Why Almost Everyone Is Wrong About Gold

THE Atlantic


by Charles A. Cerami

It isn’t going up—or down. It is not an investment. What gold does best is tell us where everything else is going.

Several thousand Americans bought English gold sovereigns for $11 or so in the early 1970s. They now find that each one is worth more than $100. Those who bought and saved the Austrian Corona coin, which has nearly a full ounce of gold, paid $50 or $60 for it at that time and now rejoice that the price is well above $300.

The emotions roused by this price movement are multi-faceted enough to mirror the whole economic trauma of the turbulent 1970s:

• Many who made these felicitous purchases feel a smug confidence in the contents of their safe-deposit boxes; but others wonder if it is time to take their gains and turn the coins back into paper dollars.

• The greater number of persons who never bought gold feel left out, and some lie awake nights trying to decide whether they should now start buying this apparently invincible metal.

• U.S. government officials try to ignore the fact that they sold off billions of dollars worth of their country’s gold hoard at giveaway prices just before it soared in value.

• The “gold bugs,” who always considered those government officials idiots deserving of impeachment, now declare that gold has proved itself the perfect risk-free investment, that it will shortly move on to $500, $600, and $1000 per ounce.

They are all wrong—the smug, the eager, the dejected, the anti-gold economists, and the fanatics who think that gold is a magic beanstalk which will grow to the sky.

In the short space of the last twenty years, gold has tried to reteach man a lesson that he keeps refusing to absorb: Precious metal is the only real money in the world—the only steady standard of value—and being money, it cannot really be an investment at all. It cannot for long go up or down in true value. Distortions lasting weeks or a few months are possible. But over the years, it stands very nearly still while everything else around it bobs up and down. We will all be better investors and citizens when this “news” is more widely understood.

The gold bugs who elevate their admiration for gold to the status of a religion have won—but it is a Pyrrhic victory. They will find that while gold is every bit as special as they have claimed, it is not headed for greater heights. It is not headed anywhere. If its value appears to keep rising, that means only that paper money has fallen further—altering the numbers but not the relative values. The length of a yardstick would not change if officials began to put more line markers on football fields. Neither does tampering with currencies and price tags alter the real value of gold. One ounce of it bought about fifteen barrels of oil years ago, and still does. This relationship could change if, for example, the total supply of oil should suddenly swell enormously; but even then, gold’s value in relation to the sum total of all world goods would not— could not—change appreciably.

To see why this is so, consider what money really is. It is a store of value, of buying power. It has to be something imperishable, savable, easily transportable, plentiful enough to cover the needs of a growing population, but scarce enough to require quite a lot of effort to acquire. And it must be costly to produce. Otherwise, people would just make more of it and spoil its value.

There is nothing mystical that makes gold the ideal money; it is merely a matter of natural accident. Nothing else meets all the criteria quite so neatly. Silver has often served the purpose, but its supply is potentially too erratic to keep values steady. Diamonds are not as uniform, not as divisible into smaller units or usable for so many things. And as for paper “money,” it is not money at all—only a warehouse receipt for the metal that a responsible government should keep in storage. Gold’s one shortcoming is a scarcity that frustrates the desire of popularly elected governments to buy more favor from more voters. If they were to increase the amount of paper money that they print in a very orderly way—in line with the productivity of their economies—they could keep these paper receipts viable and respectable indefinitely. It has been done for long periods. (The British pound, and consequently Britain’s government securities, were a steady store of value for most of the eighteenth and nineteenth centuries. There were lapses during wars and financial crises; each time the Bank of England resolutely went back to holding 100 percent coin or bullion against all notes it issued, making the banknotes “as good as gold.”) But in the end, the desire of major governments to please too many people at once results in too much printing of “money.” And then, as Voltaire said, “All paper money eventually returns to its intrinsic value—zero.”

This discussion might be just another round of theorizing about gold were it not for clear arithmetical evidence that has recently reemerged. Regardless of the dollar numbers affixed to it, one ounce of gold would have bought a good-quality man’s suit when this country was founded, or during the Civil War, or when the twentieth century opened. And it buys one good-quality man’s suit today. This despite the fact that the cost of labor in the suit has risen remarkably. All the factors of raw materials, labor, overhead, and merchandising become reflected in the single rising figure of “the price of gold.” But it is not gold that has a price; gold is what the French call the numéraire, the measuring rod by which all other prices are gauged.

Needless to say, we are talking not only of men’s clothing, or any other single line of products, but of everything in an economy. A few items can get out of line with the golden measuring rod; but in that case it means that those products are momentarily too scarce or too plentiful. A poor harvest could make corn, wheat, and soybeans go way up in price—even in terms of gold. A bumper crop could make them tumble. But in either case, farmers’ decisions to plant more or less would bring the true prices back into line in a year or two.

This principle has been at work for at least 420 years. Professor Roy W. Jastram of the University of California, Berkeley, has charted the relationship of gold to the wholesale prices of other commodities, starting with England in the year 1560. While these can fluctuate considerably, they always come back into line. Why do they fluctuate at all, one might ask, if gold is so perfect a measure of value? Chiefly because commodities have price swings based on weather, wars, and other factors that crimp the supply, inflate the demand, and so on. The recent wild rise in September and October seemed to send gold far above the level of other goods; but if the price of fuel is taken into account, gold’s rise becomes a normal development.

The steadiness of gold is nowhere so dramatically highlighted as in the hideous German inflation of the 1920s. In 1923, as everyone knows, German marks became so nearly worthless that people had to take wheelbarrows to market in order to carry the millions of marks in paper notes needed to buy a few groceries. The inflation rate had to be counted in the millions of percents. On Professor Jastram’s chart of commodity prices, paper marks zoom straight up and off the page. On that same sheet he shows how the price of those commodities looks when paid in gold: a steady line with moderate wiggles—almost identical to the charts for England and America in those same years.

