In 1982-2000, I avoided large losses by completely ignoring gold as an investment vehicle — I started thinking about it again when in July 2000 I noticed that Vanguard’s precious metals fund was its only loser over the preceding 5 years. Since 2008, I have invested consistently in gold mining stocks, and enjoyed good years (2009-10, 2016-19) and bad years (2011-15) thereby. Yet the intellectual case for gold, as a store of reality in an increasingly unreal world, grows stronger by the day. Let me explain….
The immediate reason for increased attention on gold is the Fed’s statement this week that they are considering regarding their informal 2% inflation target as a goal to be aimed at rigorously. Thus, if inflation falls short of the goal over a period, monetary stimulus should be used to create artificially a period of higher inflation to ensure an overall average of 2%.
This is madness on several different levels. Since money is primarily a measuring rod that should preserve its value over the long term, why on earth are central banks setting the inflation target at 2% per annum instead of zero? 2% per annum halves the value of your money in 35 years, only just over a generation.
Given that tax systems don’t index properly, and most bonds are not inflation-linked, this condemns bond buyers to receiving 2% less real return on their money than the income they pay tax on. If interest rates are 4% and taxes are 30%, their real rate of tax paid is 60% (their real return is 2%, but they pay 1.2% in tax). If interest rates are 3%, their real rate of tax is 90%; if interest rates are 2%, their tax rate is infinite and their real rate of return is negative. In these circumstances, it is not surprising that most people cannot save enough for their retirements, that they over-invest in risky and overpriced equities and real estate, and that speculation completely dominates sound investment.
The Fed’s latest move follows a policy over the last two decades of always finding reasons to lower rates, never finding a reason to raise them (except the election of a Republican President in November 2016, curiously enough). We also learned last week from Fed Vice-chairman Randal Quarles, the institution’s regulation czar, that the curious spike in short-term rates in September 2019, which led to a complete reversal of Fed policy and a reversion to quantitative easing, was in fact not a natural phenomenon at all. Instead it stemmed from clumsy Fed liquidity rules, which prevented banks from carrying out overnight repurchase agreements and artificially rewarded holding reserve balances at the Fed. The Fed thus pumped tens of billions of dollars into the banks in response to a crisis that was pure chimera.
For two decades or more, the Fed and other rich-country central banks have taken the view that one of the key variables in the economy, the price of money, should be managed by them as if Gosplan was the agreed mechanism for arbitrating the U.S. and global economies. Like Gosplan, pushing always for higher steel output, the central banks have a massive internal bias towards lower interest rates, and have set rates far below where they would rest in a free market. When the Fed has moved towards the market, as with the rate raising in 2004-06 and more tentatively that of 2016-18, the result has been a massive outbreak of squawking from Keynesian economists of all political persuasions. They have proclaimed loudly and incessantly that excessive Fed tightening (for which week?) caused the 2008 recession, or as last September that a strategic shift towards lower rates and easier money was essential immediately.
The world’s monetary system must be liberated from this central planning. To achieve this, there is only one reliable mechanism available: gold. Gold is relatively invariable in real value, because the cost of extracting it is related to other items in the real economy, and the supply is mostly determined by the total amount in existence, which, having been mined over at least 5,000 years, decays only a little and far exceeds any amount that can be mined within a few years. Over the very long term, gold is an excellent proxy for real economic value; my own modest research has demonstrated that the most efficient way of converting prices of 200 years ago into modern values is to scale up by the gold price.
Thus, Jane Austin’s Mr. Darcy’s £10,000 per annum, worth about 2,000 ounces of gold at gold’s somewhat inflated price in 1813, the year the book was published (Britain was off the Gold Standard at that time), would translate today, at a gold price of $1,500 an ounce, into an income of $3 million per annum. This reminds us that, while fabulously wealthy by the standards of the middle-class Bennets, he was by no means the richest man in Britain. (That would have been the Marquess of Stafford, with an income of £100,000 per annum, equivalent to $30 million today, still making him far short of Bill Gates. We are much richer today than Jane Austen’s Britain, but if anything less equal – that is yet another unpleasant result of our foolish monetary policy.)
The gold price works better than price indices over such a long period, because it avoids the tracking error in indexes, which becomes serious over the long-term. We do not consume the same goods as our ancestors did 200 years ago (relatively far less food, for example, because we are much richer and food is cheaper). Price indexes attempt to correct for this but the correction is usually fudged (for example by the “hedonic” weighting introduced in the U.S. Consumer Price Index in 1996, which causes it to understate true inflation), a problem that becomes debilitating with 100 or 200 years of compounding.
The problems of indexes are avoided by looking at the gold price, which accounts automatically for changes in consumption patterns. Naturally, major changes in gold production technology or the discovery of gigantic new fields (California in 1849, Yukon in 1896) can throw off the comparison for a few years, but the huge existing gold stock dampens this effect over time. Only the invention of asteroid mining, perhaps with the discovery of an especially gold-rich asteroid, could potentially throw off this relationship.
Since gold is an excellent measuring rod for monetary and fiscal folly, it needs to be used as such. Instead of central banks seeking to inject a constant 2% inflation into their economies, they should seek to maintain a constant price of gold in their currencies, perhaps within a 1% or 2% band, such as was used in the Bretton Woods system. Unlike the Bretton Woods system, ordinary people would be allowed to buy and own gold, thus ensuring the world’s governments cannot cheat ad infinitum, as they did under Bretton Woods. There would be no built-in 2% inflation rate; the target inflation rate with a constant gold price would automatically be zero.
Eventually, after a few years of gold price tracking, central banks should go back to minting gold coins that the public can hold, thus removing from themselves the temptation to abandon the gold price target if things get rough. Step by step, the world would then have returned to a Gold Standard, a profoundly desirable outcome.
Such an approach would solve automatically the other problems of our global economy, each of which is leading us to disaster within a decade or so. Interminable budget deficits and unfunded social security and Medicare systems would be incompatible with the fixed-gold-price rule, because they would drain the private economy and thereby push interest rates to unsustainable levels. Leverage would be so expensive and so dangerous that after a spate of bankruptcies, companies would run their businesses on a sound basis, ceasing their indulgence in endless share repurchases. Tariffs would provide useful revenue to balance national budgets. Any attempts by monetary authorities to inject money “with a helicopter” would quickly lead to a credit crisis, though it is a pity that Ben Bernanke’s original idea of dropping money on the populace from a helicopter was not tried literally over North Dakota, rather than metaphorically over Wall Street.
Modern economic policies, especially in the monetary area, are so far from being optimal, they can be described as “pessimal” – the worst that can possibly be chosen. Modern policymakers are more foolish than the restored French Bourbon Kings, who notoriously had “learned nothing and forgotten nothing.” They have, rather, learned nothing and forgotten a great deal. In particular, they have forgotten how the gold price was used, by wise statesmen like Lord Liverpool, even when Britain was on a paper money standard, as a barometer for money and credit conditions.
We are not going back towards a fixed gold price any time soon – every policy is, on the contrary, designed to force the gold price into an ever upward spiral. In these circumstances, while gold is not useful in the short-term as a measuring rod, we can invest in it for its other purpose: in a universe of foolish monetary policy it is a store of ever-increasing value.
(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)