What Will You Do With Your Gold?

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This assumes
you have bought some gold.

A lot of my
readers have read my recommendation — “Buy some gold” —
for six years. They still haven’t bought any. They apparently think
it’s good enough to have read a few reports on the importance of
buying gold. “Now I don’t actually have to buy any.” It’s like an
overweight person reading a diet book while munching on Fritos and
bean dip.

There is an
astounding amount of misinformation on gold available on the Web.
This shows the tremendous impact of the Web. Back in 1995, this
misinformation was far more limited in its scope.

Here is the
main piece of information: “Gold! Gold! I’ll be rich — rich,
I tell you! Hahahahaha.”

No, you won’t.
Here’s why.

IN THE
MANIA, YOU WON’T SELL

I have been
through a gold mania: 1979. People who had heard about gold from
1976 ($105/oz) all the way up into the range of $700 finally decided
to get in. They had seen silver make similar gains. Newcomers wanted
to buy. Old-timers didn’t want to sell. Prices soared.

Then, in one
month — January 1980 — gold’s price peaked for one day at $850 and
then plummeted by over $200 over the next few days. For the next
21 years, gold was a bad investment, and silver was even worse:
from $50 to $4.50, plus a loss of 50% in purchasing power to boot.
There was no worse investment in that era than silver. Yet all the
way down, there were coin businesses that sold people silver coins.
Some salesmen used exactly the same arguments that they use today
to persuade people to buy. For 21 years, the arguments were incorrect.
The better dealers just quoted prices and made deliveries. They
did not hype the product. They are still in business.

Newcomers
to the precious metals market don’t know this story. They should.

So, trust
me when I tell you that you will not sell your precious metals during
the mania. In a mania, buyers think, “It will cost more tomorrow.
I must buy today.” Most would-be sellers think the same thing. They
refuse to sell. Only a few see what’s coming and sell at the top.

This is true
of everything that becomes the focus of a mania, not just precious
metals. Think “dot-com stocks, March 12, 2000.” Think “S&P 500,
March 24, 2000.”

So, why hold
precious metals?

THE
CRACK-UP BOOM

This golden
phrase was coined by Ludwig von Mises. In Chapter 17 of his book
on economics, Human
Action
, he described the breakdown of a monetary system.
The breakdown begins with fiat money inflation by a government or
its licensed central bank. This creates an economic boom, as he
described in Chapter 20.

Over time,
people recognize that price inflation will continue. They begin
to hedge themselves against the effects of price inflation. They
stop lending money to be paid back in a depreciating currency. They
buy hard goods, such as gold and silver.

The crack-up
boom is not part of the normal ups and downs of commodity prices.
The following is normal.
He
who believes that the prices of the goods in which he takes an interest
will rise, buys more of them than he would have bought in the absence
of this belief; accordingly he restricts his cash holding. He who
believes that prices will drop, restricts his purchases and thus
enlarges his cash holding. As long as such speculative anticipations
are limited to some commodities, they do not bring about a general
tendency toward changes in cash holding.
The trouble begins
when people decide that they had better get rid of cash. To do this,
they must find sellers of goods who do not see what is happening or
who think the rise in prices is temporary.
When
they expect that the money prices of all goods will rise or fall,
they expand or restrict their purchases. These attitudes strengthen
and accelerate the expected tendencies considerably. This goes on
until the point is reached beyond which no further changes in the
purchasing power of money are expected. Only then does this inclination
to buy or to sell stop and do people begin again to increase or
to decrease their cash holdings.
The trouble is,
not many people perceive this change at the top of the mania. Most
people can’t get out at the top. Remember the investor’s command:
“Sell!” Remember the broker’s response: “To whom?”

As the mania
grows, public opinion changes.
But
if once public opinion is convinced that the increase in the quantity
of money will continue and never come to an end, and that consequently
the prices of all commodities and services will not cease to rise,
everybody becomes eager to buy as much as possible and to restrict
his cash holding to a minimum size. For under these circumstances
the regular costs incurred by holding cash are increased by the
losses caused by the progressive fall in purchasing power. The advantages
of holding cash must be paid for by sacrifices which are deemed
unreasonably burdensome. This phenomenon was, in the great European
inflations of the twenties, called flight into real goods (Flucht
in die Sachwerte) or crack-up boom (Katastrophenhausse).
Let me tell you
a great story. I have told it many times over the years. Back in the
1970′s, I knew a retired banker named Norbert Einstein. He was very
urbane, the model of a European gentlemen. He was the cousin of a
more famous Einstein. He told me about the experience of their Aunt
Rosa.

Aunt Rosa
was a slow learner, unlike her nephews. She did not catch on to
what the German central bank was doing until 1923, the final year
of the mass inflation. She finally figured out that she needed to
buy hard assets. But she had waited too long. There were none to
buy. Well, almost none. She did find a seller of a niche product:
bedpans. She took all of her money and bought a stack of them. Shortly
thereafter, the German government had a currency reform, the central
bank ceased inflating, and this ended the great inflation. The demand
for hard goods slowed dramatically.

There was
Aunt Rosa, figuratively sitting on top of a pile of bedpans.

In every crack-up
boom, there will be many Aunt Rosas. Your goal should therefore
be to avoid winding up with the equivalent of bedpans as your retirement
portfolio.

Mises continued
to describe the crack-up boom.
The
characteristic mark of this phenomenon is that the increase in the
quantity of money causes a fall in the demand for money. The tendency
toward a fall in purchasing power as generated by the increased
supply of money is intensified by the general propensity to restrict
cash holdings which it brings about. Eventually a point is reached
where the prices at which people would be prepared to part with
real goods discount to such an extent the expected progress in the
fall of purchasing power that nobody has a sufficient amount of
cash at hand to pay them. The monetary system breaks down; all transactions
in the money concerned cease; a panic makes its purchasing power
vanish altogether. People return either to barter or to the use
of another kind of money.
This is the end
result of every expansion of money that is not halted earlier by the
monetary authorities. But if they do call a halt, then there will
be a recession or a depression. Mises described why in Chapter 20.

