The Secret of Investing (Hint: It’s a Virtue)

The Richest Man in Babylon

George Clason’s The Richest Man in Babylon is one of the most popular and highly regarded investment books ever written. Published in 1924, the book has sold more than two million copies, and it continues to be a favorite into modern times.

In the book, Clason uses parables to illustrate principles of wealth building. The setting is ancient Babylon, and the currency is gold, but it is doubtful that Clason was actually encouraging investments in the precious metal. Instead, it is likely that Clason used “gold” generically as a synonym for “money.” Of course, the U.S. dollar was still backed by gold at this time, so the discrepancy between the two was not as severe as it is now. However, modern readers of The Richest Man in Babylon would do well to take the lessons more literally, and to save in terms of gold (or silver) instead of paper money.

Modern-Day Babylon?

The title character of The Richest Man in Babylon is named Arkad. In the book, Babylon is a once-great empire that is experiencing a massive economic downturn because its citizens no longer understand how to accumulate wealth: does this sound familiar? However, unlike our current political leadership, the King of Babylon wants to remedy the situation, so he calls on Arkad to explain to him the principles of wealth building, so that all citizens of Babylon can put his lessons into practice and the empire can be great again.

Arkad tells the king that there are seven cures to a lean purse. The first is also the most important: “Start thy purse to fattening.” How is this done? Arkad explains: “For every ten coins that you place within your purse, take out only for use but nine. Then after that your purse will start to fatten at once and its increasing weight will feel good in your hands and bring satisfaction to the soul.”

Easier Said Than Done

This advice is surely simple enough: Save 10% of your earnings. However, it is easier said than done, especially in the modern world. After all, today we are not paid in gold coins, or even in paper dollars—most of us don’t even get paychecks; we get direct deposit. “Money” is something that consists of 1s and 0s in a super-computer’s spreadsheet somewhere, and we don’t even see 10% of what we earn, which makes it that much harder for us to save it.

On top of this, we have two other forces to contend with: (1) Inflation and (2) conventional taxation. I say “conventional” taxation because inflation is itself a hidden tax. Unless you are a member of what economist and philosopher Samuel Edward Konkin III called “the political class,” you are probably a victim of the redistribution of wealth caused by monetary inflation. In other words, prices rise faster than your income, even if these price increases are not reflected in the government’s official Consumer Price Index. The result of this is that it’s harder to save. In fact, most Americans are up to their eyeballs in high-interest debt, which makes saving seem even more impractical. After all, if interest on your debt is accumulating at 12%, it doesn’t seem like it could make sense to save money at 1-3%, or even to invest in the hopes of an 8-10% return.

Secondly, there is the problem of conventional taxation. The economist Milton Friedman usually made the case for free markets. In his later years, he was an opponent of the War in Iraq and an advocate of drug legalization—about as hardcore as any libertarian could hope for. However, the unfortunate reality is that Milton Friedman’s two greatest contributions to modern life both worked to the benefit of the state at the expense of individual liberty. For one, his inaccurate analysis of the Great Depression argues that “deflation” was its cause and that the Fed should have printed more money—not surprisingly, this analysis has been openly embraced by Ben Bernanke, and contributes to the problem of redistributive inflation, illustrated above. But more pertinently, Milton Friedman is also the father of income-tax withholding.

Prior to income-tax withholding, fewer people were required to pay taxes. This is because the government knew it would be difficult to collect, so rather than having its inability to enforce tax laws become evident, it gave most earners waivers. Those who did have to pay taxes were allowed to settle up with the government on an annual basis, the same way most sole proprietors and the self-employed do today. Having this freedom allows one to spend their money first, before the tax man collects, and offers a greater chance to accumulate savings. However, with the vast majority of people working as employees and having taxes deducted directly from their earnings, they never even miss the money they rightfully earned, which is almost always a larger percentage than the 10% the fictional Arkad suggested they save.

Imagine how easy it would be to save 10% in a world where there was no taxation, or at least, taxation was much lighter and due only at the end of each year. Alas, we do not live in such a world, and thus Arkad’s advice is often difficult to put into practice.

Gresham’s Law

There’s another reason that it’s harder to save today than it was in Arkad’s Babylon, and that is Gresham’s Law, which states that “bad money” chases “good money” out of circulation.

A good example of when Gresham’s Law has come into play is at anytime in which a nation has tried to implement a bimetallic monetary standard. For instance, a government of old might have decreed that their monetary unit—let’s say the ducat—was equal to one-fifteenth of one ounce of gold; or, in other words, that it took 15 ducats to equal one ounce of gold. This is all fine and good, and citizens could freely exchange paper ducats for one-ounce gold coins at a rate of 15-to-1.

However, Gresham’s Law comes into play when the government tries to fix their currency’s value to a second commodity; let’s say silver. If this fictional government with the 15-to-1 ducat-to-gold ounce ratio suddenly decreed that ducats could also be redeemed for one ounce of silver at a rate of 1-to-1, there would soon be problems, even if the current exchange ratio between silver and gold was 15-to-1. That’s because exchange ratios between commodities are not set in stone, and are subject to fluctuations, and when gold became worth more than 15 ounces of silver, people in this fictional land would spend their silver coins and save their gold; driving the gold out of circulation. By the same token, they would do the reverse when gold fell below 15 ounces of silver—they would spend their gold and save their silver.

