This assumes you have bought some gold.

A lot of my readers have read my recommendation — “Buy some gold” — for six years. They still haven’t bought any. They apparently think it’s good enough to have read a few reports on the importance of buying gold. “Now I don’t actually have to buy any.” It’s like an overweight person reading a diet book while munching on Fritos and bean dip.

There is an astounding amount of misinformation on gold available on the Web. This shows the tremendous impact of the Web. Back in 1995, this misinformation was far more limited in its scope.

Here is the main piece of information: “Gold! Gold! I’ll be rich — rich, I tell you! Hahahahaha.”

No, you won’t. Here’s why.

IN THE MANIA, YOU WON’T SELL

I have been through a gold mania: 1979. People who had heard about gold from 1976 ($105/oz) all the way up into the range of $700 finally decided to get in. They had seen silver make similar gains. Newcomers wanted to buy. Old-timers didn’t want to sell. Prices soared.

Then, in one month — January 1980 — gold’s price peaked for one day at $850 and then plummeted by over $200 over the next few days. For the next 21 years, gold was a bad investment, and silver was even worse: from $50 to $4.50, plus a loss of 50% in purchasing power to boot. There was no worse investment in that era than silver. Yet all the way down, there were coin businesses that sold people silver coins. Some salesmen used exactly the same arguments that they use today to persuade people to buy. For 21 years, the arguments were incorrect. The better dealers just quoted prices and made deliveries. They did not hype the product. They are still in business.

Newcomers to the precious metals market don’t know this story. They should.

So, trust me when I tell you that you will not sell your precious metals during the mania. In a mania, buyers think, “It will cost more tomorrow. I must buy today.” Most would-be sellers think the same thing. They refuse to sell. Only a few see what’s coming and sell at the top.

This is true of everything that becomes the focus of a mania, not just precious metals. Think “dot-com stocks, March 12, 2000.” Think “S&P 500, March 24, 2000.”

So, why hold precious metals?

THE CRACK-UP BOOM

This golden phrase was coined by Ludwig von Mises. In Chapter 17 of his book on economics, Human Action, he described the breakdown of a monetary system. The breakdown begins with fiat money inflation by a government or its licensed central bank. This creates an economic boom, as he described in Chapter 20.

Over time, people recognize that price inflation will continue. They begin to hedge themselves against the effects of price inflation. They stop lending money to be paid back in a depreciating currency. They buy hard goods, such as gold and silver.

The crack-up boom is not part of the normal ups and downs of commodity prices. The following is normal.

He who believes that the prices of the goods in which he takes an interest will rise, buys more of them than he would have bought in the absence of this belief; accordingly he restricts his cash holding. He who believes that prices will drop, restricts his purchases and thus enlarges his cash holding. As long as such speculative anticipations are limited to some commodities, they do not bring about a general tendency toward changes in cash holding.

The trouble begins when people decide that they had better get rid of cash. To do this, they must find sellers of goods who do not see what is happening or who think the rise in prices is temporary.

When they expect that the money prices of all goods will rise or fall, they expand or restrict their purchases. These attitudes strengthen and accelerate the expected tendencies considerably. This goes on until the point is reached beyond which no further changes in the purchasing power of money are expected. Only then does this inclination to buy or to sell stop and do people begin again to increase or to decrease their cash holdings.

The trouble is, not many people perceive this change at the top of the mania. Most people can’t get out at the top. Remember the investor’s command: “Sell!” Remember the broker’s response: “To whom?”

As the mania grows, public opinion changes.

But if once public opinion is convinced that the increase in the quantity of money will continue and never come to an end, and that consequently the prices of all commodities and services will not cease to rise, everybody becomes eager to buy as much as possible and to restrict his cash holding to a minimum size. For under these circumstances the regular costs incurred by holding cash are increased by the losses caused by the progressive fall in purchasing power. The advantages of holding cash must be paid for by sacrifices which are deemed unreasonably burdensome. This phenomenon was, in the great European inflations of the twenties, called flight into real goods (Flucht in die Sachwerte) or crack-up boom (Katastrophenhausse).

Let me tell you a great story. I have told it many times over the years. Back in the 1970’s, I knew a retired banker named Norbert Einstein. He was very urbane, the model of a European gentlemen. He was the cousin of a more famous Einstein. He told me about the experience of their Aunt Rosa.

Aunt Rosa was a slow learner, unlike her nephews. She did not catch on to what the German central bank was doing until 1923, the final year of the mass inflation. She finally figured out that she needed to buy hard assets. But she had waited too long. There were none to buy. Well, almost none. She did find a seller of a niche product: bedpans. She took all of her money and bought a stack of them. Shortly thereafter, the German government had a currency reform, the central bank ceased inflating, and this ended the great inflation. The demand for hard goods slowed dramatically.

There was Aunt Rosa, figuratively sitting on top of a pile of bedpans.

In every crack-up boom, there will be many Aunt Rosas. Your goal should therefore be to avoid winding up with the equivalent of bedpans as your retirement portfolio.

Mises continued to describe the crack-up boom.

The characteristic mark of this phenomenon is that the increase in the quantity of money causes a fall in the demand for money. The tendency toward a fall in purchasing power as generated by the increased supply of money is intensified by the general propensity to restrict cash holdings which it brings about. Eventually a point is reached where the prices at which people would be prepared to part with real goods discount to such an extent the expected progress in the fall of purchasing power that nobody has a sufficient amount of cash at hand to pay them. The monetary system breaks down; all transactions in the money concerned cease; a panic makes its purchasing power vanish altogether. People return either to barter or to the use of another kind of money.

