Myths That Just Won't Die

Gold just had its best quarter in 30 years. Not surprisingly, gold bears are coming out of the woodwork en masse in the mainstream media and the analyst community (see e.g. this recent write-up by Mish on the Goldman Sachs analyst who has been screaming “short gold” since right before it started rocketing higher in early February). Below we will discuss a specific assertion that tends to be repeated over and over again.

Gold had a very strong quarter, but skepticism over the durability of the advance remains quite pronounced

If there is anything in this world that definitely has more lives than a cat, it is bad economics. Just think about it: Here we are, nearly 300 years after John Law drove France and most of continental Europe into utter ruin, and our central bankers are still doing the exact same things Law did. The only difference between John Law and the trifecta of Draghi, Kuroda and Yellen is really the modern-day level of obfuscation and the fact that there is far more wealth that can be destroyed, so it is taking a lot longer.

In terms of economic principles and the goals allegedly achievable by their policies, the difference between Law and today's central bankers is precisely zero. It is astonishing that after 300 years of supposed scientific progress, atrociously bad economics has shown such persistence in surviving. We were reminded of this agan when reading a recent comment on gold in the Wall Street Journal. No matter how often and how convincingly they are refuted, unsound economic ideas keep being resurrected with unwavering regularity, as if they were a horde of zombies.

The article in question is entitled “A Warning for Gold Bugs: This Rally Won't Last”, by one Steven Russolillo. One can certainly debate whether gold's recent rally will or won't last – reasonable arguments can be made for both outcomes. One would think though that such a debate is conditional on some rudimentary understanding of gold. Russolillo first discusses the current state of sentiment on gold, which we will return to in a follow-up post. Here we will skip ahead to another part of his argument, which appears central to his “warning”. He writes:

“Gold often thrives as a haven in times of turmoil, or acts as a hedge against inflation. Devotees love pointing to negative interest rates around the globe as evidence that has recently made gold glitter more than usual.

The problem is these theories don't take into account a fundamental analysis of gold's intrinsic value: It doesn't really have any. Unlike many financial assets such as stocks, bonds, real estate and others, gold doesn't generate any income. Valuing it is virtually impossible.”

(emphasis added)

We are continually coming across variations of the assertion highlighted above, which to our knowledge has inter alia been uttered by Warren Buffett at some point in the past. This may well be why so many people keep regurgitating it as if it were gospel.

To begin with, it is absolutely correct that gold has no “intrinsic value”. However, this is not a characteristic unique to gold. It certainly isn't differentiating gold from other things in this world. There simply is no such thing as “intrinsic value”.

All value judgments are subjective, something that has been known since at least 1873, when Carl Menger'sPrinciples of Economics was published. Value theory was one of the greatest problems classical economists had failed to solve, and Menger's insight that all value judgments are subjective and depend on individual value scales (a theory later refined further by Mises) cut through the Gordian knot. Apparently this piece of good news hasn't reached everybody yet.

As an aside to this, the only context in which the combination of the terms “intrinsic” and “value” could be said to at least make some sort of technical sense, is when describing the price components of an in-the-money option. The extent to which such an option is in the money can be said to represent its “intrinsic value”, while the remainder of its price is due to other factors, such as its time premium and volatility premium. Of course the latter partly reflects the subjective perceptions and value judgments of market participants as well.