I hate to give personal investment advice. So please do me a favour and do not treat the following as investment advice. I am expressing my personal opinion here. I do so with honesty and conviction, without a personal agenda – I am not trying to sell you anything – but with some good arguments, hopefully. However, it is still an opinion. Nobody knows what the future will bring. I don’t know what will happen to the gold price in the next week, the next month or for the rest of this year. I don’t even know what 2013 will bring but please remember, neither do all the ‘experts’ out there who are much less squeamish about giving investment advice than I am. When you invest your wealth you are alone. You have to make up your own mind. And accept the consequences of your decisions.
Having said this, I can assure you that, personally, I remain a big fan of gold. I consider it the number one asset out there. It remains head and shoulders above anything else.
Gold has not been trading that well recently. Measured in the world’s number one paper money the precious metal reached an all-time high of slightly more than $1,900 per ounce in September of last year but then retreated and has mainly been trading sideways in a wide range since. Considering the ongoing tensions in European debt and banking markets and considering that the global financial system seems forever dependent on super-low policy rates, one could have reasonably expected gold to do better. The reasons for the somewhat disappointing ‘price action’ of late are not quite clear but could be manifold. Maybe it is a bit of rally fatigue. Don’t forget, gold traded below $300 ten years ago and had just been through a decade-long, unprecedented bull run. In one of gold’s biggest markets – India – the government recently introduced new taxes and regulations to discourage investment in gold (surprise, surprise), and international central banks are not believed to match their healthy buying of recent years. But the optimists will say it is something else: things are getting better so there is less need for a crisis-asset.
This is how the Wall Street Journal put it:
Gold is still benefiting from the view the global economy is fragile, but the idea has been shaken by signs that conditions are stabilizing in the U.S.
Are things getting better? Well, as I argued here, it doesn’t really matter. Nevertheless, let’s have a look at gold as a self-defence asset.
Naturally, the financial and political establishment is rejoicing at the prospect of gold losing its lustre. After all, the phenomenal ten-year bull market was the equivalent of a raised middle finger in the face of the international paper money bureaucracy. Ben Bernanke, the money-printer-in-chief, famously answered Ron Paul’s question if gold was money by saying he thought it wasn’t, and that
I think the reason people hold gold is as a protection against what we call ‘tail risk’ – really, really bad outcomes…To the extent that the last few years have made people more worried about the potential of a major crisis, then they have gold as a protection.
And this is precisely why the establishment hates gold so much. The modern policy elite, people like Bernanke and his fellow central bankers, are tasked with avoiding bad outcomes, and they have at their disposal a body of theories (in large part faulty) and an interventionist tool kit that did not exist through most of gold’s three-thousand year history as the entire world’s monetary asset of choice. This tool kit, not least of which is the printing press, is supposed to enable the policy establishment to run the economy smoothly and efficiently and save us from depression and crisis. For the public to turn back to the ‘barbaric relic’ of gold certainly means a major vote of no-confidence for the modern financial architecture and all its supposed safety-valves.
The brilliant Jim Grant calls our post-1971 unrestricted paper money system astutely the ‘PhD-Standard’: we are asked to no longer rely on the apolitical and disinterested firmness of a precious metal to anchor the monetary system and to thus prevent financial extravagance and excess, but to put our economic fate in the hands of a bunch of self-confident and proactive intellectuals and bureaucrats who learnt how the world works by shuffling academic papers in the MIT economics department. Understandably, many people have more trust in gold. (By the way, this explains why the Financial Times, which adores and celebrates the policy establishment like no other media outlet I know of, only writes about gold when it goes down, when the gold ‘bubble’ is once again ‘bursting’, providing the FT with another opportunity to remind you that gold does not pay a dividend.)
Funny how Bernanke puts it with his ‘really, really bad outcomes’ and ‘tail risk’. He makes it sound as if you have to be a pessimist of biblical proportions to buy gold. Things must get ‘really, really bad’ because for anything else we have the Federal Reserve. Relax!
Limited understanding meets unlimited power to print
But the problem runs deeper than Bernanke implies. Much deeper.
While Bernanke’s quote contains some truth, it also reveals an embarrassing misunderstanding of the nature of the problem, a misunderstanding that he shares with the majority of his policy-buddies: he implies that these “really, really bad outcomes” are just random and uncontrollable events, unquantifiable statistical outliers, freak occurrences that simply happen, that capitalism in its mysterious unpredictability occasionally throws at us. This is nonsense but this distorted world view also shone through clearly in Bernanke’s recent lecture series. Inflations, recessions, depressions, asset ‘bubbles’ – all these things come over us like acts of God, like droughts and hailstorms, and Bernanke & Co. are charged with dealing with them on our behalf – and the rising gold price is merely an indication that some folks fail to appreciate the establishment’s good work. Hell, can nobody get any respect any more?
No – the problem runs much deeper than Bernanke seems to grasp, and that is precisely why gold is such a great asset in this environment. His limited understanding coupled with his unlimited power to produce paper money is indeed the number one argument for owning gold.
