Saturday, October 12, 2013

The strategy of dragons: hoarding your gold

 Have you ever wondered why dragons hoard gold? Well, there may be a reason. It has to do with the concept of "commodity money" as described by economists and with the history of early Medieval Europe.
(image;"Conversation with Smaug" from Wikipedia)

Here is a recent picture of a walled up apartment building in Italy. Apparently, the owners thought that it was better to keep the building empty rather than rent it; and also they made sure that no squatter would even dream to move in.

No matter how you want to see this story, we can only describe it as a monumental failure of the market. It is true that the housing market in Italy has collapsed, but housing prices didn't go to zero (not yet, at least). There are plenty of people in town who desperately need low priced housing. Renting these apartments to them would have guaranteed an income for the owners: not large, surely, but a small income should be always better than no income at all. Then, walling up all those windows must have cost some money, to say nothing of having to pay the property tax anyway. So, why?

It is a case of what I would call "the dragon strategy". The owners of this building are hoarding their assets just as Smaug, a dragon described in a novel by Tolkien, does with his gold. They were seeing their building as a form of money - their gold. It is a behavior that has to do, I think, with the very concept of "money". 

Economists say that there are two kinds of money: "commodity" money and "fiat" money. The first case, "commodity" money is when you use as money something that has an intrinsic value: say, oxen, sheep, bananas, or gold. The second kind, "fiat" money, is the current situation in the world today; it is when money is just a token, a IOU, a piece of paper with something written on it and, now, just a digital record in a computer.

Some people say that money should always be linked to a commodity of some kind; gold, for instance. But even even in a situation where money is purely "fiat", as in our times, some commodities may take the aspect of money. It is the case of the housing market. If you think about that, the whole housing bubble that exploded in 2008 was due to the idea of seeing homes not just as commodities. No, homes started having a value that went well beyond their use as places to live in. They had become tokens for exchange and for the accumulation of wealth: a form of money; objects of speculation. 

One characteristic of money is that the more you have, the happier you are; there is no such a thing as having too much money (at least for the owner of the money). That creates no problems as long as money is pure numbers in the computers of some bank. But when money is a commodity, it is a different story and two bad things may happen. The first is that the tendency of accumulating money creates too much of it. This is a waste of resources and it is detrimental to the manufacturing of other necessary commodities. The opposite one is that commodity money can be hoarded - dragon style. In this second case, a useful commodity is removed from the market, to the detriment of those who need it.

We have seen both things occurring with the housing market. With people seeing homes as money rather than just a commodity, they built too many of them. One result was the paving of agricultural land that can't be used for food production any more. Then, the overproduction of homes generated the kind of feedback we call "speculation" where evidently overpriced homes were seen as good investments. The final result was the housing bubble that burst in 2008 in the US, nearly destroying the world's financial market. It was a classic case of the evolution of interlocked feedbacks that we call speculation. In Europe, the housing situation is more complex and not everywhere the bubble has burst, yet. But surely the housing market is heading that way.

After the bursting of the housing bubble, many people found themselves in possession of something that they judged highly valuable; but they found no customers for it when they tried to sell it or rent it at the prices they wanted. In a sense, they found themselves having money, but unable to spend it; something like being stranded on a desert island with a wallet full of dollars. In many cases, the reaction was to remove the house from the market - hoarding it - waiting for better times. Since you can't bury homes underground, hoarding a building may take extreme forms as when homes are boarded up or walled up. 

It is curious to think how the behavior of some modern home owners reflects that of dragons of fantasy stories. As normal, all stories have an origin in something real and that's the case of gold-hoarding dragons. Not that there have ever been such beasts, but, if you think about that, the myth has a specific origin in late classic times and early middle ages. Do you remember Fafnir - the dragon that Sigfried kills in the saga of the Volsungs? Well, Fafnir is the first gold-loving dragon in the history of literature (apart, perhaps, for a similar character of the Beowulf saga). So, why does Fafnir hoard gold? Well, at the time when the Volsungs saga was written, people did hoard gold. The Roman empire had collapsed and with it its economic system. Even if you had gold, there was nothing to buy with it. So, people would bury their gold (together with silver, jewels and the like) hoping to be able to use it in better times. In practice, they just created those buried hoards that are today the joy of archeologists. As a result, gold disappeared from circulation. That was surely noticed and some creative person invented the myth of dragons hoarding the gold in their caves. You see? There is a logic for so many things, even for the behavior of dragons!

