Forgive me for oversimplifying, but generally, there are two types of people: those with an abundance mindset and those with a scarcity mindset.
I have a scarcity mindset and I believe it has held me back.
Growing up, I was the child of divorce living with my mother who was constantly on the edge of poverty through no fault of her own. She worried about money and I internalized her thoughts, even though I didn’t necessarily understand them. Life was OK and for the most part I had a decent childhood, but the underlying uncertainty never left. At times it culminated into acute anxiety over the highly improbable.
My concerns about the ground being removed from beneath me may have been unreasonable, as I’m sure the other half of my family (which is well-to-do) wouldn’t have let me live on the streets. However, the worry was palpable and shaped my view of the world.
As a child, I envied how other families (including other parts of my own family) lived. They had cars, had lots of interesting food in the fridge, traveled, went out, sent their kids to camp. When I was young I wished I had these things. However, as I reached my mid-teen years I rejected anything that was an unnecessary expense. It was my idea to cancel the cable and newspaper subscriptions. I cut my own hair. I never asked for money because I knew it had a bigger purpose than my frivolous needs. I had little immediate control over what money came in, but I sure as hell would tighten my grip on what went out, in fear of the day when the bottom drops out. This is the scarcity mindset.
As I look back, I can still feel the ball of anxiety in my gut. That has never left me.
Poverty was something from which to escape. Although I had my share of f@ckups, when it mattered I worked hard and studied hard to overcompensate for my predicament. Some might say this made me successful. It’s true that I have had a good career and income because of my drive for financial security. My financial security is probably now in the top proportion of Canadians, so by that measure I am a success. However, my scarcity mindset has been an inescapable hurdle.
My scarcity mindset has kept me from pursuing potential opportunities because it forced me to prioritize the preservation of security. I’ve stayed in toxic jobs, shied away from new challenges and kept to myself because I didn’t want to give up job security or lose credibility. I’ve consistently undersold my capabilities, likely giving up potential salary as a result. I have hoarding tendencies and hate wasting money, so I rarely buy stuff. I haven’t taken a proper vacation in years, because I’m always sure the money could be put to better use.
While this behaviour has helped build me a decent nest egg, it has hindered my personal growth. I see 20-something, overconfident, entitled know-it-alls rocket to positions of seniority. They’re great at playing the corporate game because they have no fear. Many of these folks haven’t spent a day of their lives worrying about money or having a roof over their head. Even as they breeze through young adulthood, they still know that they can rely on the ‘bank of mom/dad’ to bail them out. They feel like they’re owed a better job, fatter salary and thousand-dollar handbags, because they have an abundance mindset. They don’t worry about losing their job (and financial security) because they ‘know’ there’s another one (perhaps a better one) waiting around the corner. It’s moral hazard at the personal level, yet these are the types of personalities that rise to the top.
At this point in my life, I’m not sure how much I can change or if I even should. I think there is a whole class of people out there like me who value financial security (and ultimately financial freedom) over prestige and power.
The world eventually sees the balance sheet of our lives, exposing the hidden truths of individuals with the scarcity vs. abundance mindset. By that point, however, the winners have already been decided. Still, I can’t help but think that there’s an optimal balance between both mindsets.
When I was 20 years old, somehow I lived off $50 a week and still managed to eat, go out and mingle with the ladies. I probably managed this because – other than my own education – I had few responsibilities, shared a tiny shack with roommates and mooched off various people.
Now that I’m in my 40s I often joke that I make much more money but have much less to show for it.
The truth is I earn a decent paycheque and have a lot to show for it: a house, car, kids, savings, etc. I am doing things I could not have done during my sardines-on-toast-eating 20s.
Let’s look at this another way. How would I be living today if I had the same income as I did in my 20s?
I’d probably be living exactly how I did in my 20s: sharing a small apartment, no car, likely alone.
Maybe I’d have a sugar-momma, because that’s probably the only way I could afford anything beyond peanut butter sandwiches for dinner. But what kind of sugar-momma material is a 40-something year old, balding guy with a little extra cushion? This is why I think most sugar-mommas cut off their boy toys at age 30.
Poverty at 20 is cool and artsy. That’s what we all reminisce about. We had nothing, yet we had it all. We had newfound freedom and were discovering life. Our curiosity and the value and energy of youth made up for whatever we lacked. Plus, most of our friends were in the same boat.
Poverty at 40, however, is a very different story. It’s no longer edgy, it’s no longer grassroots, it’s no longer artsy. The broke people who surrounded you in your 20s have grown up, built careers and saved money. Not everyone becomes a Rockefeller, but flat broke at 40 is just sad. Perhaps this is for good reason, as it signifies a lack of foresight and discipline. Even people pursuing the most noble of causes have bills to pay and want to enjoy the occasional nice restaurant meal.
