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Barron's last week began to take notice of the bull
market in gold vs. the dollar. "There have been myriad theories for the
surge in the misunderstood metal, which is variously described as a currency,
a commodity, an inflation hedge and an asset class," Barron's
wrote, hinting at a bit of confusion.
Gold is a currency, a commodity, an inflation
hedge, and an asset class. It is not, however, an investment.
Gold, quite simply, is money. Its primary
defining characteristic is that it is and is expected to be stable in value,
which is why it remains a form of money today. (It is probably true that the
fact that it is used as money contributes to its stability of value as well.)
Thus, it is easy to see that gold is a
"currency." It is undoubtedly a commodity. Since inflation is a
decline in value of a currency, gold naturally "hedges" against
inflationary events. It can be considered an asset class, in the same way
that "cash" (i.e. short-term dollar-denominated loans) is often
considered an asset class. I note that "gold mining" is considered
its own "sector" of the S&P 500, while all other forms of
mining are in a different sector.
OK, so what is an investment? The defining
characteristic of an investment is that it produces cash flow--or has the
potential to produce cash flow in the future. This cash flow can be
considered to increase the value of the original investment. An investment's
value is not stable. It is expected to increase. (A small exception can be
made for collectibles such as art or antiques. In essence, the values of
these are related to the wealth of the group of people expected to be
interested in such collectibles.)
It is not hard to see that the only situation
in which gold is a superior asset is one in which the value of everything
else declines. If there is no credit risk (as with government bills perhaps),
then "cash" would be a superior alternative to gold if the currency
itself is stable in value, as "cash" pays some interest. Since
there are many currencies in which one can hold short-term "cash,"
the only situation in which gold is a superior asset is one in which
currencies around the world lose value, as expressed by their declining
exchange value versus gold.
In practice, when the world's primary currency
loses value significantly, it is all-but-impossible for other currencies not
to follow it lower. This was true in the 1930s, when Britain began a
worldwide cycle of devaluation, and it was true in the 1970s, when the US
began a worldwide cycle of devaluation. The reason for this is simply that
other countries cannot bear the effects of exchange rate changes caused by
these devaluations. Eventually, political pressure builds to keep exchange
rates relatively stable. The yen was pegged to gold at •12,600/oz. of
gold and •360/dollar in 1970, when the dollar was worth 1/35th
ounce of gold. In 1980, with the dollar at $850/oz., if the yen had remained
pegged to gold, the yen/dollar exchange rate would have been
•14.8/dollar. "Free trade" would not have been possible under
such circumstances, as the Japanese economy would have been crushed by cheap
imports and unfair competition.
It may rankle many to consider that gold's
value doesn't change significantly -- by more than perhaps 10% either way.
Isn't it driven by a "wave of investor mania?" Doesn't it
"decouple from currencies?" What about the incredibly short and
sudden spike to $850/oz. back in 1980? Certainly that was a case of a gold
"bubble," no?
When crude oil rises in price, it is
reasonable to conclude that the prices of things which consume crude oil in
their making will also rise in price, to reflect the increased cost of
inputs. Gold has virtually no industrial use, so this mechanism would have no
discernable effect on general prices. However, if it is true that gold is a
stable measure of value, then when "gold goes up" it means that the
value of the currency measured against gold goes down. When a currency's
value declines, markets will naturally adjust to this reality, and it will
tend to take more dollars to buy all manner of goods and services. In other
words, a) if gold "goes up" and there is no accompanying evidence
of "inflation," that may be a sign of gold's value changing, but b)
if "gold goes up" and there is accompanying evidence of
"inflation," that is evidence that the currency's value has fallen
while gold's value has remained essentially unchanged.
While the major currencies typically don't
move much against each other in an average week, currencies are certainly
capable of tremendous and sudden changes in value. Let's look at the Indonesian rupiah (IDR) during 1998-2000.
The great gold boom (dollar bust) of 1980 was
also pretty wild, but ultimately not that much different than the rupiah bust
of 1998.
In 1998, the dollar had been rising against
gold.
But, if you were an Indonesian,
gold was soaring in 1998, its price more than quintupling!
The remainder of this exercise would be to
show that prices for all sorts of things, in dollar terms, were rising in or
soon after 1980, showing that the "rise in gold" was indeed a decline
in the dollar's value. We won't look at most of the usual suspects -- CPI,
interest rates, PPI, crude prices, etc., etc., -- now, but be assured that
"inflation," as popularly conceived, was a big deal at the time,
and intensified greatly during this time. In short, virtually everything you
can point to reinforces the idea that gold is stable while the dollar
varies in value. At some point, we may look into this is more depth. To
begin with, here is a comparison of the dollar's value vs. gold and the
dollar's value versus a wide range of industrial commodities, represented by
the CRB commodities index.
Do you see how the dollar's value vs. gold leads
changes in the dollar's value versus other commodities? This is particularly
apparent in the 1980-present period. I suppose some would complain that
commodities didn't actually rise much in the 1979-1980 period. This is likely
because economies were rather depressed at the time, and also because the
spike to $800+/oz. was so brief. Basic commodities tend to lag the
dollar/gold ratio by a few months to a year or two. The commodities futures
market shows a dramatic spike during this time.
Nathan
Lewis
Nathan Lewis was formerly the chief international
economist of a leading economic forecasting firm. He now works in asset
management. Lewis has written for the Financial Times, the Wall Street
Journal Asia, the Japan Times, Pravda, and other publications. He has
appeared on financial television in the United
States, Japan,
and the Middle East. About the Book: Gold:
The Once and Future Money (Wiley, 2007, ISBN: 978-0-470-04766-8, $27.95) is
available at bookstores nationwide, from all major online booksellers, and
direct from the publisher at www.wileyfinance.com or 800-225-5945. In Canada,
call 800-567-4797.
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