Lewis is a staff writer at Forbes. On August 13th 2002, MSN posted
an article written by him titled "Fool's
Gold" in which he indicts
gold as a barbarous relic mostly on grounds that it hasn't performed
well in spite of the financial crises that have been unfolding before
I had to grit my teeth to read the
article and suggest you do the same, if only for the sake of exercising
your own mind and judgment, or maybe just for the sake of exercising
The essay reminds me of the reason
we wrote an article earlier this year called "Loathing Opportunity"
where we observed the many investors loathing gold, as an opportunity.
And so it's a good exhibit of the echo of the noise that seems further
and further away in our past. If the bear market in gold is dying,
Mr. Lewis tries to revive it here.
Mr. Lewis makes the following premises
and suppositions either explicitly or implicitly to support his
conclusion - that gold is dead (some overlap of course; repetition
is a terrific way to get the message across):
- If Gold were not a relic it should
go to $800 because of what is going on in Argentina, Corporate
America, and the Middle East.
- Gold's been dying (falling) for
twenty years and the latest rally pales in comparison to prior
ones, just when it's supposed to be making its way into the stratosphere.
- Gold is supposed to be a hedge against
financial disaster; and it isn't proving that true? (Question
mark is mine)
- Gold still backs the dollar, implicitly,
even though it decoupled long ago from its link to money, thus
(I presume) it is overvalued.
- The convenient utility of a medium
of exchange determines money, or its value.
- It isn't desirable to be a gold
bull, since it means doomsaying.
- Stocks and bonds are the best investment
ever, not gold.
"We've got a buyer fellas'!!"
That's what it would probably sound like at the brokerage office
Mr. Lewis phones when he wants to put in an order, to buy presumably.
He's been trained well… he's kept his religion so to speak.
Let me add another premise that will
support his case: why would we need gold when investors can just
flip from one currency to another?
I've heard that one many times. But
we'll have to leave it for another essay except to say that why
would the investor take the additional risk when gold has proven
to be a more (or equally) stable money relative to say the Canadian
dollar, Rand, Australian dollar, Japanese Yen, and even the Euro
over just the past five to ten years? The dangerous assumption in
this fallacy is investors would no longer need either money or a
SafeHaven, when merely the existence of the Fed creates such demand
- some would say unpredictably.
Since gold is a relic, Lewis offers
the natural secondary conclusion: it is better to sell the gold
in order to pay down the Federal deficit.
In suggesting this, he's become political
and we fear his case just may be taken with some degree of seriousness
in a world full of political fools.
This is why we criticize the article,
as well as the author's financial market prowess. We don't like
beating up on people for the sake of it. We only do when the author
is of relatively high standing, and his or her work is loaded with
what we believe to be fallacies. Then they're fair game.
Any criticism we offer is justified
by the belief that it will not only help you, but perhaps the author
as well. Besides, everybody lighten up they're only words.
is Money; the Dollar is Simply a Substitute
Clearly, Mr. Lewis doesn't grasp the significance of the role of
money in a free market economy; the only kind where money is necessary.
Mises proved money had only one function:
to foster the free exchange of goods and services (which
obviously can only occur in a free market economy).
All of the other functions created
or seen for money over time, before and after Mises, are derivations
of this single stipulation. All the attributes - fungibility, liquidity,
and the superior ability to transfer wealth through time and space
- we prefer in our money (over
and above those that other commodities or currencies possess) are
those that make it ideal for this single purpose, and which make
it so liquid. The matter of the need for a convenient medium of
exchange is easily dealt with by sound money substitutes. But it
is a mistake to assume that all currencies used as a medium of exchange
From an economic point of view (as
opposed to legal) it is incorrect to call legal tender money simply
because it's accepted payment in a court of law. Fiat money, currency,
and money substitutes can be legal tender, but they all hold a degree
of risk, as do stocks and bonds, which often are also employed as
The value of such currency is determined
by the market relative to money, and it is done regardless of government
interventions or fixing arrangements, which tend to postpone the
cumulative negative consequences of such policies at best.
