During the first stage in the credit crunch gold was popular with investors. It is not difficult to see why. It has always been seen as a safe haven, and let’s face it, anything relatively safe is greeted with open arms by all investors, as if it was some kind of new Shangri-La.

But it has been argued here that there were other factors driving up the price of gold. For example, its popularity in India as a form of jewellery, and its peculiar properties as a conductor for electricity making it ideal for semi-conductors.

But as the price rose and rose, and anecdotal evidence suggested Indians had as a result turned from buyers to sellers of gold, it seemed the yellow metal had reached top.

But, now there is a view that as the credit crunch deepens gold will come back into fashion again. There are three main, but related, reasons for this:

Firstly, there’s the continuation of fears over inflation – in the past high inflation has spelt high gold. But then, as has been argued here many times, there are good reasons for thinking the current inflation scare might be short-lived.

Secondly, there’s the turmoil in the currency markets. The US and UK are in a right mess, but the Eurozone is in even worse shape, and things are dire in Japan. So, it has been suggested currencies will experience a kind of race to bottom, no one wants to hold any of the major currencies, the result will be a search for an alternative – and that alternative will be gold. Well, that may be true – but then again, this theory overlooks the nature of business cycles. As the economies of the developed world slow, food and oil will fall in price, helping to create the next up-phase in the economic cycle. If the Eurozone recovers, then the race to bottom could change to a race to buy Euros.

Finally, there is something called Fiat money. You may know that banks can create credit. Apologies for those who know this, but here is a brief, but important, digression.

Assume there is only one bank. And this bank knows that at any one time its customers will never want to hold more than 10 per cent of their money in cash. So, assume for a moment, it has £1m deposited in the bank, that’s hard cash. It knows that at any one time customers will never want more than, say, ten per cent of their money as cash to spend. So, in that case, the bank can actually afford to lend out a further £9m. So that in total its customers now have £10m: £1mn in cash, £9mn in debt.  They will never want more £1m of this total £10mn  as cash.  In other words, providing this bank has enough cash to cover customers’ demand for paper money, it can happily lend out more money than it actually has.

But what do we mean by money? If money is the amount that sits in our bank, plus our cash that we can see and touch,  then actually this £9m the bank has lent out is new money. By creating credit, the bank has created money.

Now remove the assumption about there only being one bank. Providing all the banks cooperate with each other and there are central banks to smooth out any difficulties that may arise from time to time, then the banking system, by lending out money it doesn’t have, actually creates new money.

Now, in recent years, this system has seen a growing number of critics. They say the whole economy is based on debt, that debt carries an interest rate and that, as a result, we live in a system that is based on very shaky foundations. Furthermore, goes the argument, debt has to carry on rising, just for the system to sustain itself.

It is then argued, only a monetary system that is based on something solid, like gold, can survive in the longer-term, and that is why gold is sure to make a comeback.

This theory, though, is quite dangerous.

For one thing, it seems to have given rise to a rather unpleasant surge in anti-Semitism on some Internet sites as bankers are blamed for our ills.

Secondly, it misses rather an important point. When we borrow money we are in effect hoping to repay this money from an anticipated growth in our future stream of income. Providing the money we borrow is used to help create this extra flow of future income, then the system is sustainable.

So, Farmer Giles expects a new tractor to enable him to grow more corps. The extra money these crops bring in pay for the tractor. That’s why he needs a loan.

And this is the point. Economic growth relies on debt. Karl Marx theorized that without the gold found in the New World, the Industrial Revolution would never have been funded, and so would not have got off the ground. If economic growth is determined by innovation and then investment, then we have no choice but to borrow from future earnings. The economic depression of the 1930s was perhaps caused because our production potential created by the great discoveries of the earlier decades was not matched a rising demand. Back then, more debt was required. That’s what Keynes advocated.

The single biggest threat to the economy today is that we overreact to the credit crunch; that Democrats in the US try to enforce new tariffs, leading to a worldwide trade war; that, somehow, the US blames China for all its ills, and the backlash leads to a downward spiral.

But maybe an even bigger danger is that we turn on the banks, and in the process bite the very hand that could feed the recovery.

It may be that all this talk about gold surging in price is an early sign of this dangerous backlash. But as the central banks are run by savvy individuals such as Ben, Mervyn and Jean-Claude, this will not happen. And be grateful that it won’t.