The present crisis is not an accident of capitalism but the inevitable product of the fiat money system and the faulty theories and counterproductive policies of Bernanke & Co. The present crisis is not just another business cycle – and business cycles are, of course, also created by central banks – but the unavoidable consequence of the political decision to abandon a gold standard and to adopt – in 1971- a system of unrestricted fiat money creation. As I explain in detail in my book Paper Money Collapse – The Folly of Elastic Money and the Coming Monetary Breakdown such a system, while appearing stable for a long time, inevitably accumulates imbalances as it systematically distorts capital formation and asset pricing. The constant artificial cheapening of credit through ongoing money injection – falsely deemed to be harmless or even beneficial because moderate inflation is supposed to be good – must culminate in the present horror show of bloated banks, inflated asset prices and an unsustainable debt load.
The really, really bad outcome is entirely home-made and the fully guaranteed by-product of decades of mild to medium inflationism, i.e. the modus operandi of modern central banking. The crisis is built into the system; it is part of the game. Bernanke still believes that his ongoing money printing is saving the world when it is in fact the root cause of this entire disaster. While Mr. Bernanke poses confidently, and I believe honestly yet entirely erroneously as a fire-fighter, he is really an arsonist, and his ‘stimulus’ is adding ever more fuel to the fire.
We should not buy gold because Bernanke’s policy (and that of other central bankers) is ineffectual but because it is, in an unintended and ironic way, all too effective. This policy preserves the accumulated imbalances, it sabotages their dissolution and liquidation, and it constantly funds new imbalances. His policy is guaranteeing the never-ending crisis (almost never-ending I should say, as it will end in a currency catastrophe when the public begins to shun his fiat money and when paper money becomes a hot potato). We do not own gold because we fear that Bernanke may stop his policy of saving the government and Wall Street, and because that may then lead to a really, really bad outcome. We own gold because we think he won’t stop saving them, thus making a really, really bad outcome guaranteed.
Contrary to what Bernanke’s statement implies and what he undoubtedly believes, it is not by his policy activism that he may restore lasting confidence and stability and thus end the bull market in gold. If he wanted to undermine gold he would have to become passive, not ever more active. Paul Volcker successfully ended a gold rally (or, more accurately, put it to rest for 20 years) not by using the printing press to bail out the world a la Bernanke & Co. but, au contraire, by stopping the printing press altogether and allowing high real interest rates to cleanse the system of the imbalances from previous money production. That is what ended the last gold bull market and it is still the major threat to today’s bull market. However, I consider it very unlikely at present. Bernanke is no Volcker, and stopping the printing presses today will create bigger challenges than in 1979.
It is not the crisis that leads people to seek safety in gold. It is policy that they seek protection from.
If gold is, for the time being, retreating because the investing public sees less need for it with monetary and fiscal stimulus presently sustaining the impression – the illusion, really – of stability and sustainability, then this is a great opportunity to buy gold.
In defence of “hoarding”
Let’s look at the logic of investing in gold. When doing so we immediately are confronted with widespread antipathy towards it founded on ignorance and misunderstanding: We gold bugs are not only pessimists who want to make money when the world goes to hell in a hand-basket, we even remove our spending power from the markets for consumer and producer goods and invest our wealth in “barren” and “unproductive” monetary assets. Shame on us!
I use the term “monetary asset” as I do not want here to go into the debate about whether gold is presently money or not. I know that you cannot buy a bus ticket with a gold coin but that is not what we are discussing here. For the purpose of this investigation gold is (almost) equivalent to physical paper money, i.e. to cash under the mattress. The person who invests in bullion does so for the same reason that somebody may hold a large pile of banknotes in a safe, namely to not commit this part of his wealth to consumer goods that may fulfill his present consumption needs or to producer goods that promise an investment return (dividends and interest). He is holding money – that is, gold or physical cash- because he wants to conserve his purchasing power and retain the flexibility of spending that purchasing power on consumer and producer goods some time later but still at the drop of a hat. Money is the most fungible good, the one that can most easily be traded for goods and services. People hold money because they value that flexibility and the maintenance of their purchasing power higher than what they can get for their money at present prices, including what they can get for it in terms of investment goods at present prices.
There are, of course, important differences between gold and cash. The latter is presently slightly more fungible. Remember the bus ticket. On the other hand, there is no limit to how much paper money central banks can produce today. For the paper money holder debasement is not only a risk, it is almost a certainty, as it is the declared goal of those in charge of the money franchise. I’ll come back to that later.
Keynes had a keen eye for widespread prejudices (against the rentier class, against saving and against money hoarding) and was not above providing pseudo-scientific justifications for these prejudices. Thus, his silly ‘liquidity preference theory’ in his General Theory (in particular chapter 15), according to which it is okay to hold money to be ready for immediate transactions but not okay to hold money because you simply want to sit on the sidelines and retain purchasing power.
This is, of course, complete nonsense. Money, like any other asset, is only an asset because it fulfils the needs of its owners. Consumer goods fulfil consumption needs, investment goods promise monetary return, and money provides flexibility and security (at least honest money does) in an uncertain world.
