This article was originally published by The Human Events Group on July 3, 2014
We have proposed a system for electronic transactions without relying on trust. – Satoshi Nakamoto, 20091
With this fairly mundane comment, the person or persons known as Satoshi Nakamoto (the jury is still be out) introduced bitcoin to the world. Since then, bitcoin has attracted widespread attention and interest – as well as numerous critics. Ironically, some of its most vocal detractors, such as Austrian economist Frank Shostak and financial commentator Peter Schiff, are champions of gold. As fiat currencies (money which exists solely due to the force of law, i.e., by fiat) further decline in value, will investors increasingly embrace a cryptocurrency such as bitcoin, or will they revert to the historically tried-and-true precious metals? Will it be bitcoin or gold?
As the values of bitcoin and gold are primarily contingent on their future acceptance as money, answering the question “bitcoin or gold” requires an examination of a more basic inquiry: what is money? Money is a medium of exchange and, as such, presupposes the ability to act as a store of value. Over two thousand years ago, Aristotle noted the primary qualities exhibited by money:
Portability
Durability
Homogeneity, and
Divisibility.
Money should also, at least before becoming accepted as money, possess “alternative value.” This term is unfortunately sometimes referred to as “intrinsic” value (as nothing possesses value without demand, nothing is intrinsically valuable).2 Gold, (and to a lesser extent silver) possesses these qualities and was therefore used as money until quite recently (1971). Bitcoin critics who are proponents of gold cite its lack of alternative value as a fatal flaw.
But is it? True, unlike gold or silver, bitcoin cannot be used for a non-monetary purpose. Perhaps this is not a weakness, but rather a strength. As bitcoin lacks physical form, it lacks alternative value, but herein lies its unique attribute relative to gold – there is nothing to physically transmit. In the characteristic of portability, it easily exceeds gold’s virtues.
Does this mean that bitcoin is no different than any fiat money which can be transferred with a computer keystroke? No, as its usage derives from general acceptance, not mandate.
And unlike the experience of all fiat currencies throughout time, bitcoin is limited in quantity (it is designed so only 21 million bitcoins can ever be “mined” into existence). Nakamoto remarked that in creating bitcoin he had removed trust. But more accurately, he removed faith and fortified trust, for just as gold and silver use nature (their elemental physical characteristics) as an objective standard, so bitcoin utilizes math (cryptography).
The question of what ultimately may be the future of money may be “bitcoin or gold?”, but perhaps the answer should be bitcoin and gold. For millennia, gold and silver coexisted as money, so why not bitcoin as well? Bitcoin is so unique in the history of money, and so complementary to gold, that one day in the future, it – or some other cryptocurrency (assuming they survive government regulation and financial repression) – may become more than today’s speculative investment.
2 For a real life example of the importance of “alternative value” as a quality of money, see “Only Criminals Use Honest Money” by Christopher Casey as published by the Mises Institute. <https://mises.org/library/only-criminals-use- honest-money>.
About the Author:Christopher P. Casey is a Managing Director with WindRock Wealth Management. Mr. Casey advises clients on their investment portfolios in today’s world of significant economic and financial intervention. He can be reached at 312-650- 9602 or chris.casey@windrockwealth.com.
WindRock Wealth Management is an independent investment management firm founded on the belief that investment success in today’s increasingly uncertain world requires a focus on the macroeconomic “big picture” combined with an entrepreneurial mindset to seize on unique investment opportunities. We serve as the trusted voice to a select group of high net worth individuals, family offices, foundations and retirement plans.
All content and matters discussed are for information purposes only. Opinions expressed are solely those of WindRock Wealth Management LLC and our staff. Material presented is believed to be from reliable sources; however, we make no representations as to its accuracy or completeness. All information and ideas should be discussed in detail with your individual adviser prior to implementation. Fee-based investment advisory services are offered by WindRock Wealth Management LLC, an SEC-Registered Investment Advisor. The presence of the information contained herein shall in no way be construed or interpreted as a solicitation to sell or offer to sell investment advisory services except, where applicable, in states where we are registered or where an exemption or exclusion from such registration exists. WindRock Wealth Management may have a material interest in some or all of the investment topics discussed. Nothing should be interpreted to state or imply that past results are an indication of future performance. There are no warranties, expresses or implied, as to accuracy, completeness or results obtained from any information contained herein. You may not modify this content for any other purposes without express written consent.