Would you like another example of the dragon strategy? There is an ongoing one, although with some peculiar quirks: it is the "gas bubble" in the US. It is the idea that natural gas obtained by "fracking" is the start of a new era of prosperity. It is, much more likely, another flare of speculation, this time based on natural gas as a form of commodity money. It has all the characteristics of a financial bubble, with the classic effect of overproduction generated by excessive expectation, with companies most likely producing at a loss. But, in this case, there is a problem: unlike gold and homes, gas cannot be stored: it can only be burned. As a consequence, this specific bubble has seen market prices collapsing rather than soaring; as usual for speculative bubbles. That doesn't mean that the gas bubble won't burst; it is already showing evident signs of bursting. It is just that we won't ever hear stories of dragons sitting on a gas hoard!

So, all kinds of speculations are more or less the same. People come to believe that something has a value that goes well beyond its need and they start accumulating it - it becomes "money." Then, they accumulate too much of it and the result is the collapse of the market (the bursting of the bubble). If it is just pieces of paper ("fiat money") the final result may be banknotes burned in stoves, as it happened in the Weimar Republic after the first world war. But, if it is some kind of a commodity, people usually try to hoard their beloved "money" in any possible way; usually burying it or, if that's not possible, walling it up, as it is happening for homes.

In the end, anyway, money is only worth something if there is an economy that makes it possible to buy something with it. And if the economy collapses, money becomes worthless - no matter what form it takes. It has happened for gold at the time of the fall of the Roman Empire just as it has happened for homes in the early stages of the fall of the Western Empire (aka "globalization"). We are not yet arrived to the point of burying our gold in our backyards but that, too, may come to pass.


  1. Hello Ugo. Here in the UK we have been well and truly Smaugified for several decades. Indeed, up until a few years ago, the price of houses seemed to be the only thing that people talked about (other than the weather). Houses ceased to be home but, in the crude but memorable words of a comedian 'giant boxes that shit money'.

    And that, seemingly, is the strategy of the government over here: to inflate house prices and make people (well, Tory voters) feel that they are getting richer without having to do anything. It worked in the past, when energy was cheap and annual growth was secure, but now the benefits accrue only to the wealthy investor class. It's not just the Conservatives thinking like this, Labour as well is talking in terms of building hundreds of thousands of new houses on the countryside. Never mind that we already have enough houses to home everyone (many of which are holiday homes)!

  2. Well, here in Italy the building spree seems to have ground to a halt. At least, the government is not boasting of plans of building more lodgings. They seem to have decided that the overproduction of concrete will go all to the construction of a rapid transit railway to France; which is just another financial bubble.

  3. There is a problem of having too much money. The Chinese have this problem with USTs right now. Steve from Virginia from Economic Undertow phrases it as "Steve's First Law of Economics", which is that the costs of maintaining assets increases faster than the assets do.

    From "The Economy is like a Chicken"

    "Basically, the Chinese surplus of cash is worth less than what it costs China to manage it. The costs include inflation and an excess of capital investment. F/X cash generates inflation in China because the establishment insists that it be spent on something that represents ‘value’. There might be more value gained from gambling junkets to Las Vegas. China and her businesses swap dollars and euros for commodities, store the commodities at further cost and bid the commodity prices up to the stratosphere @ the same time."


  4. hey nice post meh, I love your style of blogging here. this post reminds me of an equally interesting post that I read some time ago on Daniel Uyi's blog: Money Attracts Girls .
    keep up the good work friend. I will be back to read more of your posts.




Ugo Bardi is a member of the Club of Rome and the author of "Extracted: how the quest for mineral resources is plundering the Planet" (Chelsea Green 2014)