Gold Begets a Meritocracy

Some investment managers may tell you to hold gold as an inflation hedge. It doesn’t work. Here’s why:

Some investment managers may tell you to hold gold as an inflation hedge.

It doesn’t work. The case for gold is primarily a case for a gold standard, and that in effect is the case for Capitalism, and a financial meritocracy.

Here’s why:

The fiat dollar itself is furthering income inequality, by putting the hurt on the poorest people in society. The Federal Reserve manages our money, and Janet Yellen is in charge of it. She wants inflation to run at 2%, which she says will create jobs.

Let’s look past the sales pitch. Driving up the cost of food and rent doesn’t help anyone, especially not the poor. It hasn’t created jobs either. Over five years past the end of the last recession, a big chunk of the workforce has totally given up looking for work. Millions more have part-time, dead-end jobs. Even though they want to work full time, many qualified people can’t find decent paying work.

Those who are lucky to still have jobs can’t save for their retirement because the banks are paying nothing on savings accounts.

The case for gold is primarily a case for a gold standard, and that in effect is the case for Capitalism, and a financial meritocracy.

Yellen is doing something, but it’s the wrong thing. She is pushing down interest rates. This helps businesses but not employees. When a business buys a machine, interest is a big part of the monthly payment, just like when you buy a car. So lower interest equals lower cost. Yellen’s plan is backfiring. She is making it cheaper for companies to replace people with robots.

The other half of income inequality is that the income of the 1% is rising. The ultra-rich don’t make most of their income from salaries, if they have a salary at all. For example Mark Zuckerberg, the guy who runs Facebook, gets paid $1 a year. He also happens to be a billionaire.

The uber-rich make their money from investments. As interest rates drop, the prices of their assets are going up like crazy. Yellen is doling out trillions of dollars to those who are eligible. How do you become eligible for the Fed’s free money? Simple. Just own bonds, stocks, and real estate. Better yet, borrow at dirt-cheap rates to buy even more (until the market crashes again).

The dollar is an ideal system for the rich and connected, the cronies. The Fed can do whatever it wants, and there’s nothing you can do.

The gold standard takes power away from the Fed, and gives it back to the people. When wages are paid in gold or silver, workers have real money in their hands. They don’t have to deposit it, unless the bank offers a fair interest rate. If not, they can take it home and put it under the mattress, and that’s what keeps the bank honest.

Gold doesn’t give the rich free money. Under the gold standard, the rich have to do what everyone else does to make their money. Work for it.

That’s the case for gold. It is, in effect, the case for a gold standard. But what about holding gold as a hedge against inflation?

The popular belief is that gold is a good hedge against inflation. Owning gold will protect you from rising prices. Is that true?

Most people define inflation as rising prices. Some economists will quibble and say technically it’s the increase in the quantity of money, however Milton Friedman expressed the popular belief well. He said, “Inflation is always and everywhere a monetary phenomenon.”

Friedman was wrong. The rising price of lattes is not a monetary phenomenon.

There you have it. The Federal Reserve increases the money supply and that, in turn, causes an increase in the price of everything, including gold. It’s as simple as that, right?

Except, it doesn’t work that way. Just ask anyone who has been betting on rising commodities prices since 2011. Certainly the money supply has increased. M1 was $1.86T in January 2011, and in March it hit $3.15T. This is a 69 percent increase. However, commodities have gone the opposite way. For example, wheat peaked at $9.35 per bushel in July 2012, and so far it’s down to $4.64 or about 50 percent. And the price of gold fell from $1900 in 2011, to $1050 late last year, or 45 percent.

Would you say that inflation is +69%, or is it -45% or -50%?

Most people look at retail prices, not raw commodities or gold. Retail prices have not followed into the abyss. Love it or hate it, the Consumer Price Index registers a cumulative 8 percent gain from 2011 through 2015 inclusive.

Let’s consider an example to help understand why. Suppose you own a coffee shop in a central business district. The city enacts a new regulation that limits the hours for delivery trucks. This forces you to pay overtime wages to your staff to unload the trucks, and of course, the carrier charges more for delivery too.

Next, the city allows poor people to stop paying their water bill. So to compensate, they raise the water rates on businesses. While they’re at it, they raise the fees for sewer, garbage, gas line hookups, fire inspections, and sign permits. The state passes a higher minimum wage law. The building inspector requires that you increase the size of your bathroom to accommodate wheelchairs, and you lose revenue-generating floor space. There are hundreds of ways by which government increases your costs.

Is this inflation?

The case for gold as an investment should not be confused with the case for a gold standard.

Not yet, costs are up but not prices. Sooner or later, all of the affected coffee shops try raising their prices. Consumers don’t necessarily want to pay more for coffee, so a few shops fail. The survivors are now charging 15% more for coffee. They have their higher prices, at the cost of lower sales volume.

The burden of government bearing down on the coffee business only increases. Every day, three constituencies conspire to drive up costs. We’ll call them the “there oughtta be a law” crowd, the “government needs more revenues” mob, and the “they served 10oz of coffee plus 4oz of ice so let’s sue them” racket.

Regulation, taxation, and litigation drive up price. Friedman was wrong. The rising price of lattes is not a monetary phenomenon (the monetary system is pressuring prices lower right now, and in my theory of interest and prices I discuss why). Rising retail prices are a fiscal, regulatory, and judicial problem.

There is no reason for the price of gold to follow retail, because there is no mechanism that connects gold to these non-monetary costs.

In other words, gold is not a hedge against inflation.

The case for gold as an investment should not be confused with the case for a gold standard.

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About the Author: Keith Weiner

Keith Weiner is president of the Gold Standard Institute USA in Phoenix, AZ, and CEO of precious metals fund manager Monetary Metals. He created DiamondWare, a technology company that he sold to Nortel Networks in 2008. He speaks and writes about free markets, money, credit, and gold.