Response to The Observenator

This one just slipped onto my screen via Ivo Vegter’s twitter feed – which is extremely active and colourful in a libertarian kind of way – for those of you into that sort of thing.

Stephen vJ aka The observeanator answers the question of a friend: “Time to buy gold again?”  To us the answer becomes a louder and louder “Yes” by the day, but not to Stephen vJ.  There are a few confusing trains of thought here that need to be straightened out. Failing to do so, his readers who don’t understand what gold the monetary metal is about may be left even more puzzled.

Stephen vJ’s answer is set out in the italicised and grey boxes, while our comments follow –  In gold…

The question is no doubt related to recent world events which typically prompt economists of the Keynesian persuasion to “stimulate the economy” by pumping money into the system in the belief that Demand drives economic activity and that more money increases Demand.

We know of course that this is wrong and that “stimulation” will lead to structural damage, bubbles and a devaluation of the value of money by means of inflating the money supply (the original source of the word “inflation”). Demand is not the driver and neither is Supply – it is like a scissor in which neither blade is very useful on its own. In short, “stimulation” in the Keynesian sense leads to economic collapse when applied on anything but the short term.

To protect one-self from these effects, some people suggest buying gold because it holds its value. I am not one of those people and this is why…

Firstly, even Keynes himself recognised the short term application of his theory with his “in the long run we are all dead” quip. See also the interview with Hayek on YouTube (called “Hayek on Keynes”) in which Hayek tells how Keynes said to him that he would stop anyone from applying this theory on the long term… and then died before he could do it.

Your first point on Keynes is really more an argument for buying gold, not against it. Keynes’ theory implemented over the long-run will destroy the economic system, which it is doing today, and this is exactly when you want to own gold.

Secondly, gold (or any other metal) is a good investment only relative to the devaluation of currencies in a fiat money system. In fact, gold (or any other metal) does not give a return on investment which is particularly good. Historically it is around 2% to 3% over the long term. The reason for Austrian School support of gold is not for its investment value but as a backing of currency – it is a rather lousy investment due to its poor growth, but brilliant for trade due to its enduring value.

Gold is better defined as money than an investment.  In this sense, gold is maintaining its purchasing power better than fiat currencies.  True, gold has only appreciated roughly 2-3% against other currencies in recent history (from the early 1800s to 1971, barring inflationary civil and other wars), but you may have noticed this appreciation has accelerated somewhat over the past decade as gold went from $250/oz in 2001 to $1400/oz today.  This is because the fiat monetary system is in the process of collapsing, and increasing amounts of paper money must be printed to prop the system up, debasing the printed currencies against gold.

Austrian school support of gold is not for its backing of currency, but that gold is market-determined or free-market money. Austrians recognise that gold actually IS money.

One head of cattle has been approximately equal to one ounce of gold for the last 3000 years i.e. metals are stable investments not high growth investments – so it depends on whether your definition of “good” in “good investment” refers to growth or to stability. If you support buying gold, you may also support buying cattle… although they don’t store as easily and are rather a pain to maintain. Both would grow in value at approximately the same rate though.

Once again, gold is money not an investment.  It is not only “good” money, but the “best” money. Which puts it up there with the best forms of saving.  Purchasing a head of cattle would be regarded an investment, owing to the risks, maintenance and marketing costs involved of merely maintaining its value. Saving real money does not require these inputs to maintain purchasing power.

In other words, don’t put your money in cash or currency. Like much else run by the government, our currencies are rather poorly managed. Relative to that, even metals and cattle are a good idea. Want to invest your money where it will grow ? Well, that is a whole different story.

Cattle would be a good idea if you have the resources to not only keep it alive but also get it nice and fat before you can market it. For the majority of people this is not very accessible.

Gold you need only store safely.

Entrepreneurship, specialization, trade and enterprise can grow at 10% or 20% even over the long term, even at real inflation adjusted terms and despite short term fluctuations. It does not depend on how much you can dig up given mining technology, reserves or labour. It depends on innovation and value add – things which can be increased exponentially by application of the mind.

Two points: 1) when entrepreneurship, specialisation, trade and enterprise grow at 10% or 20% (per year I assume), the purchasing power of gold as money rises as more goods and services come onto the market, while gold (money) supply has remained steady.  In other words, the purchasing power of gold rises as productive economic activity rises, as was seen during the late 19th century.  This is when it pays to save some of your income, which further boosts long-term economic activity.  However, the purchasing power of gold can also rise when the monetary system collapses, under conditions of declining general economic activity.  2) There is a difference between a) the profit and loss enterprise of gold mining and b) the physical monetary metal which the former produces.  You seem to be confusing the two.  The one is the production of the money, the other is the money specie itself.  An important reason why gold is the best money is because the amount you can dig up is limited as there are restrictive costs to doing so, which helps to maintain the value of the metal that has already been unearthed.