If you’re reading this and you are in your 20s, picture your life in a decade or two. Picture where your friends will be. Ten bucks says they will have done something with their lives. They did this by working hard on themselves – even though they claimed they enjoyed SPAM as their primary source of protein. I suggest you invest heavily in your brain and body. Because you’re going to need at least one of those things when you’re my age.
“In numerous years following the [civil] war, the Federal Government ran a heavy surplus. [But] it could not pay off its debt, retire its securities, because to do so meant there would be no bonds to back the national bank notes. To pay off the debt was to destroy the money supply.”
— John Kenneth Galbraith
In the investing world, you can take a 3 month view, a 3 year view or a 30 year view. One person looking at one asset class might have a different forecast depending on the time horizon he is considering. In this article, I will look at gold through a 30 year lens.
I believe that structural forces will support gold and other hard assets over the long term. While current forces may be bearish for gold in the immediate term as investors panic and liquidate everything, there are a number of underlying currents that demand a strategic allocation to the metal. While the sophisticated gold investor is already familiar with these concepts, I think it is important to re-introduce them to a broader audience who may have zero allocation to gold, other precious metals and hard assets.
The Origins of Money
Throughout history, money has always held an important position as a means to facilitate transactions, thus creating massive efficiencies within an economy. Sometimes money was issued by governments. Other times a common means of transacting arose organically within a population.
Many historians suggest that fractional reserve banking and private money creation started when gold owners stored bullion within the vaults of goldsmiths for safe keeping. As proof of deposit, goldsmiths issued paper receipts that could be redeemed in exchange for gold. Seeing an easier way to transact, when buying goods and services gold owners would simply hand over gold receipts as forms of payment instead of redeeming for gold and delivering the metal.
Eventually, enough people were doing this that some enterprising goldsmiths, who noticed that the gold in their vaults was rarely reclaimed, started lending (with interest) new paper receipts that weren’t tied to a specific gold deposit. After making these loans, more paper existed than gold in the vaults, resulting in an early example of expanding money supply and credit growth. Of course, any goldsmith that manufactured receipts far in excess of gold reserves risked a run on deposits and existing receipt holders may have experienced a loss of exchange value.
Money Creation Today
In the US today, many believe that the Federal Reserve is the primary source of money supply growth. Many also believe that the Fed creates money and simply pumps it into the economy somehow. This assumes the Fed has some sort of authority over how money is spent, but this is untrue. Monetary policy is the handmaiden of fiscal policy, but both are quite distinct.
Through open market operations, the Fed adds to the money supply by purchasing assets such as US Treasuries and mortgages. Effectively, each dollar injected this way is the mirror image of someone’s liability, giving rise to the concept that money is debt.
Think about it this way, the massive fiscal response to the 2008/2009 recession and sluggish recovery has added trillions to the Federal debt. Much of this debt was indirectly financed by the Federal reserve (although they’d never admit it) via open market operations. So instead of simply printing and spending its own money, the US government has granted an independent entity (the Federal Reserve) the right to print and lend to the government and its citizens. Some might see this as ‘checks and balances’ while others might argue that it grants unnecessary power and profit to the banking cabal that controls the Federal Reserve. In the end, the US government has added $trillions to its debt.
The truth is that while the Federal Reserve can add to the money supply the biggest driver of money growth is the private sector. And this is where it gets especially important for the gold investor.
The monetary system does not stand still – it operates on a treadmill of debt. The majority of money in the economy is created when private banks make loans. One might think that these loans are based on deposits, but the reality is that – much like the goldsmiths of days past – in a fractional reserve system far more loans are made than deposits on hand.
Modern Money Mechanics, a publication by the Federal Reserve Bank of Chicago in 1968, states the following:
” For example, if reserves of 20 percent were required, deposits could expand only until they were five times as large as reserves…Under current regulations, the reserve requirement against most transaction accounts is 10 percent…Of course, they [the banks] do not really pay out loans from the money they receive as deposits. If they did this, no additional money would be created…The deposit expansion factor for a given amount of new reserves is thus the reciprocal of the required reserve percentage (1/.10 = 10).”
They further illustrate this with the following diagram, showing the initial deposit and the cumulative expansion via additional loans.
Fig. 1: Cumulative expansion in deposits on the basis of 10,000 of new reserves and reserve requirements of 10 percent, from: FED, 1968. Modern Money Mechanics – A Workbook on Bank Reserves and Deposit Expansion. Federal Reserve Bank of Chicago, Revised Edition, February 1994, p. 11
In essence, the banking system has the legal power to create money out of thin air
The Debt-Money Conundrum
Here’s the kicker: whether the money is created by the Fed or by the private banks, the money must be paid back with interest. Because only the principal amount is loaned, only the principal amount exists in circulation. In aggregate, enough money doesn’t exist throughout the economy to pay both principal and interest on all debts.