Almost no debate, short of religion and politics, will solicit as strong of views as the topic of gold. While many in the mainstream investment community dismiss gold as an outdated and irrelevant, we strongly believe that gold’s re-emergence in the minds of investors is just beginning. The grim lessons of history suggest to us that when countries consistently outspend their means and print money to fill in the shortfalls, they risk a crisis of confidence in their currency system itself. Throughout history, investors have turned to gold as a store of value in times of turmoil to protect their wealth from the inflation caused by declining paper currency values.
Precious metals, both gold and silver, were the anchor of our monetary system for most of human history, keeping money stable and inflation subdued other than during brief periods of war and in instances where countries strayed from precious metals backing their currencies. Empires such as the Roman Empire originally transitioned from bartering physical goods to trading gold and silver coins. However, safely storing excess savings of coins poised a problem. By Medieval Europe, it became common for those with gold and silver savings to store them in the safekeeping of a goldsmith, who was in the trade and offered secured vaults. People would get paper receipts redeemable for their gold at any time. This began the movement toward paper as the medium of exchange. By the 17th century, it was common for governments themselves to issue paper currency directly and hold gold in their own vaults to back its value, replacing the role of the goldsmith.
Each step along this evolution, the end user became more and more separated from the precious metals that they once directly owned. However, in all of these iterations, people trusted that paper currencies would retain their value due to their backing of gold. This “gold standard” also restricted the ability for bankers and politicians to print money without having the actual gold in vaults to back its value. This system was the anchor of our modern global economy until 1933, which marked the beginning of the end for stable money. In the midst of the Great Depression, President Roosevelt confiscated gold from citizens and devalued the US dollar, breaking the long history of stable money. Following World War II, the US dollar became the world’s reserve currency or chosen international currency. In simple terms, this happened because we won the war and set the rules under the Bretton Woods agreement. Under this quasi-gold standard system, dollars were used for trade, but foreign governments could demand their gold by redeeming dollars at any time.
But what 1933 began, 1971 finished. In a speech that will one day be viewed as a critical moment in the history of money, President Nixon removed the final constraint to open-ended money printing by disallowing even foreign governments from redeeming their dollars for gold. This represented the final break of currency from its historic backing to gold. Despite claims that this would not lead to a devaluation of the dollar, the dollar lost over 95% of its value versus gold since that day! To view Nixon’s speech and learn more about gold’s history, view our featured video: Gold, Government and a Game Plan at www.windrockwealth.com.
Many do not realize that our current currency regime of fiat money (i.e. not exchangeable for gold) only dates back to 1971, and thus, is largely untested. Separating our currency from gold led to a massive distortion in trade since that time. Under the historic gold standard, a country’s trade was limited to the amount of gold they had saved as a means to purchase goods from other countries. When they consumed (or imported) more relative to what they produced (or exported), their gold ran low and they had no choice but to start producing more than they consumed to rebuild their stock of gold. This mechanism kept world trade in balance and prohibited countries from consuming beyond to their means.
With this gold anchor gone, countries like the US were allowed to consume well beyond their means. The US imported much more than they exported by giving the world I.O.U.s in the form of US dollars, well exceeding the amount of gold they could have exchanged for those goods. In other words, under a gold-standard the spending spree of US consumers would have run dry years ago as our vaults of gold went empty! However, as long as the rest of the world accepted these I.O.U.s instead of gold, it led to global trade on steroids. The US could consume beyond its means and other countries could sell more of their goods to hungry US consumers. However, this arrangement was not without consequences. The debt-fueled growth has led to swelling debt levels and dangerous imbalances in world trade that cannot persist.
