Buy Gold for Your Teeth and for Weddings
In various letters and our new book (with contributor Michael C S Wong), Investing in the Age of Sovereign Defaults, I have embraced a rather lukewarm view of gold. Yes, in the long run gold may hold its value in an inflationary environment that results from the world’s central banks’ quantitative easing. But in the short to intermediate run inflation is not likely to be regarded as a problem in most major countries. Debt overhang and massive productivity increases from accelerating technology and globalization have seen to that. You don’t need to hedge against inflation if there is not much inflation.
But there are longer term issues with gold. Gold bulls, especially the more cerebral ones, carefully calculate the amount of gold that would be needed in the event of a restoration of the gold standard. The current world stock of gold at current prices is vastly insufficient to support a genuine restoration of the gold standard. Ergo, the price of gold must rise dramatically over the long run. In the view of these sophisticated gold bulls, the gold standard’s eventual restoration is inevitable. Assuming restoration, their logic is impeccable.
It is my view on the contrary that the restoration of a genuine global gold standard is not likely to happen. The reasoning, laid out in our book, is that with universal suffrage and a fatal attraction to populism broadly defined in democracies, governments cannot turn over monetary policy to the discipline of an anonymous metal. Their electorates expect their governments to smooth out business cycles, socialize risk and redistribute income. Most economists, brought up in the demand management Keynesian and/or Monetarist traditions and dependent on governments for grants and jobs, tell the governments that indeed they can smooth out business cycles, socialize risk and redistribute income.
This of course is what governments want to hear. It’s in the self-interest of economists not to like the gold standard. Economists not surprisingly can give a thousand learned reasons why it would never work. I disagree. The gold standard could certainly work and work better than the fiat money system we have now. And indeed it did work better from 1880-1914 when most of the major countries of that time were on what closely approximated a classic gold standard. Gold in fact was the global currency. But politically in universal suffrage democracies, in my opinion a true gold standard will never be implemented. To butcher the famous phrase of the Prussian military strategist Carl Von Clausewitz , we better not let the perfect plan (the gold standard) be the enemy of the OK plan ( a reformed fiat money system). My advice to investors is not to buy gold in anticipation of a restored gold standard. No matter how wonderful it might be it aint going to happen.
Investors who think a restored gold standard will bring a better world should keep one thing in mind. The restoration will have to go all the way. Central banks will all have to give up their power to create high powered money. So long as central banks can immunize their domestic economies against gold inflows and outflows, hybrid systems that use gold won’t work. In the 1920s, under the so-called gold exchange standard, both the United States and France immunized the inflow of gold into their economies by offsetting reductions in the monetary base. Under the classic gold standard, these gold inflows would have reflated the US and France thus helping to equilibrate countries in deficit like the UK. And of course, another famous hybrid system, the Bretton Woods system, blew up in 1971.
Don’t forget if inflation does return and gold and other commodities soar in value in nominal terms, governments will take measures to prevent alternative stores of value from competing with their fiat money monopolies. Franklin Roosevelt confiscated American private gold holdings in 1933 and the Supreme Court rolled over and let him do it. The government of India, a poster child for bad governance perhaps, is constantly piling on taxes for the holding of gold. If you really think monetary Armageddon is coming, gold would be a good investment but make sure it is hidden along with canned foods in a place where governments can’t find it. Or perhaps get that gold crown replacement now.
With regard to the recent crash in gold prices, consider that, in the absence of a genuine gold standard (where a specific gold price can be derived), nobody can really come up with a theoretical value for gold. It offers zero in the way of cash flows and cannot be run through any valuation model. Is the current sell- off overdone? There’s no mathematical valuation model that can give you an answer. Lots of Chinese and Indian retail buyers think yes the sell-off is overdone. Indians in particular are loading up for wedding season. But who knows? At least with Apple – that other fallen angel – you can download Excel and build your own discounted cash flow model per the MBA finance textbooks. Feed your projections into the model and out will pop a value for Apple.
A Gold Alternative—the Global Corporation
Sophisticated investors worried about eventual dollar/euro/yen hyperinflation are probably putting some money in alternative sold currencies like the Singapore and Hong Kong dollars or even the Chilean peso. But for large amounts of money perhaps this alternative is not realistic.
Another “safe” alternative is available, i.e., the large global corporation. Of course in the event of a global economic collapse like 1929-1933, there will be no really safe harbors. There are certainly smart people out there calling for such a collapse. But that’s not my forecast.
A number of advantages can be listed for investing in large global companies:
1. While the governments of advanced democracies may be tottering in debt and entitlements, technology is accelerating. If you believe futurists like Ray Kurzweil, technology is an integral part of human evolution and is accelerating at an accelerating rate. Global corporations are major originators, users and therefore beneficiaries of accelerating technology. Globalization itself is made possible by accelerating technology. Go back to the introduction of screw propeller ships, railroads and refrigeration in the nineteenth century. Then add the airplane and the IT and telecommunications revolutions in the twentieth. Remember all the hand wringing about Hubbard’s Peak and how the US and the world were going to run out of energy? Technology – in this case fracking and horizontal drilling—demolished Hubbard’s Peak with zero help from the Obama Administration. Large global companies are beneficiaries of lower oil and gas prices besides being a driving force in the introduction of the fracking and horizontal drilling technologies.
