Saturday, February 25, 2012

A Completely Dumb Attack on Gold From Warren Buffett

Warren Buffett is out with his annual letter to shareholders of Berkshire Hathaway. He continues his attack on gold. This attack is as dumb and clueless as any I have seen from an oligarch. He writes:

The second major category of investments involves assets that will never produce anything, but that are purchased in the buyer’s hope that someone else – who also knows that the assets will be forever unproductive – will pay more for them in the future. Tulips, of all things, briefly became a favorite of such buyers in the 17th century.

This type of investment requires an expanding pool of buyers, who, in turn, are enticed because they believe the buying pool will expand still further. Owners are not inspired by what the asset itself can produce – it will remain lifeless forever – but rather by the belief that others will desire it even more avidly in the future.
To compare gold to the tulip bubble is simply bizarre.

Doug French has explained the period of the tulip bubble:
As kings throughout Europe debased their currencies, through clipping, sweating or by decree, the Dutch provided a sound money policy, which called for money to be backed one hundred per cent by specie. This policy, combined with the occasional seizure of bullion and coin from Spanish ships on the high seas, served to attract coin and bullion from throughout the world. 
The end result was a large increase in the supply of coin and bullion in 1630s Amsterdam. Free coinage laws then served to create more money from this increased supply of coin and bullion, than what the market demanded. This acute increase in the supply of money served to foster an atmosphere that was ripe for speculation and malinvestment, which manifested itself in the intense trading of tulips.
It was an influx of gold that caused the tulipmania. When a money, any money, expands rapidly the accompanying price inflation causes not only investors but everyone to seek alternatives to the depreciating value of the expanding money.

Tulips, as we all understand now, was not a very wise choice. But what makes it a quite unique episode in monetary history is that it was a period when gold was the rapidly expanding money. In otherwords, people will always attempt to flee a rapidly growing currency regardless of what it is. Buffett doesn't seem to understand this. A flight from a currency into an alternative is not necessarily an "investment choice" it can be an attempt to protect purchasing power during a period of a rapidly expanding money supply, rather than an "investment".

This is why Buffett's choice of tulipmania is such a bizarre choice. Tulip investments during the mania can better be described as a flight into an investment similar to the housing bubble--an attempt to hedge against a depreciating currency by investment, rather than a move into an alternative money.

It is incorrect to say, as Bufffett does, that:
This type of investment requires an expanding pool of buyers, who, in turn, are enticed because they believe the buying pool will expand still further.
What is required is an expanding money supply. When the money supply stops expanding, prices in whatever, tulips or housing, stop climbing. When the gold expansion stopped  in Amsterdam, tulip prices stopped climbing. When Bernanke, for a brief period, stopped printing money, housing prices collapsed. Thus, it is also incorrect for Buffet to say:
Owners are not inspired by what the asset itself can produce – it will remain lifeless forever – but rather by the belief that others will desire it even more avidly in the future.
The recent housing mania certainly can not be described as a "lifeless forever" product.

Buffett goes on:

The major asset in this category is gold, currently a huge favorite of investors who fear almost all other assets, especially paper money (of whose value, as noted, they are right to be fearful). Gold, however, has two significant shortcomings, being neither of much use nor procreative. True, gold has some industrial and decorative utility, but the demand for these purposes is both limited and incapable of soaking up new production. Meanwhile, if you own one ounce of gold for an eternity, you will still own one ounce at its end.
Buffett here is using a variation of the "you can't eat gold" attack on gold. He says it has limited industrial and decorative utility. The first problem with this argument is that Buffett clearly doesn't understand how prices distribute product in an economy. There are lots of things I would like to have decorated in gold: my pen, the surface of my lap top, hell, I liked to drive through a Lincoln Tunnel that was paved in gold, I'd love for my toilet to be made of gold. The reason that these uses aren't occurring is not as Buffett would have you believe that there is limited demand for industrial and decorative utility. It is because gold has stronger demand as an alternative medium of exchange.

What is going on here is that Buffett doesn't understand Ludwig von Mises' great insight that he called the "regression theorem", all money traced back starts off with use value outside of it being a money.

