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In a recent article in Fortune,
Warren Buffett reiterated his well-known view on money. Far less celebrated,
however, is the discerning view of his father, Howard
Buffett, expounded in a brilliant speech in 1948 while serving as a 4-term congressman
from Omaha. In contrast to his son WB, HB insightfully considers the
importance of money in society beyond its role as a means of economic
calculation and payment. I’ll return to this point, but first, the Fortune article requires our attention.
WB is extremely helpful to
investors by explaining his investment principles, which are invaluable, as
one would expect given his exceptional track record. But he wanders into
tricky territory with regard to money by building his viewpoint upon the
following premise: “Governments determine the ultimate value of
money...”
It is understandable why he puts
forth this notion. Apparently following prevailing conventional wisdom, WB
sees money for what it has become in this peculiar time. We now live in an
epoch that defies common practice customarily followed throughout centuries
of monetary history. Most people today have not used precious-metal money in
their lifetime, but they have experienced first-hand “money”
issued by sovereign states. This straightforward observation may help explain
why so many in the last few decades have come to accept the modernist view of
money.
This modernist view of money
ignores that market forces, which a government can influence but in the end
cannot control, inevitably determine the value of any asset. With repeated
interventions in the market process, governments disregard this basic
principle, causing disruptions to the market process that impede economic
activity and even worse, can distort money itself.
Conventional wisdom purports
that money today supposedly cannot be a tangible asset or a product of the
market process, in which individuals act by free choice to determine what is
or what is not money. Supposedly money now is merely a fiat of government and
exists only as an incorporeal bookkeeping unit, the value of which fluctuates
as a result of actions taken by politicians and central bankers, which is the
predominant feature of today’s fiat currencies.
It is important to understand
that no fiat currency is a tangible asset. Fiat currency is valueless in
itself. It is a liability of a bank, whether paper-currency issued by a
central bank or deposit- currency that is created by a commercial bank and
exists only as a record in its ledgers.
Because fiat currency is a
liability of banks, its value can be manipulated by controlling supply and
plying demand. A central bank determines the quantity of money by its
policies. Demand for fiat currency is buoyed by hyping its benefits as well
as promulgating regulations to force its circulation. Money no longer is an
even-handed mechanism in commerce derived from the market process itself.
Thus, WB and conventional wisdom
have it that gold has been demonetised by
government edict, notwithstanding its 5,000 years of history as money. This
modernist view conveniently ignores the fact that gold still preserves
purchasing power — one of the essential requirements of any money
— better over long periods of time than any fiat currency.
The modernist view overlooks the
reality that fiat currency today is accepted in payment simply because of
trust in the government imprint on a paper banknote and the accuracy of bank
recordkeeping. It also requires the heedless acceptance of the currency
issuer’s financial standing by blithefully
assuming that the assets backing its liabilities have sufficient value to
make its currency accepted in commerce. Taken together, these judgements — whether sound or not — assume
that the currency used today will also be accepted as currency tomorrow. This
belief requires a huge leap of faith, for as WB points out, the collapse of
many currencies in recent decades have “destroyed the purchasing power
of investors in many countries.” His father calls this result
“the ultimate consequences of paper money inflation.” But before
turning to HB’s view on money, further observations need to be made of
WB’s Fortune article.
WB writes: “investments
will remain superior to nonproductive” assets that “will never
produce anything.” He then goes on to state that they “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.”
To disparage so-called
non-productive assets, he then references Holland’s notorious 17th
century tulip-bulb mania, but rather than reinforcing his case, this example
illustrates a flaw in his argument. WB overlooks the essential nature of this
asset, namely, that a bulb when properly planted and nurtured will produce a
tulip, which has usefulness to some people. A tulip bulb is a productive
asset to people who value tulips. Thus, value is subjective, which is the key
point to evaluate any asset.
Further, and perhaps even more
surprising, given that he is one of the world’s foremost value-
oriented investors, it is surprising that WB glosses over the reality that
all assets can become overvalued or undervalued. Tulips bulbs became
overvalued during the Dutch mania, but sanity returned with the collapse of
their price. The key to successful investing of course is to accumulate
undervalued and useful assets and get rid of those that are overvalued or no
longer useful. Even though WB is rightfully concerned about inflation and
relates in his article that T-bills “have yielded nothing in the way of
real income” for decades, he notes that his company nevertheless always
holds at least $10 billion of T-bills. The reason of course is that they are
useful; they provide his company with dollar liquidity.