Now, you may be asking, what does this have to do with the modern saver’s difficulties? The answer is that Federal Reserve Notes—i.e., “U.S. dollars”—are bad money, in that their value is constantly decreasing in relation to the goods they can buy. Thus, there is an incentive for everyone to spend all of the money they can on goods of real value, as those goods will be more expensive (in terms of dollars) in the future than they are now. Even though most people are not conscious of what they are doing, they are subtly influenced by a subconscious understanding of Gresham’s Law, and this makes it hard to save dollars. However, it doesn’t have to make it harder to save money and build wealth, if one takes a more literal approach to the first lesson in The Richest Man in Babylon.

Alchemy: Turn Paper into Gold

Money is easy to spend because we never even see it. Inflation and taxation take away from our purchasing power and make it harder to save. Personal debts make it seem impractical to save, and Gresham’s Law incentivizes us to convert our depreciating dollars into goods. Yes, the odds are stacked against the would-be saver in this modern-day Babylon, but with a different consideration of what really constitutes “money,” saving gets a little easier.

In The Richest Man in Babylon, Arkad advises us to save gold. He doesn’t say to save one dollar for every ten, but one gold coin out of every ten. Now, putting this advice into practice in the modern day, one could briefly set aside 10% of his or her income, and use it to buy gold or possibly silver.

Don’t let your savings waste away in a bank account, as prices rise—buy precious metals. You’re less likely to spend money once it’s converted into gold or silver, as you’ll be forced to think long and hard before you go to the coin shop to convert your bullion into greenbacks—thus, you won’t be making any impulse buys you later regret. Gold is a hedge against inflation, and although you have to pay tax on the income you use to buy gold, gold itself is exempt from taxation. In short, converting your cash into gold sidesteps many of the hurdles modern-day savers face.

A Real Plan for the Modern Investor

If you follow this plan, your “purse” will soon be fat. For every dollar you are paid, preferably before taxes, set aside $0.10 to be applied towards the purchase of gold. If you are paid $1,000 a week, then every two weeks, be sure to take $200 and set it aside—immediately, before paying any other expenses. You must pay yourself first, and this money must absolutely be untouchable for any reason other than a serious family emergency.

Once you have enough to buy an ounce of gold, do so immediately and resolve not to sell the gold unless it truly is an emergency. Everyone should be able to afford to save 10% of their income, and if you cannot, then you must determine how you can either lower your expenses, increase your income, or do a combination of both so that 10% savings is attainable.

What if you have debts? It doesn’t matter: Pay yourself first. Service your debts from your remaining income. In time, you will see your wealth in gold grow faster than your debts, particularly if your interest rates are fixed. After all, inflation works to the benefit of debtors, especially when the inflation rate exceeds your interest rates, and under this scenario, the value of your gold will be gaining in purchasing power as well as real value.

The Problem With Gold

The one problem with taking Arkad’s advice literally is that most earners will have to save for several paychecks before 10% of their income can be used to purchase even one ounce of gold. With gold currently at more than $1,400 per ounce, the average American may only be able to buy one new gold coin every four months!

The main danger is that while you’re setting aside your greenbacks in anticipation of buying a one-ounce gold coin, you will dip into the funds. As stated earlier, it is much easier to spend cash on hand than it is to spend precious metals.

A secondary danger is that while you’re saving, the price of gold will keep going up, and you’ll have to save even longer. In fact, this is less of a danger than it is a near certainty. Under the worst case scenario, the dollar’s ongoing meltdown could kick into hyperinflationary gear while you have two or three months’ worth of savings sitting in cash. You could go to bed one night with almost enough to buy a new gold coin, and wake up to find that your Federal Reserve Notes are barely worth the paper they’re printed on.

One answer to this problem is to buy gold in denominations of less than one ounce. You can, after all, buy as little as one gram of gold (a troy ounce is roughly 31.1 grams). The problem with buying gold in such small amounts, though, is that the per-ounce premium is much higher. For instance, gold closed at $1,475 per ounce on April 14, and one-ounce gold Eagles were selling for $1,560, or a mark-up of 5.8%. Meanwhile, one gram of gold had about $47.42 in value, but one-gram chips were selling for $72.47, or a mark-up of 52.9%! Obviously, buying individual grams of gold is not that wise of an investment strategy.

The Silver Lining

Luckily, there is a next-best-thing to gold: Silver. And it actually may turn out to be an even better investment than gold.

Since September, 2010, silver has soared from less than $20 per ounce to more than $40—doubling in just over six months. By comparison, gold would have to be at $2,500 to match silver’s climb. And yet, silver has a long way to go before it reaches its historical valuation, relative to gold.

Traditionally, gold is valued at around 15 times silver, but even after silver’s huge gains over the past six months, it is still at just 1/36 of gold’s price. Silver should still be able to double in relation to gold, and gold itself should be headed higher.

But regardless of all this, the fact is that silver is still much more affordable on a per-ounce basis. A single, one-ounce silver Eagle can be purchased for $45 or less. Even someone on a modest income of $24,000 per year could afford to buy four ounces of silver with each paycheck. Then, once he has accumulated sufficient silver, he could choose to trade it in for gold if he wants to be as literal as possible in following Arkad’s advice. Either way, holding precious metals is infinitely wiser than storing one’s wealth in the depreciating U.S. dollar.

Persistence is the Real Secret

Whether you choose gold or silver, the real key is persistence. There are many who resolve to save 10% of their incomes and do so for a while. Perhaps a few weeks, a few months, or even a year or more. But those who truly make the commitment and do this for the rest of their lives are the ones who, like Arkad, will be called upon by kings to answer the great mysteries of wealth creation.

There really is no mystery; no secret. Persistence is the key. But the modern-day Babylonian cannot keep his savings in the paper dollars of his government. He must keep his savings in the ancient money of Babylon—in God’s money—in precious metals.