Charles Cerami is foreign affairs editor of the Kiplinger publications. He is the author of six books on business and international politics.

From 1932 onward, the United States attempted to lock gold at $35 per ounce. Considerable distortions occurred as the world’s most powerful government created an artificial level by outlawing gold ownership at home but promising to sell gold to other governments in unlimited quantities at a fixed price. But when the force of gold’s attractiveness at that bargain price broke America’s leaky dam and U.S. citizens were again permitted to own gold, the metal’s price soon readjusted. It was heavy gold buying by foreigners that drained billions of dollars’ worth of the metal out of the U.S. Treasury at $35 an ounce and made our government admit that its resources were not equal to the world’s demand. So that U.S. “gold window” was closed; the fiction that we had no desire to hold gold as part of our reserves was exploded.

More to the point, the purchasing power of gold moved right into its natural place. If we were using gold coins to pay for our consumer purchases, today’s prices would look surprisingly familiar to those who cherish a nostalgia for the numbers they knew in young adulthood. A loaf of bread would be 7 to 8 cents, a martini would cost 25 cents, gasoline (even after OPEC had done its worst) would be 10 to 12 cents a gallon, a new Volkswagen would have the $600 price tag that many remember, a new Chrysler would be $1250, and the $100,000 home could be bought for under $15,000.

These numbers are all the more astonishing because they seem to be lower than the price of goods in, say, 1967—the base year for the government’s Consumer Price Index. Government reckoning is that what $1 would buy in 1967 now requires $2.30 to buy. But in gold terms, the price would, in fact, have fallen. Some would say that this is because gold, after the period of artificial control, has “moved up too high” - that some professor of the next century will show this to be a period when it peaked and was due to pull back. Very likely true. But this data may also be telling us that we have really been in a deflationary period for some years. Even while price tags have increased appallingly, they have failed to keep up with the golden standard because energy costs have sapped so much of the world’s power to buy other things. As the prestigious Berliner Handels-und Frankfurter Bank recently pointed out, the rise in oil prices “is tantamount to a tax on spending.” That “tax,” plus swelling government taxes as inflation pushes people unjustly into higher brackets, has sapped overall buying power. If it were not for that, prices in general might now be even higher, enough to make the cost of each item in gold terms more nearly what it would have been in 1967— or in 1567, for that matter.

Why this constancy? How can we explain the fact that any one metal has the astonishing ability to keep pace with the whole spectrum of other prices? Easily enough: only when the cheapening of paper money makes people around the world fearful that they will lose buying power on what they have earned and saved do they turn to gold as a means of defense. To be willing to hold this metal— without drawing interest or dividends—indicates a belief that even a “flat” asset, incapable of growth, is better than a losing one. The demand for gold makes its stated price go up. But whenever conditions improve a little and there seems to be a chance for gains in stocks, bonds, or savings certificates, the yearning for gold ebbs a bit. This movement—approximately paralleling the inflation or deflation of other prices—keeps gold’s true purchasing power very nearly constant.

Like all forms of discipline, gold is more often disliked than loved. When the International Monetary Fund introduced its “paper gold,” as the Special Drawing Rights are often called, many said that it was long past the time when civilized man should have been ready to take charge of the “orderly and rational creation of monetary reserves.” Wistfully, we might agree. But we still don’t know how to function without gold as a reminder that we should spend only this much and no more.

Why, otherwise, would gold have made its way so quickly back into the center of the world’s monetary system? For make no mistake, that’s where it is. When the member nations of the European Community set up their new European Monetary System some months ago, they agreed to put a large part of each country’s reserves into a pool and to issue credits to member governments as needed. And as a large part of those reserves is in the form of gold, the gold will be used to back and to finance each country’s spending again. The U.S. Treasury, having once vowed to eradicate gold’s place as a reserve asset, has had to mumble a few approving words. It no longer has the power to bend Europe to its economic will.

The American public, meanwhile, keeps acquiring more respect for gold, as so many foreigners who have lived through inflations have done in the past. Some buy bullion itself from banks such as Republic National of New York, which specializes in metal trading. Some buy bullion or gold stocks from Merrill Lynch and scores of other stockbrokers. And many buy Krugerrands, the most popular gold coins because each contains exactly one ounce of gold and is minted by South Africa, a prime source of the gold supply.

Whether they are wise or foolish to do this depends on what they think they are doing. If they think they are “investing,” they are foolish, because history shows that whenever gold goes far up in price in relation to other commodities, it is due to ease for a time. If they are satisfied to put a part of their assets into a form that will keep a steady buying power for as long as they live, gold is the thing. That this metal can rise or fall sharply for a matter of months—having major effects on speculators in gold stocks or commodity futures—is obvious. But in the course of any given twelve-month period, its average buying power will be little altered. And those who simply hold bullion or coins will find their own purchasing power similarly static. Not a bad thing at a time when others are seeing their ability to buy shrink daily.

An undoubtedly apocryphal story tells that a wealthy Englishman once sought a private interview with Nathan Rothschild, head of the English branch of that family, and expressed his great happiness at having finally amassed a fortune worth one million pounds sterling. He wanted nothing more than to preserve it intact. “How,” he asked, “can I be sure to have exactly that much to the day I die?” Rothschild reached into his desk drawer, took out a small pistol, and told his caller, “There is only one way. Use this right now.” Less crisply and less memorably, he could have advised him to buy gold. €