There Is a Lot of Bullion Being Talked About the Value of Gold
Not for the first time, a quote from the late 19th century banker John Pierpont Morgan popped up in a presentation by a gold advocate, it went “Gold is the only money – the rest is credit.”
The quote was dated 1913, which, coincidentally, was the year Morgan died. It was also, by what we have to assume is a coincidence, the year the Federal Reserve system came into effect in the United States, giving the US their first national bank for over 70 years.
In the abovementioned presentation the theme was the “eternal” nature of gold. Gold had been the basis of the system of money for “hundreds of years” the speaker assured us.
Actually, the “gold standard” had a brief, and not particularly glorious history. Although the Royal Mint fixed the price of the British Pound as 4 grains of gold in 1717 by the Master of the Mint, a one Issac Newton, who is better known for other things he calculated.
The start of a gold standard can really be dated to 1871, when a just united German Empire abandoned silver and fixed its currency to gold, following the British lead.
As London was the key finance center in the world at the time, the other major European countries, plus the US (in 1873) and Japan (1894) adopted a currency policy where the gold value of their currencies were fixed in gold quantities.
Its worth noting that this was price fixing exercise: gold was valued at a fixed $21 an ounce in the US, from 1878 to 1933, thereafter, until 1971, at $35 an ounce. Gold values were legally set, and not subject to either supply or demand. The only variable was the relative value of the currency to other currencies also fixed to gold. Imports and exports of gold by countries re-balanced trade imbalances, but only at the official metal price rate.
For all the romance of the monetary system which ran from 1871 to 1914 – when World War I shut the system down – seems to attract from those of a libertarian bent, the one thing the system never delivered was macroeconomic order and predictability. Far from it.
In 1873 there was an economic contraction in the United States which ran to 1896, giving it the original title “The Great Depression” – in between there were “panics” in 1884, 1890 and 1893. Once the first “Great Depression” ended, there were further panics of varying intensity in 1901, 1907 – which led to the formation of the Federal Reserve System – 1914, 1921 and the new winner of the “Great Depression” title, in 1929-33.
From 1933, the vestigial gold standard system, limped on until 1939, when a new war forced its suspension. In 1944 a “Dollar-gold exchange system” replaced the gold standard, which in turn lasted until August 15, 1971, when Nixon broke the last link of the Dollar to gold and freed the price of gold, to be set by supply and demand for the first time since 1717.
It turns out that a commodity standard for a monetary system is structurally deflationary. Gold supply did not keep up with economic growth, so money was always “expensive.” The discovery of new gold deposits in South Africa and Alaska was what racheted the US economy out of the 1873-96 depression, but there was – and is – no way to predict when new gold supplies will be found.
This was the point of the now much reviled Bretton Woods conference, which gave birth to the Dollar-gold exchange system. Realizing that an expandable monetary base was essential for a growing world economy, the Dollar, in 1944 the only currency which could possibly do the job, was the way to avoid the boom-and-bust cycles of the gold standard. Making the Dollar freely exchangable into gold at $35 an ounce was to “keep the Dollar honest.”
For all the grief theorists and ideologues heap on the Bretton Woods system, there were no major economic upheavals from 1945 to 1971.
The economic record since 1971 is substantially more mixed.
As an exercise I decided to look at the historic prices of a group high value items in 1971 as their “in gold” value in 2019. The results were varied.
Its hard to know what to conclude when we see Roll Royces, private jets and the CEO of Exxon looking “cheap” in gold terms, but oil is more expensive. Bill Gates is five times richer than J. Paul Getty, in gold terms.
Gold, contrary to what the original Mr Morgan may have thought, is a commodity. It isn’t money, nor even near money. Central banks hold it, not because it is so wonderful, but because the price of gold is independent of currency values, and its useful. The declared gold holdings of all central banks is still a tiny fraction of the global monetary base, but – particularly if a central banker wants to avoid the US Dollar (as is the cases in China, Russia and Iran, for obvious reasons) gold has its place.
But there is a lot of bull-ion being talked about this commodity. Investors are advised to be skeptical of the gold bug’s siren songs.
Michael Colligan
Partner, Private Equity
29.11.209