The Midas Touch

What a difference a few days make. I planned on making this post last Thursday after a client meeting where the discussion included the pros and cons of an investment allocation to gold. My basic premise is no truer today than it was before gold's plunge in price Monday, but it would have given me a few bonus points to state my thesis on gold before the dramatic sell off.

The case for gold in a portfolio like the case for any precious metal is difficult to make. The theoretical support would be that it is a good inflation hedge, an historical store of value across societies and time, and uncorrelated with most other investments. But that is where the difficulty begins because those beliefs are not as ironclad as goldbugs would have you believe. In fact the most important theoretical support for gold, inflation hedging, seems to be the weakest case of the three. We'll get to that in a second, but first let's consider what gold lacks.

Gold lacks industrial use. It is not a capital good. It is a consumer good. So is bread, Travertine tile, and 55"-LED LCD TVs. Unlike bread, it won't go bad, but also unlike bread, it won't do you a bit of good if you eat it. It is durable like Travertine tile, but a lot more expensive--so much so that someone might try to steal it, which makes it expensive just to protect. One ounce of gold will buy you a pretty good TV. At the margin, I'd rather have the TV. Already there is something funny about using this soft, yellow metal as an investment asset.

Here are two of the top seven Warren Buffett quotes on gold as told by Minyanville:

3. "Gold is a way of going long on fear, and it has been a pretty good way of going long on fear from time to time. But you really have to hope people become more afraid in a year or two years than they are now. And if they become more afraid you make money, if they become less afraid you lose money, but the gold itself doesn't produce anything."

4. "I will say this about gold. If you took all the gold in the world, it would roughly make a cube 67 feet on a side…Now for that same cube of gold, it would be worth at today’s market prices about $7 trillion – that’s probably about a third of the value of all the stocks in the United States…For $7 trillion…you could have all the farmland in the United States, you could have about seven Exxon Mobils (NYSE:XOM) and you could have a trillion dollars of walking-around money…And if you offered me the choice of looking at some 67 foot cube of gold and looking at it all day, and you know me touching it and fondling it occasionally…Call me crazy, but I’ll take the farmland and the Exxon Mobils." [Note: The price of gold has changed since this quote was made. The gold would buy much less today.]

The first quote alludes to a chief problem many including myself have with gold as an investment--it has no cash flow. Aside from a potential positive roll yield when the futures market is in backwardation, a gold allocation generates no gains but does have substantial costs to maintain (transactions, storage, and carrying).  And realize that not having a cash flow of any kind (direct to the investor like a dividend or interest payment or indirect to the firm like a profit stream) means we can only value it based on the amorphous idea that someone does and will want it at a future date at a price attractive for us to sell.

Let's now turn to the historical record. To be a good inflation hedge, an asset should have a high correlation to inflation along with relative outperformance of inflation--when inflation is high, the asset is high or higher and when inflation is low, the asset is low or not as low. The first part is crucial. We want our inflation hedge to come through in the clutch. The U.S. left the gold standard in April of 1968 allowing gold to freely float when priced in dollars. It is at this point that it became investable as a theoretical hedge against dollar inflation.

Well, for the period April 1968 through April 2013 gold has only about a 13% correlation to CPI, which is to say they have basically been uncorrelated over this time span. The correlation doesn't improve much in the high inflation days of the late 70s and early 80s. The S&P 500 was even more uncorrelated with CPI at about -10%. But for what it gave up in correlation, it more than overcame in return. [UPDATE: the correlation between gold and CPI for the 1973 - 1985 period is only about 14%.]

Looking at the total return from owning gold to owning the S&P 500 with dividends reinvested over this time span, the comparison is not close. The S&P 500 returned over 6,850% while gold returned over 3,560% (see chart below). [Note: The source for these calculations is the St. Louis Fed's FRED. When using Bloomberg, I get somewhat different results for gold, about 4,400%. I will try to get clarification on this calculation to verify why there is a discrepancy. UPDATE: Looking further into the Bloomberg data it seems that the historical gold price is a composite and that the TR calculation is much closer to the FRED data, about 3,843%.]

