inflation and gold

Economics Economics Questions
1

I’ve been thinking lately about inflation and the price of gold. According to some, the “real” price of gold should be around 3,000 an ounce. That is based on a certain presumed rate of inflation and the price of gold in years past (e.g. the 80’s).

Further, some say that the value of gold when measured against other products has remained fairly stable. I have never seen any hard evidence, but one of the anecdotal tails is that the price of a modern business suit in terms of gold is comparable to the amount of gold required for a Roman senator to buy an equivalent outfit of clothing for that time period.

Finally, many anarcho-capitalist/libertarian types consider the price of gold to be the ultimate proof/evidence of inflation. So that when the price of gold increases, it’s accepted to be a result of inflation, or expected inflation as in the case of recent gold prices in reaction to Fed rate cuts. In that sense, gold then becomes the only “real” measure of the value of various currencies.

So can anyone offer insight in how to reconcile all these thoughts? How can the price of gold be considered the ultimate reference of value for fiat money while simultaneously be “adjusted for inflation” in another conversation. If gold is, in some sense, “perfect” money, it’s nominal price should equal it’s real price, right?

2

According to whom? Prices are based on future expectations, and in the early eighties, before Volcker set about deliberately causing a recession, the future expectations were that the dollar would hyperinflate (or nearly so). There had been no real history (at least not recently) if monetary-policy decicision makers taking a tough stand. When Volcker got “tough” (as tough as a fiat-money enthusiast can) on inflation, those future expectations changed and were reflected in the price of gold.

In order to believe the current price of gold is not “real,” you have to believe there is some sort of manipulation by non-government forces to keep the price down. There is some, to be sure, but enough to thoroughly distort the price by 2/3? I haven’t seen any evidence. And if there is any, the asset’s price in 1981 is not part of it.

As far as I know, this originates from G. Edward Griffin in his Fed expose, The Creature from Jekyll Island. It’s just a cutesy rhetorical device and it proves nothing. A toga today does not cost what it did in gold 2000 years ago, and what I would consider a fine suit today did not exist. How has the price of air conditioners, as measured by gold, fluctuated since Roman times? I like Griffin’s book, but he has some populist/retrogressivist and mildly anti-capitalist leanings that turn me off.

Inflation is the expansion of the money supply. The price of gold doesn’t “prove” anything. If some weird economic events caused a contraction of the money supply along with an increase in the price of gold, this would not mean there was inflation.

My answer: The person “adjusting for inflation” from the 1980s and arguing gold’s current price is not “real” on that basis is not using sound logic. That logic assumes that the market price of gold responds only to the supply of fiat money, which is absurd. The gold price could move in perfect lockstep with the supply of fiat money, even if there were no other factors (i.e. non-monetary demand for gold, substitute stores of value, etc.), so obviously, there is a prognostication element in pricing gold . . . And the prognostication can be wrong, as it was in the early eighties.

3

Gold doesn’t move in lock-step with the money supply, obviously. Changes in the supply and demand for gold see to that. So no, if its price in terms of fiat money moves up, this doesn’t necsessarily prove the money supply is increasing. However, compared to just about all other commodities its supply is the most constant. And its demand, either as jewelry or money has been, with some exceptions, relatively stable. So over the long term, it’s a pretty reliable indicator of inflation. This is why governments like to depress the price of gold if they can, because a rising gold price reminds everyone of their fiscal irresponsibility.

Of course if governments are attemting to manipulate the gold supply, it’s a losing proposition, which will eventually come back to bite them. And if hyperinflation ever becomes a reality, all bets are off as to where gold might go.

4

Here is a recent example, http://mises.org/daily/2743 Skip down to the section titled “The real value of gold”. That’s just one example, I’ve seen this type of analysis in other places.

In general, it is my impression that most people in the Austrian/Libertarian community consider gold to be nearly perfectly responsive to inflation of fiat moneys (whether it be USD or something else). Perhaps my impression is wrong in that regard, but I thought the price of gold (in terms of what it can buy whether it be business suits or apples) was widely considered to be relatively stable. If that’s true, then gold should be a very good indication of inflation of other currencies.

Accepting (based on some sound reason, such as M2) a given rate of inflation and then adjusting the historic price of a good to “real” dollars is a common practice. Using that method, the real price of gold in the 80’s was (as pointed out in the article) somewhere between 1700-3000 USD. If that is sound, then why is gold so cheap now? Is there so much less demand? Has gold itself been created/mined in such a great quantity since that time?

5

What that article says is that in the 1980s, the price of gold in 2007 dollars was about $3000, which means that the demand for gold then was much higher than it is now. Why? Probably because gold was seen as a safe haven. In a crisis, particularly a hyperinflationary crisis, the demand for gold as money will increase because people are worried about their paper money becoming worthless. So the price of gold not only increases as a result of monetary expansion, it also increases as a result of its increased demand as money. This “increase upon an increase” is what caused the spike in the 1980s. I think what the author is suggesting is that we could experience such a situation again, in which case the price of gold right now looks cheap.

