Yesterday, I stumbled across an article about investing in gold over at Get Rich Slowly1. Actually, I guess it could be better said that it was an article about not investing in gold. While Mr. Roth’s post is well-researched, the two of us are definitely sitting on opposite sides of the fence. I think that some of his reasons to brush aside gold have been presented without a clear understanding of the role of “money” in a society, and also I feel that some of his statements about historical bubbles aren’t really relevant in discussing golds current trends. Here I just wanted to take a look at a few tidbits from his article, and add my comments.
Medium of Exchange
One of Mr. Roth’s statements is this:
Let’s say I’m a shopkeeper. I have a minimart and I have a shotgun to defend my stock from looters. If we’re in some sort of post-crisis world where dinosaurs roam the earth, I doubt I’ll want your gold. It’ll be just as worthless (or as valuable) as paper money. Why? Because in reality, gold too is fundamentally a fiat currency. That is, people have assigned it an arbitrary value. That value vanishes in a crisis, just as the value of paper money does.
If I’m a shop owner in this situation — or I’m your neighbor with a vegetable garden — I’m going to be want to be paid with something real, something like a carton of eggs or some shells for my shotgun.
Gold is most definitely not a fiat currency. It can not be manufactured or printed or fabricated. There is a finite supply. I do agree that it is assigned a value, but it is not arbitrary. It might seem arbitrary given that in today’s world it is traded as a commodity (like oil). In reality, the exchange rate for gold is what is agreed to between two individuals. You could say the same thing for dollars, except anyone can create dollars.
I don’t even disagree that the shop owner may prefer eggs to gold. Barter is a great system, but it’s also a very difficult one to manage. Let’s look at an example:
Let’s say someone who owns sheep would like to make a trade with someone who owns wheat (Settlers of Catan fans, rejoice!). This situation requires that someone who has wheat to sell is actually interested in receiving sheep as payment. A barter system further requires that these people wish to exchange their items, and that the items are available for exchange, simultaneously.
So the problem with a barter system is that it does not use a common medium of exchange2. This probably needs a bit of explanation. Let’s talk about money in the abstract for a moment. Forget whether it’s dollars or coins or sea-shells. In order for something to be considered “money”, it needs to fulfill three basic requirements3. One of those requirements is that it must act as a common medium of exchange.
If, instead of trading goods directly, you use some other intermediary item as the medium of exchange, you can alleviate many of these barter system problems. After all, I really don’t want to trade my tasty sheep for a bagful of hammers. I was never really good with hammers to begin with.
Gold as a Bubble
Mr. Roth goes on to discuss gold as a bubble:
As I write this, gold is hovering at about $1500 per ounce, which is just off its April high of $1550 per ounce. But that’s not only its April high; that’s an all-time high for the stuff.
Let’s think for a moment. Have we seen any price bubbles before? Maybe even in recent history? Over the past fifteen years, we’ve seen three bubble economies:
- First, the boom in tech stocks in the late 1990s.
- Then the run-up of housing prices in the early 2000s.
- Finally, the second stock market bubble in the middle of the last decade.
While I don’t disagree that all of these bubbles happened, I think that we need to look at what was behind them. The first was a stupid and nonsensical mania that was spurred on by greedy bankers. The second was a stupid a nonsensical mania and pile of mortgage fraud spurred by greedy lending companies and bankers. The third was the result of disgusting, dishonest investments (derivatives, CDOs, etc.) assembled by and sold to unsuspecting countries and pension funds by, you guessed it, greedy bankers.
While it’s very possible that gold could enter a mania phase, we’re not there. We’re not even close. The public is barely aware of what gold is or how to buy it at this point. When you bump into your uncle Billy, who’s only ever invested in mutual funds, at your family reunion and he tells you that maybe you should buy some gold – that’s when you sell – and I’m telling you, we’re not even close.
It also doesn’t hurt to have an understanding about why the gold price tanked back in the early 1980s. I’ll spare you the long version – but basically the central bank in London started dumping gold onto the market in an attempt to suppress the price. Again, this is an article (or a book) in and of itself, but everyone knows that increased supply means a decrease in demand which means a decrease in price.
Mr. Roth talks a bit about some personal experience with gold, and no one can discount that. I’m sure that people who invested in Lehman brothers in August of 2008 aren’t likely to be purchasing much stock in investment banks for the foreseeable future, either.
Another statement made by Mr. Roth is this:
You might think that the current gold fever is the first of its kind. Actually, it’s not. Gold fever seems to strike every 20-30 years, whenever there’s a run-up in prices.
Now, I would say that this statement is just flat out incorrect. Gold fever has been happening throughout the history of the world because gold is money. As for “run-up” in prices every 20-30 years… this is just silly. The gold standard basically fixed the price and the exchange rate of gold has only really mattered for our society since the Nixon Shock of 1971. So to say that gold fever strikes every 20-30 years when we’re only 40 years into this global currency experiment seems pretty erroneous.
There are many, many people who feel that gold is an old relic, that the bubble has come and gone, and generally that investing in gold is foolish.
There are many others who as students of history look at gold as the only successful ‘money’ that has ever existed. That, along with the undeniable fact that every fiat currency in the history of the world has failed (without exception). That, coupled with the colossal levels of ever-increasing US debt has led many people to choose to preserve their wealth by purchasing metals like gold & silver.
And what will you do?