Investors’ faith in the system has been waning as the separation from gold has led to a worry about the future value of currencies. In addition, the massive overspending by the US and other developed nations has led to unprecedented debt levels and a worry about its impacts on the global banking system. Today’s global banking system is already highly leveraged by design under a fractional-reserve system. This means that banks only keep a small fraction of depositors’ money on hand, lending the rest out. For every $100 deposited, the bank may only have $10 on hand. Thus, if more than 10% of customers demanded their money, the bank would not be able to deliver. In addition to the leverage inherent in fractional-reserve banking, banks have further leveraged their balance sheets by making dangerous bets in financial markets. A growing moral hazard mentality has polluted banking given that their bad bets are bailed out by the taxpaying public, but their gains accrue to the benefit of bank executives and shareholders. Banks have transitioned from being traditional lenders to opaque Wall Street trading firms. Some reports suggest that JP Morgan alone has exposure to financial derivatives exceeding the entire world gross domestic product! In short, our banks are a faith-based system. The bank runs in the Great Depression and the near-bank run of 2008 highlight the weakness in this system. Given these realties today, the global banking system remains fragile and subject to governments confiscating the wealth of depositors as the European Union has done in Cyprus.
History suggests that investors seek the safe haven of precious metals – both silver and gold – when their trust in the system falters and the security of the banking system comes into question. Despite a pause in concerns over the banking system for the moment, the forces of continued money printing and reckless overspending suggest to us that the dangers of 2008 are not behind us. As investors contemplate the likely end-game of multiplying government debts, continued overspending and unbridled money creation, we think they will increasingly turn to gold.
Brett K. Rentmeester, CFA ®, CAIA ®, MBA is the President and Chief Investment Officer of WindRock Wealth Management (www.windrockwealth.com). Mr. Rentmeester founded WindRock Wealth Management to bring tailored investment solutions to investors seeking an edge in an increasingly uncertain world. Mr. Rentmeester can be reached at 312-650-9593 or at brett.rentmeester@windrockwealth.com.
All written content on this site is for information purposes only. Opinions expressed herein are solely those of WindRock Wealth Management LLC and our editorial staff. Material presented is believed to be from reliable sources; however, we make no representations as to its accuracy or completeness. All information and ideas should be discussed in detail with your individual adviser prior to implementation.
Gold serves a unique role in investment portfolios, not only as insurance against extreme events, but as a timeless store of value in a world of multiplying paper currency. Why own gold? In simple terms, gold has been a store of value for thousands of years because it has retained its purchasing power while “fiat”
currencies, which are promises unbacked by precious metals, have eventually been overprinted and seen their value diminish or completely disappear. Gold is a currency that has no liabilities, is outside of the fragile global banking system, and cannot be printed out of thin air like other currencies. Gold is a particularly important asset to own when money is being printed as carelessly as it is today. Policy actions today heavily increase the odds of more extreme events in the future that should be keeping all investors up at night. Many investors view gold as “insurance” against extreme scenarios, which we address below. While true, they miss the multiple scenarios for owning gold, not all of which involve an extreme outcome to recommend it as a key holding.
Extreme Scenarios
Banking Crisis or System-Wide Collapse – Is a renewed banking crisis a valid concern to worry about today? Absolutely. The world was on the verge of the largest global banking collapse in modern history in 2008. Trillions of dollars were printed to paper over the problems, but the central issues still remain. At the center is the fact that modern-day banks act more like highly leveraged hedge funds than traditional lenders. With financial derivatives nearing 10 times global gross domestic product (i.e. GDP), the global banking system remains highly leveraged and susceptible to any spark that could ripple through the system.[1] A new worry has emerged for savers as the recent “bail-in” in Cyprus led to the seizure of nearly 50% of deposits held by savers over €100,000. Many other countries are working on legislation that may allow for future bail-ins as well (including the Europe Union, Canada and the U.S.). With this risk in mind, the idea of holding cash at a bank where it earns 0% and could someday be seized makes gold held outside of the banking system an increasingly attractive alternative for concerned savers. As the entire developed world continues to print money to manipulate markets higher in the absence of healthy organic growth, the risks of a systematic global banking crisis continue to rise. However, we believe that policy makers looked over the cliff of a global banking crisis in 2008 and decided they would print as much money as necessary to avoid that fate. Thus, events moving us closer to a banking crisis actually increase the odds for the opposite outcome – that policy makers print even more money, aiding the banks, but panicking investors about inflation.