As Percy Greaves wrote:
Mises explains the origin of the objective-use value of money by tracing it back step by step from the point at which it is being valued to the point where the monetary good served only non-monetary uses, an essential point preceding the first use of anything as money.

Then Buffett goes way off, he writes:

What motivates most gold purchasers is their belief that the ranks of the fearful will grow. During the past decade that belief has proved correct. Beyond that, the rising price has on its own generated additional buying enthusiasm, attracting purchasers who see the rise as validating an investment thesis.

Gold purchasers are not for the most part buying because they expect others to do so, but because they see the Federal Reserve printing more and more money, which means the price of gold will climb in terms of the depreciating dollar. It's absurd for Buffett to argue that a gold "investment" is about expecting others to start buying gold (though this is likely to occur). Gold is bought and held based on Bernanke doing exactly what he has been doing---printing more money.

Buffett goes on:

As “bandwagon” investors join any party, they create their own truth – for a while. 
Hah! As Bernanke prints and prints, he creates the truth: Gold is a superior money to central bank managed money.



16 comments:

  1. Actually, Buffet is right. Gold is a good choice when the goal is to preserve wealth. But it is a bad choice when the goal is to increase wealth.

    When the value of your gold measured in USD raises, it is likely that you didn't get any wealthier, only that the USD lost value. If you want to get wealthier in a sustainable way, you need to invest in something that creates value.

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  2. It's not dumb. It's a calculated lie based on self-interest.

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  3. What does paper do? I collect it because I know I can pass it off to some sucker to get something he produced - for now.

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  4. What would his father say? I think we all know.

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  5. For one, you can't eat paper either. But, concerning the tulip bubble, though I can't recall the source (most likely a Mises daily article), I thought the theory that indeed it was a bubble was discredited. The new theory goes to say that the growing prices for tulips concerned new species of tulips (basically the seed, or master copies), which investors bought for reproductive purposes, and far from losing money, ended with decent gains in the mass-production of the new species of tulips.

    Though I agree with a previous commenter, in believing that Buffet is not nearly as dumb or ignorant of economic theory. It's just in his interest to keep us on funny money.

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  6. And doesnt Buffet have (or had) a major play happening in silver?

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  7. Oh, but you CAN eat gold:

    New York's $25,000 dessert sets Guinness record

    http://www.reuters.com/article/2007/11/07/us-dessert-idUSN0753679220071107

    Also, do you supposed using gold nano tech in medicine is producing something with gold? A.K.A. gold being productive?

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  8. Anonymous @ Feb 25, 2012 09:09 AM

    Actually, Buffet is right. Gold is a good choice when the goal is to preserve wealth. But it is a bad choice when the goal is to increase wealth.

    That's not what Buffet said. Buffet never said gold is a good choice when the goal is to preserve wealth. What he said was that gold is essentially a Ponzi-like investment.

    When the value of your gold measured in USD raises, it is likely that you didn't get any wealthier, only that the USD lost value.

    That's one of the main reasons for buying gold.

    If you want to get wealthier in a sustainable way, you need to invest in something that creates value.

    There is no such thing as a context-free investment. All investments are in a context of specific circumstances, and when the context is Bernanke printing money, gold becomes an attractive investment.

    If you want to have people invest less in gold, you should give Mr. Ben CTRL-P Bernanke a phone call.

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  9. Fiat money doesn't do anything. You can't eat it. It doesn't produce anything of value. You can't make a substantial return in it.

    Here's what Buffet's alter ego the gold bug said:

    The second major category of investments involves assets that will never produce anything, but that are purchased in the buyer’s hope that someone else – who also knows that the assets will be forever unproductive – will pay more for them in the future. Tulips, of all things, briefly became a favorite of such buyers in the 17th century.

    This type of investment requires an expanding pool of buyers, who, in turn, are enticed because they believe the buying pool will expand still further. Owners are not inspired by what the asset itself can produce – it will remain lifeless forever – but rather by the belief that others will desire it even more avidly in the future.

