Beware the Gold Bug

Early in the financial crisis, the satirical web-site The Onion published this fake news story, titled "Recession-Plagued Nation Demands New Bubble To Invest In."

A panel of top business leaders testified before Congress about the worsening recession Monday, demanding the government provide Americans with a new irresponsible and largely illusory economic bubble in which to invest. "What America needs right now is not more talk and long-term strategy, but a concrete way to create more imaginary wealth in the very immediate future," said Thomas Jenkins, CFO of the Boston-area Jenkins Financial Group, a bubble-based investment firm. "We are in a crisis, and that crisis demands an unviable short-term solution" . . .

That bubble has now arrived here in the real, non-satirical world: It's gold.

The price of gold has zoomed past US$1,000 an ounce, reaching an all-time record of US$1,070 on Wednesday. Suddenly, talk radio and cable television are jammed with ads urging small investors to buy coins and bars. One vendor pushes its product with this amazing slogan: "Gold has never been worth zero!" (You'd think the more relevant question might be: "Has gold ever been worth less than I'm about to pay for it?")

If you must speculate, do yourself at least this favour: Don't buy what the market loves.

Gold is a strange investment vehicle. If the typical small investor were to hear a pitch for investment in copper, zinc or molybdenum, he or she would probably react negatively. "The metals market? Are you crazy? That's no place for me." But if the metal is gold, suddenly everybody wants to play.

People think of gold not as a metal, but as an alternative form of money. $1,000 worth of copper will weigh as much as a subzero refrigerator. Molybdenum makes a lousy Christmas present. Gold is sold in coin form, and looks and feels like cash.

Unfortunately, also like cash, gold yields no return. If you put a roll of coins in a safety deposit box, a decade from now you'll have the same roll of coins--and in the interim, you'll have paid 10 years' rent on the box.

That may be a price worth paying for a hedge against inflation. At today's prices, however, investors should ask themselves some hard questions about how real the inflation risk is--and how much it is worth paying to insure against that risk.

Most U.S. indices continue to warn of deflation ahead, not inflation.

Consumer price indexes are dropping, not rising. Average weekly wages are dropping too. For the first time since 1975, there will be no cost-of-living increase in U.S. Social Security payments to retirees. (President Obama is proposing to distribute an additional $250 per retiree anyway, but this largesse will require a vote in Congress.)

Even once the recession ends, price pressures will remain weak.

The last economic cycle was powered by consumer spending: Increases in personal consumption accounted for fully 79% of the increase in U.S. GDP be tween 2000 and 2007. That consumption was financed by debt, and now the time has come for consumers to repay.

Consumers are saving more and spending less. Spending has dropped at the fastest rate since the Second World War. Savings rates have jumped.

Demand is dropping for just about everything consumers buy. On the supply side, meanwhile, labor will be in excess supply for years: Both the Congressional Budget Office and the Office of Management and Budget project unemployment rates over 7% through 2012.

In such an environment, how are prices to rise?

Gold buyers insist that prices must rise. They argue that there is something fundamentally unsound about paper money. In time, the whole system must collapse--and only gold will be recognized as a safe store of value. In this argument, gold becomes something more than an investment. It becomes an ideological protest against the consumer-led modern economy--the equivalent of dumping Canadian dollars to register a complaint against medicare's waiting times.

But what we are seeing now is not a protest. It's a stampede. The market stampeded into stocks in 1998, houses in 2005 and now gold in 2009. The stampede leaders whooped for everyone to follow--and then quietly made their escape before the crash. It's happening now again with gold.

Here's perhaps the beginning of wisdom. Folks at home: Don't speculate. Save. Maybe you regret that you didn't buy gold when everybody else was buying houses? It won't help to buy gold when everybody else is buying gold!

If you must speculate, do yourself at least this favour: Don't buy what the market loves. Buy what the market hates. Sell your gold--and buy a foreclosed condo in Florida.

David Frum is a resident fellow at AEI.

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About the Author


  • David Frum is the author of six books, most recently, Comeback: Conservatism That Can Win Again (Doubleday, 2007). While at AEI, he studied recent political, generational, and demographic trends. In 2007, the British newspaper Daily Telegraph named him one of America's fifty most influential conservatives. Mr. Frum is a regular commentator on public radio's Marketplace and a columnist for The Week and Canada's National Post.

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