Bernard Lietaer, who helped design the Euro and has written several books on monetary reform, explains the interest problem like this:
“When a bank provides you with a $100,000 mortgage, it creates only the principal, which you spend and which then circulates in the economy. The bank expects you to pay back $200,000 over the next 20 years, but it doesn’t create the second $100,000 – the interest. Instead, the bank sends you out into the tough world to battle against everybody else to bring back the second $100,000.”
The debt-money conundrum results in two conditions:
1. Systemic Competition. Like rats in a cage, society is provided too few resources. In this case, the money required to repay debts plus interest is short. This means that if one person or company is able to repay their debts another is not. This raises the level of competition within society. Arguably this has been a positive economic characteristic since the industrial revolution, however one must wonder what the world would be like if debt-fueled competition didn’t exist. Competition goes far beyond the healthy – many wars and crimes can be traced to the competition for the resources required to indirectly repay debts through economic growth. Right or wrong, money loaned into existence has created systemic competition. On an individual level, many refer to this as the ‘rat race’. On a macro level some refer to this as the New World Order.
“The problem is that all money except coins now comes from banker created loans, so the only way to get the interest owed on old loans is to take out new loans, continually inflating the money supply; either that, or some borrowers have to default. Lietaer concluded: [G]reed and competition are not a result of immutable human temperament . . . . [G]reed and fear of scarcity are in fact being continuously created and amplified as a direct result of the kind of money we are using. . . . [W]e can produce more than enough food to feed everybody, and there is definitely enough work for everybody in the world, but there is clearly not enough money to pay for it all. The scarcity is in our national currencies. In fact, the job of central banks is to create and maintain that currency scarcity.
The direct consequence is that we have to fight with each other in order to survive.”
2. The Ultimate Ponzi. If money was lent into existence on a single occasion only, the first condition would lead to a deflationary outcome and shrinking total credit. Lenders would take haircuts and, knowing this in advance, potentially would have never lent the money in the first place. Or lenders would have priced the defaults into interest rates and covenants, paradoxically making it even harder for all loans to be repaid with interest. The banking system simply would no longer exist in its current state.
In reality, new money supply begets new money supply. To reduce the number of defaults caused by the competition for money, the banking system must continually lend more money into existence. As new money is introduced it helps money flow to past borrowers enabling them to repay their debts. To adequately offset the number of bankruptcies in the system, money must continually be created. This is precisely why modern industrial economies have a implicit ‘normal’ inflation rate of 1-3%. In good times and bad, money supply simply must expand for the system to survive. Normally that money is created by banks; however, sometimes the lender of last resort (i.e. Federal Reserve) – as the only lender that can continually accept losses – steps in to offset private loan destruction in periods of extreme financial distress, such as the 2008/2009 crisis.
The Growth Imperative
When inflation must be maintained at 1-3% for the system to stay solvent, many other areas of society are significantly affected. Companies must continuously raise prices, salaries must continuously increase, economies must continuously grow, populations must continuously increase, food supply must continuously rise, and so on.
Over the long run, continuous monetary expansion leads to the destruction of the value of the dollar relative to stable assets. While continuous monetary expansion can provide a tailwind to many businesses with pricing power, I think most investors are already set up to benefit from this through the equity portion of their portfolios. Where I think many investors are deficient is in a strategic allocation to gold.
Gold is Money
Many investors have a 3 month or 3 year view on gold, but few have a 30 year view. While I agree that intermediate forces could send the gold price down, I believe that structural monetary expansion means that all long-term investors should have some strategic weight to the yellow metal, which can serve as stable money while fiat currencies around it are devalued.
While equities (and other assets) can benefit from these same structural forces, gold has different risk-return characteristics and can help to diversify a portfolio. I am not saying that investors should dump half their portfolio into gold bars. What I am saying is that, as a stable currency, gold can help mitigate the effects of never-ending monetary expansion, and most investors are significantly underweight.
Gold can provide factor exposure not obtained through traditional asset classes and may be a valuable tool in the preservation of long-term wealth in a world in which money is debt and gold is money.
(I originally wrote this in 2011 for another publication. I recently found a copy and posted it here.)
The world is experiencing the worst economic recovery since the Great Depression. So why is oil hovering around $100/bbl? And as a gold investor, why should you care about oil?
Some might point to developments in the Middle East as the reason for high oil prices. However, I believe the root cause of current Middle East angst is the steady depletion of easily accessible oil and, consequently, government revenues needed to quell the population. Everything that is happening across the Middle East — citizen revolts, government crack downs, production disruptions and oil price inflation — tells me the world may have crossed the point of peak oil.