The problem
is, central bankers and politicians are unwilling to accept this
result. So, they reinflate. The march toward the crack-up boom continues.

This
first stage of the inflationary process may last for many years.
While it lasts, the prices of many goods and services are not yet
adjusted to the altered money relation. There are still people in
the country who have not yet become aware of the fact that they
are confronted with a price revolution which will finally result
in a considerable rise of all prices, although the extent of this
rise will not be the same in the various commodities and services.
These people still believe that prices one day will drop. Waiting
for this day, they restrict their purchases and concomitantly increase
their cash holdings. As long as such ideas are still held by public
opinion, it is not yet too late for the government to abandon its
inflationary policy.
This is our present
situation. The public still prefers the boom effects of monetary inflation
to the recessionary effects of monetary stabilization.
But
then finally the masses wake up. They become suddenly aware of the
fact that inflation is a deliberate policy and will go on endlessly.
A breakdown occurs. The crack-up boom appears. Everybody is anxious
to swap his money against real goods, no matter whether he needs
them or not, no matter how much money he has to pay for them. Within
a very short time, within a few weeks or even days, the things which
were used as money are no longer used as media of exchange. They
become scrap paper. Nobody wants to give away anything against them.

We are nowhere
near this yet. But this is the end result of a policy of monetary
inflation.

What Mises
described is a breakdown in the exchange economy. Once again, I
cite him.
The
monetary system breaks down; all transactions in the money concerned
cease; a panic makes its purchasing power vanish altogether. People
return either to barter or to the use of another kind of money.

This is the
equivalent of a depression. It is an inflationary depression.

THE
DIVISION OF LABOR

In 1923, at
the peak of the German inflation, the prices of goods in Berlin
as denominated in pounds sterling were higher than the prices of
the same goods in London. Why? Because production had collapsed.
The division of labor had collapsed. To get goods imported from
outside the country, entrepreneurs had to take greater risks. Uncertainty
increased. Because the orderly markets had disappeared in the wave
of price inflation, supplies of everything became much tighter than
outside Germany. Buyers in other nations could outbid German buyers,
even in those cases where German buyers had foreign currencies and
gold.

Gold and foreign
currencies kept families alive. It did not make them rich.

Then who won?
The great winners were farmers. They easily paid off their pre-War
debts. Even before 1923, a farmer could pay off all of his debts
by the money generated by the sale of a single egg.

What counted
most in 1923 was your ability to keep your job. What made jobs desirable
were products to sell that everyone wanted: basic foodstuffs, coal,
and liquor. People in cities sold off their prized possessions and
heirlooms in order to get food. The flow of grand pianos to German
farmers never again reached such a rate.

There was
almost no way to get rich in cities. There was no asset, other than
stored food and coal, that could have made someone rich. But rich
as measured in what? The greatest urban wealth was food and coal.
Holders refused to sell.

The same story
appears in the Bible. In II Kings 6, we read of a siege that was
so horrendous that women ate their infant children, a practice which
had been prophesied by Moses centuries before (Deut. 28:57). No
one got rich in that siege.

Almost no
one gets rich in a crack-up boom. The few who do generally go bankrupt
after the currency reform, when economic conditions return to normal.

THEN
WHAT GOOD IS GOLD?

Gold serves
as a valuable asset in the time leading up to the crack-up boom.
Its price rises faster than the prices of most other assets.

In the crack-up
boom, gold serves as an insurance policy against a catastrophe.
You can buy your way out of circumstances that bankrupt others.
You preserve much of your lifestyle by selling off a widely sought-after
asset: gold. But understand: this is not a way to get rich. It is
a way not to become totally impoverished.

After the
currency reform, gold is more likely than any other crack-up boom
asset to retain its purchasing power. This means that gold is a
good investment in three phases: in the years before the crack-up
boom, during the boom, and in the reconstruction phase after the
boom.

Other assets
require trading in and out. They require almost perfect timing.
Gold doesn’t. You buy it before the boom is expected (e.g., 2001),
hold it through the boom phase and the crack-up phase, and then
re-enter the capital markets as the owner of an asset that has universal
desirability as an investment.

You don’t
get rich as a holder of gold during a time of serious inflation.
Yet get rich as an investor with capital to invest after the crack-up
boom has ended.

CONCLUSION

People do
not see gold in this way. They see it as a way to get rich in a
time of inflation. They do not understand this principle of economics:

The
division of labor through invested capital is what makes people
rich, slowly. The crack-up boom destroys the division of labor.
Most people get poor in the crack-up boom, except those who (1)
operate successfully in a low division of labor environment (think
“Amish”) and (2) debtors who live outside urban areas, who pay of
their debts with depreciated money.
The
Amish don’t pay much attention to their wealth, except maybe to buy
better horses. Debtors who learn how to play the pyramiding game in
the boom phase generally go bankrupt after the monetary stabilization
takes place.

So, don’t
expect to get rich in an age of inflation by owning gold. That’s
because you would have to sell it to get rich. Your timing had better
be perfect.

Don’t wind
up like the entrepreneur described in II Kings 7:16—20. His
timing was deadly.

February
2, 2008

Gary
North [send him mail]
is the author of Mises
on Money
. Visit http://www.garynorth.com.
He is also the author of a free 20-volume series, An
Economic Commentary on the Bible
.

Gary
North Archives

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