In a recent post, Frances Coppola questions the economic and moral stance of those who choose ‘hoarding’ gold as their mode of saving. She does this on the basis that this activity is unproductive for society, and the drain of resources prevents economic growth. Engaging in such a transaction selfishly places personal interests ahead of the rest of society.
Part 1 of my response did not address the morality issues or the role of ‘hoarding’ with respect to economic growth. Rather, it looked at the more basic issue of what constitutes money, how it has been determined, and systems of assets that stem from the choices of money. The point of that discussion was twofold: First to properly differentiate between the current fiat based monetary system based on the dollar, and the prior system based on gold. The second point was that the reason for officially departing from the gold system to the fiat system was not based on the pursuit of a higher quality of money, but on the need for political expedience. For this reason, if indeed the switch was a bad one (if we have indeed switched to a poorer quality of money), there will be an inevitable notion to seek out better quality money as the issues with the poorer quality money become apparent. It is from this foundation that I will discuss Coppolas’ comments on economic growth and morality.
Our economies don’t grow by themselves: businesses need capital in order to produce, and the creation of that capital requires investment. Investment comes from the excess production of other businesses and individuals, recycled back into the economy through lending to, and equity investment in, productive activities.
This is spot on. The fact that she understands this point puts her streets ahead of the legion of economists, central bankers and pundits who think that merely increasing the supply of money suffices to stand in place of ‘excess production of other businesses and individuals’ (savings) to sustainably fund investment. She then writes:
There is nothing productive about sitting on a hoard of gold, and the only beneficiaries of the trade in physical gold that would ensue from forcing all savings into gold would be the buyers and sellers of gold. That is not to say that the present situation, whereby debt and equity assets are “churned” on secondary markets, is much better: but at least the initial investment goes into productive activities, even though subsequent trading of the assets is largely unproductive.
In my view, this is where things go a bit pear shaped, and the confusion starts. What happens in secondary markets is merely an exchange of assets. All that is happening is an asset is transferred from one party to the next. From the perspective of the system as a whole, there have been no changes in the total number of the asset in question. Coppola calls this ‘unproductive’ activity when it is more accurately termed ‘neutral,’ strictly speaking from the perspective of total number of assets prevailing in society. From the perspective of the individual actors however, this transaction may very well be productive, given that the acquirer has a purpose in wanting to buy that asset, as does the seller in getting rid of the asset. In this sense, for the buyer and seller the transaction itself represents a step towards achieving that purpose; completing that step is productive.
By saying ‘at least the initial investment goes into productive activities,’ I presume she means original equity or debt offerings. These come about as enterprises seek funds for fresh purchases of land capital and labor, and will exchange equity in the enterprise for funding of those expenditures. It is important to properly analyze what is exactly happening and when, with respect to total assets in the system. At the exact moment a new equity issue of Company ABC has been purchased, no increase in the size of society’s assets has occurred. This is because the mere act of offering new equity does not increase the intrinsic value of Company ABC. It must dilute existing equity in order to offer an increased number of shares to the public. Investors purchasing this new offering are just changing money for shares, with no new production taking place at this point.
This inflow of money allows Company ABC to invest in land, capital and labor to produce. Assuming Company ABC accurately planned and coordinated production such that it can efficiently meet a Demand from society, the operation has been a success and the wealth of the society has increased. The value of the company rises, as does the stock, which rewards the investors who purchased the initial offering. Unfortunately, Coppola seems to assume that this is the only possible outcome. It is quite possible that Company ABC has been erroneous in its forecasting ability and cannot produce a product that people demand in an efficient manner. This means that the land, labor and capital that Company A used up in its endeavor has been squandered, lost to society. The value of Company ABC drops as does the value of the stock, losing money for initial investors. That process is ‘unproductive’ and it is a very real possibility.
The uncertainty of business prospects in the future plays in the reckoning of both business itself and those who would invest in it. It is up to those who would invest to properly assess the prospects of the business they would like to invest in, as a failure to do so would result in a loss of capital, which could have been used to increase societal wealth. These future business prospects and their effects on metrics such as earnings, revenue, profit, capital expenditure, depreciation, taxes etc may be beyond the scope of the vast majority of people. It is highly unrealistic to expect the average person to be sufficiently proficient in analysis of business prospects to the detail it would require to make accurate investment decisions, on top of performing well in their vocation. This is why most people do not make these decisions themselves, but rather delegate them to others in the form of the litany of savings, investment and pension vehicles that are available.
