Today, we present a guest post written by Jeffrey Frankel, Harpel Professor at Harvard’s Kennedy School of Government, and formerly a member of the White House Council of Economic Advisers. A shorter version appeared in Project Syndicate.
The price of gold reached an all-time record high of $2,000 per ounce this month. Mainstream economic thinking has treated gold as a side-show since the world went off the gold standard. Nevertheless, the recent spiking in the price signals some important trends. It is not merely “sound and fury signifying nothing,” as sometimes seems true of financial markets.
There are three ready explanations for the historic increase in the price of gold: (i) monetary policy, (ii) risk, and (iii) a spreading desire for an alternative to the dollar as a safe haven. Each of these explanations contains some truth.
(i) Easy money.
The first reason for the high dollar price of gold is that the Fed has eased US monetary policy very strongly since the onset of the coronavirus recession in March of this year. True, gold had already begun to climb in 2019. But the Fed had already begun to cut interest rates in 2019.
Gold’s role as a hedge against inflation has for centuries been one of the major motives for holding it. One might observe that there is little sign of inflation today. But inflation in goods markets is not the only sign of easy money. Other signals include low real interest rates, a depreciated dollar, and high stock prices – not to mention the size of the Fed’s balance sheet. Each of these signals currently confirms the aggressive loosening of US monetary policy. A low real interest rate is often associated with a high real price of gold, in theory and empirically. After all, the long-time argument against holding the yellow metal, that it doesn’t pay interest, is less persuasive at a time when other assets are not paying much interest either.
The last decade confirms the correlation. In 2011-12, during the Fed’s second and third rounds of quantitative easing (QE), the gold price was almost as high as it is now. It fell to $1,200 an ounce during the “taper tantrum” that followed Fed Chairman Ben Bernanke’s May 2013 announcement of plans for the coming end of QE, which eventually brought a sequence of interest rate increases during 2016-18. Then, as noted, gold began its current sharp ascent in early 2019, when the Fed ended its period of monetary tightening.
(ii) Risk.
Another age-old motive for holding gold is as a hedge against economic and financial risk (especially the risk of catastrophe). Although the price of gold is highly variable, its movements tend to have relatively low correlation with the price of the market basket of securities. It thus offers investors an opportunity to diversify risk. For obvious reasons, risk perceptions have been elevated since February, according to policy uncertainty indices and the VIX (the so-called “fear index”). Gold is historically one of several safe-haven assets to which risk-averse investors flee in times of uncertainty.
(iii) Diversification away from dollars
The dollar has long been the leading safe-haven currency. (The Japanese yen and Swiss franc are other safe-haven currencies.) This is one aspect of its unchallenged status as the number one international currency. But many investors around the world are becoming increasingly eager to diversify their holdings away from dollars. A new element is the extent to which the US President has sought to weaponize the dollar, using – or abusing – the exorbitant privilege of the dollar’s status, for example, to extra-territorially enforce unilateral US sanctions against Iran. Russia, China, and even Europe have thereby been motivated to find a payments mechanism that is not dependent on the dollar.
Another plausible factor is international loss of confidence in the general competence of US governance and the implied consequences for the American economy. The most egregious example is the perception that White House mismanagement underlies the US status as #1 victim of Covid-19 globally, in terms of the number of cases and number of deaths.
The decline of the dollar’s pre-eminence as #1 among international currencies has been prematurely declared many times before. It hasn’t happened, because there is no obvious challenger. The #2 international currency, the euro, still lags far behind the dollar in measures of international use (though the new prospects of a large-scale public Eurobond market brings the currency one step closer). Meanwhile the renminbi, heralded as a challenger to the dollar not long ago, has only made it to 5th, 7th or 8th place in the rankings, depending on the criterion used.
Gold is not a currency, but it is a rival for the dollar as an international reserve asset held by central banks and as a perceived safe-haven asset in the portfolios of investors. So, it has benefited from the international desire to diversify away from dollars.
