In its most sophisticated form the argument for owning gold rests on the merits of diversification as a means of protecting against risk. Specifically: just as a cash position provides a cushion against losses in the bond or stock markets, so also having 5% to 10% of your portfolio in gold is supposed to provide a cushion against the inflationary collapse of whole economic systems. This sophisticated argument-that you should put a small proportion of your portfolio into gold as a hedge-is the target of this rebuttal.
I mean to stipulate the truth of the arguments in the first paragraph, and still convince you (if you are an ordinary American citizen) that you would be foolish to own gold. Only extraordinary citizens, willing to go to extraordinary lengths, can justify ownership of gold. I am speaking to American citizens primarily; outside of the U.S., this nostrum has to be modified, as discussed below.
In making a rational decision about whether to invest in
gold, two possible outcome scenarios must be considered:
Gold can only be a winning investment under the second
scenario. If society does not collapse-if we continue to muddle
through, as we more or less have in the United States for several
centuries now-then gold is a losing investment. To see why, we
have to explore what it means to be a "store of value."
Paper currency is not a store of value ('value' =
anything a human being would desire to consume, for example,
food). At any given time paper money indexes an arbitrary amount
of value, an amount that can itself change arbitrarily (and
rapidly). Thus, the dollar bill that you placed under your
mattress on January 1, 1995 no longer buys a dollar's worth of
goods and services on January 1, 1996. Inflation of 2.5% last
year has eaten away at its purchasing power. Inflation can be
much worse: at the worst point in the early 1980s, a dollar bill
placed under the mattress in the early 1980s was worth as little
as $0.87 by the end of the year.
Gold bugs always harp on this point: that over the long term,
after year-to-year fluctuations smooth themselves out (gold can
be extremely volatile in the short term), an ounce of gold will always
buy the same amount of corn, oil, fertilizer-any basket of
material goods you care to name. The punch line of every
"Buy gold!" argument runs like this: when your
improvident neighbor has to use a wheelbarrow to carry enough
paper currency to buy a loaf of bread, you, who bought gold, will
still be able to buy just as much bread with a single coin as
ever before.
Now suppose society does not collapse-how does a
"store of value" perform under this scenario? By
definition, to store value is neither to gain nor lose value.
Hence, in a growing economy, to store value is to fall behind
in relative terms. For example, in 1995 the U.S. economy grew
about 3% in real (inflation-adjusted) terms. Hence, someone who
"invested" in the U.S. economy would have, at the end
of the year, 103% of the purchasing power they had at the
beginning of the year. Compare this to the person who put a
dollar under the mattress, and now has only 97.5% of their
initial purchasing power. Compare also to the person who put
their assets in gold, and who now has (after smoothing out short
term fluctuations) exactly 100% of the purchasing power with
which they began.
"Fine," you reply, "I'll happily give up a 3%
return on a small portion of my portfolio, so that I may have a
hedge against total disaster. That's all I expect of gold-not a
year-by-year profit, but a lifeline when absolutely everything
else goes into the toilet."
Well, suppose society does not collapse in 1996, either; or
in 1997, or 1998, or 1999 … Now we have a problem, because
although 3% doesn't sound like much, 3% compounded can
quickly add up to quite a bit of money.
Perhaps the most dramatic way to illustrate how very costly a purchase of gold can be is to imagine two people in 1926 deciding what to do with $10,000. Person A invests it in the stock market, while Person B puts it into gold. We know that the inflation-adjusted annual return in the stock market during the seventy year period to 1996 was approximately 7%; we'll assume that the return on gold was equal to the inflation rate during the period (by definition, since we are storing rather than increasing value), which in turn was about 3%. Here are the results for our two investors:
Stocks |
Gold |
|
|---|---|---|
| Initial wealth | $10,000 | $10,000 |
| Share of initial amount | 50% | 50% |
| After 70 years | $1,139,893 | $79,178 |
| Share of final amount | 93% | 7% |
To put it another way, the gold investor, Person B, who in
the beginning had 50% of the wealth held by Persons A & B
combined, now has 7% of their combined wealth. It remains true
that Person B can buy just as much corn, oil, fertilizer, etc. as
he could in 1926, because he has successfully stored value over a
seventy year period. What he can't do is buy a CD-ROM player, a
word-processing program, a ride on an airplane, and so on
(metaphorically speaking). He hasn't kept up with the growth in
the economy.
In a growing economy, only to store value is to fall
decisively behind.
But what if society does collapse into inflationary
chaos? It did in Germany, it does so regularly in Latin America;
nothing says the United States is immune forever. Then you'll be
glad you owned gold … however much return you sacrificed in
the intermediate years-or so goes the argument.
In other words, even a tiny chance of an extremely bad
outcome works out to a sizable risk-so why not put a small
fraction of your wealth into gold, just in case?
