What’s Missing From This Picture?

Mark Skousen is editor of Forecasts & Strategies, one of the nation’s largest financial news letters, and an economist at Rollins College in Winter Park, Florida 32789. For information on his newsletter contact Phillips Publishing, Inc. at (800) 777-5005.

The New York Times, that bastion of conventional wisdom, is missing a key element in its digest of financial markets. It leaves out the single most significant asset that each day reflects accurately the level of economic, political, and military stability around the world.

The commodity? Gold!

Instead, The Times uses oil, a crude and misleading substitute commodity, to measure inflation. Apparently the Midas metal doesn’t “fit” the Times’ definition of headline news.

The New York Times isn’t the only establishment publication to fundamentally mis-read how the world works. The Wall Street Journal’s front-page summary of the markets highlights stocks, bonds, currencies, and commodities, including oil. There’s plenty of room to list the yellow metal, Yet gold is omitted—deliberately.

The reason is simple: The establishment prefers fiat money over the gold standard. It wants government rather than the market to maintain authority over money. It doesn’t want to legitimatize a “non-performing” asset that might be warning of trouble down the road. The establishment is quite happy that the “barbarous relic” has been relegated to the commodity trading pits. “Gold is just another commodity,” they say.

Oil—A Misleading Substitute

The majority view is that gold is an impractical monetary metal unrelated to real economic activity. Oil is a much better choice, they say, because energy is a critical determinant of the ups and downs of the economy. After all, didn’t the energy shocks precipitate the recessions of 1973- 75, 197982, and 1991-927

Well, not exactly. All major industrial nations suffered sharp economic downturns in 1973-75, the time of the first energy crisis, but since then the relationship between the price of oil and economic performance has been cloudy. For example, Japan, which imports virtually all its oil, avoided the 1979-82 recession even though crude prices more than doubled. Germany, also a heavy oil importer, escaped relatively unscathed, while the United Kingdom, a net oil exporter, suffered the worst recession among industrial nations in 1979-82.

In 1986, crude prices fell by half, from $28 a barrel to $14. According to the establishment view, lower oil prices should have boosted economic growth. “If energy were an important ingredient in business cycles, you should have had a worldwide boom,” declares energy economist Douglas Bohi. “There wasn’t one.” (Forbes, January 31, 1994, p. 66)

Bohi, director of the energy and natural resource division of Resources for the Future in Washington, D.C., is one of the few economists who have studied carefully the impact of energy costs on economic growth. After examining the evidence in the United States, Japan, Germany, and the UK, he concludes that oil prices did not have the impact on economic activity that most economists believed.[1] Bohi discovered that energy accounts for only 3-4 percent of the total cost of producing goods and services in the United States. Oil itself accounts for only 2 percent. The cost of energy is simply too small to have a significant impact on economic growth. Also if the oil price goes from $18 a barrel to $14 a barrel, that’s a 22 percent drop for oil—but the reduction in costs for the economy as a whole is less than one-haft of 1 percent. By the same token, Bohi does not expect the current increase in oil prices to reduce economic growth.

The Tie Between Money and Gold

If oil isn’t the driving force behind economic boom and bust, what is? Bohi is convinced that monetary policy has a much broader influence on economic activity. Higher energy prices often reflect a general inflation, forcing most central banks to tighten money and bring about a recession. But not always. In 1979-82, when most world economies were suffering a recession, Japan did not impose a tight money policy and therefore escaped recession.

What better monitor of monetary inflation exists than the price of gold? There has been a strong correlation over the years between monetary policy and the price of gold. When central banks adopt easy-money policies, gold tends to rise. When they impose tight money, gold tends to decline.

The Midas metal is an ideal compass for monetary policy. Gold has certain unique features that make it the most sensitive measure of inflationary fears. It is not just another commodity. Unlike oil, soybeans, or pork bellies, gold is indestructible and is never consumed. Thus annual production is only a tiny fraction of the world’s total stock. Annual production seldom exceeds 2 percent of the outstanding gold supplies. The fiat money supply may rise rapidly or fall sharply, depending on the whims of central bankers (usually more the former than the latter). But gold supplies never decline and seldom increase significantly. Even during the gold rushes in California, Alaska, Australia, and South Africa, world gold supplies never increased by more than 5 percent per year.[2]

In his exhaustive historical and statistical study of the purchasing power of gold, Berkeley economist Roy W. Jastram concludes, “Gold does maintain its purchasing power over long periods of time . . . . Its purchasing power in the middle of the twentieth century was very nearly the same as in the midst of the seventh century.”[3] A $20 St. Gaudens gold coin would buy a tailor-made suit in the 1920s. That same coin, worth over $500 today, can still buy a tailor-made suit.

In short, gold is as steady as a rock, a standard bearer by which all currencies can be accurately measured. If the price of gold is volatile, it is not because gold itself is volatile, but because government policy is reckless and unstable.

Sharply rising gold prices are a sign of trouble ahead, whether it be inflation, war, or some other man-made crisis. Lower prices mean a return to normalcy and the avoidance of chaos or war. Stable gold prices suggest genuine prosperity and stability. Skyrocketing gold prices in the 1970s reflected a high level of inflation and financial crisis. The decline in gold in the 1980s suggested a disinflationary environment. The recent rise of gold in the 1990s implies a growing fear of more inflation. It is not surprising that Alan Greenspan and other central bankers are using the price of gold as an important gauge of inflationary expectations. Take heed, Wall Street! []

1. 1.   Douglas R. Bohi, “On the macroeconomic effects of energy price shocks,” Resources and Energy 13 (1991), pp. 146-62.
2. 2.   See chapter 11, “The Gold Standard,” in my book, Economics on Trial (Irwin Professional Publishing, 1991, 1993), pp. 128-44. In this chapter, I outline all the arguments for and against the gold standard, and expose several common myths about the yellow metal.
3. 3.   Roy W. Jastram, The Golden Constant: The English and American Experience, 1560-1976 (John Wiley & Sons, 1977), p. 189.