Gold

My previous post was on the inevitable failure of fiat currencies. It seems then as if this might be an appropriate moment to spend some time on the subject of gold.

Rarely has there ever been an asset class as hated as the yellow metal. Economists (outside of the Austrians) despise it. After all, its use as money would certainly eliminate any need for us to have them opine on the proper level of interest rates and how much money and credit should be whipped up from thin air. Gold as money would remove economists from the biggest part of the public policy debate, and this is unimaginable in their eyes. How would the free market ever decide on the proper level of interest rates? Chaos would surely ensue without their learned input.

While there are many essays out there dismissing gold as an investment and its use as money, I want to focus on one particular issue that Keynesians have been harping on for years. It seems that many economists do not like it that gold is expensive to mine and expensive to store. Surely this is waste of society’s capital:

Most of all, the barrenness of this proposal (i.e., to use gold) makes it most repugnant to those who think that the international need for liquidity can be put to better use than the financing digging gold from the entrails of the earth and reburying it in the vaults of Fort Knox and other gold graves.

Robert Triffin (1957)

Recently, Citibank economist Willem Buiter made the same argument against gold:

Gold is unlike any other commodity. It is costly to extract from the earth and to refine to a reasonable degree of purity. It is costly to store….The cost and waste involved in getting it out of the ground only to put it back back under ground in secure vaults is considerable.

The argument, as you can see, hasn’t changed much over the past six decades. It even makes a certain amount of intuitive sense.  Unfortunately, for the Keynesians, the argument fails when examined in just a little more detail.

I am not going to claim that gold isn’t costly to mine. At $1200/oz., the value of the gold mined each year is equivalent to about $110 billion, and that isn’t chump change. Better to use unbacked fiat money, which costs nothing to produce, according to most economists.

Well, from the Austrian standpoint, it costs society quite a bit to use unbacked fiat money. ABCT presumes that money and credit creation from thin air creates malinvestment. While the cost is somewhat difficult to calculate precisely, it is easily in the multiple trillions of dollars per year. How much malinvestment was revealed as technology shares crashed in 2000-2001? How much malinvestment came to light in the real estate debacle of 2008? How much malinvestment is now being revealed as emerging market carry trades unwind, Chinese (and London) real estate slumps and as oil prices plunge. Trillions upon trillions of dollars have been wasted. Gold’s burden is fairly light then relative to the costs we are piling up elsewhere due to the use of unbacked fiat money.

Unbacked fiat money also has another problem: It violates the principle that all transactions require a like-for-like exchange. All parties need to believe that they are made better off in a transaction. If you produce apples and I produce oranges, we may both be better off if we exchange some of our output. This betterment principle is violated when money and credit is created from thin air. Someone gets something for nothing. The original parties will undertake the transaction, but only because they believe that they can pass on the burden to someone else before the theft has been revealed. Some Austrians have compared the effects of inflation (the creation of money and credit from thin air) to a train since some cars arrive in the station before others. Often, fixed income investors and pensioners are at the back of the train and bear the bulk of the costs associated with the inflation brought on by the use of unbacked fiat money. Unbacked fiat money violates this like-for-like principle while gold does not.

Unbacked fiat money is nothing but theft. It sets in motion malinvestment and it violates the like-for-like principle. It carries huge, but hidden, costs and it has always, eventually, failed and been rejected by the public. I doubt this time will be any different. Mr. Buiter referred to gold as a 6000 year bubble, and perhaps this true. I am certain, however, that no unbacked fiat currency will ever establish such a record. Yes, gold may not return as money, but something will replace unbacked fiat. Nevertheless, I believe that finding something better than gold as money will be most difficult.

Disclaimer: Nothing on this site should be construed as investment advice. It is all merely the opinion of the author.