Freegold Theory: the massive revaluation of gold after the collapse of paper assets

By GoldSubject on March 12, 2010

This post describes my understanding of the so-called Freegold theory, which the brilliant blogger FOFOA has been eloquently and convincingly writing about for a couple of years. FOFOA’s blog consists of many extremely long and erudite posts that keep referring — often tangentially — to Freegold theory. This is a brief explanation of Freegold theory as I currently understand it, for those who are flummoxed by the enormous quantity of information on FOFOA’s outstanding blog.

In my last post I explained why I (along with many other people) believe that all paper assets will vaporise sooner or later, because there is not enough physical wealth in the world to satisfy the demand implied by those paper documents. The whole point of a paper asset — including fiat money itself — is that the owner can redeem it for the actual physical assets on demand. Paper assets have no value if they cannot be redeemed for the tangible assets they are supposed to represent. Sooner or later the system will have to default en masse as investors realise that all they hold is worthless paper and scramble to get out (convert the paper into money, and money into physical assets). The first few to get out will probably manage to convert their paper wealth into tangible assets; everyone else will be out of luck.

* Ultra-simple summary of the above: if you own money, stocks, bonds or other securities, you think you are wealthy because you can use these documents to obtain money and then use that money to buy houses, cars or whatever else you fancy. The problem is that there simply aren’t enough physical goods in the world to satisfy the demands of all the money and other paper wealth that exists. What would happen if everyone decided to get rid of money and other paper wealth and exchange it for cars, houses and other goods? There aren’t enough goods to satisfy all the money and paper wealth that exists. This means that much of the “wealth” represented by all this paper is non-existent. Plain and simple.

Hence the system is bound to collapse, because it is essentially a Ponzi scheme, and Ponzi schemes cannot last forever, because sooner or later an “investor” makes a claim that the Ponzi scheme cannot satisfy, at which point the whole thing collapses and all of the “investors” realize that they have lost their wealth.

The question is: when this giant default happens and worldwide confidence is completely lost in paper, how will value be stored? So far most of the wealth has been stored as fiat money, stocks, bonds and other paper assets. It was wrong to do so, because paper is too easily manipulated and cannot be trusted, but that is what happened.

So, again, when paper can no longer be trusted to store and represent wealth, how will savings be stored? The answer is that after the massive default of paper wealth — after “paper will burn”, as Another said — all of that value will be poured into gold. Gold will go back to its historic role as the best and most reliable store of value there is.

This means that they will be an absolutely gigantic, one-off revaluation of gold. Gold will become the numéraire for all the wealth of this planet, which means that it will be the unit of account used to describe the value of all goods and services in the world. The value of gold will be massively higher than $1100 per ounce. Some say the buying power of gold will increase 50-fold; others say it will increase 100-fold. Either way, this should give you an idea of how important it is to buy physical gold as soon as possible.

After the total failure and repudiation of all paper assets, paper money will still be used, but only for transactions, not for the storage of value. The long-term storage of value will be the preserve of gold and gold alone.

This means that whenever you get paid for a job, you will be paid in local currency, and you will keep part of that currency to satisfy your immediate expenses, and use the rest — the money that you want to save — to buy gold.

In one of my early posts I wrote that fiat money represents a liability on someone’s balance sheet, whereas gold is 100% equity and no one’s debt. This is why whenever you get paid, you should figure out how much of this money you intend to put away for the long term, and use that amount to buy gold. Only when you have converted fiat currency to gold can you truly consider yourself to have been paid in full.

One key aspect of Freegold theory is that the price of gold — its buying power, if you prefer — will be set by the free market instead of being manipulated by bankers and other sinister entities. I guess this is why this theory is called “Freegold”.

This is Freegold theory as I understand it. It is very straightforward and intuitive when one realises just how much paper assets have been inflated and manipulated, to the extent that an implosion is inevitable, at which point the only store of value that can be trusted is gold.

A corollary of Freegold is that those who buy physical gold now are making the investment of the century. I usually have a very strong aversion to using the term “investment” to describe gold, because gold is for the storage of wealth, not for its generation, but if Freegold does happen, the gargantuan increase in the buying power of gold will indeed make it the investment of the century for those who bought it BEFORE Freegold kicks in. If Freegold ever becomes a reality, it will be a gigantic transfer of wealth from those who own paper assets to those who own gold.

Ultra-brief summary of Freegold theory:

Money, stocks, bonds etc. represent more wealth than really exists –> massive default inevitable –> paper no longer trusted to store value –> only gold is trusted to store value –> buying power of gold massively increases. Value of gold set by free market; money used for transactions; gold used to store value. The biggest and most dramatic revaluation in history.

FOFOA insists that Freegold is an inevitable outcome; others are skeptical. In a future post I will consider the arguments for and against Freegold.

If you find this theory exciting, you are not alone. There is something undeniably intoxicating about the thought of buying a 1-ounce gold coin now for $1100 and then see its buying power rise to the equivalent of $50,000. I was initially excited about this theory, then thought it was too good to be true, and after much thought and research, I have come to the conclusion that it is inevitable. Buying gold to store wealth was always a good idea, but the reality of the Ponzi-scheme nature of all paper markets (including fiat money) now makes buying gold not only smart, but also urgent.