This week, former Congressman Ron Paul said gold could go to infinity. Many people will be tempted to buy gold based on his prediction. It’s certainly exciting to think about the upside, the profit potential. Who doesn’t want to buy whatever’s going up? However, in the case of gold, there is a serious error in this thinking.
Dr. Paul has put his finger on something very important. The government is abusing its credit, and borrowing itself into oblivion. If this continues, then the value of the government’s debt and currency will drop, probably quite rapidly. This means the price of gold will skyrocket.
Suppose you buy gold today at $1300, and then the price doubles. Should you rush out to sell the gold, to take profits? At $2600 an ounce, you have twice as many dollars for your ounce of gold.
This is a phantom profit because each dollar is worth half as much. The rise in the gold price simply reflects the falling dollar. An analogy may help clarify this key point. Imagine being on a rowboat. The boat is tossing up and down on big waves, and at the same time the tide is going out. You look up at a lighthouse on a rocky peninsula jutting out into the sea. You wonder something.
“Why is the lighthouse jerking up and down, and why is it rising?”
Your friend is in a helicopter, a few hundred feet above you. He sees that the lighthouse isn’t going anywhere. It’s your boat that’s moving.
Let’s use one more analogy to cement this important idea. A carpenter needs to measure the length of a board, so he stretches out some rubber bands. The board is 4 rubber bands long, and he cuts it. He comes back later, but finds that the board has increased in length. Now it’s 5 rubber bands long, and he wonders what’s happening.
It’s easy to see that measuring a board with something stretchable is silly. To measure length, you need something rigid. Steel doesn’t stretch or compress, which is important in getting an objective measure of length. It’s the same in taking other measurements, such as weight, temperature—or economic value. We need the right unit of measure.