Gold Should be Viewed as Money — Not as an Investment Instrument by Thorsten Polleit
- Mises.org | July 13, 2018
On May 4 and 5, 2018, Warren
E. Buffett (born 1930) and Charles T. Munger (born 1924),
both already legends during their lifetime, held the annual
shareholders’ meeting of Berkshire Hathaway Inc. Approximately
42,000 visitors gathered in Omaha, Nebraska, to attend the
star investors’ Q&A session.
Peoples’ enthusiasm is understandable: From
1965 to 2017, Buffett’s Berkshire share achieved an annual
average return of 20.9 percent (after tax), while the S&P
500 returned only 9.9 percent (before taxes). Had you invested
in Berkshire in 1965, today you would be pleased to see
a total return of 2,404,784 percent: an investment of USD
1,000 turned into more than USD 24 million (USD 24,048,480,
to be exact).
In his introductory words, Buffett pointed
out how important the long-term view is to achieving investment
success. For example, had you invested USD 10,000 in 1942
(the year Buffett bought his first share) in a broad basket
of US equities and had patiently stood by that decision,
you would now own stocks with a market value of USD 51 million.
With this example, Buffett also reminded
the audience that investments in productive assets such
as stocks can considerably gain in value over time; because
in a market economy, companies typically generate a positive
return on the capital employed. The profits go to the shareholders
either as dividends or are reinvested by the company, in
which case the shareholder benefits from the compound interest
effect.
Buffett compared the investment performance
of corporate stocks (productive assets) with that of gold
(representing unproductive assets). USD 10,000 invested
in gold in 1942 would have appreciated to a mere USD 400,000,
Buffett said – considerably less than a stock investment.
What do you make of this comparison?
To answer this question, we first need to
understand what gold is from the investor’s point of view.
Gold can be classified as (I) an asset, (II) a commodity,
or (III) money. If you consider gold to be an asset or a
commodity, you might indeed raise the question as to whether
you should keep the yellow metal in your investment portfolio.
But when gold is seen as a form of money,
Buffett’s comparison of the performance of stocks and gold
misses the point. To explain, every investor has to make
the following decisions: (1) I have investible funds, and
I have to decide how much of it I invest (e.g. in stocks,
bonds, houses, etc.), and how much of it I keep in liquid
assets (cash). (2) Once I have decided to keep X percent
in cash, I have to determine which currency to choose: US
dollar, euro, Japanese yen, Swiss franc – or “gold money”.
If one agrees with these considerations,
one can arrive now at two conclusions: (1) I do not keep
cash, because stocks offer a higher return than cash. However,
many people are unlikely to follow such a recommendation.
They keep at least some liquidity because they have financial
obligations to meet.
People typically also wish to hold liquid
means as a back-up for unforeseen events in the form of
money. Money is the most liquid, most marketable “good”.
Anyone who has money can exchange it at any time – and thus
take advantage of investment opportunities that come up
along the way.
(2) I decide to keep at least some cash.
Anyone who has near-term payment obligations in, for example,
US dollar, is well advised to keep sufficient funds in US
dollar. Those who opt for holding money for unexpected liquidity
requirements, or for longer-term liquidity needs, must decide
what type of money is suitable for this purpose. One way
to do this is to form an opinion about the respective currency’s
purchasing power.
If Buffett shared this view, a comparison
between the purchasing power of the US dollar and gold would
be in order. This exercise would show that gold – in sharp
contrast to the US dollar – has not only preserved its purchasing
power over the past decades but even increased it.
The Greenback’s purchasing power has dropped
by 84 percent from January 1972 to March 2018. Even taking
a short-term interest rate into account, the US dollar’s
purchasing power would show an increase of no more than
47 percent. The purchasing power of gold, in contrast, has
grown by 394 percent.
The yellow metal has also a remarkable property
that has become increasingly important for investors in
recent years. The reason? The international fiat money system
is getting into increasingly tricky waters – mainly because
the world’s already dizzyingly high level of debt continues
to rise. An investor is exposed to risks that have not existed
in the decades before. Gold can help to deal with these
risks.
Unlike fiat money, gold cannot be devalued
by central bank monetary policy. It is immune against the
printing of ever greater amounts of money. Furthermore,
gold does not carry a risk of default, or a counterparty
risk: Bank deposits and short-term debt securities may be
destroyed by bankruptcies or debt relief. However, none
of this applies to gold: its market value cannot drop to
zero.