Regardless of whether or not one makes his or her own investment decisions, it may be that the investor feels there are little investment opportunities available. Or, it may be that the investor has placed as much of his or her funds in equitable investments as he or she deems necessary with respect to his or her risk profile. In either case, there is money at the investors’ disposal. He or she may deploy it in other classes of goods, like collectables or commodities, or he or she may put it in the bank to seek interest. About this, Coppola writes:
If the initial investment is in gold or other hard assets, NO-ONE benefits. And if enough people invest in hard assets instead of putting their wealth to productive use, the economy will be starved of the investment it needs to grow.
To reiterate, one can use his or her ‘investable funds’ in various ways. One can exchange them for equity, debt, or some other interest in an enterprise. One can exchange funds for raw commodities or capital equipment. Or, one can place it in the bank. Coppola implies here that unless 100% of those ‘investable funds’ are put to productive use (which was implied in the preceding quote to be purchases of initial equity), the result is a starvation of investment to society and growth stagnation. She elaborates in the comments section, writing:
If, instead of buying gold, you buy an equity stake in a local business, you provide money to that business for expansion: it invests in capital, so it can produce more goods, sell more goods, take on more workers, pay you dividends and generally contribute more to the economy. Contrast that with your gold hoard – or your classic car, for that matter. It sits there doing nothing and benefiting no-one. In effect you are expecting SOMEONE ELSE to invest in the local business. But you bought your gold from a gold trader, and all he does is buy some more gold with your money. That money may NEVER find its way into the economy in the form of productive investment
As described above with the Company ABC example, the equity stake does lead to funds with which a business can potentially expand production, contributing more to the economy. I also described the neutral nature of a transaction in the market which applies to Coppolas mention of the gold transaction. No funds are removed from the system, merely exchanged for an asset. She also makes an erroneous assumption that the gold trader just buys more gold with the proceeds – the truth is she has no clue what the gold trader, or anyone will do with the proceeds from transaction. But the key bit at this juncture is the bolded sentence. Coppola suggests that by choosing to buy gold instead of investing in the business, you are passing the responsibility on to others. However, this charge of expecting others to perform can be laid upon those who invest in equity as well. They too are expecting someone else – the business – to go forth and actually produce the product. Just as a person who buys gold of is unproductive for not investing in a business, the same logic dictates that the person investing in a business is unproductive because he or she did not go about and produce the product themselves.
Of course, this is faulty logic. Leaving aside the merits of a business proposal (the business may not be worth investing in), Coppola ignores the state of the investors themselves. They may not be in a position to put money in a risky venture for the reasons given above. By putting their investable funds in other vehicles, all they are doing is transferring their funds to another actor, who in turn may do something else with it. With respect to the Company ABC example, the fact that it very well be a good business venture may be lost on your average person (otherwise everyone would have bought a stake in every successful company ever the instant it was initiated). Thus, seeing no reasonable investment opportunities, Average Al sticks his money in a savings account to earn interest. This effectively is a transaction between Average Al and the bank, with the bank having access to Al’s funds, and paying Al interest for it. Just like any other transaction, one entity gets an asset, the other funds to achieve some other end. In this case, the bank, with Al’s funds, has increased its deposit base which it can use to lend to other parties. These ‘other parties’ may include Company ABC, or investment funds which may turn around to lend or invest in ABC. The point is that just because Average Al did not directly buy equity in ABC himself does not mean he engaged in unproductive activity. It is not Average Al’s fault that he: may not understand, have access to, or be financially equipped to participate in the investment of Company ABC even though it may be a great thing. However, Al directing those funds to a bank, which positioned the bank (or a subsequent debtor) to then invest in ABC means that ultimately ABC was not starved of investment. Even if Al chose to buy gold instead of putting the money in the bank, the above holds true. This is because the funds Al spent on gold may potentially flow from the seller of gold to ABC, or from the seller to a bank and in turn to ABC. In stressing over who invests in Company ABC, Coppola misses the point that ultimate investment depends on the quality of the investment proposition and the amount of investable funds available. Moving funds around from person to person via transaction is a neutral event, which doesn’t reduce investable funds but rather directs them into the hands of those better positioned or informed to execute the investment.
