Fool's Gold

Try this thought experiment: On the deck of his boat in Pärnu harbor, a captain faces three families, each pleading for passage to Sweden as Russian troops advance from the East. The families are all clean cut, the kids not only well-behaved, but cute, as well. Any one of these families could be cast in an Ikea commercial or insurance company advertisement. To the captain, the only perceptible difference is the form of payment they’re offering.

The Saar family offers a USB stick that the father says holds crypto. “It’s Bitcoin,” he clarifies, “plus some stablecoin. It’s worth about 5,000 euros at the moment, and it’ll likely be worth even more tomorrow.”

The Tamm family has a small leather drawstring purse of gold. There are two coins which look like pirate treasure, the rest one-gram bars packaged in cardboard and plastic. “Gold is trading for over 4,000 euros per ounce,” says Mr. Tamm. “These are worth a lot.”

The Kask family’s father displays an envelope full of euro notes. “This is 3,000 euros in cash,” says father Kask. “It’s worth, well, 3,000 euros.”

All other things equal, and assuming the captain is motivated only by financial gain, which family will he take on board?

Investor or speculator?

My sixteen year old son loves to buy gold. He’ll save for months and take his money to the Tavid window at his local shopping center to purchase a one-gram plate about the size of a mobile phone chip, which, as I write this, retails for 145.40 euros. He does not have many—not enough to justify breaking into our home—but it’s the idea that counts. It pleases me that he has the discipline to save and that he desires to be financially independent one day, not bound to a government pension scheme. 

In that spirit of independence, we have regular father-son discussions about gold as an investment. We regularly disagree.

It is true that the price of gold is at an all-time high. It is true that professional investors recommend gold as a hedge against inflation and currency devaluation, especially during times of economic or geopolitical instability. They tell us that with its low correlation to stocks and bonds, it’s good for portfolio diversification. If you’re saving for retirement, then it’s possible that your investment advisor may advocate holding five percent of your portfolio in gold, though that gold, at least in the west, is almost never delivered. It’s held as a paper claim and, in that form, does its work to mitigate risk.

My crazy neighbor Pearu—he wears pajamas outdoors, blows his nose into his shirt sleeve and, like any good prophet, has predicted 14 of the last two market crashes—came over for dinner not so long ago, and at one point the discussion turned to gold. He praised my son for taking delivery of gold, remarking that he had it on good authority that the amount of paper gold sold exceeds the weight of the entire planet. I found this hard to believe, but interesting enough to look into. How much did the Earth even weigh?

Is paper a scam?

Since there is no scale at present big enough to weigh the earth, it can be calculated using Newton’s law, the motion of the moon and satellites, and the Earth's gravitational pull. Last summer, a bit drunk and staring into the night sky while listening Urmas Sisask’s “Universum,” I employed these tools and calculated the mass of the earth to be 5.97 x 10²⁴ kilograms, or six sextillion metric tons, or a six followed by 21 zeros.

The coin retailer Global Coin estimates there is 200-300 trillion USD in paper gold on the market, compared to 11 trillion USD of physical gold. Three-hundred trillion (12 zeros) is significantly less than a six followed by 21 zeros, but it is still interesting to note that there are far more financial claims on gold than existing deliverable gold. So are the Illuminati and Freemasons (Pearu’s shorthand for Jews) behind a scheme to sell non-existent gold over and over again to unsuspecting goyim?  

Alas, no. Since trading is leveraged and contracts are bought and sold without delivery, the same bar of gold could appear in multiple account simultaneously, which is not so different than the fractional reserves of the banking business. And just as with a bank run, if everyone demanded delivery at once, the system could not fulfill it. Paper gold still offers real exposure to the price of gold, provided you trust custodians like brokers, banks, and the exchanges where gold is traded.

But it turns out there are plenty of cultures who don’t trust these custodians. In countries like China, India, and Turkey, there is a strong cultural and historical preference for physical gold. Citizens of countries where there’s good reason to distrust financial institutions are likely to take possession. So does that include Estonia? 

Estonia dystopia?