Central banks have one potential “ace in their pocket” if we see renewed banking scares, but it is not a card they want to play. If a banking crisis lies ahead, policy makers will be desperate to do whatever they can to restore faith in the system. If the printing of money fails to deliver stability, then the reinsertion of gold into the currency system could be their Plan B. Napoleon successfully reinserted gold into the failing currency system during the French Revolution to restore faith. He stated “while I live I will never resort to irredeemable paper.”[2] In our opinion, policy makers would only take this action in a worst-case scenario where they have lost control of the system. As we discussed in our earlier pieces, re-backing the dollar with gold (as an example) at ratios similar to the 1930s could propel gold upwards of $8,000 per ounce.[3]
Loss of Faith in Currencies – If one extreme is a banking crisis and corresponding credit crunch, then the other extreme is a loss of faith in the fiat money system itself, a condition known as “hyperinflation”. History suggests that once central banks start printing money of significant magnitude, it is very hard to reverse course. This is because the effects of printed money serve to prop markets up artificially. Ultimately, policy makers get backed into a corner where the act of pulling back the support of easy money risks collapsing the overleveraged system from artificial levels. We believe this is the dilemma policy makers are facing today as they have become the buyer of last resort in many markets. For example, the Federal Reserve is now the buyer of over 90% of all newly issued treasury bonds, which has artificially suppressed interest rates and led to other assets rising on the opium of cheap credit.[4] At some point, the continued manufacturing of money out of thin air risks hitting a psychological breaking point. People may suddenly wake up to the reality that newly printed money is diminishing the value of their existing money. If history is a guide, the response is to swap their currency into hard or tangible assets as an alternative store of value since these assets are in relatively fixed supply versus the exploding supply of currency. At this point, the rate at which money changes hands in the economy (i.e., the velocity of money), which has been subdue since 2008, suddenly skyrockets and inflation soars. “Not worth a Continental” is a phrase many investors have heard before, but too few know its historical relevance. America’s Revolutionary War-era currency, the Continental, was issued in an amount equal to one dollar. By 1779, after being overprinted to fund war with England, it was worthless.[5] Weimar Germany after World War I is the poster child of this risk. They faced plunging their economy into a depression by stopping the printing presses, so they ultimately chose to print more money. For a period of time, it appeared to work. Their actions propped up the system, reduced unemployment, and gave the appearance of growth, until it ultimately buckled under its own weight and collapsed. Adam Fergusson, in his book When Money Dies: The Nightmare of the Weimar Collapse, wrote:
Money is no more than a medium of exchange. Only when it has a value acknowledged by more than one person can it be so used. The more general the acknowledgement, the more useful it is. Once no one acknowledged it, the Germans learnt, their paper money had no value or use.[6]
Investors today must recognize that we are conducting the largest monetary experiment in modern history with unknown consequences. We are not suggesting that these extreme scenarios are likely outcomes. However, we are suggesting that, in today’s uncertain world dominated by money printing and government manipulation, these scenarios require a serious level of understanding. Despite shielding their views from the investment public at large, our experience suggests the smartest investment minds speak of these fears behind closed doors.