Gold bears would like to think the
20-year bear market in gold means it has ceased to be money, or
as Mr. Lewis says, has decoupled from such a link. He correctly
states that confidence is still not shattered in the dollar, but
fails to tell us the difference between it and money or even what
makes him so sure that confidence in the dollar won't crumble further.
Moreover, gold doesn't back the dollar
in any way and hasn't since 1934. The link Nixon broke was hardly
real in the first place, and in the second place it only applied
to select foreign investment. Indeed, under Bretton
Woods, individual Americans were still not allowed to own, or convert
their dollars into, gold. They weren't until 1973/74 when the Par
Value Modification Act created in September 1973 began to loosen
restrictions on the private ownership of gold. It was after that
the market was free to make its decision that gold was money.
From 1934 until 1974 the dollar was
backed by gold by invitation at best. Thus if individuals didn't
have a choice in the matter then the link between the dollar and
gold was simply show. At best it was a promise by the government
to stabilize the dollar relative to the price of gold (or stabilize
the dollar by suppressing gold, which is exactly what was done and
why gold reserves fell while the dollar became overvalued).
However, gold has never decoupled
from its link to money, just its link to the dollar. It is the dollar
then that has decoupled from its link to (sound) money, which is
evident in its long-term devaluation against most commodities -
unlike gold that has kept its value relative to most commodities,
as money should if it is sound. According to the chart below, an
ounce of gold could buy more raw materials today than it could while
they were at their cheapest in 1932.
least two major devaluations in the dollar occurred in the 20th
century; one occurred from 1933-1949, as you can see in the chart;
and the other occurred from 1971 to 1980. In both cases, the dollar
turned out to be worth less at the end of the period in terms of
both gold & commodities than it was at the beginning. And in both
cases the dollar never fully recovered in the intervening periods
even as it did gradually gain back some value… just not enough to
make the previous devaluation a wash.
As you can see in one of my favorite
charts (above) of the historical progression of the dollar's value
in the 20th century (assuming the rising raw materials prices over
the long term imply falling dollar values), there are long periods
of time when paper assets became worth more than commodities and
real assets, or in other words, where raw materials prices fell
in dollar terms. It is during these times that our greatest stock
market bubbles formed. In fact, the period between 1945 and 1973
is almost twenty years long itself.
Note also the fact that declines
began in commodity prices in 1928 and carried through to 1932. Remember,
however, those prices were in terms of a dollar that was indeed
still backed by gold.
To the extent that inflation affects
a version of Gresham's law, or simply the valuation preference for
paper over real assets (as it often has in the 20th century), devaluation
then becomes inevitable when the inflation no longer sustains such
conceptual values, which it does for a while to the extent it achieves
so called full employment concurrent with rooting investment expectations
for relatively high nominal returns in dollar assets (we call this
latter condition the dollar's investment premium and measure it
by comparing equity valuations and bond yields between the major
The delinkeage of the dollar from
gold in 1934 only served to replace bank runs with dollar devaluations;
people no longer need to go to their banks to withdraw money. They'd
be going to the wrong place - if gold is money. I'm being a little
facetious now, but the fact remains that the 1933 bank panic was
halted when Roosevelt confiscated the right to own gold, or the
privilege to cash in dollars for bullion (money), probably because
people couldn't exchange their dollars for gold.
The central bank has replaced the
role that gold used to have with respect to the dollar, so there
is no need for citizens to worry about their deposits… until devaluation
time anyway, when the decreasing viability of the lender of last
resort puts into question the viability of the banking system. Even
then, it may not be that your deposits won't be there, only that
they'll be worth less.
When the dollar's value falls precipitously
it is normally the result of the economic effects (like the dislocation
of capital structure) of the prior excessive inflation and it results
in what is then naively and commonly referred to as inflation or
The seventies was an era in economic
history that can only correctly be described in terms of a tremendous
devaluation in the dollar, which was overvalued due to the government's
attempt to fix the gold price in the prior twenty years. I'm sure
there were few gold bulls in the sixties and that bearish articles
similar to Mr. Lewis' influenced many minds for years to come. After
all, it was outlawed to own gold, and even if it weren't completely,
gold had proven to be a much worse investment than any stock or
bond right up until then.
