Those who remember or read about the 1980s may consider the price of gold to be a highly dramatic variable. During the postwar Bretton Woods years, the price of gold was pegged at $35 an ounce, but after Richard Nixon severed the dollar’s final link to gold in 1971, prices soared to more than $800 an ounce by 1980. Fortunes were made, gold bugs proliferated and the price of the precious metal became a daily fascination. Many commentators considered the high price of gold to be a harbinger of disaster for both fiat currency and Western civilization.
Even if it’s trading around a record high of $2,000 these days, gold is a little boring and likely to remain so for the foreseeable future. According to a new study from the National Bureau of Economic Research, gold prices have followed some fairly standard principles since at least 1990. To put it simply, gold prices decline when real interest rates rise. That is because gold itself has zero direct yield, so at higher interest rates the opportunity cost of holding gold goes up.1 In this regard, gold is like many other assets, including crypto, tech companies, and real estate.
The price of gold also goes up (down) when demand for it as a commodity goes up (down). So, if say China becomes a major global economic power, the Chinese economy will need more gold, if only for its commodity uses, and that in turn will boost gold prices, as it did starting in 2002. There is also sizeable gold jewelry demand from India, so as that country becomes wealthier that too will boost the demand for gold and thus its price.
Under both mechanisms, gold is no longer a good hedge against bad times, as it correlates with both low-interest rates and global economic growth. Gold becomes another cyclical economic asset, and that is a big part of the reason why gold prices are no longer followed so closely or seen as useful harbingers of social and economic collapse. Instead, it is perfectly fine to have a high or rising price of gold.
The price of gold seemed so dramatic in the years surrounding 1980 because markets and prices had been suppressed for so long in the previous years. So, at that time it was very hard to know what gold truly was worth because various prices had not been tested much in the markets and by market procedures for trial and error and value discovery.
There is a broader lesson here, including perhaps for crypto. If governments wish to normalize an asset and its pricing, they often will do best with a dose of benign neglect and the simple passage of time.
Another broader lesson is that the recent history of gold prices does not bode well for any future reconstruction of a gold standard. For all the brickbats levied at the gold standard -- Keynes called it a “barbarous relic” -- the 19th-century British-led standard put in a reasonably good macroeconomic performance. Still, the modern world has some very different features. In the 19th century, rates of growth for emerging economies were slow and demand for gold as a commodity was relatively stable, leading to stable price levels.
In more recent times, economies such as China can engage in rapid catch-up growth, which in turn can cause sharp increases (and at times decreases) in commodity prices. For instance, the 2002-2012 run-up (over four times) in the price of gold would have led to strong deflationary pressures in the global economy. If the price of a unit of gold is fixed, as it would be in a gold standard, an increase in the relative value of gold means that all other prices and wages would have to adjust downward, a treacherous macroeconomic scenario.
Those big shifts in the relative value of gold would be disastrous under a gold standard, but under the status quo, they are not such big news. Gold, like many other commodities, is fairly inelastic in supply in the short run. That means if the demand goes up, it takes a while before that brings more gold into the market. In the meantime, the price of gold may rise sharply, just as it may fall sharply when demand slows. But in neither case is the gold price telling us so much about the broader future course of world history. We again have a largely neutered gold market.
Commentators on financial markets love to stress mysteries, speculative bubbles, and eventual crashes. But sometimes the actual truth is more mundane than that, and we see this even for gold prices. This is a bit of a shocking, contrarian idea, but a lot of the world, including the economic world, just makes plain sense.
Let’s enjoy that feeling while it lasts.
1Note that the correlation between gold prices and interest rates is strongest when rates are low. At higher rates, many investors won’t enter the gold market at all, and the commodity demands for gold become a more important determinant of price.
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