Continuing along the themes we’ve established earlier, gold is the proxy for money. It is the best forward-looking indicator of monetary inflation, bar none. Throughout recorded history, golden ages have been ushered in part by keeping money tied to gold, and the very same empires have collapsed when this link has been severed. Karl Marx affirmed these sentiments in Das Kapital, describing gold as the “commodity money par excellence.”
Gold in 1971 was $35/oz. The spot price of gold as of today’s (6/8) close is $1538/oz on the Chicago Mercantile Exchange.
Let’s take a moment and forget about what causes inflation (in other words, what causes the dollar price of gold to rise), and accept the reality that prices across all commodities, both food and energy, have been steadily rising over both the short and long term. If you’re an average American, you work, earn an income, and save. Over time, inflation corrodes the purchasing power of your savings. For this, we are compelled to invest our savings into interest-bearing accounts like CDs or savings accounts. These are the least risky ways of earning a return, and therefore are also the least profitable.
In an ideal world, interest rates should rise and fall commensurate to the rate of inflation. For example, if the cost of living has been rising by 5% annually, we would need to earn a 5% annual rate of return on our savings. Any rate of return below 5% would mean that as time passes, you’re actually growing poorer!
We can take a look at this concept visually.
If we accept the notion that inflation is purely a monetary phenomenon, and that gold is the de facto proxy for money, then by logic it follows that movements in gold best captures future inflation expectations. Taking this a step forward, we can then look at the performance of gold relative to the performance of interest rates as a way to standardize our analysis to reveal whether the rate of inflation is being answered by the rate of interest. The most common indicator of interest rates is the yield of the 10-year US Treasury bond, which is one of the most widely held fixed income securities in the world:
The chart is screaming something at you. It’s telling you that the price performance of gold, from 1971 through roughly the year 2000, was being answered by appropriate levels of interest rates.
Critics of this chart will point out that we’re looking at the chart on a linear scale, so recent events skew earlier ones. Fine, let’s look at the chart on a logarithmic scale:
There is only one conclusion to be drawn from this: we are living in an age of negative real interest rates, ushering longterm inflation without appropriate compensation from risk-free instruments like US Treasury bonds, CDs and savings accounts. This means that we are now required to expose our savings to riskier assets like stocks, corporate bonds, and mutual funds, simply to keep up with inflation. If we do not, the purchasing power of our savings will deteriorate over time, just as the chart above portrays.
Either interest rates need to dramatically rise, or we need a new monetary standard; one that doesn’t produce inflation as a solution to virtually every economic problem.