Check Your Crisis Barometer; It's
the Dollar Stupid!
Mr. Lewis' emphasis on the past 20 years and the use of his anecdotal
crises barometers to judge gold's performance is inappropriate.
He doesn't offer any explanation
for what has changed in the past 20 years to explain gold's death,
only that it has been devaluing over that time therefore it must
be dead. Yet he assumes Nixon's de-linking of the dollar-gold relationship
in 1973 as the official acknowledgment of its death. So why not
judge gold's performance since that date? Why would he use only
the last twenty years?
It's a convenient premise for his
conclusion, that's why. We know of a few deflationists that like
to use this 20-year period to prove their case. Gold's bear market
has lasted about 20 years now, which is not atypical for its history.
If it were declining because the
link between gold and money were broken it would have declined back
down to $35 an ounce or further, where it was before 1971. It only
took 9 years for gold to get to $800 from $35 an ounce back then,
but 20 years for it to fall back to $300 from $800, which still
puts it almost 10 times higher than the last time the author of
the article says it was money - actually it took only 5 years to
fall back to $300. From 1982 to 1997 gold prices stabilized between
$300 - $500.
From 1980 to 1985 it was a recovery
in the dollar that explained gold's $500 point decline. The dollar
index nearly doubled during that time.
But when the dollar again lost a
third of its value from 1986-1987 gold prices almost doubled, from
just under $300 to just over $500.
While it didn't decline much further
after 1987, the dollar continued to hover near its trough until
1993/1994, when gold began its trek from about $330 to over $400
as fear grew for the dollar's inevitable demise. Gold prices hugged
the $400 level until 1996, by which time the dollar's recovery was
becoming increasingly evident. The hammer came in 1997 and then
in 1998 when global currencies collapsed on fleeing money flows,
ultimately in pursuit of richer gains in the developing stock market
bubble in the United States.
Over the next five years the dollar
index gained more than 30% and over the three years 1997 - 1999,
gold fell almost 40%. Commodities too generally had their worst
years here, as well as in the previous period of dollar strength
from 1980 - 1985. The severe drop in gold prices was exaggerated
by the conspicuous pick up in gold lending activity during those
years, which ended in 1999 with the Washington Agreement.
Since 1999, and despite the dollar's
strength during 2000 and 2001, the price of gold stopped falling
and since 2001 has made a recovery, trading from $255 to $330 by
June 2002. However, although the dollar arguably peaked last summer
it only began to crumble this year - a few months ago. At the moment
it is again near its 1999 highs or its average 2000 level.
If we were to use the US dollar index
as a benchmark for gold's value, historically, we may be able to
say that gold prices ought to be in the high $300 range, but not
$800 quite yet. The reason is that in 2000, the last time the dollar
index averaged this level, gold prices averaged around $280. The
peak in the dollar index during 1999 matched the low of the dollar
index in July this year. The price of gold was at $255 at that point
in 1999, but it was higher in July of this year.
The last time the dollar was near
current levels was at its peak value in 1989 (though it's average
value was lower). In that year gold prices hovered around $380.
In 1986 when the dollar was coming off a higher high than the current
cycle but is observed at this level, the price of gold traded near
$400. That's as far back as my data on the dollar go. The only justification
for an $800 gold price today is if GATA supporters are right and
there is an active suppression of it's value relative to the dollar.
Of course, if GATA is right then
they'd still be suppressing the darn thing, which they could until...
you guessed it, until confidence in the dollar crumbles.
Two things can be gleaned from these
facts. First, gold's performance isn't all that bad relative to
where the dollar is today (compared to other times it has been at
these values relative to other fiat currencies), and considering
that the currency has only started to decline in value against other
currencies as well as many commodities.