For whatever combination of reasons, the dollar has depreciated against the euro and most other major currencies since April, which in itself partly explains the increase in the dollar price of gold. That is, gold has not appreciated as strongly when measured in terms of the euro or other currencies.
Gold’s role in the international monetary system
The sensitivity of gold to monetary policy might offer a small kernel of truth supporting the relatively small group of economic commentators who want to bring gold back out of retirement and return it to a central role in the global monetary system. Let us call them “gold bugs.” (This term is also used to describe investors who expect the price to rise, which at the moment includes more speculators who jump on the bandwagon of appreciation than those whose motivation is an ideological wish to return to the gold standard.)
The hey-day of the international gold standard, the period when most major currencies were convertible into gold, ended in 1914 with the advent of World War I. But the metal continued to play an important role as anchor to the international monetary system until August 1971, when President Richard Nixon surprised the world by abruptly ending international convertibility of the dollar into gold. Over the 1970s decade of rapid US monetary expansion, gold’s price rose 16-fold [from $41/oz. to $668/oz.], reaching in January 1980 a level that in real terms slightly exceeded the current price and by that criterion remains the record.
It is true that the three vertiginous ascents of the price of gold — in the 1970s, 2008-11, and 2019-20 — each reflected easy monetary policy. It is also true that monetary expansion was excessive in the first case, the 1970s, resulting in run-away inflation (13% in 1980). Thus, the gold bugs could argue that a rule “the central bank should reduce the rate of money growth when the price of gold is rising” might have produced a better outcome in the 1970s. But it would have produced much worse outcomes in both the 2008-11 and 2020 episodes, when monetary stimulus was entirely appropriate since the unemployment rate was very high (surpassing 8 % in 2009-11 and 10 % currently), while inflation remained very low.
Judy Shelton
The gold standard is of more than antiquarian interest. In January, Donald Trump officially nominated Judy Shelton to be one of the seven Governors on the US Federal Reserve Board. The Senate Banking Committee voted on July 21 to approve her (along party lines). The Senate leadership might choose to bring Shelton up for a final vote as early as the return from recess in September.
Judy Shelton made her reputation as a died-in the-wool proponent of the gold standard. One might almost have admired the integrity of her ideological consistency. She seemed different from Stephen Moore, the last candidate whom Donald Trump suggested for the Federal Reserve vacancy. Moore had said several times that he supported a return to gold, but then denied it. Shelton, by contrast, has built her career on this position. Her views go beyond nostalgia for the good old days. “Let’s go back to the gold standard,” she wrote in February 2009. She made it clear that she meant to abolish the alternative (the fiat-money dollar) as legal tender.
There are two big problems here. One is that a return to a gold-based monetary system would be a terrible idea. Even if low and stable inflation were the only objective, the gold standard did not deliver that. During 1873-1896, the general price level fell 53% in US and 45% in the United Kingdom due to a dearth of new gold deposit discoveries, which came to an end only with the Klondike gold rush.
Moreover, the economy does better when the central bank, in addition to the goal of price stability, also pursues financial stability and acts to stabilize income and employment as well. Monetary stimulus was the right answer in 2008-12, when unemployment was 9% and inflation was low. Conversely, monetary tightening was appropriate in 2016-18 when unemployment fell below 5 %, even below 4%. Had the Fed followed what the gold market was saying, it would have tightened monetary policy in 2010, prolonging the period of high unemployment, and loosened policy in 2018. The wrong answer both times.
Stimulus was again the right answer when the coronavirus recession hit in March of this year. Gold would have gotten that one wrong too. The recent $2,000 price would tell a true believer that the Fed should tighten aggressively, by more than 270 basis points according to one estimate.
