Warren Buffett, as usual, was right: gold is not an investment. It yields nothing and never grows. Gold, instead, is money: something people use to (1) exchange what they have for what they want, (2) store their purchasing power, and (3) know precisely how much they have in precisely measurable, divisible units. Gold is a currency just like any state-issued currency but with one crucial difference: it cannot be created at will by man; it can only be found. No one using gold as a currency has to worry about a decline in its purchasing power from a significant, sudden expansion of supply.

A willingness to hold any currency depends on confidence that it will buy tomorrow what it buys today. People will want to own gold only if they think that, within their lifetime, public confidence in fiat currencies (government-issued money backed by nothing) will weaken or even collapse.

Interest rate guru Jim Grant suggests it is prudent to have a “hedge against monetary disorder?” I agree. I believe the day is coming when everyone will see that “paper” money is worth a politician’s promise – nothing. The restoration of sound money, a prerequisite for prosperity, unavoidably will require prolonged economic suffering, some combination of debt default, renunciation of pension obligations, higher interest rates, and the establishment of an anchor for money that the powerful can’t control. That process will be chaotic and protracted. When the day of reckoning arrives is unknowable, but the forces driving its appearance are gathering strength rapidly. Yes, gold earns nothing, but it has proven its usefulness as a store of value over thousands of years. I am happy to give up some return on my capital in exchange for preserving the purchasing power of my capital.

One thing is for sure: governments worldwide eventually always and everywhere will abuse their privilege of seigniorage, the ability to “print” money and use it to pay their bills and debts — until they can’t. That won’t happen until it becomes obvious to the public that today’s money will buy less and less tomorrow.

Throughout history, fiat money has had a 100% failure rate. Because fiat money is inherently self-destructive, the fate of the modern version (what gold analyst Matthew Piepenburg calls “mouse click” money) will be no different. The only question is how long the process of destruction will take.

Any currency not anchored to something durable and inelastic eventually will be debased. The incentives are overwhelming. Who can resist a system like fiat money where, without restraint, the issuers can get something – goods and services – for nothing more than pieces of paper or entries on a computer?

Governments and the well-connected always are the main beneficiaries of this “something for nothing” con. They get the money governments “print” first. Dress this process up with impenetrable or anodyne nonsense from people with advanced degrees and you have just what we are witnessing now:

• staggering debts relative to even the most wildly optimistic estimates of cash flow available for debt service,
• staggering unfunded liabilities that can never be paid in a currency that holds its purchasing power,
• interest rates way below what they would be if there were honest, market-based price discovery,
• Stagnant real economic growth as vast amounts of capital are mal-invested in projects that will never earn a true, market-based cost of capital,
• Extreme vulnerability of the financial system to unbearable losses if interest rates rise,
• Widespread assurance from the political class that governments can borrow and spend limitlessly without adverse consequences,
• Loss of the gut feeling among the public that the only true source of wealth is production of goods and services through innovation and hard work,
• Huge wealth disparities as the elites with privileged access to money enjoy windfalls from cheaper money while the incomes of regular people who must produce something for a living stagnate,
• Widespread loss of trust in our “leaders” and institutions, as people realize they have been lied to for decades,
• Eventually, civil unrest, as people realize their financial wealth is phony and as lasting as the morning dew.

Most importantly, as government-created crises worsen, and the public gets more restive, desperate governments will respond the way they always have – with ever tighter control. The greatest risk of fiat money is loss of individual freedom.

This list of the many malign consequences of fiat money is far from complete, but sufficient to show that state-sponsored fiat money promotes behavior that is corrupt, evil, and disastrous.

Just how the fiat money system will self-destruct is unknowable, as is the timing, but we do know what won’t happen:

• Central bankers will never admit to having created a hellish mess, ever. Instead, all evidence notwithstanding, they will continue to reassure the public that they know what they are doing, have everything under control, and, with minimal pain and suffering, can fix transitory problems with adept applications of the tools at hand. They will blame economic distress on “exogeneous” factors, never their own actions. Fed Chairman Powell, for example, wants us to believe that with jawboning and a few more modest interest rate hikes, he can bring inflation down to “only” two percent. This is not plausible. When former Fed Chairman Paul Volcker vowed to whip inflation in the late 70’s, he had to take interest rates to 15%. He did this when gross national debt was $1 trillion; today it is $31 trillion.
• As the real economy weakens, inflation should ebb, but the base rate will not decline to anywhere near the Fed’s 2% objective, which even if achieved would still amount to currency debasement, just at a more gradual rate. My expectation that inflation will not remain subdued is grounded in my conviction that it arises not from external shocks but from the flooding of mouse click money into the economy. We shall see.
• So long as the Fed retains control of Interest rates, it will not allow them to rise above inflation. The Fed’s client is the federal government, not the American public. It is in the government’s interest for the interest rate it pays to be lower than the rate of inflation. That way, as tax revenues track inflation, ceteribus paribus, the amount of dollars the federal government pays in interest relative to the tax dollars it receives will decline. Conversely, savers will get paid at a rate below inflation.

In sum, whether they realize it or not, those in power have managed to delude themselves that the terrible consequences of grossly excessive money “printing” and debt accumulation can be avoided. The authorities will not abandon this delusion voluntarily nor will the public. Years of “anything goes” money has created an “anything goes” culture. The habits and customs necessary for building a prosperous, good society have been eroding for decades. It will take a crisis to induce necessary changes.