2. You don’t have to own a technology company per se to benefit from technology. Let somebody else figure out if Samsung or Apple will be the winner on the smart phone or which company will be dominant in the cloud. Accelerating technology benefits all businesses including low techs like Coca Cola and Proctor and Gamble. The important thing is that a company has globally recognized brands and is well managed.
3. As I argued in a prior letter, in an environment of accelerating technology capital’s return increases at the expense of other inputs like labor. Accelerating technology benefits humanity but does not necessarily help income distribution. But investors might as well get on the winning side of this.
4. In the post-2008 environment, a distrust of markets has brought on a tsunami of regulation in certain countries especially in the United States. The large global corporations are best equipped to hire the lawyers and the lobbyists and to fight off this tsunami. It’s a waste of resources but that’s the way things are. In the US the only way to get rid of the K Street lawyers is to get rid of the government. That’s not going to happen.
5. Money market funds pay almost nothing. A good part of their assets is in banks. So with money funds you have to worry all the time if the banking sector is all that safe. Ask the depositors in Cypriot banks. Most large global corporations pay a decent dividend in the three percent area. Better than zero and in many ways with less risk than bank deposits and money market funds.
6. If you live in a country that taxes capital gains as does the United States, rapid turnover of stocks in your portfolio is not tax efficient. With small firms which are often one product, one note pianos that require more disciplined sell approaches, you will be forced to take a more active and hence less tax efficient approach. Better let your investments – in this case the large global companies – retain earnings and do the reinvesting for you. This is not the ideal free market, tax free world of economics but it may be the best second best solution for the real world.
7. If we do flip from a world of disinflation to one of accelerating inflation, this will not be an ideal one for any companies, large or small. Economists have long argued whether stocks would do better in an inflationary environment. The 1970s were one era where inflation was bad for stock prices in real terms. But in the German hyperinflation of the early 1920s, the large non-financial companies managed to survive and their equities rallied strongly in the mid-1920s up until the global pull back in stocks in 1928-29. The big global companies have a lot of resources working for them that will enable them to survive and grow in varying economic conditions.
In various letters and our new book (with contributor Michael C S Wong), Investing in the Age of Sovereign Defaults, I have embraced a rather lukewarm view of gold. Yes, in the long run gold may hold its value in an inflationary environment that results from the world’s central banks’ quantitative easing. But in the short to intermediate run inflation is not likely to be regarded as a problem in most major countries. Debt overhang and massive productivity increases from accelerating technology and globalization have seen to that. You don’t need to hedge against inflation if there is not much inflation.
But there are longer term issues with gold. Gold bulls, especially the more cerebral ones, carefully calculate the amount of gold that would be needed in the event of a restoration of the gold standard. The current world stock of gold at current prices is vastly insufficient to support a genuine restoration of the gold standard. Ergo, the price of gold must rise dramatically over the long run. In the view of these sophisticated gold bulls, the gold standard’s eventual restoration is inevitable. Assuming restoration, their logic is impeccable.
It is my view on the contrary that the restoration of a genuine global gold standard is not likely to happen. The reasoning, laid out in our book, is that with universal suffrage and a fatal attraction to populism broadly defined in democracies, governments cannot turn over monetary policy to the discipline of an anonymous metal. Their electorates expect their governments to smooth out business cycles, socialize risk and redistribute income. Most economists, brought up in the demand management Keynesian and/or Monetarist traditions and dependent on governments for grants and jobs, tell the governments that indeed they can smooth out business cycles, socialize risk and redistribute income.
This of course is what governments want to hear. It’s in the self-interest of economists not to like the gold standard. Economists not surprisingly can give a thousand learned reasons why it would never work. I disagree. The gold standard could certainly work and work better than the fiat money system we have now. And indeed it did work better from 1880-1914 when most of the major countries of that time were on what closely approximated a classic gold standard. Gold in fact was the global currency. But politically in universal suffrage democracies, in my opinion a true gold standard will never be implemented. To butcher the famous phrase of the Prussian military strategist Carl Von Clausewitz , we better not let the perfect plan (the gold standard) be the enemy of the OK plan ( a reformed fiat money system). My advice to investors is not to buy gold in anticipation of a restored gold standard. No matter how wonderful it might be it aint going to happen.
