first majestic silver

Calculating gold's price potential

February 25, 2001

Leisure is the measure of money; the fundamental use of money is to store value, and leisure is the fundamental measure of value. *

For thousands of years, money itself was regarded as the measure of value. This was possible because money was gold, silver and "brass," and their values in terms of leisure remained remarkably stable for centuries on end. Men had an excellent idea of how long they could live in their accustomed manner on a given sum of money.

Only gigantic, world-scale events were able to change the value of metallic money noticeably. Alexander's looting of the Persian treasury poured huge amounts of gold into the Hellenistic world and provoked rising prices. So did the vast quantities of gold and silver looted by the Spanish from the Inca and Aztec empires in the centuries after Columbus. The produce of vastly rich New World mines such as Potosi had a similar result. But the gradual, gentle changes in the value of money arising from such causes were merely intellectual puzzles for a few. They stimulated the nascent science of economics, but understanding the changes in the value of money was not a matter of urgent practical necessity for everyone.

It is today! When the quantity of fiat money rises by 8% per year, it doubles every 9 years! When prices expressed in fiat money rise by 4% per year, that money loses fully half its value in a mere 18 years! These rates are typical of the _best_ of today's fiat moneys, by no means the worst of them. The only solution is a return to metallic money--but at what value?

The leisure theory of value offers a method to penetrate the confusion created by fiat currencies and to estimate the value of gold in the gold standard world of the future. Start from the thought that--as an expression of one's moral commitment to the trader principle--one should hold 6 months worth of real money. This means, for example, that if your monthly consumption spending is $2,000, you should hold $12,000 worth of gold. (And/or silver, platinum, palladium and so on, but let's keep this simple.) At a gold price of $250 per ounce, $12,000 worth of gold would be: $12,000/$250 per ounce = 48 ounces of gold. In other words, 48 ounces of gold would be worth 6 months of your _leisure;_ you could live on it for 6 months. Clearly, anyone can do these calculations based on his own circumstances; anyone can figure out how much gold will buy him 6 months of leisure.

If you decided to act on this thought, you would carry it out by first raising $12,000 dollars, either by saving it out of income or by selling off other assets. Then you would buy 48 ounces of gold and keep them in your possession. Clearly, you _could_ do this if you so chose. It might take you some time if you had to save up out of income, but you could do it in a flash if you had sufficient liquid assets to sell. It should also be clear that anyone _else_ can do the same.

But what if everyone else _did_ the same? What if _everyone,_ from prince to pauper, owned 6 months of gold? The answer is that the human-owned gold in the world would then be enough to pay for _all_ the world's consumption for six months. The saving and asset selling and gold buying of all those princes and paupers would have adjusted all prices--but especially the gold price--to bring about exactly this result. If this isn't immediately obvious to you, ponder it until it becomes obvious; it is the key that unlocks the gold price of the future.

If everyone held six months of gold, then a full year of the world's consumption spending would equal twice the world's gold stock. The world's gold stock is about 120,000 tonnes; call it 4 billion ounces (**). So the world's annual consumption spending would amount to 8 billion ounces of gold.

That is to say that world GDP would be 8 billion ounces of gold per year; for GDP is just another name for total annual consumption spending. The mantra that "consumers account for two-thirds of GDP" tiptoes gingerly around this truth. GDP is ballyhooed as a measure of total economic activity, but it is no such thing; it _excludes_ the vast majority of transactions on the (bogus) ground that to include them would be "double-counting." (See George Reisman's "Capitalism," Chapter 15.)

Nor, by the way, are increases in GDP a measure of economic progress; they merely reflect increased consumption spending in terms of some monetary unit or other, and have nothing whatever to say about the constancy of that unit, or about its value for men's lives.

With the gold GDP in hand, we go on to estimate GDP in dollars. We take the figure of 10 trillion US dollars per year for the US GDP, and apply the long-standing rule of thumb that the US is one-quarter of the world economy. Thus, we estimate world GDP at 40 trillion US dollars per year. There are undoubtedly more accurate numbers available for world GDP, but this will be good enough to illustrate the method.