This return difference is impressive. While gold was in the lead for two decades, the S&P 500 made a strong comeback to take over. Only the recent run up in gold has helped the yellow metal gain some but not all ground. And notice the long lulls for gold. This is another knock against it. For someone retiring in 1984, it would not have been a very good store of retirement value.

Over the full span the S&P 500 is over 50% higher in value. To understand how big that is think about everything you own and then imagine not having half of it.

Gold beckons you to enter, but there is no disguising what I fear.
To love the gold investment, the golden words poured into my ear,
there must be another whose heart is cold
He loves only gold.

Taxes are the price we pay to live in an insane society

It's that time of year again. Time for all Americans to take Uncle Sam's annual insanity quiz: if you can get through the tax forms and still think it all makes sense, congratulations, you're nuts! Notice that I'm not even criticizing tax rates or tax burdens for being too high. At this point I'm only complaining that the process is bat guano crazy.

There are lots of ways to raise as much revenue as we raise today while being immensely more efficient not to mention being fairer. We don't even have to give up all those wonderful special interest giveaways. There are plenty of ways to subsidize them and incentivize behavior otherwise to support all the various things without which society would break down--like jobs for tax preparers, mortgage interest rebates, 366-day stock holdings, and trains running to nowhere. Or would straightforward, simple subsidies be too obviously indefensible?

Regardless, here are my top alternatives to our current tax nightmare (each would be a wholesale replacement of all that befuddles us today):

• A value-added tax (VAT) applicable to all goods and services--no exceptions.
• A final goods and services sales tax as described here.
• A total compensation payroll tax (this means all wages and benefits including education/training, equity including stock options, and health insurance, et al. would be taxable benefits).

The whole mess reminds me of this:

Today also marks the infamous 2-year anniversary of Black Friday as it is known in the poker community. That is the day that a US Attorney unsealed an indictment against Internet poker companies sloppily labeling online poker a crime, a baseless charge that was later dropped, and shutting down effectively all online poker in the United States. As the cases against those charged with money laundering and bank fraud continue to play out and millions of dollars in player funds sit in limbo, it is not at all surprising that a government-created, quasi-black market attracted shady characters and suboptimal market outcomes. The Poker Players Alliance continues the fight for freedom.

If Marie Antoinette lived in a glass house, would her pot and kettle be black?

So I'm mixing methaphors . . . and stealing one in this case. Bob Stoops, the University of Oklahoma's rather well-paid football coach, made some comments the other day to the Sporting News regarding college football players' "pay". Having read the article, I'm not nearly as worked up as I was when the comments were related to me--so much for the reliability of hearsay.

The part where I'm stealing a metaphor comes from The Oklahoman's columnist, Berry Tramel's, article. I think he gets it basically right: message wasn't so bad, but delivery including the messenger is a problem.

Stoops' message is an argument worth having: that college football players do get paid in the form of scholarships, tutoring, athletic training, etc. Of course at some point the NCAA's basic message would be in conflict with Stoops' in that all the TV ads the cartel runs keep telling us that college athletes are almost always "going pro in something other than their sport". So much for the value of the training.

I read that Stoops says he is all for stipends. So maybe we are just arguing about the form and structure of how college football players, et al. should be paid. But if he wants to argue that a scholarship is of high value to an athlete, and let's remember that value is subjective (i.e., wage value is in the eye of the laborer), then there is a simple test we can conduct. Let athletes choose between full scholarships and the comparable amount in after-tax income. Stop making them attend classes unless they choose to attend and pay for college. If Stoops is right, then not much should change in the college football landscape.

PS. To those who would invoke the silly argument that college football players would make a foolish choice taking the money instead of the education, I'd say be careful the point you raise. Are you sure you know better how adults (nearly all college football players are adults) should live their lives than they do? If college football players are so foolish or short sighted or subject to bad decision making perhaps due to adverse influences in their lives, then are we sure no one other than the people profiting off of their labor should be making these choices for them? Are you sure college is as valuable as you think? Have you read Charles Murray? Are you sure all universities are created (and continue) equal? Does the fact that 115,000 janitors hold bachelor's degrees give you pause? How would you characterize "The Great Gatsby"? Was he . . . uh  . . . great!?

