Why I Don’t Like Gold As The Monetary Base

After yesterday’s verbal diarrhea, this post will hopefully be shorter and easier to digest. I argued yesterday that using gold as the basis for money is inappropriate, as the slow rate of increase means money will always have a deflationary impact on real output, and the conflation of gold-as-money=wealth results in mercantilism with all its evils. The second contention is largely ideological, and can be disputed. The first contention is more amenable to examination, along with its implications such as the function of gold as a store of value.

The following is based on the estimate of a stock of 145,000 tonnes of gold as of 2001 (source: World Gold Council), global gold production data from the US Geological Survey, and real GDP growth data from the IMF World Economic Outlook Oct 2008:



So much for that - I think its pretty clear that over the last half century, gold supplies could not have kept up with global growth. This implies that this growth would not have happened under a gold standard or a continuation of Bretton Woods, as deflation and recession would have been required to equalize growth with the real money supply. Incidentally, here’s the corresponding comparison for silver:



As further proof, I converted a number of commodity series* from USD value to gold value (specifically, per troy ounce). I expected to find relatively flat and declining price trends over time. What I found instead was absolutely fascinating, and requires some explanation. Here, I’m showing the price of Beef in troy ounces:



The rest of the charts are broadly similar, with the exception of pepper, which was highly cyclical against gold (incidentally, pepper looks like a 5 year bull market waiting to happen). What struck me immediately were three things:

1. The relatively low volatility from the 1980s onwards;
2. The sharp decline in price in the 1970s, which I more or less expected;
3. The relatively high volatility both in and prior to the 1970s.

My take on this is that because of the expansion of the USD money supply in the mid to late 1960s due to Vietnam and Lyndon Johnson’s domestic policies, the USD became increasingly overvalued relative to its convertible price to gold – i.e. real activity in excess of the monetary base. When Nixon took the USD off gold convertibility, the next decade saw a combination of inflation and stagnation, which may have been an adjustment process of real goods and services with the nominal money supply. Equivalently, the USD had to fall to its ‘true’ value against gold. Thereafter in the 1980s, market forces (and Paul Volcker) took over and gold became just another commodity.

The 1960s however, is harder to explain, with volatility an order of magnitude higher than the 1980s. It is somewhat ironic to me that Bretton Woods (which was essentially a gold standard but without the necessity of holding gold reserves) provided nominal price stability, but real price instability, and the floating rate period the exact opposite. While this is insufficient empirical evidence against using gold as the monetary base, it tends to confirm my doubts about the stability of such a system.

Sources:
Gold Stocks - World Gold Council
Silver stocks - http://www.gold-eagle.com/editorials_99/mbutler110799.html
Gold and silver production data - US Geological Survey
Commodity price statistics - Unctad Handbook of Statistics

*Beef, Cocoa, Coffee, Cotton, Palm Oil, Pepper, Rice, Rubber, Tin, Wheat