Now we can get our estimate of the potential value of gold. We simply divide the GDP measured in US dollars by the GDP that would be measured in gold if everyone held 6 months of gold: 40 trillion dollars per year divided by 8 billion ounces of gold per year equals 5,000 US dollars per ounce of gold. If everyone were holding 6 months of gold, the gold price right now would be US$5,000 per ounce.

Actually, US$5,000 per ounce is a conservative figure, for it ignores the fact that governments and their central banks hold immense amounts of gold. Their holdings are just over one quarter of the total gold stock: 33,000 tonnes, about one billion ounces of gold. As long as they continue to hold that billion ounces (which seems likely in the foreseeable future), there will be only 3 billion ounces available for individuals to own. This lower gold stock would lead to a world GDP of only 6 billion ounces per year if individuals were to hold six months of gold. The end result is an estimated gold price of 40 trillion dollars per year divided by 6 billion ounces of gold per year: US$6,666 per ounce of gold. To the single digit accuracy which is all that this rough estimate deserves, call it US$7,000. Come the day!

By this point you are probably jumping up and down with impatience, eager to remind me that these price estimates rest on nothing more than the assumption that men will make a conscious, deliberate _choice_ to hold six months worth of gold. This would be their personal, private, free choice--their moral choice. It is not written in the stars, not pre-determined. They could choose otherwise; and if they do choose otherwise, the value of gold will be otherwise. You needn't remind me, for that is _my_ fundamental point: the value of gold is determined by men's moral choices--even in a world of meddling governments and fiat money. The astonishing thing is that a single assumption about the leisure value of men's gold holdings is _sufficient_ to fix gold's value!

We can even turn the calculation around to deduce the choices men are actually making regarding gold. At today's gold price of around US$260 per ounce, the entire 4 billion ounce gold stock is valued at only US$1,040 billion. This is enough to support merely 0.025 of a year's consumption spending of US$40 trillion: a mere 1.3 weeks of leisure instead of 6 months. There are 26 weeks in 6 months, so the average owner of gold falls short of 6 months of gold by a factor of 20! If we exclude government holdings from consideration and use the lower gold stock figure of 3 billion ounces to derive our estimate, the factor is even larger: 26!

This factor of between 20 and 26 is an estimate of how far we are from a healthy gold standard world, for my figure of 6 months of gold was chosen artfully. It is by no means arbitrary. What men have done men may do, and an average money holding of 6 months was attained in the US at the end of WWII. In 1945, the US GDP was a little over twice the M1 money supply, meaning that the average user of US dollars was holding ready cash to the value of about 6 months of leisure. (In economists' jargon, the "velocity" of money was 2.1/year. See Reisman, "Capitalism," Table 12-1, pg. 523.) Not coincidentally, the US dollar was then widely believed to be "good as gold." This was in a fully modern economy complete with insurance companies, a stock market, and even fractional reserve banks.

The tremendous financial strength implied by those large cash holdings was a very good thing; it propelled the legendary post-war boom. To own six months of the world's premier money is to prepare yourself for a smooth and easy transition to a healthy gold standard economy of the future.

Six months of gold also positions you to earn large profits, for that factor of 20 to 26 is also an estimate of the real leisure profits to be made as the world rediscovers the merits of golden money. Your modest 6 months of gold could multiply 20-fold to 26-fold, could become 120 to 156 months worth! Even allowing for errors of estimation (and for some cautious profit-taking along the way), your modest 6 months of gold could turn into 50 – 100 months worth!

Before you object that such huge gains on such a simple investment are absurd and impossible, remember the 1970s. During that decade, gold's exchange rate _did_ rise in dollar terms by a factor of 20!

That nominal 20-fold increase spread over 10 years was an average nominal rate of return of 35% per year. Of course, consumer prices in dollars roughly doubled over the 70s which reduced the real (leisure) gain to about 10-fold, so the average real rate of return was "only" 26% per year. That puts the risky, bubbly stock market returns of the past few years into perspective, doesn't it!

The price of gold is a rocket fueled for launch. We know its ultimate destination approximately. We just don't know the length of the countdown.

A similar calculation for silver suggests another profitable line of thought and action. There are actually fewer ounces of silver in human hands than there are ounces of gold. Furthermore, that quantity has been _decreasing,_ not increasing as gold has been!

Quackgrass Press

(*) The philosopher's stone


The leisure theory of value

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