WB considers gold to be a
non-productive asset, but neglects to even consider why gold has been valued
for 5,000 years. The Mona Lisa is also a non-productive asset that
“will never produce anything”, but the Mona Lisa has value
— usefulness — as art. Gold has value too, but not of course as
art. Rather, gold’s usefulness arises from its reliability in economic
calculation to determine the price of goods and services. In other words,
gold is money, and therefore is no less useful than other so-called
non-productive assets like the paper banknotes and bank ledger entries that
we call dollars, euros, yen and pounds. Like gold, they produce nothing
unless they are loaned.
Right now gold is undervalued, based on my historical measures. Gold is also
particularly useful during the present period of global financial uncertainty
and worries about sovereign debt defaults because it does not have counterparty
risk. More importantly, given that it is a tangible asset and not a bank
liability like fiat currency, gold’s value — like that of the
Mona Lisa — does not come from government. Gold’s value comes
from the market. It always has, and it always will, even though its price is
often distorted by government intervention.
Turning one more time to the Fortune
article, WB neglects to mention the role of saving money. He defines
investing to be “forgoing consumption now in order to have the ability
to consume more at a later date.” The same definition can be applied to
savings, but with one difference. One uses money to make an investment,
whereas saving is the process of accumulating money itself.
Prior to the fiat currency era
in which we live, saving money was deemed to be safer than investing. Saving
money was the principle means for the middle class to prudently accumulate
wealth for retirement or a “rainy day”. Several decades of fiat
currency changed that time- honoured practice of
preparing for an uncertain future.
Further, if any of the older
generations of people who learned and followed that practice to plan for the
future are still with us, they have been forced to adjust their ways by the
current zero-in- terest rate policy of central
banks. They have only the alternative of accumulating physical gold for their
savings because savers of fiat currency have learned that the cost of living exceeds
the interest income earned from their fiat currency savings.
Apparently WB believes that
there is no role for saving money today and would have everyone buy stocks
for the long haul. Given this omission to even consider savings, maybe he
believes the skills that enabled him to be a successful investor can be
transferred to everyone on the planet, and that
everyone today has the temperament to blissfully accept the risks of
investing. That viewpoint overlooks the important role of savings in our economy.
Here is where WB and HB part ways.
It seems that HB did not share
his son’s view in regard to savings. From his 1948 speech, he feared
the political consequences if “the frugal savings of the humble people
of America” are eroded by inflation. He bemoans: “Some day the people will almost certainly flock to
‘a man on horseback’ (his euphemism for an autocrat) who says he
will stop inflation by price-fixing, wage-fixing, and rationing.” He
concludes that this outcome would be avoided with a currency redeemable in
gold.
HB intuitively understood that
gold is money. But he also insightfully, and profoundly, understood that
“there is a connection between human freedom and a
gold redeemable Money.”
Observing that “one of the
first moves by Lenin, Mussolini and Hitler was to outlaw individual ownership
of gold”, while tactfully not mentioning that President Roosevelt did
the same thing in 1933, HB goes on to conclude that “you begin to sense
that there may be some connection between money, redeemable in gold, and the
rare prize known as human liberty.” This connection exists because:
“In a free country the monetary unit rests upon a fixed foundation of
gold or gold and silver independent of the ruling politicians.”
The experience of recent decades
illustrates HB’s insight that currency redeemable in gold has
“acted as a silent watchdog to prevent unlimited public
spending.” Without this constraint, which exists because gold cannot be
conjured up out of nothing, HB notes that throughout history “paper
money systems have always wound up with collapse and economic chaos.”
Thereafter, human liberty disappears, just like: “Monetary chaos was
followed in Germany by a Hitler; in Russia by all-out Bolshevism; and in
other nations by more or less tyranny.” His observation is a chilling
prospect, given the downward path of the dollar’s purchasing power and
the concomitant erosion of time-honoured rights in
modern America.
So my recommendation is to read
both Buffetts together. Reading one without the
other will not provide the complete picture of what money is, and what money
has become. More importantly though, one will only learn from reading the
older Buffett why gold is money, and why gold and human liberty are
inextricably interlinked.
Originally published on Goldmoney here
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