I couldn't suppress a grin as I read the headline in Saturday's Financial Times: "In gold they rush. World economy: Bullion's sharp rise in price is prompting a rethink for the first time in four decades about whether the metal should have a monetary role, write Robin Harding, Javier Blas and Alan Beattie."
My Dad, economist Edward C. Harwood, predicted that gold would one day reassert itself in world monetary affairs, with or without the permission of the politicians. In February of 1963 he wrote this to his colleague John Exter:
[Photo of one-ounce gold piece
with Edward C. Harwood's profile on it.]
"Perhaps the ultimate return to the gold standard and monetary health will be a slowly progressing evolutionary type of development beginning here and there and finally accepted on a wider scale as it works in practice. It is too early to visualize details of procedures, but almost surely freedom to contract in terms of and ready availability of gold, perhaps in metric weight units for universal convenience, will be aspects of the final solution. Such are my present random thoughts."
Most economists don't know this, but a real return to gold has already happened, at least in the minds of the public. In fact, some of us never left it. My mantra has always been: You can take gold out of the standard, but you can't take the standard out of gold.
However, convincing the power brokers of its value as a barometer of monetary value will be difficult. After all, taking away the world's central bankers' raison d'etre will not be done without a fight.
The editors of the Financial Times scoffed at Zoellick's mention of gold in his recent communique to the press. Although the FT's journalists who wrote this piece give it a more fair trial, they are still skeptical. Here are their doubts, which I will dispel for you one by one:
1. "The very extent of the rise in its price ... shows the difficulty of using gold as money. Since the turn of the millennium, ... the price of gold in dollars has risen by 498 per cent.... [In terms of the general price level, this equates to] [d]eflation of 75 per cent in a decade.... 'Gold is a very poor reference point because it fluctuates so widely' says Fred Bergsten of Washington's Peterson Institute for International Economics."
The FT and Bergsten have forgotten one important detail: Gold was the U.S. monetary standard from the 1870s until the 1970s, as it was also for other countries. When the world went off this standard, the need for banks to hold gold ceased, causing a glut of supply. Ever since, central banks and international institutions have been selling off tons at a time. Also, this coincided with a return to more conservative monetary policy during the time of Reagan and Volcker. (Note that the world's central banks have not been so stupid as to sell it all off.)
When the Fed got back into the inflating business in the 1990s, it didn't take long for the public to realize that gold had not lost its luster after all. Their increased demand started gold back up to its real value. Therefore, it is the inconsistency of central bank policy that has caused the great fluctuation in the dollar "price" of gold, not anything related to the nature of the metal itself. Gold is simply coming back into its own, and I doubt it will lose that luster anytime soon, at least in the public's eyes (and that's what really counts).
2. The authors also cite stagnant gold mining output, but their figures are misleading. First of all, remember that central banks and international institutions were net sellers of the metal until 2009 and that most of the gold in the world is stored in their vaults. Total new annual production represents only about 1.5% of total world supply. Second, world gold production has not declined as the article implies but rather will probably peak in 2010 at around 2,630 tons, according to the World Gold Council. The article cites production from only a portion of the current world sources. Third, in 2010 central banks were net buyers of gold. Increased demand will increase production.
3. The authors state that the movements of the gold price have "little connection to the price of things that people actually buy...." But no one is claiming that gold tracks the price of things. What gold tracks is the quantity of money circulating. This is what is so very valuable about gold: it actually tells us about money supply, through market sensitivity. To be fair, even the FT journalists do quote Derry Pickford of Sloane Robinson in London: "Gold along with other asset prices can tell us if there is an erosion in the general purchasing power of money rather than jut the cost of current consumption."
4. The authors quote John Makin of the American Enterprise Institute, who complains that "Fed critics who cite the rise in the price of gold as a signal of incipient higher inflation have to acknowledge that they are in effect calling for the Fed to tighten policy." Not true, Mr. Makin. What we are calling for is that the Fed not loosen monetary policy right now, because by doing so they are going to cause a devaluation of our dollar and will very likely cause a bubble in assets and/or general prices that will come back to bite Dr. Bernanke (and the rest of us) in the backside. And according to Wal-Mart (NYSE:WMT), price inflation is already happening as I write.
So don't let those gold skeptics dismiss its usefulness in future world monetary policy just yet. Harwood might be right, and before too long the world's monetary power brokers might just bring their own evolution forward as quickly as the public has done.