Marriage: a matter of equality before the law

Here comes another post where I relate an on-going discussion I've been having with a friend. The friend is a self-described conservatarian (part conservative and part libertarian). He struggles with some issues of libertarian ideology such as full drug legalization and same-sex marriage. He is thoughtful in his disagreement, when he has disagreement with my strict-liberty philosophy, and this extends to a careful treatment of the same-sex marriage issues. While he is not yet a supporter of same-sex marriage, he is very tolerant of those who are homosexual, and he is questioning his position on the marriage issues. He is willing to learn.

He brought today a new argument that he had heard recently. For background, this relates to an earlier segment of this debate we've been having where I invoked Mike Munger's rather good argument (I believe it is a very good argument) that the issue is not about some slippery slope to three-way marriage, etc. Today the argument brought was something along the lines of the following (I am paraphrasing and probably butchering as well):

The state should be blind in many respects in the marriage contract: Blind to race, blind to national origin, blind to religion, and blind to sexual preference. But the evolutionarily natural and by far historically predominant state of marriage has been between a man and a woman. If the state begins sanctioning the marriage contract between man and man or woman and woman, then the state is no longer blind to sexual preference. The state is making a judgment about conditions within marriage that it was previously blind to. Therefore, the state should not disrupt the natural and common understanding of marriage (man and woman). Otherwise, why not man-woman-woman? Why not spinster sisters who want to avoid inheritance tax? Etc.

The argument itself is a non sequitur and the additional worry at the end is a red herring. It is a strange twist to say that the state is treating people equally by not allowing some people major advantages it offers others because some don't meet a rather arbitrary condition: heterosexual union. 

As we discussed it further, we seemed to get bogged down in the slippery-slope part where if the state says that being a man and a woman are not essential conditions for marriage, then, according to the argument presented, there is no logical way to draw the line limiting it to two people, etc. The idea is in part an attempt to "corner a libertarian" by making me take a difficult position through reductio ad absurdum. If so, he was barking up the wrong tree. My argument was as follows: 

There may be a logical straight line (pun intended) as well as a liberty-principled reason to support marriage contracts among more than two people, but that is a battle for another day. It is not the current debate, and it doesn't shed light on how we should settle the current debate over same-sex marriage. What's more, many of these hypothetical marriages do not follow logically from allowing same-sex marriage. We can draw lines about what will and what will not be considered a legitimate marriage contract. 

I was searching for an analogy in the law to help make this concrete. At first I thought of liable and how it is different in different jurisdictions and somewhat arbitrary, but with liable we essentially get to a point where a balance is struck. Then I thought patent law might be a better analogy as it is a creation of the state as is the marriage contract (in case it isn't obvious, this entire discussion has nothing to do with how a particular religion defines marriage--it is only about state-recognized contract). But then the best analogy came to mind, and I sent the following email:

Forget the liable analogy. This one is much better, I think, to express my argument against the logic you were laying out this morning: The minimum age we allow people to get married.

This is something that has varied arbitrarily throughout history and varies today across societies. In the US it is usually 18 with the exceptions of Nebraska (19) and Mississippi (21). Most states allow minors to get married with parental or judicial consent generally limiting this group to 16 and 17 year olds. There are also pregnancy exceptions for females below 18 along with some other exceptions in various states.

I would equate same-sex marriage prohibitions with age prohibitions for those 18 or above. So Nebraska and Mississippi become the problem cases. Nebraska and Mississippi might argue that if they are forced to move their restriction down to 18, then why not 17? Why not 14? Etc. That isn't the issue. The issue is if legal, consenting adults can marry. Arguments could be made that those below the arbitrarily-set age of majority, 18, should still be allowed to marry, but that is not the issue at hand. Changing the definition of state-sanctioned marriage to include same-sex couples may weaken the case against three-person or more marriage, but that is not the issue being addressed. The issue is whether the state-sanctioned marriage contract can be rightfully limited to couples that are comprised of one male and one female.