    This type of investment requires an expanding pool of buyers, who, in turn, are enticed because they believe the buying pool will expand still further.

    Owners are not inspired by what the asset itself can produce – it will remain lifeless forever – but rather by the belief that others will desire it even more avidly in the future.

    The major asset in this category is Federal Reserve paper notes, currently a huge favorite of investors who fear almost all other assets, especially real estate and commodities (of whose value, as noted, they are right to be fearful). Federal Reserve notes, however, have two significant shortcomings, being neither of much use nor procreative. True, federal reserve notes have some fireplace and wallpaper utility, but the demand for these purposes is both limited and incapable of soaking up new production. Meanwhile, if you own one dollar of Federal Reserve note for an eternity, you will still own one dollar at its end.

    What motivates most Federal Reserve note purchasers is their belief that the ranks of the fearful will grow. During the last crash that belief has proved correct. Beyond that, the rising price has on its own generated additional buying enthusiasm, attracting purchasers who see the rise as validating an investment thesis.

    As “bandwagon” investors join any party, they create their own truth – for a while.

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  10. Anon. 09:09 AM: "...When the value of your gold measured in USD raises, it is likely that you didn't get any wealthier, only that the USD lost value..."

    The median price of a home priced in ounces of gold has plummeted over these last 10 years. I thought that this would be the case, that home prices would come down and that gold prices would go up. That is why we became renters in '04 and took our saving out of the stock market and put it into gold and silver. Thus, my wealth -- 90% of which is in gold and silver bullion -- as measured in home purchasing power, is skyrocketing.

    So, I disagree that holding gold or silver does not allow one to increase one's wealth. There are lots of leads and lags in important capital asset prices in times of inflation. Go look at the Weimar period and how gold skyrocketed while home and commercial real estate prices stagnated, relatively (due to imposed rent controls).

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  11. Perhaps Warren's aversion to gold is rooted in the "Ben Graham’s Curse in Gold" as David Galland wrote here: http://www.zerohedge.com/news/guest-post-ben-graham%E2%80%99s-curse-gold

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  12. People who bought gold at $250/oz have increased their wealth. In past monetary systems, you could lend gold and earn interest on it. Buffet is establishment now. Governments hate gold.

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  13. I do understand the distinction between gold as an investment, which Wenzel is saying it really isn't, and gold as a hedge against inflation/complete monetary breakdown. My only issue with gold as a hedge against monetary debasement is that you have to be able to accurately forecast that this will continue. As obvious as we regular readers of EPJ think this continued debasement is, (1) you very well could be wrong, a you would have been in the early 80s if you assumed that the gold price run up would continue, (2) if markets already share your view, then that info is in the current price. Only future debasement BEYOND what is already expected would push prices further, and trying to pro edict this is very difficult.

    Problem with gold is, if you are wrong, the consequences could be devastating (-60% cumulative from 81-00). Even from 81-11, its total return is no greater than rolling over a 1 month t-bill.

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  14. Honestly I don't buy precious metals because I want to invest... I buy it to preserve wealth. Its the only way to "save" "money".. when you have dingle berries in washington going print print print print print print, figuratively speaking. OF course its all on computer. But same thing for the most part.

    The only good thing we have going for us is the fact the USD is a reserve currency.

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  15. Wasn't it Hume who hypothesized about an angel coming down to earth and doubling everyone's money overnight? Fortunately in our age we don't believe in angels but central bankers. Anyways as I see it, if everyone's money would be doubled overnight, not everything would double in price. Some goods might increase 200%, some 100%, some 50% etc. Items with supply restraints would increase more than items whose production could respond quicker. Rembrandts would increase more than some living artist. Investments here would make you "wealthier". The other half of the equation would be goods whose demand increase as a result of increase money. If the demand increased for gold, as an alternative money, then owning gold would make you wealthier.

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  16. "Buffett doesn't seem to understand...Buffett clearly doesn't understand...Buffett doesn't understand..."

    I think the sad truth is that Buffett understands these things perfectly, which is why he can lie with such conviction.

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