Goldbugs, Nihilism and Trading Profits

Goldbugs who trade gold while believing in it make an easy target for major banks and brokers...

GOLD and SILVER are for many people the cure for our economic sickness, writes former financial trader Mark Griffith of MovingToyShop books. They want to see paper currency backed by precious metals again.

Their opponents often call them 'goldbugs'. A goldbug, or anyone who wants to see some sort of treasure metal backing our banknotes, is usually anti-inflation and pro-saving. Savers tend, for very good reasons, to belong to the Hard Money camp. They're people who want money to keep its worth over time – to be a reliable store of value, as economists phrase it. Goldbugs, or metallists, want money to be hard.

There are two very reasonable attacks on the metallic currency camp. The simple attack says that the gold (or silver, or platinum) supply is unreliable, and would make advanced economies more affected by politics in countries (like Russia or South Africa) which mine lots of precious metals. Of course advanced economies already suffer this from countries rich in oil, but a bullion-backed currency increases the sources of supply instability.

The more sophisticated attack says that having a fiat currency (paper or digital money that is money only because the government says it is) is useful, a positively good thing. In fact some economists known as chartalists, followers of 'Modern Monetary Theory', even deny that high levels of government debt need be a problem.

Chartalists argue that the accounting identity government spending minus taxes = (savings minus investment) minus net exports shows that the state should only go into surplus to remove financial assets from the private sector in times of inflation. The fact that it is difficult for a state with a metal-backed currency to stay long in debt is therefore for some chartalists a drawback.

This point of view, shared by many (but not all) neo-Keynesians, is that as long as a government accepts its own paper tokens back as taxes then there is no real problem with at least moderate monetary expansion, printing as many tokens as is convenient to get things done. The state is sovereign, its writ runs in that territory, the laws behind fiat money make it real. Believing is seeing.

Whereas at first hearing advocates of metal-backed money sound old-fashioned and a bit superstitious. Economic historians bring up the moment in 1925 when Winston Churchill as Chancellor of the Exchequer put the Pound Sterling back on the gold standard at its pre-WWI value, substantially increasing unemployment. There is also the feeling that precious metals are something vulgar from mankind's childhood. Chancellor Gordon Brown in 1999, before selling off much of Britain's Gold Bullion reserves at the twenty-year low (averaging $275 per Troy ounce), cheerfully called gold a "barbarous relic". True, the old treasure metals don't rust, don't cause rashes on the skin (therefore good as jewellery) and can be dug up with quite primitive methods because they so rarely form alloys with other elements. But how can it make sense in the industrial era to just pile up metal for safekeeping, instead of investing in companies & ideas which make returns? Thomas More's Utopians would have praised the young Gordon Brown: the 'noble metals' are a throwback, something shiny to decorate the nest.

At this same first hearing, neo-Keynesians and chartalists look sophisticated in contrast, since they openly acknowledge that money is a social object – pieces of paper only holding value because society chooses to give them that value. Their position is that fiat currencies (like all the major currencies since 1971) get their value from the states that issue them accepting their own banknotes back in taxes. It is hard to shake the feeling that chartalists are seeing deeper precisely because they concede that really it is all shallow. If money is only a social convention like April Fool's Day or giving Easter eggs or wearing a tie to the office, then the economists who accept this comfortably are surely the less deceived?

Not necessarily.

The thing is, if you accept money only works because we say it does, then the same goes for believing money should be backed by metal. That too is a social belief about money. If you have a community of people who think and keep insisting (despite all the hand-wringing of economists trying to educate them) that a currency backed by silver is more "real" than one backed just by the government's say-so then, precisely by the fiat principle, they are right. If money is what people think it is, this trick cuts both ways.

Worse still, if some members of the public trust money because they think (mistakenly) it is backed by something they consider more reliable, and other members of the public are quite comfortable seeing money as a kind of government-issued trading token (closer to the truth it might seem), then it is not clear ifanyone is right or really knows what money is worth. If the token only works because lots of people think it is more than a token, then neither side is correct. And if there is no final truth, then the tokenists are no closer to the truth than the metallists.

This slightly dizzying paradox has a parallel in the curious split between two important types of financial traders: 'fundamental traders' and 'technical traders'.

Typically, financial traders and speculators who believe that underlying changes move prices (for example that frosts in Brazil move coffee prices or South African mining disputes move platinum prices) are called 'fundamental traders'. They believe it is possible sometimes to beat the market, and that markets differ from each other.

