Recently a New York Times article screamed “Prices Surge as Investors Rush to Safety of Gold.” In reality there was no rush and the gold price did not surge. Gold was up less than 0.5% on the day in question and is up only 6% in 2011, less than the increase in the S&P 500. For 10 years, the gold price has edged quietly higher, rarely moving more than 1% up or down on any given day. Along the way, the media argued that each new high was driven by panicked investors who were fleeing from equities. I would argue just the opposite. Individuals and institutions, reacting rationally to expansionary monetary policy, are merely exchanging cash balances for gold. This has little to do with geopolitical turmoil or perceived troubles in the economy and stock market. It is a currency trade, pure and simple.
The basic mechanics of monetary policy and money creation remain a mystery to most people. Few are aware that most new treasury debt is purchased by the Federal Reserve with brand new dollars; that China buys large quantities of dollars every day with newly minted Yuan or that Japan created 39 trillion ($481 billion) new Yen in the two weeks following the earthquake. As James Grant points out in his March 25th Interest Rate Observer, “when the materialization of nearly a half-trillion dollars in a fortnight’s time stops astounding reporters, it’s past time for a monetary reappraisal.” Perhaps reporters are more unaware than unimpressed. With everyone printing at once, the value of one currency relative to another (the exchange rate) never reflects the magnitude of the new supply of money. All currencies decline together while appearing to not decline at all. While this provides ample cover for our central bankers to perpetuate the print-off, it results in inflation, progressively severe boom and bust cycles, perpetual deficits and an increasing inequality of wealth.
Under a gold standard, in which paper money is convertible into a fixed weight of gold, the threat of dollar to gold conversion compels monetary restraint on all central banks. In our present unreserved monetary system, that threat has become reality and the qualities that define our money as sound have been transferred, at the margin, from paper to gold. We have seen the creation of gold denominated shares by hedge fund manager John Paulson and others; the passage of a bill in the Utah legislature allowing gold and silver coins to be used as legal tender; and the conversion of cash balances into gold bullion by major investment and endowment funds. Even the manufacturers of our money have been exchanging paper for gold - witness the buying of bullion by the central banks of India, Bangladesh, Sri Lanka, China and Thailand over the last year.
Economic stimulation through currency depreciation is the unwritten, unspoken policy of today’s monetary leaders. While our Federal Reserve receives a disproportionate amount of the blame for this dangerous game, all central banks are active participants. In response, gold is predictably performing its role as the only supply constrained currency – its price is adjusting upward. Despite the headlines, it has done so in an orderly, methodical way for over a decade. Other commodity prices have risen as well, but only the gold price has risen with a consistently tight correlation to the growth in world money. This has won converts to the idea that gold must be the centerpiece of monetary reform. It has also shortened the road forward to a modernized gold standard.