The role of gold in our financial system is a complex topic. In one form or another, the issue continues to resurface like a particularly stubborn pool-noodle. However, unlike a stubborn pool-noodle, views of gold are invariably and inexorably linked to a layer-cake of beliefs: political, social, economic, with nuts of religion sprinkled throughout.
Religion, in fact, is particularly illustrative about gold. The Bible tells us that Moses ascended the mountain to receive the word of God and write down a set of rules that would allow us all to get along. While he was away - stone tablets make for slow dictation, I'll wager - folks waiting for him apparently got really bored. Taking what I imagine is inspiration from Zues in their copy of Ovid, they decided to worship a golden bull.
A gold bull, or a set of written rules? What an interesting dichotomy. The story has always struck me as intriguing, simply because there is so much more to it than meets the eye.
One the one hand, we can choose to worship a piece of golden metal: a physical, tangible, external and limited incarnation of our faith. On the other, we can place our faith in some rules scratched onto a piece of stone. Our confidence is then placed in an intangible force, one that impacts our lives only through the agreements made with one another, agreements that deal largely with how we deal with one another.
Tying the monetary supply to the amount of gold available, by design, limits the amount of currency in circulation. It prevents monetary expansion when our Animal Spirits trend bullish. This slams on the brakes when rapid change threatens: the system is designed to limit the rapid rise in liquidity that feeds rapid, and frequently disruptive, change.
With our full faith and credit shackled to an external control, the pace of change is slowed. Events are biased to the status quo, the zeitgeist eschews change and leans... conservative.
Alternatively, we can place our faith in our ability to interact with one another, in a set of rules that we agree to. Whether chiseled on stone tablets or written on futures contracts, these agreements govern our interactions and, in the final analysis, place our full faith and credit on our ability to work things out.
This does mean that things change a lot faster: not only because external limitations are removed, but also because all that change requires now is agreement. In fact, if we all agree to change the rules, then even the rules can change. To those predispositioned to resist change, to those wired to find comfort in the familiar, this is anathema.
We saw this throughout 2010, when fiscal conservatives howled and watched their bearish portfolios ripped to shreds in the wake of the changed rules embodied by QE2. We will perhaps see it once more as the rules change once again, allowing Europe to address its current crisis.
As Kahneman tells us in Thinking, Fast and Slow, we are naturally lazy. Mentally taxing tasks are against our very wiring, especially when an alternative exists. Rationalization is, then, post-hoc; we make a decision that is in-line with our predisposition, and then find a way to rationalize it. Changing ones mind is in itself difficult. If you have a conservative predisposition, adjusting a world-view to encompass new rules extremely painful, the quotes on the tape be damned.
If the story we tell ourselves is aligned with our natural inclinations, confirmation bias will be strong enough to ignore prices on the tape and increasing red on our P&L. In fact, I would be shocked if those that worshiped the golden calf thought theirs was an act of anything less than perfect religious devotion. As Exodus tells us, had they not sacrificed their own gold and jewellery to create the golden calf?
A person's views on the role of gold, or, indeed, any external arbitrary limitation on our financial system, tells us more about the person expounding the view than it does about their level of education in economics. It speaks to what they place their full faith and credit in, in the very basic sense of the term. It speaks to their locus of control, to their comfort with Rousseau's social contract, to their level of comfort with change.
Sadly, this does imply that we will never be rid of the discussion of monetary basis. It further implies that the discussion will continue to be nuanced with the layer-cake of political, social, and economic views, flavored with the requisite sprinkling of religious nuts throughout, and about as useful as the aforementioned pool-noodle.
As this facet of economics holds up a mirror to the human condition, we who manage positions in the finance markets can recognize this discussion for what it is, and react accordingly. Say, when faced with extremely bullish price-action despite looming European default, we can recognize that our temptation to take bearish bets comes from the visceral revulsion of our id as it reacts to the rules changing once again and hears the clank of a can being kicked further down the road.
With this recognition, we can then resist the temptation to, say, buy calls on the crashing VIX in an attempt to stand in front of the stampeding bulls. And if, despite knowing and understanding all of the above, we still buy said calls on the VIX, as I did on Friday right before the close...
...well, then we deserve to be beaten senseless. With a pool-noodle.