Another, odder, group believes something very different. 'Technical traders' think in contrast that all important information is already in the price, "already in the market" (because insiders will always get the important news first, before the rest of us, and straight away trade on it). Their principle is that you can learn what is happening by watching the price charts alone. Hence their other, less flattering, name – 'chartists' (not to be confused with the chartalists a few paragraphs ago!)

Chartists also think that, because the price is the place to watch to learn new data, all markets are effectively alike. Trading zinc is a lot like trading wheat for them. Chartists = technical traders believe in shapes of price lines (they use terms like "head and shoulders" or "false bottom" to describe price lines). They believe in magical price levels, and thereby in "resistance" to prices going through those "levels".

A typical 'level' (in the Dollar/Sterling market), for example, is 2 Dollars to 1 Pound. This means that if the US Dollar reaches 1.90 to the British Pound and starts to approach 2 to 1, the market will act as if there is downward resistance, with selling of Pounds at those levels, constantly pushing the rate back to 1.95 or thereabouts. But if the Dollar is falling heavily, and "breaks through" then it might go to 2.05 or 2.10 against Sterling, and then likewise there will be the opposite kind of resistance, upward resistance, to it moving back through that level. However much fundamental traders denounce this as superstition, they have to pay attention to technical traders' predictions because they are self-fulfilling. Once a big group of people think there is a 'level' at 2 Dollars to 1 Pound then, by the power of crowd belief, there is a level at 2 to 1.

Here is where it starts to get muddling.

Because oddly enough a lot of technical traders or chartists believe in metal-backed currencies. You might expect the people who see all markets as alike, and who believe in the power of markets to absorb all (or almost all) information before we can use it, to see money as just another kind of stuff. But many of them don't think like that.

Neo-Keynesians and chartalists ask, if all other kinds of markets are interchangeable for technical traders and chartists how can any of them think money is so special? Why should there be some magical importance to gold (or silver, or platinum), making them better than paper promises redeemable against tax? This is an important and reasonable theoretical question, to which goldbugs and treasure-inclined technical traders do not have a very good answer. They tend to refer to history, and handy facts like gold not rusting, (and they hate the idea that tax might have a central place in supporting the value of money). But then, according to the neo-Keynesian & chartalist view that money is what we as a society decide it is, metallists don't need to produce an answer, do they? If goldbugs like some kind of commodity backing their money, then their preference is as good as anyone else's.

You could say each side connects with the utility of real stuff like bushels of barley or 50lb bars of copper at a different point in the theory. Fundamental traders (many take the neo-Keynesian or chartalist view) see each market as connecting to a real commodity, each of which can stand in for money. Technical traders (many of whom take the monetarist or neo-classical view) see markets as far more interchangeable as places to trade, but needing to be based on one special supercommodity (gold, silver, perhaps some basket of commodities including oil). Their notion is that money, in the centre of the system, must be in some way made more solid than futures contracts in cocoa or shipping space. Seeing is believing.

In fact it's a philosophical disagreement, not made easier to discuss by most money traders and business people getting annoyed by the slightest mention of the ph-word.

Which brings us to the paranoid tone in the writings and conference speeches of many goldbugs. They write of a conspiracy among central banks to hold down the price of gold by selling off bullion in co-ordinated waves (and buying it back days later at lower prices). Campaigners for metal-backed currencies passionately believe that paper money is intrinsically worthless, so want – like sports fans – to see their commodity climbing up the charts. This is partly so their savings hold their value and also (confusingly) so they can buy gold low and sell it high, the same way gold-agnostic traders try to do in any commodity. The reason this is confusing is that if a goldbug really thinks only gold has real value and paper has none, he would buy and hold gold, not sell it. He would surely not care what its apparent value in Dollars, Euros or Yen appears to be. If he wants to sometimes exit gold and take a trading profit measured in some puny fiat unit like British Sterling or the Euro is he not thereby admitting tacitly that paper/fiat Sterling, Dollars, whatever, are just as much effective money with real value as his beloved precious metal of choice?

In a curious way, and certainly without meaning to, goldbugs have become a component in central bank management of fiat money. Because central bankers can rely on private investors to emotionally buy gold at numerous price levels ever since the 1970s, regardless of the trading logic of purchasing at a given price – and then usually sell back at the wrong moment – those central banks have a reliable set of counterparties, a minor source of income, and paradoxically even a stabilising factor.