Investors who think a restored gold standard will bring a better world should keep one thing in mind. The restoration will have to go all the way. Central banks will all have to give up their power to create high powered money. So long as central banks can immunize their domestic economies against gold inflows and outflows, hybrid systems that use gold won’t work. In the 1920s, under the so-called gold exchange standard, both the United States and France immunized the inflow of gold into their economies by offsetting reductions in the monetary base. Under the classic gold standard, these gold inflows would have reflated the US and France thus helping to equilibrate countries in deficit like the UK. And of course, another famous hybrid system, the Bretton Woods system, blew up in 1971.
Don’t forget if inflation does return and gold and other commodities soar in value in nominal terms, governments will take measures to prevent alternative stores of value from competing with their fiat money monopolies. Franklin Roosevelt confiscated American private gold holdings in 1933 and the Supreme Court rolled over and let him do it. The government of India, a poster child for bad governance perhaps, is constantly piling on taxes for the holding of gold. If you really think monetary Armageddon is coming, gold would be a good investment but make sure it is hidden along with canned foods in a place where governments can’t find it. Or perhaps get that gold crown replacement now.
With regard to the recent crash in gold prices, consider that, in the absence of a genuine gold standard (where a specific gold price can be derived), nobody can really come up with a theoretical value for gold. It offers zero in the way of cash flows and cannot be run through any valuation model. Is the current sell- off overdone? There’s no mathematical valuation model that can give you an answer. Lots of Chinese and Indian retail buyers think yes the sell-off is overdone. Indians in particular are loading up for wedding season. But who knows? At least with Apple – that other fallen angel – you can download Excel and build your own discounted cash flow model per the MBA finance textbooks. Feed your projections into the model and out will pop a value for Apple.
A Gold Alternative—the Global Corporation
Sophisticated investors worried about eventual dollar/euro/yen hyperinflation are probably putting some money in alternative sold currencies like the Singapore and Hong Kong dollars or even the Chilean peso. But for large amounts of money perhaps this alternative is not realistic.
Another “safe” alternative is available, i.e., the large global corporation. Of course in the event of a global economic collapse like 1929-1933, there will be no really safe harbors. There are certainly smart people out there calling for such a collapse. But that’s not my forecast.
A number of advantages can be listed for investing in large global companies:
1. While the governments of advanced democracies may be tottering in debt and entitlements, technology is accelerating. If you believe futurists like Ray Kurzweil, technology is an integral part of human evolution and is accelerating at an accelerating rate. Global corporations are major originators, users and therefore beneficiaries of accelerating technology. Globalization itself is made possible by accelerating technology. Go back to the introduction of screw propeller ships, railroads and refrigeration in the nineteenth century. Then add the airplane and the IT and telecommunications revolutions in the twentieth. Remember all the hand wringing about Hubbard’s Peak and how the US and the world were going to run out of energy? Technology – in this case fracking and horizontal drilling—demolished Hubbard’s Peak with zero help from the Obama Administration. Large global companies are beneficiaries of lower oil and gas prices besides being a driving force in the introduction of the fracking and horizontal drilling technologies.
2. You don’t have to own a technology company per se to benefit from technology. Let somebody else figure out if Samsung or Apple will be the winner on the smart phone or which company will be dominant in the cloud. Accelerating technology benefits all businesses including low techs like Coca Cola and Proctor and Gamble. The important thing is that a company has globally recognized brands and is well managed.
3. As I argued in a prior letter, in an environment of accelerating technology capital’s return increases at the expense of other inputs like labor. Accelerating technology benefits humanity but does not necessarily help income distribution. But investors might as well get on the winning side of this.
4. In the post-2008 environment, a distrust of markets has brought on a tsunami of regulation in certain countries especially in the United States. The large global corporations are best equipped to hire the lawyers and the lobbyists and to fight off this tsunami. It’s a waste of resources but that’s the way things are. In the US the only way to get rid of the K Street lawyers is to get rid of the government. That’s not going to happen.
5. Money market funds pay almost nothing. A good part of their assets is in banks. So with money funds you have to worry all the time if the banking sector is all that safe. Ask the depositors in Cypriot banks. Most large global corporations pay a decent dividend in the three percent area. Better than zero and in many ways with less risk than bank deposits and money market funds.
6. If you live in a country that taxes capital gains as does the United States, rapid turnover of stocks in your portfolio is not tax efficient. With small firms which are often one product, one note pianos that require more disciplined sell approaches, you will be forced to take a more active and hence less tax efficient approach. Better let your investments – in this case the large global companies – retain earnings and do the reinvesting for you. This is not the ideal free market, tax free world of economics but it may be the best second best solution for the real world.
7. If we do flip from a world of disinflation to one of accelerating inflation, this will not be an ideal one for any companies, large or small. Economists have long argued whether stocks would do better in an inflationary environment. The 1970s were one era where inflation was bad for stock prices in real terms. But in the German hyperinflation of the early 1920s, the large non-financial companies managed to survive and their equities rallied strongly in the mid-1920s up until the global pull back in stocks in 1928-29. The big global companies have a lot of resources working for them that will enable them to survive and grow in varying economic conditions.