My reasons for investing in physical gold
With the advent of cryptocurrencies in the very recent past, some people are starting to believe that investing in gold is outdated. Learning about physical gold in a monetary context is something that is no longer formally taught in universities. This seems to have made gold just like any other commodity in the modern era. For full disclosure, I personally “invest” in gold and silver and I believe that it should be a fundamental component of any investment portfolio.
Physical gold and silver are meant to act as a hedge against inflation, essentially maintaining one’s wealth despite the current economic climate. I basically maintain a personal gold standard with roughly 10% of my investable assets being of physical gold and silver. However, in order to truly understand the uses for gold and silver in terms of your investment portfolio, you need to understand the critiques of investing in it as well. In order to make a fully informed and intelligent decision on anything in life you must understand all sides and form your opinion and position from there.
Now, a lot has changed since gold and silver where literally handed back and forth between individuals as a form of currency. Due to the Coinage act of 1965, the United States dimes and quarters no longer contained silver. This led to a phenomenon known as Gresham’s law to occur within America. Gresham’s law essentially states that bad money chases out good money in an economy. This leads to the use of fiat money and all the consequences, good and bad, that come from that. However, this is a related but separate topic and will therefore be the subject of a different post.
Case Foundation
Since the global economic system has changed so much since the ancients literally exchanged pieces of gold and silver as currency, to speak of those precious metals in that context is an obsolete idea. This demands us to think of gold in a new context. So far, the person who I have found to have built the best case for gold in this new, modern context is James Rickards in his book The New Case for Gold which you can find on Amazon HERE.
As I stated in the beginning of this post, to truly understand the benefits of owning gold, you must know the counter arguments on why you should not. This brings an idea that I first heard from Robert Kiyosaki. There are three sides to every coin, the two faces and the edge. Those standing on the edge are in the position to make an intelligent decision, since they can see both sides, which allows them to make an informed decision.
6 major critiques of gold
Rickards gives six major arguments against gold that you normally hear from its adversaries, and then he explains why those arguments are false or ironically a reason for owning gold. Below are the six critiques of gold, an explanation of what the critique means, and a short explanation of why it is either false or actually a benefit of gold.
Physical Gold is a “Barbarous relic”
The Idea of gold as a “Barbarous relic” seems to have been derived from a statement given by John Maynard Keynes in his book A Tract of Monetary Reform written in 1924.Keynes stated, “In truth, the gold standard is already a barbarous relic”, and he was right about this in 1924. It can be seen throughout history that countries would come off the gold standard during times of war in order to expand their money supply and credit to finance the war. In this context, England had come off their gold standard to finance world war 1.
In 1925, Winston Churchill wanted to return to the gold standard with gold at the same price as it was before the war. The only problem with this was that England had expanded their money supply significantly, and if the price of gold were set to the prewar price, it would cut the amount of money significantly, literally overnight. This would induce a deflationary depression where the prices of assets and goods would drop significantly. The United States endured a similar depression four years later with the Great Depression occurring in 1929. Keynes was against this prewar price of gold for the gold standard and suggested a much higher price as to avoid the deflation, Churchill did not listen, and this resulted in exactly the deflationary depression that Keynes predicted.
Essentially, it is not that gold itself is a barbarous relic, it is that the gold standard was at that time in that context.
There is not enough physical gold to support finance and commerce
This is somewhat related to the above critique. Any amount of gold can support any amount of commerce, it just depends on the price of that gold with respect to the relevant money supply. As long as the price of gold is stable and is set at a nondeflationary level, any amount of gold can support the economy. It is a simple matter of taking the ratio of the amount of official gold that country has to the money supply.
The gold supply does not grow fast enough to support global growth
I brought up the term official gold in the above point. There is actually a difference between official gold and total gold. The total gold is self-explanatory, it is all the gold, period. Official gold, on the other hand, is only the gold that is owned by the government in order to support their money supply. As of 2016, the United States official gold supply is only about 20% of its total gold.
This means that there is plenty of room for the official gold supply to grow. For the government to acquire more official gold, they must print money and buy gold out of the free market. They print the money to buy it at market price so that the ratio of official gold to money supply does not change, therefore keeping the price of gold relatively stable with that large of a buyer coming into the market. This is almost identical to what the Federal reserve does with buying treasuries now, so this would not be something completely new.
Essentially, the physical gold production does not support inflationary global growth. This would make the difference between nominal Gross Domestic Product (GDP) and real GDP to be minimal, counter to what we are seeing now as of this writing in May of 2021.
Physical Gold caused the great depression
The economic research done at the federal reserve done under Ben Bernanke showed that the money supply of the United States was never constrained by the gold supply during the Great Depression. The topic of money creation is a major rabbit hole that could be the topic of entire novels, so I will not go to far into details with it here. However, one of the major forms of creating actual currency units (money) in the economy is through bank lending. To be superficial, when you get a loan from the bank, the bank creates that money for you to give to the seller of whatever you are getting the loan for. That money is then destroyed as you pay back the loan.
During the Great Depression, consumers did not want to borrow money and banks did not want to lend it. This is why the money supply did not grow during the Great Depression, not because it was constrained by gold.
Physical Gold has no yield
Physical gold is not supposed to have a yield. It is used as a hedge against inflation and a preserver of wealth. It has been used as such for thousands of years.
Let us look at buying a car as an example. In 1965, the sticker price of a brand-new V-8 Ford Mustang Coupe was $2,734 and the gold price was around $35.50. That means that it would take about 77 ounces of gold to buy that car back then. This is a rather sporty car as well, probably one of the best on the market at the time. Today, with the spot price of gold being about $1,850 as of May 16, 2021, that same amount of gold would buy you a $142,476 car. Now, we will assume a 30% capital gains tax for selling the gold, which would mean you have around $100,000 to buy a new car. That would probably get you todays equivalent of the Ford Mustang Coupe, so I would say it did a good job preserving wealth.
Physical gold has no intrinsic value
Intrinsic value is the value that something has just for existing, or in other words, it is valuable in and of itself. In the context of goods, the intrinsic value is basically derived from how much labor and raw materials went into creating the product. With gold you pretty much just need to mine it, smelt it, maybe purify it, and then put it in any form that you want (there is more to this process, but it is irrelevant to the current discussion). However, in today’s context, the intrinsic value of gold is irrelevant. Yes, it has properties that make it an ideal from of money, it does not corrode or melt by just sitting in your safe.
Basically, if the intrinsic value of physical gold were relevant in today’s monetary sense, gold miners would be extremely rich and would always be in business. However, in reality, if the market price of gold drops too much, the gold miners cannot cover their cost of production and they go out of business. So today, it is really the subjective value, the value given based on the needs and wants of the individual, that matters. As a critique for gold, this argument that it has no intrinsic value is irrelevant in today’s context, it pretty much became irrelevant once Gresham’s law took place and the gold standard was no longer followed.
Conclusions
To understand why it is important to own physical gold as a form of hedge against the uncertainty of the economic and political environment of the day, you must understand the arguments against owning it as well. Again, true intelligence is when you understand all sides of an argument, then you can make an intelligent, informed decision. Of the six critiques of gold written about in this post, the first four are false, the fifth is really an argument in support of gold, and the last one is irrelevant in the modern context. In its most fundamental concept, owning gold is similar to owning insurance, but it is an insurance policy protecting your wealth from the hostile environment that is the world we live in.
To you wealth and future,
James Forsythe