In 2006, Small Capital and Value shares rose by 65% to 80%. They fell the least in 2008 and recovered the fastest in 2009 / 2010. They are the only shares which have to date returned to levels above their pre-2008-crash levels. The same can not be said for gold. On the short term they may be more volatile than other investments and may be affected by poor economic policy… but the entrepreneurs sitting behind them are flexible, adaptable and resilient. If their short term volatility makes you nervous, just don’t look at your investment on a daily basis.

Gold made all-time highs in GBP and EUR terms this week.  In USD terms gold made an all-time high in November, same thing in JPY terms, while the ZAR has held up moderately better against gold. Let’s not confuse investing in the business of production of the metal with money again. A good exercise would be to price the “Small Capital and Value shares” in gold and see whether they have broken above pre-crisis highs.  The point is any good investment SHOULD outperform money, i.e. gold.  If this isn’t the case, and your returns will be worth less in gold ounces than the ounces invested, you have lost.  Gold is the numeraire in which earnings should be measured, rather than in fiat paper money.

For more on the value of metals over the long term, read Mark Skounsen’s “The making of modern economics”. He relates a particularly interesting story about a wager between two economists on the value of two metals over a two-decade period in which metals lost. I support gold as a means to back currencies in a proper free-banking system… but not as an investment or even a hedge against risk. It is simply too stable for that.

We support gold as money itself in a free-banking system with no central bank or any government regulation of the banking industry. Legal tender laws should be dropped and currencies be allowed to compete freely on the market. Laws giving banks the cover of taking deposits as a debt and not as a bailment should be altered to stop the everyday embezzlement of depositors.  But enough of that, the system is headed that way because the current monetary system will ultimately self-destruct, in which case the risks become more interesting, and holding gold becomes more attractive.

A small default of even 1% of the quadrillion dollar derivatives market will leave the financial system insolvent overnight. A collapse of US Treasuries will wipe out bank capital, and leave the financial system insolvent. Not to mention the other possible risks that could bankrupt the financial system.

These are very real risks that would see the value of gold bullion go parabolic to the topside. Gold reached trillions of dollars in both German mark terms in the 1920s and even higher heights in Zimbabwe. Gold is money that does not require the solvency of the financial system or government to perform its function as money, which is in stark contrast to government and bank created fiat money.

The risk to keep your eye on when gold becomes attractive is not a collapse in the stock market which central banks can control, it is a collapse of market confidence in either the financial institutions or the money they have become used to.

This is where gold will come into its own as money and will outperform just about anything under the sun.

4 Responses to “Response to The Observenator”

  1. Simon Brown says:

    All well and good, and the easy answer is that one buys what is going up, as is gold.

    BUT a serious problem, while gold is rising in USD the strong Rand is taking the shine off the gains, and with the move is Rand likely to be stronger anybody buying gold in SA is not going to be on a winner until rand weakens WHILE gold strengthens.

    • freeman says:

      USD is worse than ZAR. ZAR is worse than Gold. Gold price gains in USD will outstrip Gold price gains in ZAR. BUT, the ZAR price of Gold will keep steadily rising, as it has done for decades.

      Moreover, your comment seems to miss my pal JGalt’s point. Forget “investment return”. You are not buying “an investment”. You are buying real money, plain and simple. It is your 100% guaranteed protection against fiat currency failure…which is coming.

      This is not an ALL-OR-NOTHING game Simon. No one is saying take ALL your money and buy gold. By all means buy small companies, but large companies, buy farm land, buy cattle, buy good assets. But buy gold as well. You simply can’t afford not to.

      People who aren’t buying gold are missing out on the biggest financial/economic/monetary trend in history…

  2. Stephen vJ says:

    This is the best response to my article yet. Well done Human Action. Love your site and the work you do… and thanks for taking the time to read my piece and for giving it a good dose of reality. My central point was that gold is great for carrying barefoot across a mountain border in case of the impending doom you talk about, but not so much as a long term investment which is something entirely different. Even a cow can beat that growth on the long term, but it does not carry as easily over a mountain and you seem to add to that concept. Your points about monetary use of gold is something which was botched to an extent in my piece and I appreciate the correction.

  3. Quintin says:

    Interresting article!