6

The price of gold is the cost of the next ounce of gold measured against the scarcity of all the other things in the world. I do not trust it to indicate anything above the obvious that central bankers are evil.

As for inflation, all indicators are meerely measurements of the results of inflation and are not inflation themselves nor are they indicators of inflation. Inflation is the increase in the supply of money and/or credit no more and no less. The price of gold or the increase in CPI or oil are just the results of inflation or the expectation of future inflation.

7

Yes, you can determine an “inflation-adjusted” price. But that doesn’t mean the price in the 1980s was right or that the current price is wrong.

Like I said, the price in the 80s reflected expectations of out-of-control inflation as far as the eye could see. That turned out to be wrong. Thus, prices receded. Gold isn’t “cheap” now – it was just priced incorrectly then. The gold price, like the price of any other asset, looks into the future. You don’t buy gold for what it’s “worth” today and ignore what it will be worth tomorrow, next week, next year, and 10-30 years from now. And when those future forecasts change, the current price changes accordingly.

8

An article that will help you understand gold is Gold and Economic Freedom by none other than Alan Greenspan, former chaiman of the Federal Reserve Bank. It is contained in Ayn Rand’s book Capitalism: The Unknown Ideal. The rest of the book is worthwhile too.

Inflation is money devaluation. The value of anything is dependent upon its supply and demand. Something in low supply, and likewise low in demand will not have a high value. Likewise with something in high supply, and high demand. Something in high supply and low demand will have very low value. The money maker is something in low supply, and high demand. The man with his hands on that supply will reap great wealth.

Any material goods we may possess represents our labor. We work to obtain material goods, food, clothing, housing, etc. Metal coins represent labor. It takes labor to dig the metal from the ground, purify it, and stamp it into a specific size coin. When money becomes scarce because of the greater amount of goods available on the market, then prices go down, and the metal’s trade value becomes high. This will prompt some to go searching and digging for these metals again to perhaps strike it rich. As the metals are found and minted into coins, and more money reaches the marketplace prices will begin to rise. When it gets to the point that the labor in finding and digging the metals exceeds that of other occupations to provide a livable wage, the supply of metals will decline. If the manufacturing, and production of goods continues to incease, it will prompt a new search for metals to coin.

Currency, or paper money is a bit of a different animal. Paper money used to be warehouse receipts. The paper had written on it the item stored, and the place of store. One size of paper could represent a peanut, or a peanut farm. A one hundred dollar silver certificate could be printed on the same size piece of paper as a one dollar silver certificate. You however cannot take two coins of the same metal and stamp a “1” on one, and “100” on the other. Originally Federal Reserve Notes, 1914, and 1934 series were redeemable in lawful money. In other words you could take them to a bank and get metal coins for them. The banks were the warehouse, and certificates, and bank notes were the receipts.

Certificates are no longer in circulation. Federal Reserve Notes are no longer redeemable in lawful money. In fact they are not redeemable in anything. Our money is a paper standard. In that case a $5 note should be five times the size of a $1, and the $100, one hundred times the size. Of course a $100 note would be like having one hundred $1 notes. You would want to let that stay in the bank, and get a receipt for it, which you could carry around much easier. This is the reason the certificates became popular. One hundred silver dollars is not a light or small load. One hundred double eagle gold coins would be a bit smaller, but not any lighter, and would have the equivalent value of two thousand silver dollars.

Printing money with nothing to constrain the amount in circulation except the speed of the printing press, and the amonut the bank is willing to lend, there is no natural balancing force between the items used as a medium of exchange, and the amount of goods available in the marketplace.

The U.S. Dollar is in such great supply in relation to the goods in the marketplace, so prices go up. Part of this is due to war. Wages are paid to produce military goods which are not available in the marketplace, but the wages are spent in the marketplace. We no longer manufacture much of anything to export, and therefore import a great quantity of goods. When the supply of U.S. Dollars in the marketplace decreases enough, the foreign exporters loan our money back, by such negotiable papers as treasury bonds, so we can buy goods from them again. When these countries start swimming in U.S. Dollars because we do not produce something they need, they are not going to want them anymore, and want to exchange them for something. The only thing we have is businesses and land to trade to get that money back, so we can buy more goods from them.

Immediately after the September 11, 2001 disaster the Fed pumped $50,000,000,000 into the economy. They did not drop it from planes over the country. No, it was loaned to the government. The present wars are kept in progress by continuous loans from the Federal Reserve Bank, pumping more money in the marketplace without an equivalent increase of goods resulting in the decreased value of the U.S. Dollar, i.e., Federal Reserve Note, and therefore an increase in the amount of dollars to buy the same goods.