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Golden opinions

Policy-makers can learn from the long history of monetary gold


The attributes of gold usually cited as making it useful as money are summed up by the World Gold Council as follows:


“Gold’s scarcity, the fact that it does not corrode or tarnish, its malleability and status across civilisations have made it eminently suitable as a form of money.”


There is more to be said. The function, history and continuing relevance of gold as money are well explained in Lewis Lehrman’s latest book “Money, Gold. and History” (see podcast here and book).


Mr Lehrman highlights the crucial role gold money played in the advance of civilisation:


“Money was a sacred link among people because it represented saved labor, the permanent link between work, family, past and future”


He adds: “It had become no less than the lifeblood of an enduring culture, the haemoglobin of commercial civilisation” (page 24)


Indeed. But not even these are sufficient to explain the amazing persistence of its use as the monetary standard – from ancient times right up to the suspension of gold convertibility by President Nixon in 1971.


One key and frequently overlooked attribute is that its price is forward-looking: the spot price incorporates expectations of future prices. This is a natural byproduct of several key features – the variety of motives people have for holding gold, its universal appeal to peoples across time and space, its liquidity and the high ratio of above-surface stocks of gold to annual production.


Mr Lehrman:


“Today’s global stock of aboveground gold in all its forms is approximately 3 to 6 billion ounces, perhaps more – close to one ounce per capita of the world population. Because of gold’s lasting value, and the human incentive to conserve all scarce resources, these 3 to 6 billion ounces represent most of the gold that was ever produced. “


Annual production has been enough only to increase the stock of gold by about 1.5% a year in the long run.


Because there is a market for gold in every country, at all times, any holder can sell his or her gold if they so wish. So the entire stock is willingly held at prevailing prices. The right measure of demand for gold is not the demand for the additional newly-mined annual tonnage but the entire above-ground stock.


But that also means that at all times, holders of gold are scanning the future for any upcoming development that might affect its value. So the price sensitively incorporates all such expectations. Market information of a quality that cannot be produced even by the latest computers and mathematical equations about future states of the world is instantaneously incorporated in one figure – the gold price. And that price is immediately the same in all countries (except where governments impose physical controls or tarrifs on gold flows), though of course it may be expressed in terms of local currencies .


Backward-looking consumer and/or retail price indexes such as those used to set targets for central banks and guide their policies under current monetary policies do not incorporate such forward-looking indicators. By themselves, these measures of inflation contain no information about future prices or expectations. Yet life is lived in time. People are forward-looking. Our decisions on spending and investing now are influenced by expectations of the future. So central bankers find themselves being forced into making forecasts, and we see them making efforts to incorporate them into policy-making.. This is what is behind the fashion for “forward guidance”.


When linked to gold, money guides financial institutions, investors, and governments, as if by an invisible hand (to coin a phrase). It quietly helps us anticipate future events and adjust in good time. Of course, gold is not an infallible guide either – as Mr Lehrman also makes clear; it often overreacting to anticipated events and exhibits short-term volatility. Its claims to consideration as a monetary anchor rest not on any romantic view of its history or foresight but rather on humanity’s bitter experience with the alternatives; inconvertible money has become too closely linked to successive crises.


The inability of the current monetary policy paradigm to incorporate expectations of the future is one reason why central bankers, like blind men, led us into the catastrophe of 2007-08.


It is astounding that most economists continue to assume the future lies with fiat money, despite our poor experience of it.


This is not the first time they have been taken by surprise. As economist David Laidler pointed 10 years ago:


‘…just as things went wrong in the US in 1929, even though the price level seemed to be behaving well, so they went wrong in Japan at the beginning of the 1990s under similar circumstances, and again in the United States, and to a lesser degree in Europe too, in 2001. In each case an asset market bubble seems to have developed and collapsed without this event being preceded by any general upsurge of inflation (italics added)


Laidler, D. (2003), ‘The price level, relative prices, and economic stability: aspects of the inter-war debate’.


Equally, the recent credit boom and bust explains why economists – though remaining wedded to fiat money – are again fussing about whether to incorporate “asset prices” in their measurement of inflation. Some of the most distinguished economists, starting with Armen Alchian and Benjamin Klein in 1973, say that they should. But because nobody can figure out how to do it, in practice economists and policy-makers have ignored this warning.


At the Bank of England, Mark Carney has tried linking monetary policy to ‘thresholds” or “knockouts” linked to forecasts of specific variables. Today he gave up his short-lived effort to link interest rate policy to unemployment. His updated forward guidance is pretty feeble. However, he felt obliged to hazard a new guess:


“When the point comes [for rates to start rising] the adjustments will be gradual and limited.”




The Bank’s monetary policy committee made another bold forecast:  in future, they said,  the medium-term level of rates would be “materially below the 5 per cent level set on average by the committee before the financial crisis”.


How, one may ask, do they know?


The history of monetary policy in the UK suggests that upward adjustment to rates tend to be delayed, and all the more sudden and abrupt when they finally happen. In the ‘bad’ old days, this was usually prompted by a sterling crisis. That can’t happen today, people say. Really?


It is significant as well as amusing that central bankers should feel it necessary to feed markets with guesses about the future – even though they have no clue, really, about what will happen. It tells markets little about what they, the central bankers, will do. But it does show they dimly understand that basing policy on backward-looking measures is inadequate.


Gold has many drawbacks. For example, because it does not bear interest, it sets up a tension between safety and profitability in banking – a conflict that was only held in check by extremely conservative banking practices of the 19th century. This is not compatible with lender-of-last resort and deposit insurance or modern banking and central banking. Under gold, there is a temptation for central banks as well as commercial banks to increase risk by holding more interest-bearing securities in their portfolios and economizing on gold and capital.


But as they grapple with present perplexities, modern central bankers should do well to reflect on the reasons for gold’s long history of relative success as an anchor. Unlike inflation targeting regimes, it was a real anchor for the long-term price level. At a time when government and central bank policies have injected such uncertainty into the future of money and prices, a reliable anchor is just what we need.