.
Will copper go from $3.02 to $4.02? Maybe. But that is not why copper-using businesses buy it (at least not in the falling interest cycle—see part IV of Keith’s Theory of Interest and Prices).
Suppose Acme Piping Inc. buys copper at $3.02. It adds $1.98 worth of labor, and turns the metal into pipes. It sells a pound of pipes for $6.00. It spends $5.00 ($3.02 + $1.98). We can say that this $1 of profit is an incentive to produce plumbing.
And there is another incentive. If Acme has a debt of $1,000,000, with a monthly payment of $15,000, then it must sell at least 15,000 pounds of pipes. If not, then its creditors will seize the business. It would like to sell at least 20,000, so it makes the payment, and has a profit of $5,000 left over.
If you wonder why the “worthless paper dollar” can buy so many great products, it’s because every debtor is exchanging whatever it can produce and sell to get enough dollars to service their debts.
When the interest rate falls, several things change. First, the incentive to borrow increases. If Acme had decided not to borrow to buy a new pipe-making machine when the rate was 6%, the company may be more tempted at 3%. Total debt goes up as more businesses take this greater incentive.
