Why I hold Gold: Why I am a Long Term Optimist and consider holding gold and Optimistic Endeavor, and Why I think the Stagflationary Scenario is more likely Macroeconomically in the Intermediate term (next several years)
June 05, 2010
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Wow, long title :) Here it is again -- Why I hold Gold: Why I am a Long Term Optimist and consider holding gold and Optimistic Endeavor, and Why I think the Stagflationary Scenario is more likely Macroeconomically in the Intermediate term (next several years). I have made these points before scattered in several different posts and I will consolidate them here.
The argument against holding Gold only as a hedge against "inflation":
We must first disabuse anybody of the incorrect assumption that gold is an "Inflation" hedge... period. I have said this many times in the past, that gold is not only a hedge against inflation, but (and more importantly) it is a hedge against financial shenanigans and economic instability (loss of confidence).
There is absolutely nothing in economics that has only one cause and one effect. There are primary causes and secondary causes (and always multiple ones), and the primary cause at one time might become a secondary cause at a later time!!
"Gold is only a hedge against inflation". First this is an incomplete statement because it does not distinguish between monetary inflation and price inflation (most people are not even aware of the difference). And gold is a hedge against inflation (first and foremost it is a hedge against monetary inflation and is one of the few asset classes to respond to it early and directly. Moreover, all monetary measures are *NOT* created equal and you must use the proper, and in fact clearer/simpler form of money measurement, to understand monetary inflation, which is the True Money Supply / TMS - see: Steve Saville: Thoughts on Monetary Inflation. M2 and M3 have *non-monetary* components and are invalid for understanding the true scope of monetary inflation/deflation) and it is also, perhaps more importantly, a hedge against financial instability / loss of confidence.
It the 1980s, we had massive inflation. However gold dropped. So there is a contradiction right there. Why? Because Volcker's policies returned confidence back to the financial markets. And the future outlook, even though it was inflationary at the time, was deemed to be bright enough that people poured back into equities and left the safety of gold. (An example of a primary cause and a secondary cause switching importance).
The case for the stagflationary scenario in the intermediate term:
I have been hammering on the topic because it is the critical issue to understand how all of the advanced economies government's action will not only fail to produce the desired effects, but will more importantly make matters worse. The main issue is Debt Saturation - http://caps.fool.com/Blogs/ViewPost.aspx?bpid=357428. It is critical to understand that an increasing debt load has decreasing marginal utility and there comes a point due to servicing requirements that all new debt has a negative economic impact. This is why we were NEVER going to be able to borrow and spend our way out of a crisis that was caused by too much debt to begin with.
This sets up an extreme deflationary environment (this debt load is unsustainable) within which the Federal Reserve will monetize unprecedented amounts of debt at unprecedented rates. Which will result in a simultaneous deflationary and inflationary outcome: stagflation. There is NEVER anything in economics and especially macroeconomics that has only one cause and one effect. There are always multiple effects with varying degrees of influence (both in absolute value and transience). There will be deflationary impulses and there will be extreme monetary inflation, the Fed will see to that. Which means that I think the most likely outcome will be a combination of the two: stagflation. Economically correlated assets go down in value (like your home and equities as a general asset class) and things you need to buy/consume (such as real assets / commodities) cost more. Really the worst of all possible outcomes.
I do think that most inflationists discount the amount of debt that is collapsing (even though most deflationists use measures like M2 and M3, which have a lot of non-monetary components to prove their point) while at the same time most deflationists discount the amount of monetary inflation the Fed can generate (they argue that the Fed creating base money is like pushing on a string because the banks don't have to lend, even though I am many others have pointed out that the Fed has gone around the banking system and has started monetizing private sector debt directly, which is a trend that is likely to increase not decrease). Most people on either side of the debate is not considering strong evidence that both forces are significant.
The case for holding gold as an optimistic endeavor:
I am bullish on the very long term prospects for the economy of the US and the world.
.... Now that might seem odd, because aren't all the people who invest in gold assuming the world will end? The answer is no, at least for this gold investor. I invest in gold not because the world might end, but I invest because I firmly believe it WILL NOT!!. If I was uber-bearish for the very long term, I would build a bunker underground, stocked with years of food and buy guns. Gold? For the end of the world? It makes no sense. Why would a useless shiny metal rock be something to collect if civilization ends?
It is the same thing with fiat currency (such as the US dollar). If you really thought the world would end, why collect little pieces of green paper with faces on it? How is that possibly useful? If there is no government to give you goods in exchange for it, then there are better items for a bunker mentality.
So I invest in gold because I am an optimist.
I am not bullish on the US government. I think they will inflate the dollar into worthlessness (or devalue it highly at least). But ultimately economies WILL recover, and I want to trade my gold in for something useful. Shares in a profitable alternative energy company, or a company the produces / distributes water from seawater to sustain drought countries, or any number of productive future endeavors.
Gold is simply a way to maintain purchasing power as the worlds economy goes through this large and needed contraction. So as an optimist, you should invest in gold :) Just my $0.02 (silver coins of course, not actual pennies ... :) )
Why I am long term optimistic and certainly no permabear:
The problem is that there are no straight lines. Not in nature and not in the systems that humans create. We as humans want to see linear realtionships, but they are a myth by and large. The world is inherently nonlinear. But more importantly, the world is cyclical. The are all kinds of very long cycles in nature: the fast 11 year solar cycle, 13 year cicadas, 26000 year precession cycle of the North Pole, etc.
There are also economic cycles that last a very long time, such as the 33 year Long Valuation wave cycle, or the 40 year Kondratiev Wave cycle.
But humans are *very* bad at picking out cycles that last more than 1 year. And we always want to extroplate linearly.
So I agree, the next several years will be marked by economic contraction. We were on a broad upswing for many decades and now we will contract for a long time as well. It does not make sense that we will just grow indefinitely with only brief pauses (1975, 1982, 2000, 2008).
But this is PRECISELY the reason why I am *NOT* a PERMABEAR
Because the world is cyclical. Nothing goes up forever, and nothing goes down forever.
Uptrends need to be corrected down. And once those corrections are complete, in both size and duration, the human race goes back to making progress.
The human race will always make net progress in all of it endeavors.
This is why the stock market will *never* go to "zero".
Every advancement, whether it is with the market or economy or any other endeavor, there is a hiatus and an appropriate retracemnet, but then the next wave will advance.
It is the reason why I am very optimistic for the future. Because after the current correction plays out (and I have layed out my case for why it is not over many times. Others don't agree with me and that is fine) the next bull run will be truly awesome.
Because it has to do with this idea of net advancement.
We do have a finite world with finite resources. But we have *unlimited* potential in how efficiently we use them. The advacements we have made in the last 100 years in all areas of science, but most importantly materials science, is nothing short of astounding.
As long as humans have the creative will to continue to learn and grow, we will never become extinct. We will face our challenges and come up with solutions. Our fate is very literally in our own hands. And I have no doubt whatsoever of the outcome.
Which makes very very long term bullish on the prospects of humanity. It also makes me very long term bullish on the prospects of human endeavors. And yes, that includes the stock market. I am not bullish for the intermediate term. Like I said above, we are in a long cycle, and that cycle is not over. But it will not go down forever.
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