Sooner or later, the consequences of the mandarins’ fantasy that they can control events will emerge with a vengeance. The details always differ, but the general theme is clear. Wildly promiscuous money printing sows the seeds of its own destruction. By causing interest rates to be artificially low, it encourages companies, consumers, and governments to borrow massive amounts of money relative to their underlying cash flows; conversely, it encourages banks to lend massive amounts relative to their equity. Inevitably, economically unviable investments proliferate, and people take out loans they will be able to pay back only if economic conditions remain favorable and interest rates stay low. They never do, however, because the “anything goes” borrowing and lending mentality guarantees that

• companies will make uneconomic investments.
• consumers will spend way more than they can afford; and,
• governments will continue spending without restraint.

As economic conditions from malinvestment and reckless consumption cause cash flows to fall increasingly below expectations, banks start to worry about whether their loan losses will wipe out their equity. In response, they start to withdraw credit and raise the interest rate they charge. As each bank tries to protect itself, the efforts of banks collectively exacerbate the very problem each bank is trying to avoid. A race to minimize exposure to credit losses turns into a stampede. The more leveraged the bank, the greater is the panic.

As borrowers find they are less able to extend or roll over loans, they cut spending. If they still cannot service their debt, they face bankruptcy.

Everything banks and borrowers do to protect themselves makes everything worse: less spending, less credit, higher interest rates, more business losses, more loan losses.

The only way to delay this doom loop is via a deus ex machina. The Greeks had Zeus, the Romans had Jupiter, we moderns have central banks.

As of December, 2022, central banks can claim they have prevented the world from falling into an economic death spiral without triggering uncontrollable inflation. But, stress fractures are beginning to show up everywhere:

• The Fed’s effort to quell inflation by raising interest rates has caused currencies globally to fall against the US dollar. Since cross border transactions are settled in dollars (USD), prices outside the United States have been surging. Also, since many countries have borrowed in USD, their interest costs and debts in local currency terms have erupted. If these countries raise their interest rates to combat higher prices, they risk a deep recession. They have no choice but to choose between high inflation or high interest rates and a shrinking economy. Their sad future is now.
• America is not yet facing as stark a choice, but the respite is likely to be only temporary. to As the Fed has raised interest rates, the USD has offered foreigners protection from depreciation of their home currency, and a superior yield to boot. Gold, which pays nothing, compares unfavorably. Thus, the American dollar has been strong against other currencies and gold, but neither the currency nor the economy is immune to what has been happening in the rest of the world:
  • American global systemically important banks (SIBs) have counterparty risk with mammoth, very highly leveraged European and Japanese banks. The entire global banking system faces widespread bankruptcy risk if interest rates rise just slightly from their recent multi-thousand-year lows.
  • Federal spending will continue to rise relative to tax revenues. The deficit will have to be financed via debt. Primary dealers, who buy government securities from the Fed and then sell them to investors, do not have the balance sheet capacity to absorb the debt that must be financed. The resulting lack of liquidity may force yields higher. Rising interest rates mean a weaker economy.
  • Foreigners, who hold $7.296 trillion of US government securities, may want to sell down their holdings to support their home currencies and lower the extent to which their economies are exposed to what the Fed does with interest rates.

In sum, sooner or later American policymakers will face the same terrible choice now confronting the rest of the world. Let interest rates keep rising and watch the economy weaken and financial markets drop. Create more mouse click money to suppress interest rates and watch the value of the dollar drop relative to hard assets such as capital equipment, commodities, real estate, and precious metals. Soothing words from the Fed notwithstanding, the choice cannot be avoided. Ironically, “printing” money to reduce interest rates leads to their running away if (when) confidence in fiat money craters.

I don’t think any central bank will do whatever it takes to get rid of inflation. The costs are too immediate, acute, and visible. The damage from inflation, although worse for the public in the long run, is hidden until everyone catches on to what is happening. Expect a few more modest interest rate hikes, and then a quiet reversal at the first sign of rising unemployment, bankruptcies, and loan losses.

Markets have far more faith in the ability of the Fed and other central banks to play god than I do. History, the natural human tendency to avoid criticism, perverse incentives, and the self-defeating nature of any of the Fed’s choices are on my side. The fact that nothing awful has happened to date is on the side of markets.

If you hold some physical gold, you have some protection against the implosion of fiat money purchasing power. If your concerns prove overblown, you have money tied up in gold that could have produced more wealth for you elsewhere, but you probably would not have lost much purchasing power.

If you don’t have physical gold, you don’t miss out on higher yielding alternatives, but you face impoverishment if concerns about the collapse of fiat currencies prove true. Framed that way, the choice seems an easy one.

What disconfirms the case for physical gold? Cryptocurrency is an unlikely substitute. Its price is volatile, and its store of value immaterial. Would you rather park your wealth in a system based on computer code you don’t understand, where your ability to access your wealth is dependent on an anonymous computer network, or in a stable, rare metal that has served as money for millennia? If you have a problem with your cryptocurrency, you have no idea whom to contact. With gold, you can know where it is and whom to call.

Reality is more complicated than I can grasp. I may have missed reasons why gold will not prove as robust a store of value as I have portrayed. Prudence suggests that you have a meaningful position in physical gold, but don’t bet the farm.