In the 1970s, with oil-crisis-fuelled price inflation hard on Nixon decoupling the US Dollar from gold in 1971, gold did indeed soar. It rose from below $40 to over $800 per Troy ounce of weight in ten years. This would correspond to a prise rise of almost 2,000% for the decade, or well over ten times annual rates of inflation the US actually saw in those years. Of course, some of this was taking into account past inflation too – price rises in the US since World War 2, implying a steady fall in the value of the Dollar. Another reason this happened was because the re-entry of gold into world finance came as a bit of a surprise to many. It returned as a popular commodity rather than a technical back-room support for paper notes that only central bankers needed to give time to.

We have generous helpings of crisis again, but history never repeats itself quite so neatly. Expectations are better known now. Those late-1970s, early-1980s levels are the prices that today form the basis of pro-gold investors' beliefs about the Dollar-denominated value of gold (or the gold-denominated value of American Dollars, to put it the other way round). Of course, since gold gives no dividend or yields no interest, but offers purely capital gain or loss, many economists would protest at the use of the word 'investor' there. They would call this habit 'gold hoarding'.

And as a result of these ingrained beliefs that gold should sooner or later go up by this much or reach that price, private gold hoarders become easy meat for the experienced traders who work for central banks and other banks.

Central bank traders indeed prefer gold not to zoom up to high levels (that would be embarrassing for the currency they manage) but less is at stake for them, both materially and emotionally. Banks might want to hold gold prices down long-term (or have gold rise slowly), but they have more freedom to buy it or sell it as they wish short-term. They have much longer credit lines than the private rampers of gold. As the man goldbugs see as the arch-villain, John Maynard Keynes, famously said "the market can remain irrational longer than you can remain solvent." That applies to how gold should be rationally priced as much as anything else. Not surprisingly, market traders inside big banks are also more emotionally neutral than goldbugs.

Which is odd. It is odd given that it is technical traders who take a more neutral view of most commodities, seeing them as all behaving the same way, with the same buy/sell patterns in their price charts. It is just on the subject of precious metals that they lose their cool. On the topic of bullion, many technical traders suddenly come over all fundamental. In financial markets, as in most card games, the trader with less emotional investment in the outcome wins most of the bets. They are less prey to versions of the gambler's fallacy, a common trap for inexperienced financial traders and card players alike.

All this is what makes people who want gold or silver to rise long-term against fiat currencies into unwilling and often unwitting partners in what the central bank traders are trying to make happen in the market.

It needn't go like that though. If bullion investors, be they technical or fundamental in outlook, wanted to make major profits the secret is surprisingly simple. Or at least easy and difficult at the same time, rather in the way that emptying the mind during Buddhist meditatation sounds easy but in practice is so hard to do. What a pro-gold investor / hoarder / trader has to do is to decide whether he wants to pile up more gold or turn quick profits in paper currency. The more clearly he decides this, the sharper his trading system.

Most traders know in theory they need to set targets and rules to discipline themselves.

A sensible system would be to decide on a rationale for:

• taking a fiat-currency profit when buying gold low and selling it a bit higher, versus
• keeping some of that more valuable gold long-term.

A trader might sell half of a gain to recoup fiat currency (on the basis that these are still the tokens that rule his daily life and pay his bills) and keep the other half of a gain in the precious metal (on the basis that the fiat currency is losing value day by day). That same trader might act differently when he loses on a gold trade, taking more of the loss in fiat-currency funds. Many percentage splits could be tried. But without an overall strategy like this (and a strategy is usually the opposite of a belief), the goldbug who trades gold while believing in it is an easy target for experienced traders at major banks and brokers.

Goldbugs are often outraged at the way central banks and their allies manipulate prices, pull buyers into sucker rallies to trap them, put pressure on people with open positions, and so on – seemingly unaware that all traders do this in all markets if they can.

Believing in something is lethal to trading profit. In the cold, hard world of the financial markets nihilism is the best kind of cynicism. The less you believe in, the more profitable trades you make. In a curious way, the nihilists of monetary theory (chartalists), have something in common with the nihilists of monetary practice (financial traders): for both groups nothing else much matters if today's numbers add up.

Whether on the other hand this neutral, tokenist view of money helps the other daily users of currencies (plumbers, bakers, hairdressers) is a different question. Most ordinary people do not believe paper money has intrinsic value. However, they generally take it on trust that most other people believe it has. Until the 2007-2008 credit crunch most ordinary bankers did not believe overnight accounts with other banks were intrinsically safe. However, they reckoned they were safe because they thought the banking system as a whole believed they were safe.

In the financial markets it's dangerous to believe when other people don't. But taking the smart-alec angle, relying on other suckers believing when you don't, can turn out even worse.