Gold has been rising again of late.  It recently broke back though $900 an ounce, after flirting with the $830s a week or so ago.

It is not surprising.  Inflation is back in the news, and in times of trouble investors don’t let it be, instead they often plump for gold.

But there’s more.  The long-run average for the price of gold in ounces to oil in dollar per barrel is 16.  Right now the ratio is around 7, ergo the price of gold is set to shoot up.

Some have been predicting an imminent rise in the price of oil to $200, so if that is right, and the gold oil ratio returns to its historical average, gold should hit $3,200 an ounce.

Tempting isn’t it?

Just remember, gold may always glisten, but don’t be fooled into thinking it is set to glisten more than normal.

This is what Capital Economics have to say on the matter: “Gold bulls understandably like to include the period between the mid 1980s and the end of the last decade when the ratio was relatively high. But this was a period when oil prices were flat or falling, which rather undermines the argument about inflation-hedging. If we focus instead on the more recent period of sharply rising oil prices, the average gold to oil price ratio since 2002 is around 10. And if anything, this ratio seems be trending downwards, not upwards.

“What about the 1970s? The ratio of gold to oil actually fell for several years after the oil price shocks in both 1973 and 1979 (and not just for the short periods that might be dismissed as a temporary underperformance). What’s more, this was during two periods of much higher inflation than we are seeing or likely to see soon despite the undeniable upside risks.

“Finally, the assumption of a reliable long-run relationship between the price of gold and the price of oil is fundamentally flawed. There may be many good reasons why the relative price will change over time: in particular, rapidly developing economies need more oil, but they do not necessarily require more gold.”

But let’s assume the 16 ratio is right, and over the long-term gold and oil will head towards that ratio.  Oil would need to fall to $61 for the current price of gold to be right.

There can be no shortage of people out there who think it is poetic justice. The International Monetary Fund, that once seemingly-almighty financial institution, is short of money. Even more poetically, it could be argued it is down to the arrogance of its policy moves during the last decade.

Bank mangers used to be unpopular individuals. How many failed businesses blamed their bank? How many individuals felt tempted to put a picture of their bank manger on the wall and throw darts at it? It is not to say that bank mangers were necessarily wrong, but to the individuals who were turned down for loans it must have seemed that way. But, during that era of plentifully available credit, which may or may not be coming to an end, bank managers appeared to have been replaced by salesmen. No longer were we required to go cap in hand to the banks if we wanted money, they were coming to us.

A similar principle applied to the IMF. But this time, it was countries that had to get the begging bowl out, and no doubt many finance ministers were made to feel two inches tall in the process. The UK was not immune, and in 1976, under the chancellorship of Dennis Healey and Prime Minister James Callaghan, the IMF bailed out the UK, or more precisely the pound, enforcing its austere regime upon the UK, and leaving the high and mighty at the Treasury with egg all over their face. In fact, Mr Healey must have felt like even more of a silly Billy in the years that followed, after the pound surged, thanks to North Sea oil. Maybe the embarrassing IMF rescue was not, in hindsight, necessary after all.

In the late 1990s though, the IMF seemed to get it wrong. When the economies of East Asia, and then Russia, hit crisis, the IMF rode in over the horizon, and, just like John Wayne, insisted everything was done its way. So that was less government expenditure and higher interest rates. Curiously, the IMF’s remedy for East Asia and Russia was the exact opposite of the approach taken by Ben Bernanke in the US right now.

The result of the IMF policy was this. Western banks by and large got their money back, and nasty crisis in the West was avoided. But many countries of East Asia, with Malaysia heading the list, and then the following year, Russia, suffered very nasty recession as a result.

The most famous critic of the IMF policy during this period is Joseph Stiglitz, winner of the Nobel memorial prize for economics.

The IMF did not mange to endear itself to the governments and people of that region; its action created a great deal of mistrust for western financial institutions. Many blamed the IMF as being solely responsible for the economic hardship that followed in those countries – and according to Stiglitz some even refer to events in their countries as either pre- or post-IMF. That’s how strongly people in the region feel about its support during that period.

Ironically though, while a Western financial crisis was avoided – even with the failure of Long Term Capital Management, which was partially caused by the Russian crisis – it could be argued that the roots of today’s credit crunch were laid.

Certainly China and Russia have gone to great lengths to ensure they never need IMF help in the future. In Russia, Western resentment grew – which explains much of the current friction between Russia and the West, while China ensured its economic boom was fuelled by savings.

