Gold does nothing, and as Warren Buffett said in his recent annual report:
Today the world’s gold stock is about 170,000 metric tons. If all of this gold were melded together, it would form a cube of about 68 feet per side. (Picture it fitting comfortably within a baseball infield.) At $1,750 per ounce – gold’s price as I write this – its value would be $9.6 trillion. Call this cube pile A.
Let’s now create a pile B costing an equal amount. For that, we could buy all U.S. cropland (400 million acres with output of about $200 billion annually), plus 16 Exxon Mobils (the world’s most profitable company, one earning more than $40 billion annually). After these purchases, we would have about $1 trillion left over for walking-around money (no sense feeling strapped after this buying binge). Can you imagine an investor with $9.6 trillion selecting pile A over pile B?
Beyond the staggering valuation given the existing stock of gold, current prices make today’s annual production of gold command about $160 billion. Buyers – whether jewelry and industrial users, frightened individuals, or speculators – must continually absorb this additional supply to merely maintain an equilibrium at present prices.
A century from now the 400 million acres of farmland will have produced staggering amounts of corn, wheat, cotton, and other crops – and will continue to produce that valuable bounty, whatever the currency may be. Exxon Mobil will probably have delivered trillions of dollars in dividends to its owners and will also hold assets worth many more trillions (and, remember, you get 16 Exxons). The 170,000 tons of gold will be unchanged in size and still incapable of producing anything. You can fondle the cube, but it will not respond.
Admittedly, when people a century from now are fearful, it’s likely many will still rush to gold. I’m confident, however, that the $9.6 trillion current valuation of pile A will compound over the century at a rate far inferior to that achieved by pile B.
Buffett misses the point on gold, something he doesn’t often do in economic matters. Gold is valuable because it is beautiful, and it can’t be used for much aside from beauty. Gold can only be used for things that are not necessary (with a few small exceptions), and is thus a luxury item. Wait, doesn’t Buffett own a scad of jewelry stores, and he doesn’t get this? Jewelry is not a necessity, but something to please those we love with something of beauty.
Beyond that, gold is divisible, easily melted down, and doesn’t weigh a lot relative to its value. It is an ideal store of value.
Gold does nothing, and that’s good. We need some things in this hectic world that do nothing. What is the value of doing nothing?
Quietness. Pause. Repose. Reflection. Measurement Standard.
Fiat currencies change every day, and the price of gold relative to chose currencies changes similarly. Gold doesn’t change; it’s like God in that way. We don’t measure it. Because it doesn’t change, it measures us, because we do change.
I’m not a gold bug. I own no gold, aside from my small wedding ring and few other odd bits of jewelry. But there is a lot of value to a pretty commodity that has little usefulness aside from beauty. Think of silver for a moment. Whether in electronics or photography it has significant industrial value. Though both are used as currencies, and stores of value, silver responds more to the economy, and gold just sits there.
Maybe that’s what Robert Zoellick meant when he talked about gold as a reference point for the global economy. Unlike fiat currencies, which are manipulated by finance ministries and central banks, gold can’t easily be manipulated. Gold is the measuring rod of economics, whether we like it or not.
That brings me to Eddy Elfenbein’s Gold model, and my refinement of it. Gold reacts to real interest rates. As real interest rates rise, gold falls, and vice versa. Think of it this way: when real interest rates go down, there is less loss to holding gold, because fiat currencies suffer from financial repression.
Gold can’t easily be repressed; it is far less susceptible to government manipulation because it is something real and tangible — far harder to manipulate.
Some have suggested that gold could back the currencies of major emerging markets, and I think that would be a good idea, but I think none of the large emerging markets except Russia would dare or even want to do it. Statists like fiat currency, because it gives them one more lever of control over those that they rule. Gold-backed currencies are for limited governments, and in general, most emerging market governments don’t think that way.
With Mr. Buffett, I will agree, I would rather have the businesses and the farmland [pile B]. They will likely be more valuable in the long run than the gold. But I might take the $1 trillion of “walking around money,” and use it to buy 10% of the cube of gold [pile A], leaving me with a piddling $40 billion of walking-around money. I might look at the gold, and think how beautiful it is.
Fondle it? Nah. Just admire how unchangeable it is. Businesses change; technologies obsolete whole industries as they create new ones. Companies can be mismanaged, or outcompeted. Very few last longer than a generation; they change a lot, and require constant management.
Farmland depletes unless you take the time to maintain it, and cheap potash supplies are getting scarce. Besides, perhaps one of my great-grandchildren will note 100 years from now how the global economy has a hard time with the population shrinking globally. At that point, with less pressure to increase yields, farmland might not be as valuable. I’m not predicting this; it’s only possible — I’m only saying that arable land, another really scarce resource in the world could in some scenarios become less valuable in real terms.
The real value of the gold would be as a hedge against governments and central banks that financially repress their populations by holding interest rates, making it difficult for savers to preserve value. And that’s what gold does best, preserving value, as it sits there, beautiful, doing nothing.
So, when governments and central banks debase their currencies, as in the ’70s, the 2000s, and create conditions where real interest rates are negative, gold flies in terms of the debased currencies, and then crashes back down if you get a Paul Volcker-type, and policy normalizes after a lot of pain, which this generation seems unwilling to take. Until it does take the pain, there will be the tendency for gold to go higher, and more so, if real interest rates remain negative.
So, sit back and and watch the gold measure the policies of governments, central banks, even us. Gold does nothing except sit there and look beautiful, and that’s what makes it so valuable.