Speech given to the Gold Investing conference held in Geneva on May 18th 2006
Among the Anglo-Saxons, there is a school of thought called the “Whig view of history,” which sees the course of events as an unrolling tapestry on which is woven a record of a steady, ineluctable progression from barbarity to civilization.
Yet, ironically, the Whigs’ own supremacy — mostly enjoyed during Britain’s years of commercial and military triumph in the 18th century — was underwritten by a system of rapidly expanding government debt, deviously and often corruptly financed through the offices of the fledgling Bank of England.
As a result, the period was not unblemished by periods of wild, speculative excess and interposed monetary panic, the most spectacular instances of which were the two, partly interrelated schemes whose respective Mississippi and South Sea Companies served to give us the word “bubble” itself.
No one who reads the accounts of those roistering times can fail to be entertained by the tale of human folly they contain, though not without a rueful reflection that they also prove the Whigs were hopelessly optimistic in their perception of man’s relentless self-betterment.
For, indeed, our own experiences of just the past decade show that, if we follow a recipe that mixes the eternal human failing of avarice with the oft-recurring mass delusion that one lives in a “New Era,” and which allows the kitchen to be supervised by sharp-minded financiers, it will produce just as explosive a cocktail today as it did nearly three centuries ago.
But there is a more enduring lesson to be had from such events, beyond the satisfaction of deriving a suitably uplifting moral from such a juicy tale of scandal and excess.
Shortly after the excitement of the two bubbles had passed, a much more momentous and enduring change began to unfold.
As David Hackett Fischer put it:
“In the very hour of the Dauphin’s birth, a deep change was silently occurring in the dynamics of European history. Once again, an important indicator was the movement of prices. At Paris in approximately the year 1729, the price-equilibrium of the Enlightenment quietly approached its end. A new movement began which might be called the price revolution of the eighteenth century.”1
Quoting data from Ernest Larousse,2 Fischer shows that, between this time and the outbreak of the French Revolution, fuel (firewood and charcoal) prices almost doubled and cereals went up by two-thirds to three-quarters. Yields on government bonds, rents, and land prices all rose sharply.
Not entirely a coincidence, Kindleberger tells us that the number of country banks in England expanded from “perhaps a dozen” in 1750 to “almost 400” by the turn of the century as their similarly profuse Scottish cousins multiplied the issue of banknotes fifteenfold in just two decades.3
Meanwhile, across the chilly North Sea, Braudel remarked that “it was easier to borrow money in Holland in the 1750s than … in the 1980s.”4
We need not deal too minutely with the several other parallels this era offers with our world of today — the rapid increase of trade around the globe; the growing urbanization; the swift adoption of new techniques of industry; the infrastructure booms and busts; the soaring military expenditures and endemic conflicts which added a political imperative to the pre-existing financial and commercial impetus toward indebtedness and inflation.
But what we must underscore is that this brief narrative has been chosen to illustrate the essential truth that at all inflations are matters of financial excess for, as the great Ludwig von Mises is apocryphally said to have quipped, only the institution of government could take an honest piece of paper and make it worth less through the simple act of printing something on it.
As we ponder our lot today, it cannot be over-stressed that the system under which we labor is as inherently inflationary as any of which even the wildest monetary crank could dare to dream.
Though things were bad enough when commercial banks held only fractional reserves of something as inflexible as bullion, they are now no longer constrained by any effective reserve system whatsoever.
Rather they must only comply with the protocols of the Basel capital standard and, in truth, this is no standard at all.
To the age-old “Real Bills” fallacy that a supposedly sound elastic currency only responds to the “needs of business” — forgetting that business needs naturally expand when liquidity is deep, interest rates are low, and prices are rising — we have since added the “Real Banks” fallacy to compound it.
Under this, the intention is that restraint is imposed because banks can lend only a multiple of their capital.
What this neglects to add is that, as liquidity swells and credit abounds, the banks who give rise to this can effortlessly create their own capital from thin air simply by borrowing it from one another and from selling bonds or stock to those whose loan accounts they themselves have just credited!
Add in the fact that our twisted ingenuity has employed our globe-encircling computer networks to construct an ever more extended fantasy of asset speculation on the foundations of ever thinner slivers of “capital” (i.e., “Real Bank”-created margin) — and the capital markets operate not so much on an equity base as on the thinnest of junior-lien varnishes!
This is why we are able to talk of savings gluts even as our pension provision and medical insurance schemes fall increasingly into jeopardy and where even the most thrifty have given up the ghost (a telling case is that of the Japanese who, from being perhaps the developed world’s best savers a decade ago, have been reduced by the “zero interest rate policy” and “quantitative easing” to the point where they are now barely putting more aside than their profligate American cousins).
