Gold has always been considered a smart investment and for good reason. In a world where the financial markets are constantly in flux, gold tends to at least hold its value. Gold prices are generally believed to be a barometer of economic health, as a sharp increase in the price of gold usually indicates a high demand for the precious metal, which is in turn spurred by investors who are fearful of a volatile market. The correlation between gold prices and market stability is best seen in the consistently low prices during the 1980’s and 90’s, where during the twenty year period of 1979 through 1999 the highest gold price was $486 per ounce in 1987 and the lowest was $272 in 2000 following the Clinton-era budget surplus. After the dot-com bust, increased economic insecurity and rising fuel prices, gold began it’s unprecedented ascent from $272 in 2000 to its all-time high of $1,923 in April 2011. Since then, world-wide economic growth has sent gold plummeting to its current price of $1,292 (as of July 2013).
Due to the recent plunges in gold rates, Federal Reserve Chairman Ben Bernanke answered questions from the press at a recent Senate committee hearing. Bernanke characterized gold as “an asset that people hold as a sort of disaster insurance” and that the price drops mean that investors have more confidence in the future of the market. Yet, despite Bernanke’s Harvard and MIT education, he eventually concluded that “nobody really understands gold prices and I don’t pretend to understand them either.” Yet, while the average person might be infuriated over Bernanke’s seemingly inept response, the history of the price of gold and monetary policy is a very convoluted story.
For years, paper money in each country was usually valued by precious metals, for example the British “pound” once literally represented a pound of silver. In the 19th century, gold was used as the standard in the United States and there was intense political division over whether or not to abandon the gold standard and replace it with silver. William Jennings Bryan, who is now better known for his attack on evolution in the Scopes “monkey trial”, gave a speech where he characterized the adherence to the gold standard as a crucifixion on a “cross of gold”. Essentially, the argument boiled down to a need to increase the monetary supply and stabilize the habitually unpredictable economy. Ultimately, decades of boom and bust led to the establishment of the Federal Reserve, which furthermore led to the appointment of a Federal Reserve Chairman who has no idea how gold prices work, and the big question at hand is: does he have to? Or even further, does anyone at all understand the fluctuation of gold?
Nobel prize winning economist Paul Krugman doesn’t claim to understand gold prices, but he offers a few theories in his article for his New York Times blog, “Golden Instability“. He uses a different method of analysis and looks at the relation between the price of gold and inflation/deflation and found that when the price of gold was fixed by the gold standard, rapid deflation occurred which triggered an economic crisis at least once a decade from 1873 to 1933. On the other side of the spectrum, libertarian politician Ron Paul advocates a type of return to the gold standard in which precious metals could be accepted a legitimate tender. Ron Paul bases his argument off of a theory in which inflation is bad and unnecessary and the stability of precious metals is preferable.
In the end, what the competing arguments all illustrate is that the international financial system is extremely complex and even Harvard educated, Nobel prize-winning economists are arguing amongst themselves on how it works. While we may want to think of the people at the helm of our national bank should have mastered the inner-workings of the market, its healthy to remember that the world’s smartest people have been formulating theories about money since Socrates and we still have big unanswered questions.