Be Your Own Bank: The Case for Gold and Precious Metals
So now we’ve come to the fun part of the series. For the next few weeks, I’ll be making the case for and against a few assets that I’ve found helpful or even integral to the process of becoming our own bank. In this part of the blog series, I’ll be explaining the specific mechanisms behind these assets and how they assist our banking functions.
If you haven’t read my previous posts in this series, here is Part 1, Part 2, and Part 3. But here's a small recap: The primary functions of a bank are storage of assets and lending in order to maintain and increase the value stored at the bank. Because of general economic inflation, part of the bank’s job is to make sure their lending beats the rate of inflation, while being paid for their troubles. Banks are helped in doing this by a system called Fractional Reserve Banking, in which the money they hold in reserve only needs to be a fraction of that which was deposited to them. In this way, they put a multiplier effect on the functional liquidity of the economy, because they get to use the same dollar in multiple ways. While we can’t be legally as effective as banks in this endeavor, we can find various goods and services which achieve a similar function for us through collateralized loaning, allowing us to also use our money in more ways simultaneously.
Goods versus Assets
Just to be clear, most of us actually do use our money in multiple ways already. After all, things like cars or computers are often used for different things at the same time. Cars are mainly source of transportation, but can also be vehicles of income (being an Uber or Lyft driver, for example). Our laptops and computers are also multi-functional. However, each of these goods often depreciate in value over time. A car loses much of its value once it is driven out of the seller’s lot. And even a refurbished computer is never bought for its original full price.
So, when I talk about assets that we can use to serve us as a bank, I want to stick to assets that, on average, almost always appreciate in value. Furthermore, because we are taking a loan on these assets rather than selling them, the assets need to be worth the loan while still appreciating all by themselves. This is what primarily gives us multiple uses of our dollar.
What’s the Deal with Gold?
And now we come to our first asset class to collateralize: Gold, silver, and other precious metals.
There’s a sense of nostalgia and fondness when thinking about acquiring and using gold for personal banking. After all, for a long time in human history, we used these things as actual currency. Gold was the major medium of exchange all the way up until the 19th century for most civilizations, empires, and nations.
The case for gold can be made in its utility and rarity. Since gold is so rare relative to many other naturally mined metals, demand for it outstrips its availability and supply. Additionally, gold doesn’t oxidize like many other metals, retaining its allure and usefulness. It’s also extremely malleable. This combination allows gold to be used in a wide variety of applications, from jewelry to technology.
The utility argument can be made for other precious metals as well. Silver, for example, is used in much of the modern world, including in semi-conductors and solar panels. These metals, while not having gold’s legacy, have maintained their worth and demand across long stretches of time.
How to Use Gold and Precious Metals
For our purposes, gold and precious metals can be collateralized in a few different forms: Jewelry, coins, and bullion. Jewelry is the most prevalent form, since this is the normal use case for most people. It’s accepted by nearly all services which will offer a loan on it. But the percentage of pure gold or silver (or other precious metals) in jewelry is quite low, and so we wouldn't be able to loan much from it. Coins are a rare form, difficult to obtain, and are only really existent in old coinage that was used in centuries past. Bullion, or bars, is probably the best way to get a loan for the metal you are offering. However, these are far, far more expensive, since the entire bar is purely and singularly that material.
Once you have the metal you desire to use in one of these forms, obtaining a loan is quite easy. There are many storefronts, banks, and even online services that can provide financing for your loan. The value of the loan can be up to 60% or 70% of the actual value of the item. This is where the general appreciation of the item comes into play. While you are taking the loan out (and paying it back), the gold being stored still appreciates in value, often matching and beating out inflation. So after the loan is done and you receive your gold back, when you collateralize it again, there is a high probability you can obtain a higher loan amount for it.
This is the value of loaning rather than selling an asset. By loaning, we retain ownership of the item in question, and because it’s an appreciating asset, we never truly lose value. Furthermore, we never need to worry about taxes, since loans are not a tax event. Thus, we get to keep more to spend. This value compounds upon itself over time, earning us more money from the money we initially paid for in the first place.
It’s important to shop around with various services and banks, since different places may offer higher or lower rates for your loan.
Next, let’s look at the pros and cons of using this asset class to become our own bank.
