Gold and Economic Sovereignty
Gold has historically been the bedrock of economic sovereignty, serving as a tangible anchor for monetary systems. Since the establishment of the Federal Reserve on December 24, 1913, gold’s role as money has been supplanted by bank credit—a shift that fundamentally alters the nature of economic exchange and value preservation.
J.P. Morgan famously declared, “Money is gold, and nothing else.” While technically precise—gold alone fulfills money’s core functions (unit of account, medium of exchange, store of value)—modern convention often equates “money” with bank credit. For this book’s focus on common stocks and investing, we adopt this shorthand, acknowledging that it subtly perpetuates the fiat paradigm. However, the distinction is vital: gold is money; bank credit is a derivative, a claim on value that degrades over time.
Bank credit fails as a reliable medium because it does not store value effectively. Its inherent instability—driven by monetary expansion—undermines its utility as a unit of account and erodes its purchasing power as a store of value. Denominating an economy in a self-depreciating metric is a deliberate policy choice, one that imposes a hidden tax on capital and fosters economic distortion.
Inflation as a Predator of Real Capital
Inflation, the persistent rise in prices due to an expanding money supply, is not a neutral phenomenon—it is a mechanism of wealth confiscation. By inflating nominal asset prices, credit expansion masks a critical reality: the erosion of real returns on capital. Investors who fail to account for this hidden tax risk consuming their principal, mistaking nominal gains for genuine growth.
Warren Buffett addressed this in his 1977 Fortune article, How Inflation Swindles the Equity Investor, wherein he noted that the average return on equity for American businesses averages roughly 12%—a structural constant akin to a bond coupon. Inflation, however, reduces the real value of this return. Consider a $200,000 equity investment yielding a return of 12% ($24,000 annually). With 5% inflation, the real return on capital equals 7%. If the investor spends the full $24,000, he impairs his capital: $210,000 is now required to match the prior year’s $200,000 in real terms. This shortfall—$10,000—represents capital destruction, silently extracted by inflation.
Hyperinflation: Accelerating Capital Collapse
In extreme cases, such as hyperinflation, the destructive force intensifies. Take a shop owner with $500,000 in inventory, earning a 20% profit ($100,000), bringing his capital balance at year end to $600,000. Under 50% annual inflation, the cost to replenish that inventory rises to $750,000. Despite a nominal profit, the owner faces a $150,000 deficit to maintain the same stock level—a 30% reduction in real capital. This dynamic triggers a downward spiral of capital destruction where profits lag behind rising costs, production is pointless, and the economy regresses.
Under hyperinflation, a perverse incentive arises, making it rational to consume capital rather than invest it. Sadly, this destructive dynamic is not exclusive to capital goods—this regression spreads to people: According to a survey from February 2018, 64% of Venezuelans lost an average of 11kgs of weight the year prior. 61% went to sleep hungry and 20% did not eat breakfast.
Central Banking and Deficit Monetization: Institutionalized Theft
Inflation is not an accident; it is a feature of centralized credit issuance. When governments spend beyond their means, issuing debt to cover deficits, central banks intervene by purchasing this debt with newly created money—a process termed deficit monetization. This expands the money supply, devaluing existing currency and imposing a stealth tax on all holders. By granting a monopoly on currency issuance to central banks, the state secures a mechanism to finance unlimited deficits, embedding inflation as a policy tool.
Historically, gold constrained such excess. Its scarcity forced governments to tax or borrow within limits, aligning spending with real resources. The shift to fiat currency severed this discipline, enabling unchecked credit expansion and systematic wealth extraction.
Why Stocks Fail to Outpace Inflation
Buffett’s analysis reveals a sobering truth: stocks are not immune to inflation’s toll. The average return on equity for U.S. firms of approximately 12%, as evidenced by historical S&P 500 data, remains relatively fixed, regardless of the inflation rate. Several factors compound this vulnerability:
- Taxes: Capital gains taxes apply to nominal increases, not real gains, taxing illusory profits inflated by currency devaluation, and
- Cost Drag: Rising input costs force firms to reinvest more just to maintain operations, diverting funds from growth and reducing real returns.
Strategies to Protect Capital
Inflation, as a pervasive tax on returns, cannot be fully escaped within a fiat system. While no strategy eliminates this burden, investors can adopt measures to lessen its impact, recognizing that these are partial defenses rather than cures:
- Pricing Power: Invest in companies with robust market positions—demonstrated by high returns on invested capital.
- Real Assets: Own gold, land, and commodities, which historically correlate with inflation and preserve value better than cash or credit-based instruments.
These approaches aim to slow capital destruction, not prevent it. Inflation’s systemic nature—rooted in fiat currency and deficit monetization—ensures its reach is inescapable, underscoring the limits of individual action within a flawed monetary framework.