Now at last we can lay bare the fallacy of this whole line of
thinking. Please run the following movie in your head: society
has just collapsed and you, whistling cheerfully, tossing your
gold coins in hand, stroll down to the store, shouldering ahead
of those wretches with their wheelbarrows of worthless paper
currency, to buy a loaf of bread …
What's wrong with this picture? Two things: either you will
be beaten bloody, and your gold robbed, before you ever get to
the store; or, you will be followed home and murdered in your
sleep-and your gold robbed.
First moral: if you are going to buy gold, you have to
buy a shotgun too. Under precisely those conditions where
gold will finally pay for itself, it will be far too dangerous
for an unarmed person to carry gold. If you truly believe that
you need to own gold, then it follows directly that you need to
own a shotgun too. Bars on the windows and a Doberman wouldn't
hurt either.
"Ah," you think, "it's the personal physical
possession of gold that causes the problem. Come to think of it,
even short of societal collapse, there's enough crime about that
I wouldn't be comfortable storing thousands of dollars of gold in
my home, anyway."
As it happens, a variety of repositories provide storage and
security services for gold investors. They do charge a fee, of
course, so that the return on your gold investment, absent a
collapse, grows even worse; but at least you won't have to run
the risk of physically possessing gold.
So let's run that movie again: now, after society's collapse,
you stroll quietly past the desperate wheelbarrow pushers,
heading for your gold repository, where you will exchange a
smidgen of your gold for some silver coin that you can take to
the preferred customer line in the grocery--the same silver that
government employees are paid in--nothing too dangerously
prominent about that …
Now what's wrong with this picture? Well first, take
out your local yellow pages and see whether you can find a local
repository-because, in the event of a collapse, it certainly
won't do you much good to have your gold at a distance-surely you
are not under the illusion that the trains will still run on
time, after society has just collapsed? And how were you going to
pay your fare, anyway?
Second, stroll up to the repository again and replay that scene.
"Hey, you, back off !" (spoken by a large, menacing guard holding an AK-47).
"Stand aside," you reply calmly, "I'm a depositor here."
"Yeah? What's your name?" (Consults list in hand)
"Get out of here, you #&$%! We've got no record of
you" (Sticks AK47 in your face) "Git!"
"I'll call the police," you say. Well if the police
are still working, then paper currency is probably still working
too, and the whole scenario dissolves-society has not collapsed.
Seriously, what makes you think your ownership certificate is
going to be honored after the collapse of society? If I'm a
repository owner, then with all this gold in my possession, I can
hire as many large hungry people to brandish AK-47s as I need, so
why should I allow you access to your gold-what's in it for me?
Of course, if you are Ross Perot, or Donald Trump, or a General
in the National Guard, or a physician with needed skills, then a
deal may be struck…but we stipulated at the beginning that
you were an ordinary citizen.
Second moral: under precisely those circumstances where gold would pay off as an investment, you can't possibly trust anyone else to hold your gold for you. And if you are thinking that you will keep your gold in a repository just until things start to look grim…have you ever seen pictures of a run on a bank…it isn't very pretty. Besides, how are you going to get that gold home, without a shotgun-do you really think the repository employees are going to keep mum about this guy in the red Camry, now heading West on Main Street, with thousands of dollars of gold in the trunk?
For an ordinary American citizen to own gold is a despairing
and paranoid act. To be consistent, you must buy a shotgun at the
same time as you purchase gold. You should also lay in a year's
supply of canned food, buy a generator, construct a high wall
with broken glass on top…you get the idea. There is no
defensible half-way point once you set foot on the paranoid road.
If you are going to buy gold, you must think and act like a
survivalist. Gold only pays when society collapses. And if
society collapses, it will take more than gold to keep you alive.
"But what about an attack of raging inflation, short of
societal collapse-shouldn't I hedge my portfolio in some
way?" If you wish, and particularly if you are willing to be
consistent by also hedging against deflation (hint: low
coupon government bonds). You can hedge against high inflation by
investing in companies that own real estate or natural
resources-including gold and other precious metals. Because these
are stocks, which often pay a dividend, you won't suffer quite as
much if no inflationary spiral occurs. Note, however, that most
ordinary Americans are already hedged against inflation,
via their ownership of a home. Gold, to coin a phrase, is gilding
the lily for homeowners.
What if you are not an American citizen? Then a
collapse of society is orders of magnitude more likely. But, it
will be a local, not a global collapse. A Swiss bank account,
bearer bonds denominated in several hard currencies (dollar,
mark, yen), stock certificates-all protect against the collapse
of your immediate world, even as they allow you to participate in
the growth of the global economy. And, these forms of wealth are
far easier to hide under your coat.
Only a pessimist owns gold, and pessimists who do not also own guns are laughable.