Advantages of Using Gold and Precious Metals
The first advantage for using gold and precious metals is the ease and efficiency of using it. More often than not, you can liquidate your gold within a day, as the process of evaluating it and getting the loan is very fast. Even online services don’t often take more than a few days to respond, after which it’s still an easy and quick process to obtain a loan based on your items.
Another advantage is that, unlike real estate (which we will talk about soon), upkeep for most of the items in this asset class is almost non-existent. Gold itself doesn’t oxidize or rust in a normal environment, so keeping it doesn’t get much more complicated than simply buying and storing it somewhere safe. For those that do rust or oxidize, like silver, there are ways of storage that keep the metals mostly clean, with a need to only take care of it once in a while.
These advantages allow gold and precious metals to be an incredible store of value that is easily liquidated without much trouble. However, there are a few key disadvantages that we must be aware of.
Disadvantages of Using Gold and Precious Metals
The first disadvantage is that, in the loan process, we don’t often hold onto the item we are using for the loan. Instead, it’s in possession of the bank or service provider until the loan is finished. Because of this, whether someone buys and participates in using this asset depends on whether or not the services which provide the loans are trustworthy in securing their customers' assets. If you don’t feel you can part from any gold or silver you purchase, or don’t trust the bank or service to keep your items secure, then this is a dead-end in terms of its banking functionality. Yes, these assets can still be kept in storage, but it will only be fulfilling a single function rather than multiple functions at a time.
A second disadvantage is the high interest rates these kinds of loans usually go for. The lowest interest rates that I’ve found hover between 10% and 11%. However, more often I’ve found interest rates that go as high as 15% to 20%. This is on top of the fees required upon transaction. So for any collateralized loan, the investments we make with that loan need to exceed, at minimum, a 10% return. This isn’t the most difficult thing, if you know what you’re doing. But if we’re attempting to simply augment our current financial situation by becoming our own bank (rather than investing in or starting new businesses), this asset class may not be the best for us.
The third, and probably worst, disadvantage is in the valuation of the assets themselves. The general consensus is that gold, silver, and other precious metals always appreciate over time. This is not necessarily true.
Let’s take a look at this gold valuation chart across the past century.
As you can see, while gold has been relatively stable in the past five years, across 100 years, it has actually fluctuated a lot. And even though it seems to have risen quite a bit from the early 2000’s, when we extend the time frame of investment to the 1980’s, the current valuation of gold has actually not yet even reached its past peak. In fact, gold has stagnated below that peak the last few years.
It gets worse. Let’s look at the valuation of the dollar.
As we can see, from the peak of the 1980’s the dollar has actually lost about 30% of its value. So when we take this rate of inflation into account, we realize that the current value of gold has depreciated as much as 55% when compared to itself.
This seems pretty damning until we remember one thing: we are comparing gold to itself. If we take all the past century into account, even given the parabolas and accounting for inflation, gold has still generally increased in value. Yes, it depends on when it was purchased, but on average it’s still a steady line of increasing value compared to the dollar.
Furthermore, we are not spending this asset as we would spend dollars. Instead, we are collateralizing it for dollars to use. Whether the dollar to gold ratio (or any precious metal for that matter) is higher or lower, we get multiple uses out of the asset we have purchased, providing we do our due diligence in terms of income and interest.
Evaluation: Good or Bad Asset?
Whether or not you decide to use this asset for your banking functions depends on a few things.
Disclaimer: Again, as I've said before, I'm not a qualified financial advisor. Please do not take anything that I've written or posted as financial advice of any kind. I believe each person should do their own due diligence and research before making any kind of decision for your own personal finances.
First, you need to determine whether or not the asset value, with its fluctuations, is worth your trouble. Second, you need to determine whether or not investments or loans you make to others will give at least a 10% return on your investment (ROI). If you can, then you will need the capital to obtain the gold or silver or other precious metals.
After that, however, the process of using gold to become your own bank is quite simple. By collateralizing it, you are now on your way to earning more money with the money that you already have, and will perpetually have, as long as you don’t sell the asset.
I hope this was a good primer and help for your decision on whether to use gold or other precious metals to become your own bank. Next week, we talk about Real Estate!
Header Image courtesy of Pixabay, taken from here.