This is why the middle-class poor are able to “invest” so much even as they spend more than every last earned penny on iPods, designer beers, exotic holidays, and vast McMansions — plowing money into ETFs and emerging bond funds even when it costs $200 a pop to fill up the 6-year-lease-bearing new Hummer in the driveway.
This is a world, then, in which an asset such as gold may justifiably rise to match the increase in the quantity of paper money — but it is also one in which such an asset can itself become the medium within which easy money incubates yet one more bubble, as may have happened sometime in the past nine months.
In such a world, it is vitally important that we do not confuse money — especially today’s money, near limitless in its supply — with wealth, whose own supply is, by its very essence, severely limited.
Nor must we ever forget that “capital” is not simply a digital entry, tapped effortlessly into the computer of some financial clearing house, but that it is a useful, productive resource that needs to be hewn from the earth, processed, and assembled — not in the hushed, marble halls of banking, but in the harsh and unforgiving environment of mines and quarries, fields and forests.
On the one hand, therefore, we must consider the supply of new money — for which there is no marginal cost of production, no lead time to be endured, and which presumes no prior industrial capacity is in place to bring it about.
On the other, stand the two very different demands that this money can be used to satisfy: the first for today’s equally superabundant financial assets; the second for those economically-scarce, real resources whose production takes time, effort, ingenuity, and entrepreneurial vision — and which, of course, requires its own inputs of scarce resources, in turn.
In his retrospective of what was a highly successful trading career, the great Richard Cantillon, the father of modern economics, offered us first hand observations on these points, drawn from his experience of both John Law’s French “system” and of John Blunt’s counterpart in England.
Firstly, he spoke of what happened when inconvertible money chased financial assets:
“The facility of a Bank enables one to buy and sell capital stock in a moment for enormous sums without causing any disturbance in the circulation….”
“In 1720, the capital of public stock, and of Bubbles which were snares, and enterprises of companies at London rose to the value of £800 million sterling, yet the purchases and sales of such pestilential stocks were carried on without difficulty through the quantity of notes of all kinds which were issued, while the same paper money was accepted in payment of interest.”5
And, secondly, regarding the interaction of that same money with scarce, real resources:
“An abundance of fictitious and imaginary money causes … disadvantages … by raising the price of land and labor, or by making works and manufactures more expensive….”
As Cantillon also pointed out, the first demand is sometimes forced to give precedence to the second:
“As soon as the idea of great fortunes induced many individuals to increase their expenses — to buy carriages, foreign linen, and silk — cash was needed for all that and this broke up all the systems….”
But, of course, that was in an age when there still was hard cash — in the form of specie — to be had.
Our hordes of avid property speculators, our myriad hedge fund gunslingers and our swarming private equity corsairs face no such impediment today.
So, even though it will not collapse the bubble in so direct a manner as it did three hundred years ago, an ever more compelling case can be made that our environment is now in a process of change to one in which the old-style consequences of our plethora liquidity are at last filtering into people’s pay packets and thence into the consumer goods which they demand — and demand in a growing proportion from overseas suppliers.
For example, wages in the US private service sector (which accounts for 80% of all employment and in which 85% of all new jobs since the 2003 trough have been created) rose at an annualized pace of over 6% these past three months — a pace not seen since the early 1980s (and one given solid corroboration by the more qualitative NFIB monthly survey of small businesses).
In fact, if we can believe the press, labor markets are even getting tight in China (and will get tighter still if they do succeed in paying people to stay at home on the farm instead of migrating to the cities) and in Japan, while you only have to open the Indian papers to read how salaries and staff turnover rates are rocketing in the world’s back-office which they call the BPO sector.
Cantillon aside, financial history provides copious illustrations of the essential truth that, at root, all inflations are matters of financial excess and it is hard to escape the conclusion that we are currently in the process of adding yet another chapter to this hefty tome.
Indeed, we would forcibly argue that, for its scale, spread, speed, and sheer ferocity, the present inflation — not just of money, but of all forms of credit and of the manifold derivatives constructed thereon — is beyond all parallel.
To support this contention, we can draw attention to the exuberance in the financial markets — not least the record-setting flood of debt-financed takeovers and buyouts — but also to the rise in the prices of houses, office blocks, objets d’art, diamonds, autographs, metals, soft commodities, energy products, formerly exotic stocks, and — until very recently — just about every variety of bond.
Ask yourself whether the prices of all these disparate entities are rising, or whether the price of money is falling?
Also, pace the millennialists among the gold lovers, however misguided this “exuberance” turns out to be, this concurrence does seem to belie the theory that for gold to do well, market psychology must be wholly negative, that fear alone is what drives gold higher.
Before an audience of gold bugs, I am fairly convinced that, this far, I have been preaching to the converted — even if I hope that I have based my sermon on a slightly different text.