My son was born in 2010. He is too young to remember the era when returns on Estonia’s second-pillar pension funds were sometimes so low they were effectively wiped out by management fees. But his parents and teachers (and neighbor Pearu) are of that generation, so it is understandable if he dislikes the idea of a bank’s balance sheet standing between him and his metal.

In the 1990s, it was difficult, if not impossible, for anyone to know which Estonian banks would go bankrupt and take their customers’ savings with them. The ‘90s also were an era where Estonian stocks were the “investment” rage, while in the west the purchase of individual stocks was considered too volatile to be safe for the retail investor, at least those who wished to play the long game and save for retirement.

Understandably, Estonia’s colorful history has fostered a climate where consumers can easily fall victim to the classic advertising trope—gold as the stable alternative to inflation, currency instability, and geopolitical uncertainty. And the physical gold most promoted here is the worst kind: a commodity re-packaged in plastic and cardboard, branded, and sold for a huge premium over spot price. They are made with sellers in mind, not buyers, and are sometimes described as “gold packaged for anxiety” or “gift gold.”

One gold merchant has advertised gold for people who are just like Pearu: “…kes on arusaanud et maailma rahandus ja majandus ei ole päris see mida nagu me lehes loeme...” (“…who have understood that world finance and the economy aren’t exactly as we read in the papers…”).

Tavid’s founder, hedging a bit by using the word “öeldakse,” (“it is said,”) has advocated that 30 percent of your pension portfolio should be held in gold as a hedge against systemic financial instability. Yes, you read that right: thirty percent.

Thirty percent falls well outside the US and European Union advisory norms, which are typically five to ten percent. Morningstar, the investment research firm used heavily by brokerages and advisors, recommends gold not exceed 15 percent of a portfolio at its upper bound. So does Estonia’s financial climate justify gold holdings that are six times above the international norm?

Paul Krugman has answered this way: “In general I’m with John Maynard Keynes, who called the fixation on gold a ‘barbarous relic.’ You can’t use gold to make payments (other than the occasional bribe): Try buying a house with ingots. Some people seem to believe that gold will offer a refuge if society descends into chaos, but let’s be real: Do you really think gold bars would help you navigate a Fallout-type post-apocalyptic landscape?”

Invasion economics

Even if you’re a disciple of Pearu and hold 30 percent of your life savings in gold, let’s consider the impracticality of holding that in physical gold.

On a day in late April, Tavid offered a one gram gold plate for 145.40 EUR, and the spot price of gold was 129.15 EUR per gram. That’s a 12.6 percent premium. The merchant’s buyback price on the same day was 128.50 EUR, making the round-trip spread about 13.1 percent of spot. If my son were willing to consider buying bullion coins from a second-hand dealer at a coin show, for example, he would likely cut that round-trip spread in half. Since those tiny gold plates have a high fabrication cost per gram, and also carry the marketing costs of heaping fear and paranoia on buyers, they are indeed the most expensive way to own gold—by far.

And what about the scenario when my son wants to sell that plate? There is no fractional reserve requirement, no liquidity coverage rules, and no buyback obligations for gold merchants. Gold is not cash, it’s a commodity exposure, and a dealer is legally closer to a jeweler than he is a bank. So if, in a crisis scenario, many customers want to sell their plates at the same time, how much cash reserves does Tavid hold? And what if the apocalypse happens on a weekend? Would the Tavid window even be open?

If Tavid is closed, then a pawn shop will typically add a profit margin of 40 to 60 percent on what they sell, meaning my son is unlikely to get anything close to the spot market price. On another day in late April, I checked those prices, too. On that particular day, a Tavid one-gram gold plate sold for 143 EUR, and they would buy for 125.20 EUR. Lombard24 would sell one gram of gold (form undefined) for 126.24 EUR and would buy for 108.54 EUR.

It doesn’t make sense that physical gold, with its massive markups and difficulties in unloading it, is the portfolio diversifier that it’s advertised to be. But then it must have some positives, right? It must be great in a crisis setting? Well, no.

