David Einhorn made an excellent speech to the Value Investors Conference:
On the anniversary of Lehman’s failure, President Obama gave a terrific speech. He said, “Those on Wall Street cannot resume taking risks without regard for the consequences, and expect that next time, American taxpayers will be there to break the fall.” Later he advocated an end of “too big to fail.” Then he added, “For a market to function, those who invest and lend in that market must believe that their money is actually at risk.” These are good points that he should run by his policy team, because Secretary Geithner’s reform proposal does exactly the opposite.
The full taunting can be found by reading the speech; I am just happy to note the substantial overlap between his themes and the arguments I have been making over here. Does that mean there is something to Einhorn’s support of gold?
When I watch Chairman Bernanke, Secretary Geithner and Mr. Summers on TV, read speeches written by the Fed Governors, observe the “stimulus” black hole, and think about our short-termism and lack of fiscal discipline and political will, my instinct is to want to short the dollar. But then I look at the other major currencies. The Euro, the Yen, and the British Pound might be worse. So, I conclude that picking one these currencies is like choosing my favorite dental procedure. And I decide holding gold is better than holding cash, especially now, where both earn no yield.
Gold is an odd investment. It trades – even in less tumultuous times – completely out of any relationship with its metallurgical properties; unlike some exotic and rare metals that justify their expense by delivering tremendous benefits, gold has limited industrial use. It has some value as decoration, but largely sits tucked away in ingot form in vaults. Essentially, we dig it at great expense from South Africa and Peru and bring it west and bury it again at great expense.
We do this because we have done this. Why is gold a hedge against instability or poor governance? Because it has been, and people assume that it is in accordance with some immutable law. If Easter Islanders ran the world, perhaps we would race to invest in large rock heads.
To go back to Einhorn’s logic, the reason he is getting into gold is not that he has a new belief in shiny metal, it is that he has an increasingly dim view of the management of our currencies. On this point, it is hard to disagree.
Krugman’s original criticism of the enduring popularity of gold contrasted the active management of monetary policy with the passive approach of simply allowing gold demand to dictate an entire economy. Fair enough. But what if the outlier is the success of the fiat currency system?
Representative democracy only works so long as the majority refrains from voting to seize the minority’s stuff (in other countries, money, in the US, typically rights of some sort). There is a world of gray between giving voice to the beliefs and values of a culture and simply following the passions of the masses, and many countries have run aground. Why would central banking be any easier?
If the US had been on the gold standard – or the oil standard, or the silver standard, or any other external metric – we would never have been able to pump such an enormous amount of money into the economy. It would have been blindingly obvious that the US could never get that much stuff and would need to default when the bill came due. With the dollar, however, it is clear that we will print enough dollars to constantly declare ourselves current; the question is how significant the debasement of the original currency will be, and that is much more difficult.
A good economist – Krugman, for example – would argue that this is precisely the point; a gold standard economy would be in a far, far deeper recession than we currently find ourselves. On the other hand, a gold standard economy would limit the intergenerational loss of wealth; the suffering would be borne by those on earth today, not their children or grandchildren. And it would make it rather more difficult to use the opaque tunnels that have defined this particular series of government interventions.
Note the mechanism the government has used to prop up the economy: subsidizing the large banks. When the government gives Wells Fargo access to capital at a near-zero interest rate, it is doing Wells Fargo a favor. Wells can turn around and lend the money for near-zero…but why would it do that, unless all of its competitors price to this level? In a world of banks teetering on the edge and consumers who are untrustworthy, the clearing price for debt will be high. Furthermore, Wells is not forced to continue to buy California real estate. It can take its virtually free dollars and buy up items it finds more scarce and valuable than future, fixed dollars (the outcome of a newly minted mortgage): finite resources, and the currencies most closely linked with them (Australian, Canadian, and New Zealand dollars, Brazilian reals).
If providing these gifts required trucking shiny metal to San Francisco, the public might object. But when the gifts are delivered via obscure acronyms and monetary policy, who is to know? There is a vague sense that the government has spent a lot of money and many people who live at a remove from the finance industry have not drunk from the well, but in the typical American optimism, that largely creates demand for additional programs. Will the government be able to bear down and get religion? When has it shown this level of discipline?
For years, the discussion has been that our deficit spending will pass the costs onto “our grandchildren.” I believe that this is no longer the case and that the consequences will be seen during the lifetime of the leaders who have pursued short-term popularity over our solvency…To slightly modify Alexis de Tocqueville: Events can move from the impossible to the inevitable without ever stopping at the probable.