It is from this fundamental misunderstanding that Coppola draws the conclusion that ‘hoarding’ wealth in gold is immoral. She writes (brackets mine):
Economically, because it [hoarding] deprives the economy of the investment it needs to increase production to a level where everyone’s needs can be met – which surely must be the goal of any civilised society. And morally, because hoarding a surplus when there is no reason to assume that it will be needed in the future, is sheer greed, and refusing to use that surplus for the benefit of others is sheer selfishness. So when people put their savings into unproductive assets, they are guilty of both greed (because they have taken more than they need) and selfishness (because they have deprived others of what they need). I’m sorry to use emotive terms, but we are no longer in the realms of simple economics. We are dealing with the morality of hoarding
As I discussed above, my buying gold does not deprive the economy of funds for investment, because the money I spent is now in the hands of someone else, who does something else with it. My reasons for buying gold are irrelevant; the bottom line is that I did not destroy investable funds merely by exchanging them for another asset. Nor did I create investable funds if I chose to invest in Company ABC. The investable funds were created when I chose not to use my own surplus production on consumption, as Coppola correctly wrote in the opening quote. The sum of investable funds is only reduced should I decide to spend them on consumption. The only thing that changes thanks to my transactions is the individual who does or doesn’t make the investment in ABC, should it be worthy of one. There is no greed and no selfishness because I am not ‘hoarding a surplus.’ Again, I am giving it to someone else in exchange for an asset. I cannot stress that point enough.
Coppola then points out that the only way this ‘hoarding’ becomes moral is in the event of Financial Armageddon, in which case it would be prudent to ‘hoard now.’ She then writes:
So, is this financial Armageddon likely? Are we really facing global hyperinflation, currency collapse and economic meltdown? I don’t think so, because the whole argument comes from an inverted view of the world: even if the dollar crashed against gold, it still would not be experiencing hyperinflation if its value held up against other measures.
In Part One, I wrote about how the role of the dollar in the gold based monetary system was as a currency that had a claim on a certain weight of gold. This definitional relationship means that if the dollar ‘crashed against gold,’ it indeed has lost its value against everything else as well. This is because other goods and services are priced in dollars, which in turn is priced in gold. Under the pre-1971 system, a pair of shoes worth $35 could in turn be said to have been worth one ounce of gold, given the dollar was worth 1/35th of an ounce of gold. A ‘crash’ of the dollar, leaving it worth for example 1/3500th of an ounce of gold would then mean the pair of shoes would be worth $3500.
Note that in real terms, the price of shoes does not change. One ounce of gold could have purchased the pair of shoes before or after the crash. However, being able to buy after the crash requires one having owned the ounce of gold prior to the crash. If one owned the gold, fell asleep during the crash and woke up afterward, that ounce of gold could be exchanged for $3500 to procure the shoes. If one had owned the $35, fell asleep and woke up after the crash, he or she would find that he could buy virtually nothing. His or her ‘savings’ of $35 had been completely eroded by the decline in the value of the dollar. Given the option of owning the gold or owning the dollars pre-crash, clearly the former option is superior. The question then becomes one of how to anticipate a crash, or even a material decline in the value of dollars, such that a switch to gold is prudent.
In Part One, my distinguishing the ‘official’ dollar based system from the ‘unofficial’ gold based system was done to show that it is possible for people to ‘switch’ between them simply by purchasing gold. The rationale for doing so is that by not doing so, one will suffer a loss in purchasing power due to an inadequate compensation for a declining currency. Note, the money in question here is ‘investable money’ that remains AFTER one has made all of the ‘direct investments’ he or she deems necessary or prudent. That money could sit in a bank earning interest. The negative interest rate environment in which we are in currently, with inflation higher than nominal interest rates, ensures that money employed in this manner will lose purchasing power.
