As the year ended the gold rush continued, with an ounce of gold setting you back $4,500. However, pause for a moment — has gold really gone up or has the dollar simply come down?
For 3,000 years an ounce of gold has roughly tracked the price of a large cow, regardless of how kings minted — and clipped — their coins. Viewed this way, the jump in gold over the past five years looks less like a gold boom and more like a sustained depreciation of the dollar.
The US has certainly done its part to undermine confidence in its currency. Since 2008, through measures such as quantitative easing, it has expanded its money supply by about 7% per year, the same pace as the South African Reserve Bank.
Historically, currencies had always been linked to a certain weight in precious metals. As acceptance of paper money grew, national banks — under pressure from their governments — issued new notes without corresponding backing in a precious metal. This was especially true in times of conflict and eventually always caught up with them.
After the French revolutionary wars the Bank of England suspended specie payments in 1797, resuming only in 1821. Again in 1914, with World War 1 under way, the bank abandoned its promise “to pay the bearer” until 1925. When it reinstated the gold standard it pegged the pound at an unrealistically high rate, forcing Winston Churchill to abandon it in 1931, resulting in a 30% devaluation.
As the end of World War 2 approached the democratic nations of the world gathered at Bretton Woods and decided to float their respective currencies against the dollar, the only one still tied to gold. However, guns and butter soon had the US spending more than it earned. It printed new money to pay the bills, and when the French insisted on exchanging the paper for gold, former US president Richard Nixon had no choice but to make the final break. In 1971 the world entered the era of fiat currencies.
What should the price of a large cow be? I doubt we’ll find out from the divinations of the world’s central bank governors. To be clear, the interest rates business people find in the marketplace reflect demand and supply. The rate set by central banks is an artificial rate, linked tenuously to Keynesian theories that suggest government can fine-tune the economy. In reality, if the central bank sets this rate too low they are forced to buy bonds to maintain the rate, pumping new money into the economy.
Over the long term, it is money supply growth that drives inflation. McCandless and Weber (1995) described an almost one-for-one correlation between money supply growth and inflation, and showed comprehensively — across 110 countries — this did not correlate with economic growth. In fact, countries with lower inflation were the ones to experience better growth rates and stability.
We therefore have to be supportive of our own Reserve Bank governor, who has made the case for a 3% inflation rate. I would be even more supportive if he adopted the constitutional mandate to protect the value of the rand and aimed for a zero inflation rate.
What about the US? Jerome Powell’s turn at the helm of the US Federal Reserve comes to an end in May. Speculation is President Donald Trump will replace him with his own man, Kevin Hassett. The expectation is Hassett will set about lowering the Fed’s interest rate, necessarily increasing the money supply and therefore US inflation.
The gold bulls should therefore expect another bumper year. Like France in 1970, global central banks will continue to ditch US bonds in favour of the precious metal. If differing inflation rates ultimately set exchange rates, further weakness of the dollar can be expected. Perhaps we can also predict another 12% appreciation of the rand this year. R14.80 anyone?
• Emerick, an entrepreneur, is deputy chair of the Free Market Foundation board.
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