However, there is one concept being banded about here glibly and without notice, which I cannot help but deplore.
It is a supposition that is utterly unfounded, both economically and logically and, far from being a mere foible, it is important to extirpate it since adherence to it must seriously affect rational thinking and investment planning.
I have personally had a long, weary experience trying to dispel this myth and whenever I have entered the lists in this cause, I have tended to find that my arguments have been warded off not by any superior use of a countervailing logic, but more by resort to a slippery and evasive terminology.
Yet, we must recognize that we can never have a meaningful debate, or reach any viable conclusions from one, if our terms are not laid out and rigidly and unalterably defined beforehand.
If you doubt this, just think of the verbal and mental tangle that results from our masters’ use of evasive words, or ponder the evils visited upon us by the State in its cynical use of Orwellian propaganda.
So, at last, let me come out and say it — much though I wish it were true — and as readily as I accept that it once was true, Gold is NOT today “money.”
Nor, regrettably, under our present political system and amid our existing cultural milieu is it ever likely to become one again.
Be under no misconceptions, I wish it were money. I’m a hard core Austrian who advocates a 100%-reserve, specie standard.
I propound the need for free banking in a world where no special legal privileges attach to the institutions that offer such services.
In my darker moments, I would also be tempted to abolish the other pervasive and artificial legal privilege of limited liability incorporation and partnership.
I dream of living in a strict-construction, minimalist-government, constitutional republic where personal liberty and private property are sacrosanct and in which the state is the servant of the individual citizen, not the self-serving drover of the dumb, collective herd.
I also believe that the first series of economic stipulations — the provision of hard money — is necessary for the survival of this political ideal, and that, in turn, such a polity is a precondition for the maintenance of the monetary nirvana described above.
If anyone wants a refreshingly candid acknowledgement of the validity of this, I would refer them to Article 100 of the Swiss constitution wherein it specifically states that, “in the fields of credit and currency, in foreign trade and in public finance, [the federal government] may, if necessary, depart from the principle of economic freedom.”
Unfortunately, the Progressives and the New Dealers have exorcised the spirit of Jefferson no less completely than the Milnerites and Fabians have banished the memory of Bright and Cobden, or than the fellow travelers of Saint-Simon have triumphed over Say, and the doctrines of Engels have superseded those of Erhard.
But, why am I so adamant that gold is not money?
Because any meaningful definition of the term starts and finishes with the fact that money is the medium of exchange. It is “current money,” i.e., it is “currency.”
Money is the present good most readily accepted in voluntary exchange — accepted without quibble or discount (and, ideally, without compulsion) in final settlement of a trade by a sufficiently large preponderance of economic agents as to be effectively universal.
The two other properties often cited as evidence that some entity fulfils the criteria required of a money are that it is a “unit of account,” or that it is a “store of value.”
But, even without bothering to ascertain whether gold does come up to the mark on these, we should insist that these two be recognized as the distinctly secondary and consequential concepts that they are.
The first — the “numeraire case” — is merely a matter of a naturally arising calculational convenience. It does not precede a commodity’s use in monetary exchange, but rather proceeds from it.
Now, be honest: how many of you here — among you the most fervent of the faithful — reckoned the cost of your airfare, or the honorarium for your speech in terms of ounces of gold, rather than in mundane amounts of dollars, euros, or francs?
The second quality — the store of value — is only an admirable adjunct, a desideratum, and one much more an aspiration than an inevitability, as a glance at either today’s fiat monies or at the financial record (even under past metallic standards) will soon reveal.
That therefore gold is not money — not for any economically important fraction of people or in any economically significant subset of the world economy — must surely be incontrovertible.
Had I a grain of gold in my pocket, I would not be able to use it here to buy a drink at the bar — and that’s not just because a Swiss hotel might charge more than the value of that grain!
Had I an ounce or two of gold, I would not be able easily to swap it for a fancy Swiss watch here in a Geneva jewelers.
Had I ten bars of gold, I would still have to endure substantial inconvenience, delay and suffer a painful discount (possibly hidden as a commission) in order to swap it for a private equity partners’ company car — the Lamborghini Diablo.
Indeed, one of the high priests himself, James Turk, recently admitted as much to the New York Times:
“Indeed, Mr. Turk has established his own online payment system … through which he and his fellow gold bugs may enjoy the thrill of buying goods and services via gold, not cash…”
“In some ways, it is a symbolic exercise. While the payment system is supported by $100 million worth of gold, no merchants have agreed to take bullion as payment, although Mr. Turk hopes that day may come….”6
Mr Turk may merit our admiration as a tireless proponent of the virtues of gold, but what he has effectively confessed to here is that, contrary to his many other arguments to that end, gold is not therefore money!
What it is, of course, is a scarce asset — if, perhaps, not one which derives too much of its demand from genuine productive use, rather than from a desire to escape some of the problems caused by our over-abundant paper money.
