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Gold is a valuable thing to store. However, it is not a store of value.
Gold has intrinsic properties that make it valuable. However, it does not have intrinsic value.
I mention this, because, at some point, you will read about gold as a store of value. You will read of gold’s intrinsic value. Every time you read either of these phrases, you will know that the author does not understand economic theory.
Consider this. The price of gold has moved above $1400 an ounce in recent days, up from the low $1300’s. Presumably, this has been in response to the turmoil in Libya, which has reduced the immediate supply of oil. The rising price of gold indicates the possibility of continuing turmoil in the Arab world.
These fluctuations in the price of gold indicate that immediate changes in external circumstances can affect the price of gold. There has been an unexpected increase in the demand for gold.
According to all schools of economics except for the Marxists, the prices of goods and services rise and fall in terms of changes in the markets, which include consumers’ tastes, monetary changes, changes in supply, changes in the price of alternatives, and changes in the public’s expectations of future prices. There is therefore no fixed measure of value.
Economic value is subjective. It is imputed. Buyers compete against buyers; sellers compete against sellers; and people’s assessments of future conditions are always changing.
These changes drive prices up or down. People have subjective assessments of the objective future. They also have expectations regarding other people’s subjective assessments of the future. Through competitive bidding, people establish objective prices in various markets.
The important fact to understand here is that objective prices are the result of competitive bids by people with subjective assessments of the future: immediate and more distant assessments.
GOLD IS NOT A STANDARD OF VALUE
There is a widespread mistake in economic analysis within those circles that are called the hard-money camp. People are under the impression that gold is a standard of economic value. This concept is foreign to economic theory.
Yes, we speak this way. The Bible says that a virtuous woman is worth more than rubies (Proverbs 31:10). But it does not say exactly how much more valuable than rubies she is. It does not offer a formula. There is no good virtuous-woman-to-rubies ratio that is normal. The price of a virtuous woman on a free market does not fluctuate around this ratio.
To make this clear, consider the fact that the price of oil can rise without an accompanying rise in the price of gold. There is a tendency for the two to rise and fall together, but this is only a tendency. No one is sure why this tendency exists. It may be that both of them move in expectations of rising price inflation. But consumer prices have barely budged since 2007, yet the price of oil was extremely volatile in 2008 — far more so than gold’s price.
We read that the price of gold has not changed. Only the price of the dollar has changed. Again, this is obvious nonsense. The price of gold went over $1,000 in March 2008, only to fall to about $750 five months later. Yet consumer prices did not change.
The lesson here ought to be that gold is not a measure of value. Then what is? Nothing is, any more than there is a measure for the value of a virtuous woman.
Individuals impute value. They think something is valuable to them at this moment. This can change, moment to moment. People are constantly changing their assessments of what items or services are worth to them.
There is a story in the Bible of Esau and Jacob. Esau was hungry. Jacob offered him a meal of stew in exchange for Esau’s birthright as the eldest son. Esau decided that this was a reasonable exchange (Genesis 25:34). We think this was a foolish exchange, but Esau had a different assessment. His hierarchy of values was present-oriented. He discounted the value of a distant birthright.
Individuals have very different assessments of the future. The average American owns no gold. He does not know where to buy gold coins. He probably has no awareness that the United States Mint produces bullion gold coins. He surely has no knowledge of the fact that the Mint did not do this until after Ron Paul persuaded President Reagan’s gold commission in 1981 to ask Congress to pass this legislation in 1985. Yet we read about the price of gold in the financial press.
The fact that the average American owns no gold indicates that the average American does not assess the future in the same way that the average gold bug does. The typical buyer of a gold ETF or other gold fund is not thinking the way that the average American does.
Gold is not a standard of value. It moves up or down in terms of individuals’ competing assessment of its prospects in a world of fiat money. The general public thinks of their national currency unit as a standard of value, but it isn’t. That is not because fiat money is uniquely a fiat economic standard. All standards are fiat. We say “let it be,” and then either buy, sell, or do nothing. It is the composite bids of those people who actually buy and sell that establish the price of any asset. There is no earthly source of composite value. There are only objective bids.
Physical measures of the weight and fineness of a gold coin do exist. These measures establish the degree to which a coin deviates from this standard. They enable us to determine whether a coin is a counterfeit. But they do not tell us what gold is worth. Only the free market does that.
Gold possesses intrinsic physical qualities. It is extremely durable. It is malleable. It has a certain luster. All of this in combination has made gold a popular investment tool down through the ages. But there is no intrinsic value to gold. Value is not intrinsic. It is imputed.
A CONFUSION IN TERMINOLOGY
Pro-gold commentators speak of gold’s intrinsic value when they mean historic value. Gold has generally held its price down through the ages. This price has varied. Gold fell from over $800 per ounce ($2,100 in today’s purchasing power) in January 1980 to just over $250 in 2001. Then it rose to today’s price.
Over centuries, an ounce of gold has bought varying quantities of goods and services of varying value. The heir of someone who bought an ounce of gold with his labor in the era of Jesus could take that ounce of gold and buy goods and services today. But there are very few services that have remained the same, other than the world’s oldest service industry. The amount of bread that the heir can buy would be considerable, due to the enormous increase of agricultural production. The tools of production that a person would have bought in Jesus’ day barely exist today. If they still exist, the Amish buy them.
