Investing in gold

The reasoning of Warren Buffet about the value of gold in his letter to the shareholders of 2011 is not a correct one. He compared a stock of gold with an investment in companies and concluded that gold has no productive value and so you could better invest your money in these companies. He mixed up a number of economic concepts.

Some theory first. Goods and services are the output of the economic system. Natural resources, human labor and capital are the input factors. The system is reciprocal, or otherwise stated, the outputs are exchanged against the inputs. To accomplish this process the concept of purchasing power is invented. Purchasing power is the reward one receives for participating in the production process. This reward is used in turn to buy the output of the production process. This reciprocal process has some similarities with the law of conservation of energy.

In a market economy the relative prices for goods, services and the input factors are determined only by demand and supply relationships. That is on relative scarceness. To facilitate the exchange of purchasing power against goods and services the concept of money has been invented. Money can take different forms, but its main role is that its value must be preserved over time. Money is a store of value.

Warren Buffet looked at gold as an investment in a company. He should have looked at it as a store of value. The value of gold does not come primarily from its production value, but from its attractiveness as a store of value. This attractiveness is mainly based on its ability to replace current paper money.

To understand the growing attractiveness of gold compared to paper money one must understand another important part of the economic system as it exists nowadays. An ever growing part of the system is not based on the reciprocal market based production process as described above, but on public controlled spending. As long as the public spending is financed by the purchasing power earned in the market economy, through taxation, nothing goes wrong. Instead of spending this money on an individual base, it is spent by the society as a whole. Things goes wrong if the spending is based on deficits. Now government throws in new money which is not related to purchasing power. We see the debt levels of states are growing rapidly over the years. We see at the same time price levels rising in the economy and less and less real economic growth. More and more public spending is needed to keep the economy from collapsing. This is the result of the destructive impact of the parasite nature of governmental spending.

Finally a last way out is a default on the debt, and deflating of all the assets in the economy. This deflating of assets is against other money, normally foreign currencies (if there are any left) and gold.

As of today it looks that all countries (currencies) are in the same situation, and this makes gold so attractive as the last resort for a store of value.

So, if you had your savings of 100K USD invested in Berkshire Hathaway, and at the day of reckoning, the USD devaluates 50% against the money power of gold, then of course your investment in Berkshire Hathaway devaluates with the same percentage. Nothing intrinsically changed with this investment, only the true purchasing power of your 100K turned out finally to be only 50K. All the rest was a bubble caused by public spending. So, at this point in time you can still turn your 100K into true value preserving purchasing power of 100K by putting it in gold.

That unique opportunity did Warren Buffer not tell to you.

April 2012