Measurement requires a standard of reference. We accept this universally in the mathematical and scientific world. Suggesting that the length of the meter or the volume of a liter be constantly changed and tinkered with would defy common sense. Money is no different. It also requires a standard of reference to measure the value of goods and services, yet we have abandoned this concept in the monetary world.
We have a monetary standard of reference. It is gold. Its value has remained stable for centuries. During 300 years of international gold standards going back to the late 17th century, gold has reliably acted as a monetary standard. This history of gold’s stability of value makes it the only reliable monetary reference. To obtain an objective, relative value of anything monetary, requires that one reference it against gold.
Gold has two prices, the spot price and the optimum price. The spot price is the daily price of gold (POG) which under our fiat dollar can vary wildly. The optimum POG is the price level. At the optimum POG, debtors and creditors are in balance. Neither will gain an advantage over the other when entering a contract due to inflation or deflation. In a fiat monetary regime with an unstable, rising dollar price of gold, the optimum price is constantly adjusting to the changing spot price as contracts unwind. This is a slow, long process. It can take a decade or more for various dollar-denominated contracts to unwind and adjust to the new price level. One way to think of it is that the optimum POG is a proxy for the price level slowly adjusting to inflation or deflation. The optimum POG can’t attain equilibrium with the spot POG unless spot stabilizes at a fixed value over a period of time. A gold standard stabilizes the dollar at a fixed price of gold. On a gold standard, the spot and optimum POG are the same. By aligning the optimum and spot POG, the price level remains stable. With a stable price level, there is no inflation or deflation. Roy Jastram demonstrated this in his book, The Golden Constant, which analyzed the price level in Great Britain and America during their gold standard years. Meticulous price data recorded by British officials going back to 1560 showed that prices orbited about the fixed price of gold but always came back in alignment with gold. Jastram’s data showed that the price level remained stable without inflation or deflation when Great Britain and the U.S. properly maintained gold standards.
Understanding gold is instructive for viewing anything monetary, including market indices. The Bretton Woods gold standard fixed the dollar to gold at $35/oz. The price level remained stable, and the American status for anyone desirous of wealth was to become a millionaire. Today, anybody who owns a 1200 square foot home in most urban coastal areas of California is a property millionaire, yet they may have a standard of living near the poverty level. A millionaire is no longer a wealth status. A billionaire is now the status symbol of wealth with government budgets and debt denominated in trillions.
The process of devaluation has occurred slowly over 48 years and becomes imperceptible to our daily lives. Dollar devaluation gets accepted, or possibly rationalized, as progress’ inevitability, and it skews our ability to understand the economic world around us. What gets lost in dollar fiat chaos is that there is absolutely no reason for it to occur. There is no reason, other than we abandoned the monetary stability of the gold standard in 1971, that oil should not still be $2/barrel, a new car $2000, or a single family wage earner able to support one’s family with a constantly increasing standard of living. Academics, economists, and politicians advocated for the end of the gold standard and stable money and justified it as economic progress. The inevitable result is that government grows reflexively to attend to the chaos that it creates through dollar devaluation. Those who get left economically behind petition the government for subsidies, welfare, and transfer payments. Corporate welfare is equally dependent on subsidies and the growth of government. Mature businesses prefer big government’s heavy hand of regulation, high taxes, and entrepreneur’s lack of access to capital that prevents competition. New government programs and bureaucracies emerge to administer to the economic distress which ensures continued government growth. Taxes inevitably rise to meet the need of expanding government which crowds out economic growth and increases government dependency. This negative cycle continues with decline and collapse or until a return to stable money and low taxes create an economic foundation for new growth and progress.
Market indices are no less skewed by this process. We celebrate each 1000 point Dow milestone and fret like Chicken Little during the onset of even the smallest decline. Lost is any relevancy to what markets are actually indicating. Markets are an indicator of growth and wealth but without a reference, there is no objective valuation. Is our standard of living really better today with a Dow of 23,000 than in January 1966 with a Dow of 7800?
With a floating dollar, the only way to measure real economic growth indicated by market indices is against the optimum POG. The problem is there is no data for the optimum POG. There is only data for the spot POG. The optimum POG can only be estimated by understanding how the duration of debt and contracts adjust. The spot POG is an unreliable indicator because it may or may not reflect the true price level under fiat money. Only when the optimum POG stabilizes with the spot POG can the spot POG act as a reliable reference. There are three distinct periods relevant to the below chart when this occurred. During the Bretton Woods gold standard years at $35/oz, Greenspan’s Great Moderation period at $350/oz, and today due to accidental Fed management at $1300/oz. The Dow index adjusted for gold indicates the real level of growth during these periods.
Prior to 1971, Bretton Woods aligned the spot and optimum POG, and real economic valuations are indicated on the chart. The Bretton Woods years from 1944-1971 are a period of sustained economic growth. The large decline prior to Bretton Woods is obviously the Great Depression. After 1971, one must view peaks and valleys of the chart in terms of fiat chaos where the spot POG was changing chaotically and the optimum POG was adjusting to it.
Chart of Dow to Gold Ratio (link is to Macrotrends interactive chart which shows dates and corresponding ratios)
The market decline from 1971-1981 reflects the rise in gold from $35/oz to $850/oz. This was the chaotic stagflation, high interest rates, and declining living standards of the 1970s. Gold’s rise to $850/oz reflects a steep Dow decline but if viewed in terms of the optimum POG, which was slowly adjusting from $35/oz to $350/oz, the real market decline was not nearly as great as the chart indicates. Nobody would suggest that the 1970s were economically worse than the Great Depression, but the chart, based on the spot POG, indicates that.
Fed Chairman Greenspan roughly stabilized the dollar around $350/oz from 1983-2003. The optimum POG adjusted to equilibrium with the spot POG at $350/oz and another sustained period of growth occurred with the return of stable money and Reagan’s tax cuts. Economists label this the Great Moderation but since they ignore gold, they are unable to explain it.
Greenspan presided over a deflation from 1997-2001 indicated by the spot POG falling from $400/oz to $250/oz. The lower spot POG distorts the Dow index peak in 2000. The optimum POG, which never adjusted to spot at $250, would indicate real Dow index gains below the charted 2000 peak.
The spot POG rose from the stabilized $350/oz level beginning in 2003. It reached $1900 in September 2011 under Bernanke’s QE base money creation experiment. The optimum POG began adjusting from $350/oz and reached equilibrium with the spot POG at $1100/oz in July 2015. The spot and optimum POG have been moving in relative tandem since July 2015. The charted decline starting in 2000 and the gain starting in 2011 would in real terms be dampened out by the optimum POG.
With the spot and optimum POG aligned in equilibrium today at $1300 and with the Dow at 23,000, we get a Dow-gold ratio of 18. In July 1960 the Dow-gold ratio was also 18. In real terms, our standard of living is at the same level economically as it was in July 1960. Celebrating new Dow 1000 point highs is an illusion. We understand this because while technological progress has advanced our lifestyle, our real standard of living has declined. That’s why college graduates are living with their parents, it takes two income earners to support a family, and retirement keeps getting pushed further into the future.
It is possible to create a data set that estimates the optimum POG going back to the end of Bretton Woods. This would be an illustrative project. When plotted against the Dow, it will show the real economic progress (lack of) since abandoning gold as the monetary reference. The result would demonstrate what should be apparent. The fiat dollar has been a disaster for real economic growth.