This is the end result of every expansion of money that is not halted earlier by the monetary authorities. But if they do call a halt, then there will be a recession or a depression. Mises described why in Chapter 20.

The problem is, central bankers and politicians are unwilling to accept this result. So, they reinflate. The march toward the crack-up boom continues.

This first stage of the inflationary process may last for many years. While it lasts, the prices of many goods and services are not yet adjusted to the altered money relation. There are still people in the country who have not yet become aware of the fact that they are confronted with a price revolution which will finally result in a considerable rise of all prices, although the extent of this rise will not be the same in the various commodities and services. These people still believe that prices one day will drop. Waiting for this day, they restrict their purchases and concomitantly increase their cash holdings. As long as such ideas are still held by public opinion, it is not yet too late for the government to abandon its inflationary policy.

This is our present situation. The public still prefers the boom effects of monetary inflation to the recessionary effects of monetary stabilization.

But then finally the masses wake up. They become suddenly aware of the fact that inflation is a deliberate policy and will go on endlessly. A breakdown occurs. The crack-up boom appears. Everybody is anxious to swap his money against real goods, no matter whether he needs them or not, no matter how much money he has to pay for them. Within a very short time, within a few weeks or even days, the things which were used as money are no longer used as media of exchange. They become scrap paper. Nobody wants to give away anything against them.

We are nowhere near this yet. But this is the end result of a policy of monetary inflation.

What Mises described is a breakdown in the exchange economy. Once again, I cite him.

The monetary system breaks down; all transactions in the money concerned cease; a panic makes its purchasing power vanish altogether. People return either to barter or to the use of another kind of money.

This is the equivalent of a depression. It is an inflationary depression.

THE DIVISION OF LABOR

In 1923, at the peak of the German inflation, the prices of goods in Berlin as denominated in pounds sterling were higher than the prices of the same goods in London. Why? Because production had collapsed. The division of labor had collapsed. To get goods imported from outside the country, entrepreneurs had to take greater risks. Uncertainty increased. Because the orderly markets had disappeared in the wave of price inflation, supplies of everything became much tighter than outside Germany. Buyers in other nations could outbid German buyers, even in those cases where German buyers had foreign currencies and gold.

Gold and foreign currencies kept families alive. It did not make them rich.

Then who won? The great winners were farmers. They easily paid off their pre-War debts. Even before 1923, a farmer could pay off all of his debts by the money generated by the sale of a single egg.

What counted most in 1923 was your ability to keep your job. What made jobs desirable were products to sell that everyone wanted: basic foodstuffs, coal, and liquor. People in cities sold off their prized possessions and heirlooms in order to get food. The flow of grand pianos to German farmers never again reached such a rate.

There was almost no way to get rich in cities. There was no asset, other than stored food and coal, that could have made someone rich. But rich as measured in what? The greatest urban wealth was food and coal. Holders refused to sell.

The same story appears in the Bible. In II Kings 6, we read of a siege that was so horrendous that women ate their infant children, a practice which had been prophesied by Moses centuries before (Deut. 28:57). No one got rich in that siege.

Almost no one gets rich in a crack-up boom. The few who do generally go bankrupt after the currency reform, when economic conditions return to normal.

THEN WHAT GOOD IS GOLD?

Gold serves as a valuable asset in the time leading up to the crack-up boom. Its price rises faster than the prices of most other assets.

In the crack-up boom, gold serves as an insurance policy against a catastrophe. You can buy your way out of circumstances that bankrupt others. You preserve much of your lifestyle by selling off a widely sought-after asset: gold. But understand: this is not a way to get rich. It is a way not to become totally impoverished.

After the currency reform, gold is more likely than any other crack-up boom asset to retain its purchasing power. This means that gold is a good investment in three phases: in the years before the crack-up boom, during the boom, and in the reconstruction phase after the boom.

Other assets require trading in and out. They require almost perfect timing. Gold doesn’t. You buy it before the boom is expected (e.g., 2001), hold it through the boom phase and the crack-up phase, and then re-enter the capital markets as the owner of an asset that has universal desirability as an investment.

You don’t get rich as a holder of gold during a time of serious inflation. Yet get rich as an investor with capital to invest after the crack-up boom has ended.

CONCLUSION

People do not see gold in this way. They see it as a way to get rich in a time of inflation. They do not understand this principle of economics:

The division of labor through invested capital is what makes people rich, slowly. The crack-up boom destroys the division of labor. Most people get poor in the crack-up boom, except those who (1) operate successfully in a low division of labor environment (think “Amish”) and (2) debtors who live outside urban areas, who pay of their debts with depreciated money.

The Amish don’t pay much attention to their wealth, except maybe to buy better horses. Debtors who learn how to play the pyramiding game in the boom phase generally go bankrupt after the monetary stabilization takes place.

So, don’t expect to get rich in an age of inflation by owning gold. That’s because you would have to sell it to get rich. Your timing had better be perfect.

Don’t wind up like the entrepreneur described in II Kings 7:16—20. His timing was deadly.

Gary North [send him mail] is the author of Mises on Money. Visit http://www.garynorth.com. He is also the author of a free 20-volume series, An Economic Commentary on the Bible.

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