Sunday 5 December 2004

Put not your trust in politicians

Thanks to Stuart Dickson for drawing my attention to this story.

The Economist proclaims that:

The financial world, it sometimes seems, is broadly divided into those who believe in gold as the ultimate currency and those who don’t. In the latter camp are most economists, the most famous of whom, John Maynard Keynes, described gold as a “barbarous relic”.
I suppose that statement is correct although I can't help pointing out that most of those "economists" have failed to provide any logical or consistent explanation of their subject, especially monetary economics. For that you need to consult these guys who are firmly on the other side of the divide.

The Economist continues:

It used to be that gold bugs touted the yellow metal’s credentials as a hedge against inflation. But the link was anyway pretty feeble, except for currencies with hyperinflation. And though consumer prices have risen a bit this year, it would be hard to make the case that inflation is about to roar anywhere in the developed world.
But the Economist is wrong: the link is not feeble. I wrote this a couple of years ago:
Since 1913, the pound has lost 98% of its value and the dollar has declined by 95%. As long as we have a fiat currency with money being created out of thin air, inflation will continue. The Austrians showed that sound money can only exist if it is 100% based on a commodity, probably gold or silver.
I don't think that losing all but 2% of your money in less than a century is unimportant. An annual inflation of 3% would wipe out half of your savings in just twenty-three years. It's no mystery why we have a pension crisis. Consider this quote:
"Regardless of the dollar price involved, one ounce of gold would purchase a good-quality man's suit at the conclusion of the Revolutionary War, the Civil War, the presidency of Franklin Roosevelt, and today."
Peter A. Burshre
I recall reading somewhere that an ounce of gold would also buy you a good-quality toga in Roman times. That's consistency. I'd rather trust gold and silver than any politician. Let's see, it's about twenty centuries since the Roman regime was at its peak. Will the Economist sell me a 2,000-year subscription at today's sterling rates?


David Farrer said...

Comments made on previous template:

Roland Watson
Some "experts" suggest 5%-10% of your portfolio in gold. I also like silver but it attracts VAT here unlike gold. 
The buy-sell spread on gold is only a a few % each way, so not bad.

23 December 2004, 14:31:31 GMT
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Squander Two
Invest in flat unpopulated land near the equator. Sometime in the next ten years, demand for it will surge. It might also be worthwhile investing in quantum ratchets, though I have no idea how one would go about doing so. 
I have a question for you clever investors. What's the minimum amount of money that is worth investing in gold? Would it be worth it with, say, £200? Or do you need at least £10000 before the benefits become more than negligable? 
(Yeah, like I've got the funds to invest in anything.)

10 December 2004, 15:25:06 GMT
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I've always thought that stamp-collecting and coin-collecting was very statist. What could be more obsequious to the faux prestige of the state than buying wee bits of paper & glue, or base metal, at hugely inflated prices, just because they have been officially sanctioned. 
Like National Savings and government bonds I would tend to avoid these "investments": it only encourages them.

8 December 2004, 05:52:48 GMT
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Neil Craig
You don't actually read them that decreases the value (I am only slightly kidding). 
Something which they arn't making any more (courtesy of Mr Twain) such as land, historical artifacts such as paintings, (comics), penny blacks etc. 
The alternative is something which pays a dividend which is more risky but probably does better on average.

7 December 2004, 22:47:19 GMT
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'My name is Dickson,I was too dim for college, and nothing that I know can be considered knowledge'. Apologies to fans of Benjamin.

7 December 2004, 13:20:48 GMT
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The fundamental questions in "The Economist" article are: 
-"Is the rise in the price of gold merely the flipside of the dollar’s fall? Or does it point more broadly to a loss of faith in central bankers’ promises?" 
It seems pretty clear that the answers are: 
1. No 
2. Yes 
In line with Friedman's preference for "...a monetary system based on a basket of commodities rather than just gold and/or silver" what commodities should investors be including in their own private portfolios to overcome the massive risks inherent in the Dollar-based system, and the novel threat to the stability of the gold-based system posed by Neil? 
(Of course we will include some comic books if Neil insists. May I read them after you?)

