Back in September, 2003, John Embry published an article, "15 Reasons to Own Gold". People who acted upon his advice have been benefited tremendously. Before and since then there are many writings on the reasons for owning precious metals. In this article, I would like to elaborate another role of precious metals, which people may be aware of but I haven’t seen any detailed writing to establish it more formally and clearly.
As an economist trained in the tradition of the monetarist school of economics, I believe that increasing in the money printing will lead to inflation in the long-run, especially true in current economic environment. As Milton Friedman (1994, pp.195) pointed out, “I know no example in history of a substantial inflation lasting for more than a brief time that was not accompanied by a roughly corresponding rapid increase in the quantity of money; and no example of a rapid increase in the quantity of money that was not accompanied by a roughly corresponding substantial inflation.” Wealth cannot be created by printing paper money.
However, it is well documented that money printing does not lead to inflation immediately. It takes time for the printed money to show up in price and income, and the time lag will become shorter as inflation and expectation increase. Based on history of U.S., U.K. and other western countries, Friedman (1994, pp.221) pointed out that it would take 16 to 24 months for increased money supply to have “affected the price level appreciably, and inflation has occurred or speeded up.” It is short sighted to claim that QE won’t cause inflation because of current low CPI. It is blind sighted to claim there is no inflation given commodities and stocks increase significantly since Jackson Hole speech by Bernanke.
So the paper money flying off from Ben’s helicopter won’t create wealth, and it will take time or a diffusion process for the paper money to show up in overall price level and lower purchasing power. The people who picked up Ben’s money and/or convert their own paper money into precious metal or other hard assets early can have a higher share of wealth. The total wealth in the world is fixed at a point in time. Paper money is not wealth but a promise that you can convert them into wealth. The people who convert their paper money early to physical assets will have higher share of the global wealth than the people who convert late. The wealth is redistributed from people who don’t act or act late to the people who act and act early. We are in a historical period of huge wealth redistribution because of mismanagement of monetary systems.
Gold and silver play important role in this wealth redistribution process. This role of precious metal is related but different from its issuance role. Convention claim is that buying precious metals will preserve investors’ wealth. This theory suggests that buying precious metals can increase investors’ wealth too.
This wealth redistribution theory applies not only to portfolio managers and individual investors, but also to sovereign countries. China, Japan, Russia and other countries that have large US dollars as foreign reserve will or have to convert their U.S. paper to hard assets as U.S. debt being monetized. It is not just about wealth preservation, it is also about increasing their country wealth.
Source: Milton Friedman (1994), “Money Mischief: Episodes in Monetary History”
Disclosure: Long silver and gold, silver and gold mining stocks