Second, gold's value is still largely
determined by the dollar's value as a money substitute, or a medium
of exchange, which value is determined not by how easy it is to
go to your local ATM and withdraw it.
If the message isn't clear, try this:
gold should not go up in terms of the dollar simply because there
are problems in Argentina, Corporate America, or the Middle East
unless those problems undermine the value of the dollar. To the
extent any of them are consequences of the currency inflation, and/or
the currency policy required to sustain it, they are merely symptoms
- more accurately called moral hazard. I suppose Mr. Lewis would
disagree that anything which happens outside of the US economy has
anything to do with the rampant nineties Fed inflation.
At any rate, our assessment of gold's
past performance is really moot because we see the fact that gold
prices haven't gone to the stratosphere yet as an opportunity made
conspicuous for the brave by the dollar's still young bear market.
In fact, this is the first cycle
I know of since 1929 where the dollar didn't turn down ahead of
a major bear market in stocks, and in 1929 it was because the dollar
was fixed on a government gold standard.
In the early seventies the dollar
had already been falling for a few years before the infamous 73/74
collapse on Wall Street; during the eighties it had been falling
for almost two years before the 1987 stock market crash.
Thus in light of current dollar weakness
it is way to early, if not naïve, to judge gold's performance in
terms of ultimate meaning. Let's see what happens after a year or
more of this kind of dollar decline. It's the future we're interested
in. The past is for journalists to write about. The trouble is most
of them seem to be unable to recall much beyond the past twenty
Mr. Lewis' eyes are on the wrong
ball. He should be using only the dollar as his crisis barometer,
and by that measure he is right, confidence is still high in the
dollar generally, and relative to gold.
That's why gold is still cheap. Get
Sound Money Activists Aren't Pessimists
Gold bulls aren't pessimists. They have a vision of capitalism working
better when it is supported by a system of sound money. It doesn't
get much simpler than that.
The dire circumstances Mr. Lewis
writes we should not hope for, we only know to be inevitable. Maybe
we're wrong. But how could we be? They seem to be happening. Besides,
if we're going to make the transition from corrupt to sound money
of course there will be turbulence.
Certainly to the extent that the
world economy has become dependent upon the system of inflation
and dollar recycling, rising gold values will result when such a
system fails to sustain the value of the dollar and those businesses.
But inflation is a problem largely because it leads to poor investment
decisions, known as malinvestment. In other words, those businesses
may not necessarily be sound in the first place.
The problem is one of economic justice
and freedom. Inflation undermines all of that and so it is unjust,
if not unsustainable. It is
a hidden tax; meaning most of us are too dumb to see it, which is
plain true. After all, even the Fed chairman reportedly can't see
it, even as the whole world depends on it and decries its demise
as bad for the rest of us.
Now the Bank for International Settlements
writes a piece that asset bubbles are just as bad as inflation when
they know well that asset bubbles are a result of the inflation.
What are they trying to do, plead
ignorance? Give me a break. Inflation is not accurately defined
in terms of prices or their rate of change. It's a widely known
fallacy to assume so. Inflation is too much money, something
that is hard to measure because money supply figures only account
for the supply side of the equation to the exclusion of any reliable
calculation of the demand concept for money. Still, it has proven
more reliable to at least define inflation in terms of money supply
changes than prices, even if the money we're referring to is only
currency, or money substitute.
All that gold bulls ask is that we
stop producing so much green cheese and start producing productively.
That can only sound pessimistic to a moron.
Lewis' criticisms of gold are the
naive ramblings that are a symptom of the last ten to twenty years
of historical perspective, about the lifespan of the careers of
most investment professionals today, including myself. In order
to get from the system of inflation as it is today to a system of
sound money as we hope it is tomorrow - for the sake of capitalism
and the best of our means of life - those that have benefited from
the inflation would probably lose tomorrow.
Yet it is a delusion to think most
of us have benefited from it, and probably even that any one ever
will in the end. The only thing dire about this system of inflation
failing is the social response by our governments and future starving
billionaires... and the acts they have yet to condone to sustain
their power, privilege, and everyone else's pecking order.