Therefore, one is forced into buying some sort of asset with that money. This is precisely what current central bank policy is designed to accomplish. But again, I’ve established that our hypothetical investor has already made the ‘direct investments’ he or she wishes to make. He or she is done buying stocks, commodities, collectibles or investing in initial equity offerings. The remainder of that money needs to keep its value until the date upon which a new suitable investment opportunity presents itself. In the absence being able to keep value in dollars, the alternative is to do so in gold. The relationship is quite clear – the persistence of real interest rates below 2% coincides with periods of persistent rises in gold, with periods of outright negative interest rates coinciding with some of the larger spikes. This is illustrated below:
The reason that gold rose in the 1970s was the persistence of real interest rates at a low/negative level. Notably, rising, double digit nominal rates were prevalent then. The fact that inflation was even higher meant a lower trending and negative real rate. That changed when Fed Chairman Paul Volcker raised the Fed Funds rate to 20%, raising the real rate of interest along with it. This tanked the price of gold. For the duration of the 80s and 90s, the real rate of interest declined, but remained steady between 2-6%. The price of gold during that time underperformed. In the early 2000s, real interest rates trended below 2% and persisted there since, frequently slipping into negative territory. The spike above in 2008 coincided with the 30% fall in gold during the crisis. The determination of central banks to ease has pushed the real rate sharply lower in to negative territory yet again, coinciding with the tripling of the gold price since.
In terms of the ‘competition’ between gold and fiat money, during the 70s gold proved to be superior at performing the value-storing function of money. During the 80s and 90s, fiat money managed this function better. Since the turn of the century, once again it has been gold that has performed better. In part one I remarked that with the quality of money in mind (as determined by several attributes), gold is superior to fiat. The crucial characteristic tilting the scale is the scarcity issue. Good quality money must have some degree of scarcity. The potential of fiat to be made unlimited at the whims of political expedience means that the potential constantly exists for scarcity to completely disappear, taking its value as money with it. The state of the real interest rate is the best barometer one has available to determine what vehicle is better to save in at that particular point in time.
What if financial Armageddon doesn’t happen? What if – as Izabella Kaminska has suggested in her recent series of posts, “Beyond Scarcity” – we are entering an era not of insufficient production to meet everyone’s needs, but an era of OVER-production? If there is actually more than enough production to meet everyone’s needs, then hoarding is pointless and surpluses are worthless. The value of a surplus is determined by the extent to which it is needed, regardless of the medium in which it is stored. Surpluses by definition are not “needed” now, at least by the holder – though as I noted above they may be needed by others. But if they are not needed in the future either, they have no value.
I’ve read Kaminskas series, and have reservations about it, which I may or may not discuss at length in a serious of posts of my own about the subject. Coppolas next point is more or less correct, but there are two things to note here. First, by writing that surpluses (savings) are of value regardless of the medium in which it is stored, she implicitly repudiates her prior implication that all investment that isn’t ‘direct’ is unproductive and deleterious to society. Second, a world in which all needs and wants of man could be met would indeed render savings valueless. But the world as it stands is nowhere near such a state. I disagree totally with the idea that man has already conquered scarcity and that we are suffering from overproduction. I will deal with that in later posts. Finally, Coppola writes (brackets mine):
So why do they do it [hoard gold]? I don’t know, but I am reminded of the story of Moses on Mount Sinai (Exodus chapter 32). He spent rather longer up the mountain than the Israelites were expecting. They became fearful that he wasn’t coming back, and that (more importantly) God had abandoned them. So they turned to another god. They melted down all their gold jewellery and created a golden calf, and they bowed down and worshipped it…….
I too am reminded of a biblical passage from Matthew, about wise and foolish builders. Accepting the virtues of Christ was compared to the wise man who built his house on a foundation of rock. Knowing the virtues of Christ yet ignoring them was compared to a foolish man building a house on a foundation of sand. The ‘virtues’ of quality money are widely known to man and as a race we have constantly strived to find goods that best fit these virtues. To identify a good that does it better than the rest, and to accept it as money is to build the monetary foundation on a rock (or at least as close to a rock as can exist in humanity). To identify such a good and ignore it, surely is building a monetary foundation on sand.