The second problem is that Shelton has recently even failed the test of ideological consistency. As soon as the prospect of appointment to high office arose, she abandoned a lifetime philosophy in order say what Trump wanted to hear. What he wanted to hear, after he occupied the White House (not before), is that the Fed should loosen, even faster than it has. Shelton has dutifully adopted Trump’s position, $2,000 gold or no $2,000 gold. The switch fits into a general swing from a Republican campaign for tighter monetary policy when Barack Obama was in office, to agitation since 2017 to open the floodgates of liquidity.
If Shelton were to take a seat on the Fed Board, her vote would probably be determined neither by the price of gold nor what is good for the economy. Almost certainly, if the Democratic candidate wins the election in November (and is allowed to take office), she would suddenly remember the discipline of gold and rediscover the urgent need to tighten money – even if the economy were still very weak at that time (perhaps as the result of a second dip in the recession). On the other hand, if Trump remains in the White House, she will probably vote to double down on the current monetary stimulus, even if inflation starts to become a problem.
We have become accustomed to toadyism and cronyism in this Administration, from the Justice Department to the Post Office. But the Fed has been blessedly free from it until now. The Senate should not approve this nomination.
This post written by Jeffrey Frankel.
Nice discussion all the way around especially the take down of Shelton on monetary policy. A wee note on this wisdom:
‘Although the price of gold is highly variable, its movements tend to have relatively low correlation with the price of the market basket of securities.’
Financial economists might go even further noting that gold historically has had an average return that is negative, which could be explained by gold being a negative beta asset.
Shelton is irrelevant. She is a good red sea conspiracy booster. Her policies would obliterate white wealth and trigger bankruptcy after bankruptcy. Famine and starvation would be next. The debt bubble is too large. That is the result of pretend/extend model of dollar standard business. The gold standard was pump and dump model. All scams to benefit the wealthy via usury. The
Loan quality was terrible this summer. Banks have began reeling in the originations, which will slow credit growth this fall and winter.
All my white wealth is gone. I spent it on large bags of pork rinds and Dukes of Hazard DVDs. What really got my goat was when I discovered that 60% of the pork rinds bags was a large pocket of air on the top of the bag.
Now I have limited my exposure to free markets by digging for tators and eating possum innards. I am safe, and I know if Mitch McConnell refuses to pass COVID-19 unemployment benefits and fails to repair Republican sabotage of the U.S. Post Office, Powdered Toast Man will save low-income Americans being evicted from their homes and apartments.
https://www.youtube.com/watch?v=Ln9oxGf_cos
If they don’t die before then, because their medication is laying under a 2,000lbs pile of mail at the USPS Philadelphia Distribution Center as donald trump can’t handle democratically decided elections.
An interesting article on gold by “moneyness: http://jpkoning.blogspot.com/2020/08/the-case-for-banning-gold-mining.html
I remember when Central Fund of Canada used to be the best way to go to purchase gold. This was years ago. I think now they are administered by Sprott, which in my book makes them much LESS trustworthy. That is all I can add on this topic. It’s a shame, because CEF used to be one of the better avenues for purchasing gold in a sea of scam artists.
A vehicle which involves direct holding of gold, as I believe was the case with the Central Fund, is often better than a vehicle which invests in gold futures. It has often been the case that investors in precious metals futures funds do worse than those investing in the physical commodity because of “the roll”. Selling the front-month future as it is about to expire means selling into a market with lots of other sellers. Rolling into the soon-to-be front-month means buying when there are lots of other buyers. Sell low, buy high. It is even possible to lose value on futures in a rising market because of the roll. Physical gold holdings involve storage cost, but there is no recurring transaction cost and no roll.
None of which has a thing to do with monetary policy, of course.
Real interests declined over the last decade amidst a rising dollar, higher stock prices, and weak inflation. Meanwhile, gold ranged between $1000 and $2000. I think this article only looks sound if you focus on the last two years. Otherwise, the identification of monetary ease falls apart.