The truth is simple if you've got
the courage of your own conviction, or if God is answering, as Einstein
It is inappropriate if not inept to compare the current situation
to either that of the seventies or 1987. They are quite different.
For one, 1987 wasn't a crisis for
the dollar, as it turned out, and as became evident in its ability
to stabilize against most commodity markets after 1989. Since stock
values had crashed and multiples were somewhat more reasonable after
1987, the Fed could afford to raise interest rates and affect some
deflation. Today, any rise in interest rates only threatens to further
undermine equity values and therefore the dollar. It didn't then.
Also making the current situation
incomparable to either the seventies or 1987 is the fact that
the dollar has yet to decline materially.
To be sure, we haven't really had
a full blown financial crisis since the seventies, but to say that
what is happening now won't lead to one is naïve, wishful, or plain
optimistic. It would be hard to call it objective.
Financial disaster turns into crisis
only when the value of the dollar is compromised such that the lender
of last resort becomes powerless. Until then the inflation can postpone
almost any financial calamity all on its own. Believe it.
There is no financial crisis that
could happen which we cannot afford to bailout so long as the dollar
is able to hold its value while the Fed is able to create more and
more of it's quantity. If such policies did not corrupt the value
of the currency Mr. Lewis would be right, gold would indeed be a
But they do. And when the currency
experiences devaluation, or debases, therein lies the tax in such
For it's those policies that determine
the dollar's long run valuation and have for all of eternity. It's
those policies that create asset bubbles, which turn us into believers,
but which often prove monetary or nominal in nature.
Gold of course only goes to the stratosphere
when the financial crisis manifests in the dollar.
Mr. Lewis figures we are in a crisis, yet admits confidence is high
in the dollar. Of course, we aren't in a crisis technically, but
it's fundamental inevitability is why gold bulls call it one right
now. Mr. Lewis interprets that to mean we're in a crisis, and questions
why gold hasn't responded as if one presented itself, since he's
deemed that it has. But then he provides us with the answer when
he implies this is the worst it'll get, because it is by his very
example of confidence in the dollar that has yet to erode which
explains why his own bias is bearish on gold. When
Mr. Lewis' own confidence in the dollar drops, perhaps then he'll
have a better perspective in which to judge gold's performance.
For then I suspect the crisis will have matured.
Of course, every street beggar will
be calling for a doomsday by then.
It's true equities have been the best performing asset over the
past century even after accounting for the devaluation of the dollar,
and I would never argue that it isn't more worthwhile to invest
one's "money" than to hoard it; only that excessive inflation and
resultant asset bubbles make it unwise to invest for the long haul
due to the difficulty in assessing a businesses prospects for the
long term in an environment of excessive inflation (malinvestment).
For instance, even if the Dow is
up 3,000 and some percent from its peak in 1929 to its peak in 2000,
its components are entirely different today, save a few such as
GE. I don't know of too many static or passively managed portfolios
that would have been able to keep up with the continually (through
time) updated Dow over the century.
I'm certain that if we measured the
value of the Dow according to its original components the difference
between those returns and gold's returns would shrink in gold's
favor. Sure, investors can be active. But beyond the past twenty
years it is usually the minority of them that have made money through
the crisis years and the fat years. These booms and busts we experience
through time are largely monetary in nature.
I would contend that absent the inflation,
our markets would work better, long term savings and investment
would be easier to assess the prospects for, and gold might very
well turn out to be a relic. But so far Fed inflation policies sustain
gold as a long-term growth industry.
The bear market in gold thus draws
inevitably to a close. It can only be the dollar, which is fool's
gold; for the same reason that bubbles can't exist in gold prices.
If gold were really a relic than Mr. Lewis is right. Banks should
sell it. But if gold is a relic in the current global inflationist
system of production, so is money. And so is capitalism. This I
would believe in today's (bigger) government managed economy.
Ridiculous. But patience is required,
for only time will tell.