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In
which currency are your assets denominated?
The
answer to the above question is: whatever currency you like. An asset is what
it is, and its value can be measured in terms of any currency or any other
asset. For convenience and possibly for tax-related reasons, someone who
lives in the US is likely to express asset values in terms of US dollars and
someone who lives in France is likely to express asset values in terms of
euros; however, the US-based person could choose to calculate in euros and
the France-based person could choose to calculate in US dollars. The point is
that the currency in which a person chooses to denominate their assets is
solely a function of how the person does their accounting. The assets
themselves are not inherently denominated in any particular currency.
We'll
further explain using the examples of gold and gold mining companies.
Regardless
of what currency you use to purchase gold bullion, after you have made the
purchase you own ounces of gold. You don't own ounces of US$-denominated gold
or euro-denominated gold. Gold is gold. You can then choose to measure the
performance of your gold in terms of dollars or euros or Yen or barrels of
oil or bushels of wheat or the S&P500 Index or something else entirely.
The choice is yours, and the choice won't alter the fact that what you own is
a certain quantity of gold ounces.
By the
same token, the fact that you use Canadian dollars to purchase the shares of
a gold-producing company on the Canadian stock market doesn't mean that you
end up with a C$-denominated asset. What you actually end up with is
ownership of a certain percentage of an asset that contains in-ground gold
and that produces gold. You just happened to part with Canadian dollars in
order to obtain your stake in the asset.
Currencies
have experienced wide swings over the past few years, both relative to each
other and relative to assets, and more wide swings are likely over the next
few years. There is also a significant risk that all the major currencies
will suffer massive declines in purchasing power within the current decade,
making it increasingly difficult to measure how you are really doing. Are you
actually making progress, or is the progress an illusion created by the
debasing of the currency you happen to be using in your calculations?
Unfortunately,
there is no ideal way to quantify the real (inflation-adjusted) return on
your investments. Gold tends to maintain its purchasing power over the very
long-term and is thus the ultimate 'accounting yardstick' when dealing in
periods of several decades or more, but under the current monetary system
gold's purchasing power tends to vary a lot over the course of a single
decade. For example, there was a dramatic increase in gold's purchasing power
during the 1970s, a relentless decline in its purchasing power during the 80s
and 90s, and a substantial rise in its purchasing power during the first
decade of the new Millennium. If gold's purchasing power continues to rise
over the years ahead then measuring performance in gold terms will yield an
unrealistically poor result, while measuring performance in terms of any fiat
currency will likely yield an unrealistically good result for the opposite
reason.
One
possible solution would be to apply common sense. Although there are no
available statistics that reliably quantify the change in a currency's
purchasing power, a rational and observant person should be able to come up
with a reasonable 'gut feel' assessment for how quickly the currency (or
currencies) they use is (or are) losing purchasing power. This 'gut feel'
assessment could then be used to quantify real progress.
Another
possible solution would be to assume that the annual rate of decline in any
currency's purchasing power averages out, over the course of a decade, to be
roughly equal to its annual monetary inflation rate minus an allowance for
productivity growth. For example, the total increase in the supply of US
dollars over the past 10 years equates to an annual compound rate of about
9%, so if we assume that there was an average of 2%/year productivity growth
during this period then we end up with a 7%/year estimate of purchasing power
loss. This may be a little on the high side, but it's probably not far from
reality.
Steve Saville
www.speculative-investor.com
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