• 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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