What makes gold unique is this: a person can buy something of considerable value with an ounce of gold. He could buy almost nothing today with a tool of production or even a high-quality consumer good in Jesus’ day. The range of goods in Jesus’ day was limited, though not much less limited than in 1750.
There is great confusion regarding the value of gold through time, not because gold has changed but because everything else has. There is a market for gold all over the world. There is no market for the things gold would have bought 50 years ago, except as items for the “Antiques Road Show.”
People say that the price in gold of a fine automobile in 1925 would be about the same today. But the concept of “fine automobile” has changed radically. What is astounding is that a common metal coin that does not change through time can purchase anything of value in the future.
This is gold’s great benefit: its continuity of value over time. People will still impute value to gold in a century. There are very few investment assets that will surely maintain a comparable value over the same time period.
Every line of mass production gets better over time except gold. Yet gold, by not changing at all, maintains value through time.
We should not confuse this with intrinsic value. We should understand it in terms of intrinsic physical qualities. Gold’s most important attribute is its high imputed value in relation to its weight. It is expensive to mine.
BAD POLICIES, GOOD GOLD
This continuity of value is of great service to someone who is concerned about looming disruptions due to government policies and central bank policies. If gold muddles through as an investment asset, then it becomes a sought-after investment when the general public at last figures out the government promises will not muddle through.
It is not that people can get rich with gold. It is that they are less likely to get poor.
The stability of gold’s value through time is in contrast with the stability of government promises, especially concerning the stability of the national currency unit.
Politicians lie. Gold muddles through. Central bankers make grandiose promises. Gold muddles through. Economists make grand claims about the ability of economic forecasting tools to bring stability to the economy. Gold muddles through.
The business cycle makes and breaks investment plans. Gold muddles through. The structure of personal and corporate debt changes over time, bringing to ruin people’s plans. Gold muddles through.
Employers hope for success in terms of their plans for the future. When those plans hit the brick wall of uncertainty, the plans may die. Gold muddles through.
The typical father in India buys gold for his daughter’s dowry, just as his father did, and his grandfather did, stretching back through time to before the Bank of England. A gold necklace worn by some lovely young bride in 1500 will look just as good on a bride today.
Think of a bride wearing Federal Reserve Notes. This image just doesn’t have the same sense of permanence.
The simple farmer in India may not be able to read, but he will buy gold for his daughter in confidence that a piece of gold is worth more than all the collected assurances of stability issued by all of the Federal Reserve Chairman.
The Western investor trusts the promises of politicians, who he knows lie for a living. He trusts the assurances of a Federal Reserve Board Chairman, when he knows that the same man did not see the crash of 2008-9 coming.
Who shows greater wisdom: the simple farmer in India or the hot-shot money manager on Wall Street?
Gold is not for hot-shot investors. It is for simple people who know enough not to trust the promises of politicians and the assurances of Federal Reserve Board Chairmen.
Gold is a lasting testimony to the lies of politicians. They stand in front of the cameras and tell the voters that things will be just fine one of these days. Real soon now. The voters dream of golden years in retirement.
Congress is Lucy. The voters are Charlie Brown. The Social Security system is a football. We know what is going to happen. Charlie knows what is going to happen. It will happen.
Gold is for the skeptical investor who says, “She’s going to pull the ball away. I will not kick it.” He sits on the sidelines, amused at the gullibility of Charlie, year after year.
The politicians treat the voters just as good-looking men with no visible means of support treat ugly rich heiresses. They tell them what they want to hear. The voters believe, just as ugly rich heiresses believe. Gold is a barbarous relic. That was the assessment of the slickest talking economist of the twentieth century: John Maynard Keynes. He sold himself to the British government in his capacity as a Treasury official. He told the young economists of his day what they wanted to hear: that their predecessors were old fogies, that gold is a barbarous relic, and that the world would be a better place if it allowed governments to run deficits and central banks to create money without the fear of a run on their gold by barbaric simpletons.
The economists bought it. The politicians bought it. The central bankers bought it.
Some illiterate farmer in India never heard of it. If he had, he would have bought even more of the relic if he could have afforded it. Trust a British official? “Another gold sovereign, please.”
Keynes spent his early years in the British Civil Service working on India’s affairs. He did not persuade Indian farmers. They did not persuade him.
But, somewhere, there is a great granddaughter of some Indian farmer of Keynes’s day who has a necklace with a few British gold sovereigns that her great grandmother wore to her wedding back when Keynes was forming his ideas on monetary theory.
When it comes to believing Keynes or Patel, I’ll stick with Patel . . . as long as he is not a graduate of Cambridge.
Gold is a valuable thing to store. Believe this with the trust of an Indian farmer. Don’t pay attention to a self-educated gold promoter who tells you that gold is a store of value or has intrinsic value.
Understand the logic of gold before you buy it. The logic of gold is that, fifty years from now, someone will buy that gold with something of value.
Ben Bernanke does not believe this. That’s another reason to buy gold.
March 4, 2011
Copyright © 2011 Gary North