China is possibly unique in the history of economics in developing while maintaining balance of payments surpluses. Its booming economy has also helped contribute to a global glut of savings – which helped underpin the borrowing boom in the US and UK.

It is a complicated web we weave, but if you squint a bit, and take a look at the current economic crisis from a certain angle, from the angle of Chinese savings and trade surpluses, you could even make a case for saying the credit crunch is down to the IMF policy decisions of 1997 and 1998.

And that brings us back to the poetic justice. For the IMF makes its money from interest payments on its loans to countries. And ever since the debacles of 1997 and 1998, customers have been thin on the ground.

Banks have changed their spots, and shed their images of being run by bank managers in the mould of Captain Mainwaring, from Dad’s Army, to a dynamic hub of financial salesmen – maybe that has also contributed to the credit crunch too, but that is another story. The IMF, on the other hand, is perhaps suffering from decades of not being sufficiently customer focused, and is now running short of money.

The solution is simple enough, though. The IMF is selling some of its gold. In all, around $6bn of gold is going to be coming up for grabs, that’s around 12 per cent of its total holdings.

As you know, gold hit its all-time high earlier this year, and although it has fallen slightly since, it still is up on the price a year ago, which itself was up on the price a year before that. It would appear that if you are going to sell gold, now is a good time.

No doubt Gordon Brown is wishing his timing had been fortuitous. He sold gold from the UK’s vaults when the price was much lower than today – bringing in much criticism – although we are not sure he could possibly have foreseen how prices were going to rise.

Interestingly, Gordon Brown has often called for the IMF to sell its gold. But Brown wanted the proceeds to be used to write-off some Third World debt – we are not sure that the IMF, which wants to generate revenue, will see it quite like that.

Sometimes it seems as if there are two types of bubbles.    The are good bubbles,  which while they fuel too much hope and can lead to pain when they burst, are at least built upon foundations which create wealth.  Examples of good bubbles include the dotcom boom, and the rail road boom of the mid-19th Century.  History may even tell us that the credit boom of the first decade of this millennium was a good bubble, because it funded new technology and lubricated the economy as it went through a period of change.

Some bubbles are just plain irrational.    They occur because investors pile into something for no better reason than it rose the day before. 

There were elements of those characteristics in the dotcom bubble and the credit bubble – but atleast there were other reasons for these booms too.

Sometimes, bubbles such as Dutch Tulips or the South Sea Bubble were built on and crashed on the founding stones of greed and fear.  

Sometimes, if seems as if the property bubble is another such example.

Here is another example.

This morning, the BBC focused on a yellow metal.  It told us how to acquire it, and why in times of doubt, it is such a good bet.

Maybe it is a good a bet, but be under no doubt, any growth we see in the price of gold from this point onwards is down to one factor only.  It is rising because it went up the day before.  People are buying gold because it is rising in price.

Other factors, such as demand for gold rising because of its popularity as an item of jewellery in India or OPEC Countries, and its use as a conductor of electricity, ceased to be relevant some time ago; the current price of gold is far too high to be explained by these factors.

The yellow metal may rise some more, maybe a lot more – but the boom in the price of gold is a bubble, and when the mass media jump on the gold bandwagon you know this must be true.  What goes up, must come down –  and gold will not be an exception to this rule.

Gordon Brown wasn’t a fan of gold.    It sits in vaults doing nothing – you can’t make new medicine out of gold, you can’t grow more food with gold, or use it to fuel aircraft.     Okay, you can actually use it to build some items of IT, because its peculiar properties make it ideal as a conductor of electricity, but as a general rule of thumb gold is a dead weight.  It looks pretty, but that’s about it.

So when Gordon Brown quite literally sold the family gold a few years ago, just before it shot up in price, and cost the UK a tidy sum in the process –  he was actually doing what many economists approved of.

Today, economists are not fans of gold.  Last year, for example, Capital Economics often poured scorn on the idea that gold was set to rise in price as fears over the economy grew.

The truth is that gold’s position as a place of last refuge is illogical, in fact it’s purely down to psychology and history.

Sure, in the past, wars were fought over gold, it funded new empires, but there is something else that characterises that period in history when gold was the only true form of money.  Economic growth was awful.   Take as an example Western Europe from 1AD to 1820.  According to Angus Maddison (the authority on these things),  GDP per capita during that period just managed to double.    Yet between 1950 and 2003 GDP per capita almost quadrupled.    

