Understanding Gold 4
On August 15, 1971, Nixon, by executive order, broke the dollar-gold link that had anchored the Bretton Woods international monetary system since 1944. (The link was officially severed in February 1973.) This was the beginning of the global floating fiat monetary system that still exists today. A gold standard is a fixed-value monetary system that links a currency with gold’s proven history of stability in value. Under a fixed-value system anchored by gold, discretionary domestic monetary policy is not compatible. It is not possible at the same time to both maintain a value and manipulate a value. A gold standard does not allow tinkering with the value of a currency to achieve perceived economic policy goals. Under the monetary stability of a gold standard, changes in economic growth become dependent upon fiscal policy. A gold standard establishes a reliable, efficient, unwavering standard for measuring the galaxy of goods and services in an exchange economy without inflation or deflation—a unit of account. That should be monetary policy’s only goal. When monetary policy is stable and efficient, fiscal policy then becomes the source for policies that promote economic growth. Ascendent Keynesian and monetarist economic theory that desired to achieve economic goals through monetary manipulation chaffed under the golden constraints of Bretton Woods and advocated for its termination.
The proponents for ending Bretton Woods believed breaking the dollar link would relegate gold as just another commodity, no different than pork bellies. When the U.S. and France dropped silver as money in 1873, its monetary value declined. Silver’s industrial use for coating film in the emerging photography industry solidified its value to gold at a much lower ratio. Keynesians and monetarists assumed the same would happen to gold. Chairman Henry Reuss of the Banking and Currency Committee of Congress—his wife was a Ph.D Keynesian economist—predicted that gold would fall to $6 an ounce. Nixon’s act would finally relegate Keynes’ barbarous relic to the dustbin of commodities. Instead, gold quickly rose to $70 an ounce. By January 1980, it hit $850 an ounce. The 70s became the era of inflation, stagflation, currency chaos, capital controls, economic malaise, and political change. Supply-side economics, a revival of classical economics, stepped into the void of economic confusion with the time-tested solution of stable money and growth oriented fiscal policy. Reagan’s return to classical economics policy unleashed two decades of global growth. Today, we find ourselves in economic deja vu all over again.
The severing of the United State’s 182 year history of maintaining stable money linked to gold did not alter the properties of gold that established it as mankind’s monetary reference. Gold’s monetary reference, based on stability of value, remains exactly the same today as it was in 1971 and a thousand years before that. While Nixon set the dollar free from the constraints of gold’s stability, he could not repeal the unalterable natural properties of gold. Gold’s value does not change, only the value of the dollar changes, now untethered from anything real. Dollar instability is broadcast in real-time by changes in the price of gold. This is the gold signal.
Gold is a fixed monetary reference that the dollar floats in value against. Changes in the price of gold reflect only changes in the value of the dollar. Understanding the gold signal, transmitted through changes in the price of gold, provides a predictive foundation for our economic world. Awareness of future inflation and deflation are easily understood and predicted through the gold signal.
The Fed and its legions of economists admit they no longer understand inflation. Fed officials scratch their head and reconcile this as a mysterious “new conundrum” outside the bounds of their contrived, backward looking economic data and demand-side economic model. Sometimes there is nothing new under the sun. Inflation is a decline in the monetary standard, as it always has been. The same definition holds true for deflation. The gold signal always transmits the first indication of inflation or deflation through change in the monetary reference point—the equilibrium point defined by a dollar price of gold where debtors and creditors are in balance.
This was easily understandable when Nixon first broke the dollar-gold link. The price of gold rapidly quadrupled from the Bretton Woods monetary reference price of $35 an ounce. This signaled ensuing inflation which mirrored a devalued dollar. Arab oil producers quadrupled the price of oil, refusing to exchange the real value of oil for the declining value of an untethered dollar. The termination of Bretton Woods and devaluation of the dollar was responsible for the oil crisis of the 70s and the follow-on stagflation and malaise that conventional economic wisdom still blame on OPEC. Gold signaled these events.
We are now 45 years into the global fiat experiment, yet the gold signal today remains just as true and predictive. Continuous Fed error, growth inhibiting fiscal policy and regulation, manipulation of interest rates, unprecedented excess reserves, multiple cycles of inflation, deflation, boom, and bust have clouded and confused the reference for interpretation of the gold signal. Yet amidst this economic chaos, gold remains unwavering. The gold signal transmits through the noise of central bank monetary illusion and provides clarity for those who can interpret its message. Referencing the gold signal is essential for understanding today’s global financial system.