These two features – protection against
currency devaluation and payment default – explain why people
have opted, whenever they had the freedom to choose, for
gold as their preferred money. Another important aspect
at this point: In times of crisis, the holder of gold –
if he or she has not bought it at too high a price – can
have the hope that the value of gold is likely to increase
and he or she can exchange gold for, for instance, shares
at a significantly discounted price.
This way, gold can help boost the return
on investment. Inspired by Buffett’s return comparison between
stocks and gold, and after giving it some further thought,
one might have good reasons to come to at least the following
conclusion: Gold has proven to be the better money, it has
proven itself to be a better store of value than the US
dollar or other fiat currencies.
The two-star investors typically do beat
around the bush when it comes to critical comments. For
instance, Buffett told his audience once again that US Treasury
bonds are a terrible investment for long-term investors.
With a yield of currently 3 percent for ten-year US Treasury
bonds, the return after tax is around 2.5 percent. With
consumer price inflation currently around two percent, inflation-adjusted
rate of return is just 0.5 percent. Buffett’s message was
unequivocal: do not invest, at least not currently, in bonds.
Those who had hoped that the star investor
would make further critical comments on the deep-seated
problems of the US dollar – which represents a fiat currency
with a money supply that can be increased any time in any
amount considered politically expedient – had hoped in vain.
But it cannot have escaped the star investors that it’s
not all sunshine and roses when it comes to the fiat US
dollar.
Munger, for example, bluntly stated that
central banks’ low interest rate policies, in response to
the 2008/2009 financial crisis, have helped boost stock
prices and bring shareholders windfall profits. Quote Munger
in this context: “We are all a bunch of undeserving people,
and I hope we continue to be so”.
Buffett and Munger share a long-term perspective.
They keep pointing to the enormous increase in income that
has been achieved in the US over the last decades. Compared
to Buffett’s childhood days, Americans’ per capita income
has increased six-fold – a most remarkable development (especially
so if we factor in that the US population has grown from
123 million in 1930 to 323 million in 2016).
From Buffett’s and Munger’s point of view,
the US system works, both politically and economically:
Everyone has benefited, the wealth growth of Americans has
been much more substantial than for people elsewhere, and
crises have been overcome. The two investors thus form their
assessment – as many do nowadays – on factual findings,
based on what the eye can see. Counterfactual outcomes –
things that would have happened had a different course of
action been chosen – are left out.
If one takes a factual point of view, however,
it is rather difficult to see the dark side of fiat money.
For instance, that fiat money fuels an incessant expansion
of the state to the detriment of civil liberties; the increase
of aggressive interventions around the world, all the wars
causing the deaths of millions; the economic and financial
crises with their adverse effects on income and living conditions
of many people; and last but not least, the socially unjust
distribution of income and wealth.
All these bad things would undoubtedly be
unthinkable under a gold-backed US dollar, at least to their
current extent. The objection that the increase in the wealth
of the past few decades would have been impossible without
a fiat US dollar does not hold water: Economically speaking,
it is wrong to think that an increase in the quantity of
money, or a politically motivated lowering of the interest
rate, could create prosperity.
If that were the case, why not increase
the quantity of money ten-, hundred-, or thousand-fold right
now and thereby eradicate poverty worldwide? If zero interest
rate could create wealth, why not order central banks to
push all interest rates down to zero immediately? Why not
enact a new law that requires zero percent interest, or
abolishes it altogether?
Buffett and Munger have undoubtedly given
their shareholders a great opportunity to escape the vagaries
of the fiat money system, to defend themselves against the
central bank-induced inflation, and to also become wealthy.
Unfortunately, however, the serious economic, social, and
political problems that fiat money inflicts upon societies
cannot be solved this way.
For that reason, one should deliberately
reflect Buffett’s return comparison between stocks and gold
– and make oneself aware of the fact that gold can be viewed
as a form of money that may even deserve to be called “the
ultimate means of payment.” For the investor, there are
no convincing economic reasons to discourage holding gold
as a form of longer-term liquid funds – especially if the
alternative is fiat money.
This timeless insight was already suggested
by economist Ludwig von Mises (1881-1973) in 1940: “The
gold currency has been criticised for various reasons; it
has been reproached for not being perfect. But nobody is
in a position to tell us how something more satisfactory
couId be put in place of the gold currency.”
Note: The views expressed on Mises.org
are not necessarily those of the Mises Institute.