There is considerable historical evidence that people paying with gold in crises effectively “overpaid” for goods, compared to those who used a trusted currency. In crisis conditions, liquidity, trust, and divisibility seem to matter more than theoretical value. Refugees fleeing Nazi-occupied areas often paid with gold coins and jewelry, but smugglers, border guards and boat operators preferred hard currency and would accept gold only at a discount.

But is there an argument for the portability of one-gram plates of gold? Could you jam more plates up your rectum than coins? Is Paul Krugman right about them being useless in a post-Apocalyptic landscape? Let’s return to our not-so-far-fetched, semi-dystopian scenario with the Swedish captain.

Return to the harbor

Our captain coldly eyes the families. It might make his decision easier, he thinks, if one of these were families were in comparatively more dire straits. But, alas, in our experiment they are indistinguishable, save for their methods of payment.

The captain considers the memory stick that the Saar family is offering. He doesn’t have a laptop with an internet connection to even determine what’s on the stick. And, if he did, he’d have to find a teenager to show him how to use it. So even if the Saar family is telling the truth, how long would it take him to get online and sell the crypto?

He studies the gold that the Tamm family offers. For a moment he considers biting it, since has seen that done in movies. But what exactly is this bite supposed to tell him? What if it’s just a cinematic cliché? How is he supposed to know if it’s real? And what are these little gold plates? They are not Krugerrands, which he has heard of but never seen.

He has little problem understanding the envelope of euros offered by the Kask family. While these are not the currency of his country, they are something familiar to him. And they are not 200-euro bills that he might be suspicious of, but smaller denominations, sufficiently weathered but with watermarks and holograms intact. If he takes this family, he will not have to wait long to use this currency. He can take it to his bank, convert it to Swedish Kronor, and within the time it would take him to value the crypto or gold, he could replace the aging engine in his boat and return to collect another family.

Ask the experts

Was the conclusion of our thought experiment accurate? Let’s turn to those who have spent inordinate and unhealthy amounts of time thinking about life in post-apocalyptic environments: video game writers.

Interestingly, designers of post-apocalyptic video games usually treat cash as worthless, since the system that gave that money value has collapsed. Usually, barter becomes the system, or there are newly invented currencies. In Paul Krugman’s example, Fallout, the currency is bottle caps, inventively backed by clean water! In The Last of Us, the currencies are scrap metal, alcohol, or scavenged parts, a shoutout, essentially, to Soviet Russia.

However, when apocalypse is not total, where a part of the outside world remains “normal,” the money from functioning regions remains the currency of choice. This is seen in games like Escape from Tarkov, about a fictional Russian region cut off from the global economy. It is true, as well, of the Stalker game series that was inspired by Tarkovsky.

So from our Swedish captain’s viewpoint, it is logical that euros will win the day.

Reliability

With gold prices per Troy ounce (slightly over 31 grams) hovering around 4,000 euros, I admit that gold can seem tempting. But it’s sobering to remember that after historic highs in the late 1970s and early 2010s, gold remained below its peaks for decades.

But as a Hail Mary appeal to my son, I asked him if I buy gold, am I not trafficking in the same evil element Pearu is always warning us against? Because according to an investigative report by the New York Times, the gold game is rigged. Justin Scheck, Simón Posada, and Federico Rios write that the “[US] government's program of gold sales is based on a lie. The [United States] Mint is actually the last link in a chain that launders foreign gold, much of it illegally mined, for an insatiable market.”

My son is only starting to listen, but he hasn’t yet bought into the idea that he ought to put his savings in something more boring than gold, like an index fund or treasury bonds, at least until we reach the point where we really do need to prepare for the worst. When we reach that point, I’m not sure what advantage having gold will bring. I’d rather have a firearm.

I’ll choose something common, like a nine millimeter handgun, whose ammunition is in the widest production globally and may itself be used as a currency. I’ll also get a pump action 12-gauge shotgun, also common and versatile with easily-available ammunition. I’ll leave the fancy weaponry to professional soldiers and those raised on video games. What I want is reliability.

Scott Diel has an MBA from the John M. Olin School of Business at Washington University. But like Binx Bolling in The Moviegoer, he uses it only in self-defense.

This story was originally published in the Estonian magazine, Edasi.