7 December 2004, 09:13:37 GMT
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David Farrer said...

David Farrer
I see what you mean Andy. The lender would demand increasing interest but that itself would be anticipated in the WoodWorld scenario. 
Of course in the real world no one anticipates inflation absolutely correctly. As Friedman writes: 
The effects of unanticipated or misanticipated inflation on debtors, creditors, employers and employees are all special cases of a more general principle: Inflation injures individuals with net nominal assets and benefits individuals with net nominal liabilities. 
The state itself is one of the main beneficiaries of inflation as it has net nominal liabilities. It's the poor pensioner on a fixed income or one that doesn't rise enough to keep up with prices who suffers. 
That brings us back to the desirability of a non-fiat currency system. Friedman prefers a monetary system based on a basket of commodities rather than just gold and/or silver. I have no problem with that but he still thinks that a gold standard is better than what we have now: 
Even if gold is not a very suitable commodity, it does not follow that a private system based on gold is worse than what we now have. Historical experience suggests that while a gold standard may produce either inflation or deflation, it is unlikely to produce as serious an inflation as even a relatively successful fiat system (such as our own) and that the inflations which have been produced by particularly unsuccessful fiat systems dwarf anything that might result from new discoveries of gold.

6 December 2004, 19:43:45 GMT
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Andy Wood
If I was an estate agent I would say agricultural land. 
Buy land. I have it on good authority that they aren't making any more. (Mark Twain, I believe.)

6 December 2004, 18:53:20 GMT
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Neil Craig
There may be no safety even in gold. Sometime, probably within the lifetime of most of us, somebody is going start mining a metalic asteroid (several millions of tons, 2% gold or platinum). 
My advice is invest in comic books - I have just found 50 copies of Warriors of Plasm no 1.(If I was an estate agent I would say agricultural land).

6 December 2004, 18:49:26 GMT
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Andy Wood
If you stuck your savings under the mattress they would lose half their value in 23 years. People don’t do this very often perhaps, but why should they suffer a capital loss if they did? 
But, given that it costs almost nothing to deposit cash in an interest bearing account, I don't see this as being a significant problem. It's only in a world with a zero or negative nominal interest rate (which would also have a negative inflation rate) where it's sensible to keep your assets in cash. (Unless, who knows?, your hobby involves carrying suitcases full of cash to Bermuda.) 
That would compensate the lender for the loss of his capital but he would also lose some of the real value of his income (the 2%) as inflation affected that too. If the monetary authorities “accommodated” this extra demand for money there would be further inflation ad infinitum. 
No, I don't agree with this either. Wages, like other prices, will increase at the rate of inflation, provided that the inflation is anticipated, so those losses will be compensated too. 
Like I said, it's unexpected inflation that's the real problem, so a worker will lose out if he accepts a job offer on the assumption that inflation will be 0%, but turns out to be 3%. 
Yet more further reading from David Friedman:

6 December 2004, 17:34:24 GMT
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David Farrer said...

Andy Wood
No, I don't agree. The higher interest rates in the inflationary world do compensate for the devaluation of your investment. Consider the two worlds 0% inflation, 2% interest rate and 3% inflation, 5% interest rate. 
After 1 year, £100 in the bank will become £102 in world 1, and £105 in world 2. Suppose now that a widget initially costs £1. In world 1, it will still cost £1 after a year, and your deposit will buy you 102 widgets. In world 2, it will cost £1.03, and your deposit will still buy you 102 widgets. (There is a small error in those numbers due to my using discrete rather than continuous compounding, but it illustrates the point.) 
The purchasing power is identical in both worlds. The fact that the compensation comes via interest payments from your bank doesn't change that.

6 December 2004, 17:06:52 GMT
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David Farrer
Yes, interest calculations would make a difference to what I said. If you stuck your savings under the mattress they would lose half their value in 23 years. People don’t do this very often perhaps, but why should they suffer a capital loss if they did? 
You said that: So, if the interest rate was, say, 2% in a world with no inflation, it would be 5% in an otherwise identical world with 3% inflation. Therefore, the devaluation of your investment would be exactly compensated by the additional interest that it earns. 
That would compensate the lender for the loss of his capital but he would also lose some of the real value of his income (the 2%) as inflation affected that too. If the monetary authorities “accommodated” this extra demand for money there would be further inflation ad infinitum. 
I think we’re sort of in agreement now!

6 December 2004, 16:25:08 GMT
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"My late uncle owned a quarter of a racehorse" 
A sound investment. If nothing else, it'll keep you fed for a couple of days (depending on exactly which quarter you get, of course).

6 December 2004, 13:47:22 GMT
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David Farrer
My late uncle owned a quarter of a racehorse and he (the uncle!) seemed very happy with life.

6 December 2004, 10:40:57 GMT
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Surely the wisest thing to do is spread your risks. 
I like David's reasoning when it comes to sticking a bit of money away in precious metals; but I feel happier holding some equities, bonds, property, cash, racehorses or whatever too.

6 December 2004, 09:49:17 GMT