My first-best solution is that the state should have no role in marriage--there shouldn't be a marriage penalty or benefit in tax policy, exchange of assets, etc. My second-best solution is that the state should not discriminate when sanctioning a marriage by considering the genders of the marriage participants. We've come a long way since the Army recruiter's standard question for Winger and Ziskey: "Are either of you homosexuals?" We still have a ways to go.

Highly linkable

I'm back from my unintentional hiatus. Now that my bracket is busted and other things have been put to bed, at least for a while, I can get busy with a lot of blogging that has been on my mind. To begin, let's get some good links in.

Megan McArdle takes just six minutes in this Cato Daily Podcast to very effectively explain what insurance is and what it is not and why Health and Human Services Secretary Kathleen Sebelius is in the camp of confusion. The all-too conventional wisdom is that insurance is about a transfer of expense, but this should obviously be nonsense. How could a redistribution scheme be a profitable endeavor? Insurance is rather a transfer of risk.

While we enjoy the excitement of March Madness, let us not forget the madness that is the non-free market of college athletics. Dave Berri has a column on Freakonomics asking simply, "How about a free market for college athletes?"

Speaking of Freakonomics, if you'd like a scary example of how quickly a consortium of "experts" can slip into technocratic thinking and tyrannical behavior, listen to this Freakonomics podcast on fighting obesity. There was a strong vein of Kling's oppressor-oppressed narrative running through these progressives.

John Cochrane explains why boogeyman-like fears of genetically modified organisms (plants, foods, etc.) is not only misplaced, anti-science, and anachronistic, but it is also very bad for the poorest among us. GMO just ain't the big, bad wolf.

Finally, Stephen Landsburg makes a point in principaled agreement with me by showing in two videos how magnificently wealthy we are.

Highly linkable

This Los Angeles Review of Books interview with evolutionary biologist Michele Pridmore-Brown touched on a lot of interesting topics including some good challenges to the Paleolithic man obsession currently in vogue. I myself am sympathetic to the Paleo ideas, but like all things it must be taken in moderation and in proper context. The magnitude of how Paleo you go matters, so to speak. 

Scott Sumner lays out a great explanation as to why we can all say, "Well, here's another nice mess you've gotten me into!" 

Last month the great economist Armen Alchian passed away. Among so many other contributions such as the importance of property rights, Alchian is famous for the Alchian-Allen Theorem which for example tells us why we're more likely to find the highest quality apples in Washington, D.C. rather than Washington state where they are grown. Don Boudreaux shared his thoughts on Alchian in this brief Cato Daily Podcast. David Henderson offered his remembrance in this WSJ article. 

Elizabeth Warren suggested what?

A $22 per hour minimum wage might be reasonable.


Here is a telling passage from the full article on Huffington Post:

"If we started in 1960 and we said that as productivity goes up, that is as workers are producing more, then the minimum wage is going to go up the same. And if that were the case then the minimum wage today would be about $22 an hour," she said, speaking to Dr. Arindrajit Dube, a University of Massachusetts Amherst professor who has studied the economic impacts of minimum wage. "So my question is Mr. Dube, with a minimum wage of $7.25 an hour, what happened to the other $14.75? It sure didn't go to the worker."

It seems she basically believes that employers wouldn't pay workers without people like her making them. Now that is dumb. She also severely confuses average worker productivity with marginal worker productivity. Claiming that the minimum-wage worker in 1960 grown at the rate of productivity growth is the equivalent to the minimum-wage worker in 2013 is 1 + 2 = 7. That is dumber. Has nothing else changed since 1960? Job descriptions, labor pools, employer compliance with regulations, et al. all the same? Are we really sure the worker who should be earning the MINIMUM wage today is equal to the worker in 1960 who should have been earning the MINIMUM wage plus the AVERAGE growth in worker productivity?

Think about this simplified thought experiment that ignores A LOT of other changes: A grill cook with little capital equipment at a fast-food burger joint in 1960 can produce 200 burgers per hour. A grill cook with lots of capital equipment at a fast-food burger joint in 2013 can produce 500 burgers per hour. Should the worker in 2013 be paid a full 2.5x more than the worker in 1960, or should the guy who bought the capital equipment be paid something, which eats into the 2.5x for the worker?