Moderate Scenarios
Shortage of Physical Gold — There is compelling evidence suggesting that there is not enough physical gold relative to the amount of paper contracts written on it today. Some reports suggest that as many as 100 contracts of paper gold exist for every one bar of physical gold.[7] To benefit from this, investors do not need an extreme outcome to see the value of gold unlocked, but they do need to own the actual physical metal. Many investors think they own gold, but what they actually own are paper contracts with no ability to receive the actual physical gold. Recent actions by global banks such as ABN AMRO are early warnings that cracks may be developing in the gold market. They defaulted on delivering physical gold to clients who owned it (instead redeeming them in cash).[8] These paper claims dwarf the amount of physical gold that can be found at today’s prices. Paper claims include most precious metals mutual funds and exchange traded funds (“ETFs”) and gold held in “unallocated” bank accounts (i.e. those not held in the legal title of the account holder, but commingled with other investors on the balance sheet of a financial institution). Prospectuses of most ETFs allow redemption in cash to investors. Thus, this could result in an investor being redeemed out of their gold holding at an inopportune time well before gold reaches its peak value. The gold market mimics the fractional-reserve banking system in that a small amount of physical gold underlies many paper claims. As more investors realize this, there could be a scramble to secure the actual physical gold, driving prices up significantly. Under these conditions, we’d expect a wide premium to develop benefitting physical gold over paper claims on gold that can’t deliver the underlying metal. Compounding matters is the fact that gold is commonly leased out by central banks around the world. This makes it hard to accurately analyze who actually owns the gold as messy international accounting rules allow more than one party to claim the same gold on their respective balance sheets. Leading investment minds, such as Eric Sprott of Sprott Asset Management, have extensively investigated this issue, posing the question, “do western central banks have any gold left?”[9] We believe there is much less physical gold available than meets the eye – at least at today’s prices.
The physical shortage will accelerate as more investors include precious metals as a component of their portfolios. In addition to investor demand, governments around the world continue to increase their holdings of gold, especially countries like China where gold represents only a small portion of their reserves today. For those that doubt the viability of gold as an asset, it is instructive to see what the governments of countries bailing out other weaker countries generally require for collateral – a country’s gold! There is also a camp of thought suggesting there could even be a hidden game underway today, orchestrated by policy makers. Central banks may be active in suppressing the price of gold in the paper derivatives markets as they quietly accumulate physical gold on the cheap. Some believe that once they own the majority of physical metal on their balance sheets, they will cease these actions and gold will be revalued suddenly, perhaps over a weekend. This would suddenly give them a valuable asset to offset many of their liabilities. If this is true, the problem is that too few investors will be holding any physical gold at the time to benefit.
Hedge Against Inflation – Without having to assume any type of extreme scenario, gold will be a good investment if the world keeps printing money to try and solve its problems. We believe they will keep printing as the lessor of evils. Printing money will lead to a decline in the value of currencies versus gold, stoking inflation as devalued currencies buy fewer goods. This is the number one reason to own gold – as a hedge against central bank risk and the overprinting of money. We believe that irrespective of money printing ahead, the reckless printing since 2008 already makes currency devaluation versus gold a high probability event. Historical data suggests that inflation often follows money supply growth, but with a lag. Since 2008, we have increased the money supply upwards of 260% in the US.[10] In addition, we are currently printing approximately $1 trillion dollars a year as our long-term liabilities continue to grow out of control. To us, this suggests a high risk of inflation ahead at a time when inflation-protected investments are very cheap and unloved by investors.
In closing, gold is not a one-trick pony. Own gold for the likely moderate scenarios, but rest assured that gold is the best asset if we get pushed to the extremes.
Brett K. Rentmeester, CFA ®, CAIA ®, MBA is the President and Chief Investment Officer of WindRock Wealth Management (www.windrockwealth.com). Mr. Rentmeester founded WindRock Wealth Management to bring tailored investment solutions to investors seeking an edge in an increasingly uncertain world. Mr. Rentmeester can be reached at 312-650-9593 or at brett.rentmeester@windrockwealth.com.
All content within this article is for information purposes only. Opinions expressed herein are solely those of WindRock Wealth Management LLC and our editorial staff. Material presented is believed to be from reliable sources; however, we make no representations as to its accuracy or completeness. All information and ideas should be discussed in detail with your individual adviser prior to implementation.
Are Gold Stocks Good Long-Term Investments?
Today, many mainstream financial pundits fail to see gold and silver mining stocks as viable investments. Inappropriately, they blindly compare gold stock returns with various broad stock index returns since 2008 which leads to erroneous conclusions.
But others disagree. WindRock recently moderated a panel discussion that featured Peter Schiff, Doug Casey, and Adrian Day on the appropriate role and opportunity gold and silver mining stocks represent.
The panel discussion addresses such questions as:
Why comparing gold and silver mining stock returns with broad stock market indices can be misleading;
Which investment criteria investors should utilize in selecting gold and silver mining stocks;
When physical gold and silver should be considered instead of gold and silver equities; and
