The complement to understanding the dollar price of gold is understanding how the Fed works. Google “how the Fed works” and you won’t find much. Most is bland repetition from federalreserve.gov to satisfy the bureaucratic requirement of a quasi government agency that operates under the legislated guidance of Congress. You know, “Consistent with its statutory mandate, the Committee seeks to foster maximum employment and
price stability 2 percent inflation.”—which is carte blanch for the Fed to do whatever it wants and justify it with unintelligible economics gibberish.
To the credit of the Fed, it is open about its actual operations. Anyone who spends time on the Federal Reserve website will find an explanation of Fed actions. This should disappoint conspiracy theorists who prefer that the Fed remain a mythical creature from Jekyll Island. The Fed does accomplish its mundane, required tasks in an efficient manner. The Fed clears checks, keeps circulating cash in new condition, and distributes U.S. mint currency to regional banks. The main ancillary roles of the Fed are lender of last resort and regulation of the banking industry. The Fed’s responsibilities and regulatory role increase with each new monumental Fed screw-up. The financial crisis of 2008 was a banner year for the Fed.
The rest of the info you will find in your google search is academic interpretation of how and why the Fed creates money. This is mainly confirmation bias that justifies whatever action the Fed takes under its constantly evolving academic theories.
The ability to create money out of thin air without restraint combined with the dollar’s status of reserve currency is what has elevated the Fed to master of the universe in a fiat world. Since 1971 this has included Friedman’s monetarism, finally abandoned by Volcker after it blew up the global financial system in the 70s. Keynesian funds rate manipulation based on monetarism. Greenspan’s Maestro funds rate manipulation based loosely around the price of gold at $350/oz. There was never official recognition that Greenspan observed the POG in his monetary deliberations, but Greenspan’s history with gold before becoming Fed Chair is well known. This period is now called the “Great Moderation”. The magic formula of relatively stable money combined with Reagan and Clinton era tax cuts reignited global growth for two decades. (Clinton’s 1996 capital gains tax cut on property unleashed capital formation and was massively stimulative.) Bernanke ignored gold—he has no understanding of gold beyond tradition—and the dollar began inflating again leading up to the 2008 financial crisis. This led to the great global QE liquidity flood experiment now reaching its end limit amid stagnated growth and unsustainable debt burdens. Despite its maniacal, Terminator-like sense of purpose, the Fed’s Sisyphean QE monetary effort arrived at nought. Unfortunately it is the working and middle class who remain in financial Hades.
The Fed does not create or control credit, though its management of base money may indirectly affect the demand for credit. Ideally, the Fed creates and extinguishes base money to balance creditors and debtors with zero inflation or deflation. Contracts, savings, investment, and capital formation operate at peak efficiency when the value of the dollar remains fixed in value. This is so anchored in common sense that the Federal Reserve’s 2 percent inflation goal, based upon blatantly rigged hedonic quality adjustments and selected chain weighted data, requires Orwellian Fedspeak echoed by a compliant financial media to attain economic justification. The same applies for acceptance of negative interest rates.
Base money, cash and reserves, can be thought of as a dual set of closed loops connected to the Fed that the Fed completely controls. Reserves can flow to cash or cash can flow back to reserves. Cash and reserves never leave the loop or the Fed’s control. Beyond creating money out of thin air, the Fed has the equal ability to sell assets whose purchases created base money and remove any or all cash and reserves from existence. Therefore, the Fed can pump newly created money into the loops or drain existing money from the loops. When the Fed prints money, it is not distributing money to individuals or households. (At least it has not gotten to that point yet.) It remains within the Fed’s closed loop as cash or reserves. Banks create credit by lending against base money reserves, and cash acts as circulating medium. The supply of base money created must match the demand for cash and reserves. Any deviation in supply relative to demand results in a decline in the monetary standard. When supply exceeds demand, the dollar loses value, inflation, or when demand exceeds supply, the dollar gains value, deflation. The optimum dollar price of gold–where debtors and creditors are in balance–is the reference at which base money supply matches demand.
When the Fed ignores gold—the monetary Polaris, unit of account— as a standard of reference for creating base money, it flails about without a reference, going from inflation to deflation and back to inflation. Ultimately, the Fed will always devalue because it is a hidden tax that serves the interest of government and the elite.
Currently there is $2.1 trillion of base money that sits dormant as excess reserves in depository institution accounts earning interest from the Fed. There is no demand for this excess base money and it should not exist. The Fed wants to remove the excess reserves and normalize but has no idea how to do it other than very slowly over an undefined period of time—and hope that market indices maintain their perpetual upward slope over the interim.
With the onset of open market operations in the 1930s, the Fed traditionally held short-term treasuries as assets against its base money liabilities. This assured that the Fed’s assets were always equal in value to its liabilities. This changed after 2008. The Fed now holds agency mortgage-backed securities, federal agency securities, and treasuries of higher duration on the yield curve. This has added greater risk to the Fed’s balance sheet. Conceivably in another financial crisis, the Fed could become insolvent, though the Fed and Treasury will never allow this to happen. Other central banks have extended their risk beyond the Fed. Global CBs now hold equities, ETFs, and corporate bonds as assets along with government debt. There is not enough government debt available to sate the demand for the post 2008 global CB liquidity flood and still maintain a free market. Despite the Fed’s hint at normalization, major central banks continue to expand their balance sheets with monthly asset purchases of $200 billion per month.
The Fed in any real sense cannot change the quantity of money; it can only change the value of money. This is a central bank’s achilles heel. Despite its econometric models, dissertations, equations, imagined theories, and legions of PhD economists, the Fed can only do three things. It can decrease the value of the dollar, increase the value of the dollar, or maintain the value of the dollar. Academic theory posits that the Fed can conjure economic growth with its monetary magic wand by manipulation of the quantity of money. This is an idea that has been around for as long as there has been money. No kingdom, country, or empire has ever devalued itself to prosperity. Ever. Yet, history’s lesson fails to dim the Fed’s seduction for the siren call of free money and power.