As Henry Hazlitt has pointed out so well in his critique of Keynesianism, the “hoarder” of money does not speculate in money, as Keynes alleges, but simply refuses to speculate in bonds and stocks and other assets at prevailing prices. He has absolutely nothing against investing in “productive assets”; he just does not want to buy them at the current inflated and artificial prices.
Concerns about the stability of the overall economy and the sustainability of high asset prices are most prevalent at the end of credit booms when cheap money has created a false sense of prosperity and economic vitality, and when the prices of bonds, stocks and real estate are elevated by years of easy credit. In a system of inelastic money, such as a gold standard, growing demand for money at that late stage of the cycle will cause money’s purchasing power to rise and the money-prices of goods and services to fall (deflation). At the new and lower prices demand shifts back from money to other, non-monetary assets. “Hoarding” ends naturally; it is self-correcting. When money’s purchasing power rises, the opportunity costs of holding wealth in the form of money rise, and so does the attraction of spending that money on consumer or producer goods.
That money is not an unproductive asset has been argued by W.H. Hutt in his seminal essay “The Yield from Money Held” from 1956. For an excellent exposition of this view see this speech by Hans-Hermann Hoppe on the same topic. Holding money – and in particular inelastic money proper – is a sensible, legitimate, rational and by no means destructive strategy.
As I’ve argued repeatedly, we have had an on-and-off (but mainly on) fiat money boom for 40 years. Capital misallocations and asset price distortions are massive. How big they are and where precisely they are located, nobody can tell. We would have to stop printing money and let the market expose the dislocations and then liquidate them but that is the one thing that authorities do not want to let happen. Be that as it may, the public’s desire to step back from inflated and systematically manipulated asset markets is understandable and entirely justified and naturally translates into demand for money – but proper, apolitical and honest money. i.e. gold.
But Bernanke & Co., just like Keynes in his time, do not want you to disengage from speculation in bonds and stocks and real estate. Moving to the sidelines is strictly verboten. You have to keep playing – with your own hard earned savings. The policy establishment believes that it can manipulate the economy by manipulating your desire for assets through the manipulation of interest rates via the printing of money. These manipulations have to be ever more blatant, direct and heavy-handed. Manipulation used to be conducted in a roundabout way by just administratively easing the refinancing conditions for banks and then waiting for the ‘stimulus’ to play out in the wider capital markets and the economy. Now that this policy has brought us the aforementioned imbalances, the central banks have to manipulate asset prices openly and ever more directly via ‘quantitative easing’.
Here is Bernanke defending the practice in 2010:
This approach (quantitative easing) eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action. Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.
If you believe that this brazen manipulation by the paper money bureaucracy is going to work and that it will restore and then guarantee stability and prosperity, you can do without gold. Jump right back in. Put your savings at the mercy of the Great Manipulator! Good luck!
I would only feel comfortable participating in these asset markets if I were confident they were not rigged. It is not a good idea to invest in assets whose prices are artificially inflated for political reasons. The biggest danger, in my view, presently exists in bond markets, in particular in government bonds. As to equity markets, where would they trade without zero interest rates, and where will they trade when inflation picks up?
Sitting on the sidelines makes a lot of sense to me. I want to hold money but it cannot be paper money or bank deposits, as both represent state fiat money that the policy establishment will continue to create like confetti. Additionally, a bank deposit may be your asset but it is equally the bank’s liability, and banks everywhere are on life-support. Therefore, you have to go back to the eternal and international form of money: gold, which is not anybody’s liability but just your asset.
What about other ‘real assets’, such as property or farmland? Well, I guess you have to have considerable wealth to invest meaningfully in farmland. Also, the yield on farmland in places like Europe is very low and often dependent on state subsidies. With governments everywhere going bankrupt you have to expect those subsidies to be cut at some point with potentially adverse consequences for the value of that land. Be that as it may, I think it is generally a bad idea to invest in a way that makes you dependent on government spending. Additionally – and this is something that applies to all forms of real estate – you have to expect the level of property taxes to rise. This is low-hanging fruit for the taxman as things are getting desperate for him, too.
All major central banks are in pretty much the same sticky position. None of them have an exit strategy. The Fed has not expanded the monetary base since June of last year. That is not because monetary prudence has set in but because the steroids from the last round of QE are still working. Banks are doing the money creation themselves again. M1 has expanded by 14 percent since last summer, non-annualized. No deleveraging here. Additionally, the myth of Treasurys as safe assets is still alive and kicking, against all evidence to the contrary and probably thanks to the present fixation with Europe. When banks and sovereigns come under pressure again the monetary floodgates will be opened. Just look at the ECB and their recent €1 trillion-plus money injection.
“We’re on crack,” as John Hathaway, the manager of the Tocqueville Gold Fund put is so astutely in the Wall Street Journal. The financial community is completely addicted to cheap money and ongoing stimulus. Just wait for the withdrawal symptoms to set in and you can rely on another round from Bernanke & Co. Unless I see a Volcker-like figure emerging, the avenger of the paper standard, I am happy to sit with eternal money.
In the meantime, the debasement of paper money continues.
This article was previously published at Paper Money Collapse.