I don’t think the world will run out of oil anytime soon. However, based on the advice of expert geologists, I do believe that a) the world is running out of inexpensive oil and b) global demand is pressuring oil prices.
Given these pre-conditions, it is my view that the world has entered a new boom-bust cycle driven by oil prices. Oscillating oil prices — as opposed to credit cycles — will repeatedly stimulate and crash the highly levered global economy. Governments have not recognized this new cycle, and as part of a fruitless effort to retain control over deteriorating real growth and rising unemployment central banks will print more and more money, risking a hyperinflationary depression (stagflation at best). The only respite for many investors is gold.
The 2008 Financial Crisis was the First of Many
During the last thirty years debt has spread like a cancer throughout the developed world. Today’s consumption was financed by tomorrow’s higher revenues, creating a vicious cycle between growth and the need for debt. This system worked as long as growth needed to repay expanding credit could be subsidized by inexpensive energy.
Unfortunately, rising oil prices have stealthily and persistently chipped away at the foundation of our heavily indebted financial system. Ultimately, in 2008, oil prices and total debt passed the threshold beyond which the economy could not operate, and the financial system came crashing down. With collapsing demand, oil prices fell.
Many mistakenly point to sub-prime mortgages and CDSs as the cause of the 2008 crisis — I believe they were merely the transmission mechanisms. In reality, rising oil prices eroded the weakest links in the increasingly levered global economic system.
Enter the Central Banks
As we’ve witnessed repeatedly since Richard Nixon suspended dollar convertibility into gold, the Federal Reserve solves all economic problems with the monetary cure-all. Either by using the proverbial helicopter or the Treasury as an intermediary, central banks have repeatedly pumped liquidity into the economy and bought bad debts from the private sector. This effectively transfers the bad debt to the taxpayer by way of liability and currency debasement. In addition, fiscal policy (which is often the hand maiden of monetary policy) adds additional public sector debt in the name of stimulus. In whole, debt burdens and money supply rise. Of course, all this is done under the assumption that the economy will somehow be able to repay these new debts through future growth.
In the new boom-bust cycle driven by oil prices, the central banks are unknowingly impotent. As the economy crashes, they print money to stimulate economic activity, but it is short-lived and inflationary. More stimulative is the lower oil prices caused by the crash. However, any renewed growth and inflation sends oil prices back up towards another threshold, once again breaking the weakest links of the economy…and the default-bailout-growth cycle repeats.
Right now, oil price inflation is most noticeable when we fill up our gas tanks. But as high oil prices become pervasive throughout the economy the destruction of aggregate wealth will intensify. This will increase the number of weak links throughout the economy. It will also increase the sensitivity of those weak links to higher oil prices — another vicious cycle.
Consequently, as the default-bailout-growth cycle repeats and rising oil prices become more omnipresent, periods of economic growth become weaker, and periods of economic bust more frequent and persistent. Eventually, as the cycle repeats, the sharp economic contrasts of boom and bust blend together becoming a permanent shade of economic grey.
In a world of economic grey, defaults become more frequent, bailouts to support financial infrastructure and the growing mass of unemployed cause monetary growth to spiral out of control and economic ‘successes’ are characterized as periodic episodes of stabilization.
Assuming current policies persist, and until we find an alternative economic subsidy to inexpensive oil, over the long-run this cycle would turn into a hyperinflationary depression, as central banks print, the economy shrinks and the masses suffer.
The reversal of the cheap energy dividend would spell the end to middle class society, as the limited number of ‘haves’ hoard their wealth, food and weapons. What little wealth and property the middle class controls would be sequestered by the elite as the middle class citizens lose their jobs and default on their debts. Eventually the middle class become serfs living a life of subsistence, providing the labor to toil on the land they once owned – a less punitive alternative to debtors’ prison.
Those that are able to escape the drudgery of indentured servitude will be the middle class citizens who default while the system still works in their favor or who have nothing to default on. Unfortunately, the defaulting unemployed also cannot pay rent so to avoid the unfortunate trade-off between serfdom and homelessness one must own land that isn’t mortgaged or own enough assets to buy a home or pay rent indefinitely. In other words, to survive or thrive in this grey economic future one must either reduce their dependence on income or have a large enough asset base to generate cash flow.
Saved by Gold
As they did in 2008, central banks will print money to bail out collapsing financial infrastructure and support a growing mass of unemployed. While each cycle may begin as a deflationary shock, causing gold prices to decline, the eventual monetary response will destroy currencies and send gold prices soaring. This has already started to happen.
Unless high ROI replacement energy sources are found, over the long-run this cycle could turn into a hyperinflationary depression, as central banks naïvely fight a losing battle. Savings could be wiped out as the value of paper currency plummets, and in the new boom-bust cycle one of the few ways to protect wealth over the long run may be to own gold.