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This makes me think of Samuelson's 1958(?) "Exact Consumption Loan Model", where the natural rate of interest is below the real growth rate of the economy. The real growth rate of the world economy (population + productivity) will be/has been somewhere around that 2%. If the natural rate is below the growth rate, the economy "needs" some sort of bubble asset. Samuelson called it "money" in his model, but it wasn't really (or didn't have to be). It could be gold, or land (and the house price rise was really a housing *land* price rise), or anything in relatively inelastic supply. But as you say, bubbles are unstable. Even if the economy "needs" a bubble, it could be one asset, or another. So sentiment could suddenly switch from land, to gold, to Tbills, to whatever. And one bubble could collapse, as another one grows.

It's not a bubble, it's a response to central banks around the world engaging in inflationary stimulus. The gold bubble will only pop once central banks raise interest rates, which doesn't seem like it's going to happen anytime soon.

"If the natural rate is below the growth rate, the economy "needs" some sort of bubble asset."

Nick, could you elaborate? Are you saying that an asset bubble somehow equilibrates the real and natural rates?

"As long as it remains cheap to borrow and other asset prices are depressed, one can expect gold prices to remain high"

Livio, banks certainly aren't borrowing at the short rate to buy gold. Do you think investors are borrowing to buy gold? That would be insane, moreover, is there any evidence of this actually happening?

JP, try this old post from Nick, 'Do We Need a Bubble'

Its not necessarily that investors are borrowing to buy gold - that may be happening but I have no evidence. Its just that investors often have cash balances they wish to invest and with stock market returns low, interest rates on investments low, the temptation is certainly to put it in gold and reap a speculative return. That is quite risky if the price drops suddenly but this pattern has occurred before.

Thanks Declan. That's the one.

The empirical fit on that post Livio links to looks pretty good to me. I think it has also performed quite well out of sample too.

Why would low real interest rates cause a bubble in gold prices as opposed to some other asset. (Real estate? Patents? Swiss Francs? Silver? etc.)

The gold market is primarily buying from consumers in India, in China and Central Banks. Cheap money has very little to do with any of these markets. However, I expect that cheap money will soon find gold. That should make things interesting.

Having a finance background, the nature of the discussion of gold always surprises me. Why not start with the nature of the asset in question, and from there figure out how it behaves in alternate "states of the world"?

Every asset is a claim on a set of cash flows. The timing of those cash flows defines an asset's duration. Gold is a claim on the cash flows from leasing it: mostly for jewelry use. These cash flows continue in perpetuity. Therefore, gold is the longest duration asset available in the economy.

Does the above correctly describe the claim represented by the asset? In what states of the world will that claim do well? Why should one of those (the only one?) be the observed correlation with negative real interest rates?

An even better way to frame the question:

If you were to construct a claim on a set of cash flows that rises in value when real interest rates fall below zero, what would that claim look like?

Nick, RSJ, thanks for that link.

Nick, what about this post?


"If you don't like beans: try clothes, furniture, towels, landscaping, wine, scotch, copper, insulation, tobacco, dentistry, cutlery, steel, bricks, canoes, lumber, art, education, books, guitars,...., whatever. At negative real interest rates, why wait? Why not buy them now?"

Does this describe the same process as the bubbles in Lucas and what Livio is referring to?

Why does nobody consider the fact that some gold investors -- myself included -- consider gold to be a real currency. It is, in fact, traded as a currency by all major currency traders, under the currency code XAU. And as a matter of real fact, gold is actually used in international settlements believe it or not.

Could it be that golds intrinsic value is that of a common currency market for which there is no central manipulator for holders of the underlying asset can use to discover prices against other assets without the risk of policy imposed inflation or policy induced hyper-inflation?

No, no... that couldn't be it. What silliness. People trading gold in the settlement of debts. Hahahahaha... who'd ever do that? http://en.wikipedia.org/wiki/Metal_as_money

Many people are concerned that trillions of dollars of fraudulent derivatives will cause a financial meltdown and collapse of the monetary system. Owning gold and silver has to be looked upon as a form of insurance against monetary collapse.

Why gold? Why not canned goods?

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