As such, you may rightly judge that it continues to suit you and your clients to count some of it in your holdings.
I would not cavil at such a choice, though I would gently point out that the success of any seemingly sound investment is critically dependent on the initial price one pays.
In that context, it must be noted that the equation is an entirely different one today, at a spot price anywhere between twice (in the case of Canada) to more than three times (as in South Africa) that which prevailed in the major producers’ local currencies when gold hit its late 1990s lows.
Back then, only the very best managers on the most productive properties could afford to do anything more than high grade, indulge in financial engineering, or skimp on maintenance and investment.
In contrast, whatever political and geological difficulties they may still face, miners have, for some while, been paid increasingly well to try to expand output, even as they have been moved to close out their hedges.
Be that as it may, you will each have your own ideas about what value gold may now offer and this brings me to the stage where it’s traditional to indulge in a little stargazing.
The average conference audience is comprised of three parts; one seeking confirmation of already-held prejudices; one third who’d do anything for a day out of the office; and one third looking for an instant hot tip to phone into their broker during the coffee break.
But, here I must disappoint you, for it would be an act of folly to bet on an imminent end to this present feverish rally, just as it would be an equal and opposite act of misjudgment to get carried away and start Googling targets higher and higher into the stratosphere every time the ticker grinds northwards.
Estimations of present worth are difficult enough without introducing the uncertainties of the future.
To say, as has been said here today, that gold is bound to appreciate against one paper currency or another (without specifying which or when) is not to say much at all. Nor is this sufficient to demonstrate that gold represents the best medium by which to preserve one’s capital under all circumstances.
We must pause here to point out the irony that if gold were money — as its acolytes proclaim it is — we would not be pressed to accumulate much of it at all, for money is not wealth, but merely the medium by which wealth is transmitted from one owner or creator to another.
Gold’s apotheosis as money would, therefore be marked by a distinct dematerialization of its sacred corpus as it transubstantiated from a hoarded asset to a more trustworthy facilitator of exchange.
Forecasts, I believe, can only be made on two time scales and even then, never more than qualitatively.
On the short (and inherently sharp) end, there are those who have developed a feel for market positioning and who can scent its tactical vulnerabilities. There are those who are attuned to the changing state of the herd’s delusional mindset and can decipher how it is being guided by its own continually revised body of post-hoc myth.
These, the people who used to be called “tape-readers,” have the knack of making just enough sense out of the surrounding cacophony to trade profitably and with sufficient regularity for this to be beyond the confines of blind chance.
Unfortunately, I’m not one of them — nor do I envy the Tudor-Joneses and the Trader Vics as they attempt to make sense of the market with which they are confronted today.
Conversely, over a long haul that stretches beyond the infamous bonds of Keynesian mortality, the basic economic verities are undeniable and ineluctable.
Eventually, the chickens do come home to roost, even if the misguided actions taken under the influence of a whining collectivism or by reason of naked political cynicism can delay a recognition of the trends and can divert their costs onto unsuspecting shoulders for longer than many who foretell the end can credit.
Reluctantly, I cannot fail to conclude that we are on a path toward ever less personal liberty and to ever greater violations of the sacred rights of private property.
Thus we are on a path where genuine entrepreneurialism and the creation of real wealth are very much hampered.
It is a path whose weary milestones are scored with the wasteful disincentives of welfarism and which is misleadingly signposted with the daubings of post-modernist voodoo, its billboards shrieking the slogans of group victimhood and emblazoned with demands for the suppression of the individual.
It is a path whose crumbling paving stones are being overrun by the toxic, green shoots of that shrill new Inquisition which is today’s cult of environmentalism.
It is a path that echoes to the cadenced tramp of men marching out to fight yet another vain war in the hope of postponing, by feats of arms, the impending decline of our present suzerains.
This is also, by necessity, a path to monetary adulteration and to a creeping corruption of body and soul.
It is a path beside which Atlas may, indeed, be seen to shrug.
In such a world, it is likely to be the case that people will, from time to time, seek to acquire holdings of a relatively scarce, high value-by-weight, easily fungible, liquid, storable, real asset as an alternative to their holdings of a much less scarce, eroding value paper asset, such as comprises today’s money.
In such a world, gold may therefore command a higher price than it did in more innocent times when the side effects of our ongoing decline were less severe and when the prospect of our fall was much easier to ignore.
If you hold that this kind of dread and defensiveness explains at least part of the metal’s rising price, it is hardly a cause for universal rejoicing. For, though it is understandable that gold’s long-suffering believers now feel gloriously vindicated, we must temper our present glee with the thought that the rally being enjoyed may be no more than a waypoint on our road to a self-imposed and wholly unnecessary ruin.