Sounds like you have an idiosyncratic definition of “monetary ease”. If you look at the real fed funds rate relative to historical norms during expansions, you’ll see it has been low through most of the expansion. If you compare the fed funds rate to standard Taylor Rule guidance (https://www.frbatlanta.org/cqer/research/taylor-rule), you will also find that the funds rate has been low since around 2013. By standard definitions, monetary policy has been easy for more than the past two years.
I just had a late night random thought. What happened to commenter Frank in south Georgia ?? Hope he’s still out there reading, I miss his comments and positive contributions to this blog. I think he was older and I dare not let my mind wander too far on what the reasons would be. He’s kinda quiet anyway, so I’m going to assume the best.
Frank in Georgia, if you’re out there reading give us a holler and let us know you’re wearing a quality mask and staying 10 feet away from the grandkids.
https://i.redd.it/c17k6zcop1j51.jpg
Get your Metamucil stirred up and big black magic marker ready.
I feel a warm fuzzy when I watch this:
https://www.youtube.com/watch?v=FScY9n_TWHg
Menzie, I know you get mildly angry because I always get off topic from Economics, but don’t you think the video of Melania walking down the aircraft stairway fits somewhere in a graduate level class specializing in diminishing returns ??
https://www.youtube.com/watch?v=oShTJ90fC34
This graph could even uncannily remind Melania of a part of donald trump’s anatomy:
https://www.google.com/imgres?imgurl=https://personalexcellence.co/files/graph-diminishing-returns.gif&imgrefurl=https://personalexcellence.co/blog/law-of-diminishing-returns/&tbnid=yD0yUcUELZ0T9M&vet=1&docid=TK39qQqWKOiSeM&w=800&h=533&source=sh/x/im
It is super hard to figure out why British citizens had had it with the EU isn’t it?? Well, the EU knew better about efficiency, didn’t they?? It’s a very sharp group.
https://www.nytimes.com/2020/08/25/world/europe/golfgate-ireland-coronavirus.html
The only way the EU might be more efficient is if they had donald trump’s loser son-in-law in charge of ventilator sourcing. Then they could have picked up 45 ventilators from Russia—-zero of the 45 that actually work.
https://www.thedailybeast.com/jared-kushners-private-channel-with-putins-money-man-kirill-dmitriev
The primary problem with fixing any price, e.g., gold, cpi, S&P, foreign currency, anything – is that it would never be the primary goal of the Fed or of the government. Something more important will always come up – e.g.,wars, covid, climate, depressaion – leading to monetary and financial instability at just the wrong time.
Yes, and beyond that, fixing any price in dollar terms is a form of market intervention. Why is one intervention less subject to corruption or poor judgement than another? Price fixing is price fixing. Isn’t price fixing something those nasty socialists do?
The risk with intervention in the cost of overnight credit is that a policy error can be very harmful. The benefit is that such intervention gets at the problem monetary policy is meant to address fairly quickly. Tricky, and problematic in recent years. If a better idea comes along, we might want to try it (and we have, with less than ideal results).
Only by defining the goal of monetary policy as stabilizing the value of the dollar relative to gold can intervention in the gold market get at “the problem” monetary policy is meant to address. The idea is extraordinarily circular.
The most serious current supporters of something like a gold standard are Austrian free banking types such as Larry White. So they would get rid of the Fed and use gold as the standard of value for the dollar. As it is, Shelton has at times played footsie with this view, but obviuosly is not saying anything about it now that she is up for being on the Fed Board of Govs.
BTW, when Hayek proposed free banking, he suggested using a broader commodity standard, not just gold.
Yea but commodity prices in general are not exactly stable. Stephen Moore also touts a commodity standard.
You really wouldn’t be getting rid of the Fed though. Only socialism and a abolished usury standard would do that. A gold adjusted currency would need a central bank somewhere like the BOE did during the 18th19th century to manage gold flows. Free Banking is just internationally created banks which would be one massive central bank, globally. Amazing Austrian idiots can’t tell that.