How was it that growth suddenly started to accelerate – surely a factor behind this was the way money changed.    In an economy that is seeing changes in technology, there is a danger that demand will lag behind supply – this is why major economic recessions have often followed periods of technical innovation. 

And when growth did occur, it was often facilitated by new discoveries of gold.    Karl Marx, for example, argued that the Industrial Revolution was funded by the discovery of gold in the new world.   It would appear that economic growth needs an expansion of the money supply,  or, in other words, economic success was held back simply because of the psychological power of  a yellow metal.  They say iron pyrites is fools gold – because it looks a little like it, but is in fact worthless. Well maybe the true fools gold is gold itself – and the day monetary policy was no longer determined by gold supplies was the day  economies were freed up to enjoy their potential.

In 1980, gold hit $873 an ounce, a record that had remained unsurpassed until a few months ago.    But it seemed as if gold’s day was over.  During the recessions of the early ‘80s and early ‘90s, it stayed short of the previous peak – maybe at last its importance was gone – for good.

Actually, that argument is not completely contradicted by the current high price.  Sure, gold has been hitting all-time highs with regularity, soaring past  $1,000 an ounce last night – but then again, in real terms, that’s after allowing for inflation, gold’s price in 1980 is the equivalent of $2,170 today – so maybe gold hasn’t quite regained its former glitter.

It’s not that there aren’t solid reasons for the price of gold to go up – not only does it have applications in the world of IT, it is also especially popular as a form of  jewellery in India – and so as the economy of the subcontinent grows, demand for gold goes up with it.    But then lately, there has been anecdotal evidence that at its current price, many Indian families have been cashing in on their gold, with $1,000 dollars or so proving much more attractive than an ounce of gold.

So, why then is gold suddenly so high?

In part it is rising today because it went up yesterday.    Investors are noting that gold has risen in price, and therefore they are buying more of it. This is, of course, the definition of a bubble, and can not continue indefinitely.

Others are investing in gold because they can’t think of anywhere else to put their money.  

But there are other factors at work – presumably some countries are buying gold to replace dollars in their foreign reserves.  

But finally, of course, gold is seen as a hedge against inflation, and a place of safety.

It is not logical that gold should be either of those things. It’s just the way it is perceived.

And whether it is logical or not, the fact that gold is so high shows how pessimistic speculators are.    If history is any guide – then the high price of gold today is an indication of very tough times ahead and rising inflation.

Back in 2005 we ran a series of articles predicting future rises in the price of gold. That prediction seemed safe then – but will the yellow metal continue to rise?

It does seem that markets are still underestimating the seriousness of the current economic crisis – which would suggest gold has further to rise.  But cut through that, is there a solid, rational reason for gold to be so high,  and the answer is No.

For some time now we have said gold has got to be a commodity with a rosy outlook. Our rationale was manifold. The inevitable fall in the dollar, we argued, would lead to greater demand for gold. Gold as an item of fashion would see rapid demand, as the economy of India, where gold is especially popular, grows. At the same time, gold has some peculiar properties making it ideal as a conductor of electricity, while at the same time it is very resistant to the surface corrosion that is commonly suffered by copper, silver, or tin/lead alloys. As a result it is commonly used for the contacts in electrical connectors.

But, even so, with the yellow metal passing $900 a troy ounce, it does seem to have enjoyed an exceptional run.

A year ago it was trading at $600, the year before that $500, and in mid-2005 it was in the low $400s.

Can the run continue? While it is true that demand from India and IT could explain rises in gold over the long-term, it is difficult to believe they can have justified the recent surge.

And yet, according to the FT, the wise men and women of the City are betting it will rise higher, with some buying contracts agreed which will only be profitable if gold passes $1500 an ounce.

If only they had read Investment and Business News two year ago, and followed our advice then, they would be rich – if only we had followed our advice then. Can it continue? Last week, Capital Economics put a seed of doubt into the mix: “The rally in gold is still essentially a play on dollar weakness, with little hard evidence of additional support for gold either as a safe haven or as an inflation hedge. As such, gold only looks attractive at these levels if the euro is heading well above $1.50. Secondly, there is plenty of anecdotal evidence (particularly from India) that prices above $800/oz are a serious constraint on fundamental demand from the jewellery market. Finally, the last time that gold prices reached these sorts of heights (in January 1980) they also soon collapsed – falling by some $200 within two weeks.