The Rage,
Looks like you do not know much US history. We did not have a central bank between 1837 and 1913. But we were definitely on a gold standard for most of the period after the Civil War up until the Fed was founded. One can argue that this was ultimately being defended by the BOE, but it was being enforced in the US by the leading New York private banks, and it led to a serioud deflation.
That is why 1896 was one of the two times in US history that a major party nominated a keynote speaker because of his speech, in that case, William Jennings Bryan who concluded his barn burner with “They shall not crucify us on a Cross of Gold!!!” (Wendell Willkie in 1940 for the GOP was the other with his “One World” speech.)
I have to award the best RNC speech yesterday to Don Jr.:
https://www.towleroad.com/2020/08/coked-donald-trump-jr/
Donald Trump Jr. gave a taped speech at the first night of the Republican National Convention, which CNN called a “parade of dishonesty”: “While CNN also watched and fact-checked the Democrats, those four nights combined didn’t have the number of misleading and false claims made on the first night of the Republicans’ convention.”
But after Donald Trump Jr’s speech, viewers were not talking about its content (which was filled with so many lies it’s not worth sharing in full), they were talking about drugs. “Coked” was still trending on Twitter early Tuesday morning.
I watched Andrea Mitchell as she tried to intervene the ever rude Peter Navarro:
https://talkingpointsmemo.com/news/peter-navarro-plasma-treatment-covid-19-fda-stephen-hahn
White House trade adviser Peter Navarro on Tuesday defended President Trump’s emergency authorization of convalescent plasma therapy as treatment for COVID-19, even after Food and Drug Administration Commissioner Stephen Hahn conceded that he had overhyped its effectiveness.
When pressed during an MSNBC interview on Hahn’s tweet the night before that the criticism he’s faced over his remarks about the benefits of convalescent plasma was “entirely justified,” Navarro hit back at the notion that emergency approval of the unproven treatment for COVID-19 “falsely inflates hopes.”
“I don’t accept that,” Navarro said. “That, to me, is like a crazy talking point.”
After pointing out that both Hahn and the Mayo Clinic have said that the emergency approval of using plasma to treat COVID-19 reduces the possibility of having a proper randomized study on it, MSNBC’s Andrea Mitchell asked Navarro whether Hahn was wrong.
“On the issue of not being able to do randomized trials, what is the calculus here?” Navarro said. “Are we going to wait to use something that can save thousands of lives just so we can have a study that tells us what we already know?”
Mitchell cut in to point out “yes, that is scientific practice, sir” because it’s how vaccines and drugs are approved. Navarro responded by circling back to asking whether it’s worth waiting for a therapy that “likely works.”
“This is an important debate for the American people and your viewers to have: Do you want to wait for a therapy which likely works to get these scientific studies which are going to take three, six months, whatever?” Navarro said. “Or do you want to have the right to try?”
And we thought Bruce Hall was an idiot! Navarro kept insisting safety is enough and whether we know something works or not is unimportant. Hey let’s just skip phase III clinical trials. Navarro is even dumber than his boss.
“After all, the long-time argument against holding the yellow metal, that it doesn’t pay interest, is less persuasive at a time when other assets are not paying much interest either.”
However, a $1000 treasury bond is guaranteed to pay you back $1000 at maturity. For gold, you can only hope to find another buyer to get your money back in the future.
“However, a $1000 treasury bond is guaranteed to pay you back $1000 at maturity. For gold, you can only hope to find another buyer to get your money back in the future.”
If you assume high inflation, a bond’s constant nominal value is a not very convincing argument, the conservation of purchase power is easier with gold in such a scenario.
Then what’s the history lesson re: gold? Since you note “assuming high inflation”, does the risk of owning gold (and storing it and finding a buyer when ready to sell) stand the test of time?
Would purchasing TIPS be more prudent as an inflation hedge?
If you bought gold in 198 when there was high inflation and before it crashed, it was a pretty awful conserver of “purchase power.”
Oooops, should have read “1981.” There I go again getting sloppy. Good thing I have my leather pants on, :-).