By John L. Chapman, Ph.D. Washington, D.C.
On July 9, 1896 at the Democratic National Convention at Chicago, Democrat nominee William Jennings Bryan ended his acceptance speech with lines that have become famous in American political history:
If they [William McKinley and the Republicans] dare to come out in the open field and defend the gold standard as a good thing, we shall fight them to the uttermost, having behind us the producing masses of the nation and the world. Having behind us the commercial interests and the laboring interests and all the toiling masses, we shall answer their demands for a gold standard by saying to them, you shall not press down upon the brow of labor this crown of thorns. You shall not crucify mankind upon a cross of gold!
The burning issue of the day — indeed, the issue dominating the 1896 election — was how to end a trenchant recession that had begun in 1893 and had led to double-digit unemployment, labor unrest, and falling prices which hurt farmers and other debtors. Mr. Bryan, in an historical precursor, called for large government-directed stimulus, but solely of the monetary variety: interestingly, the social mores of the day still dictated broad bipartisan agreement on the sacred inviolability and sanctity of property, and hence progressive income taxation, let alone redistributive welfare spending, were still to be discovered by Mr. Bryan’s 20th century political descendants. But a monetarily-induced inflation, in the form of a move away from gold and toward bimetallism, would serve just as well: Bryan thought that introducing silver as money at an artificial 15:1 value ratio to gold would cheapen the currency by inflating the money supply, offering relief to burdened debtors in the Midwest farm belt at the expense of “Eastern Establishment” banking interests (by contrast, the current market-based, or currently “correct”, silver:gold ratio is 55:1; while not as divergent a century ago, the artificial 15:1 ratio would have devalued gold).
There has been no U.S. Presidential election since 1896 in which monetary policy was the dominating issue under debate, and only in 1980, when Ronald Reagan made Jimmy Carter’s weak dollar a major point of critical focus, was the monetary system again addressed in a consistent way (as important to the success of economic policy in its inducement of growth and progress). Writing in Forbes last week, however, John Tamny has correctly declaimed against ignoring the dollar’s importance to economic growth any further, and his essay is both a warning and a call to a seminal opportunity for current Presidential contenders: ignoring the fate of the dollar guarantees continued economic torpor, while engendering monetary reform can lead the U.S., and the world, to renewal. Equally so, via the simple statistic of the dollar price of gold, Mr. Tamny has captured the summary essence of the last 40 years of fiat currency management by a monopolist central bank that, at the end of the day, can fare no better than any other monopolist ever will.
In short, Mr. Tamny examines the last 40 years’ of Federal Reserve management of the supply of dollars, and notes the following cardinal facts:
Over the last ten years the price of an ounce of gold has risen 595%, and over that same time frame the S&P 500 has gone up a paltry 2.9%. ……. In the 1970s gold rose 1,355%, while the S&P essentially went flat over the same decade with a return of 16%. Conversely, in the 1980s gold fell 52% and the S&P zoomed upward by 222%. In the 1990s gold’s decline continued by 29% and the S&P roared, up 314% for the decade.
Gold is a great predictor of our economic health because as the most constant, objective measure of value in existence, its price is the single best measure of the value of the most important price in the world: the U.S. dollar. Put simply, a fall in the price of gold signals a strengthening dollar, and a rise in the yellow metal signals a weakening one.
Strictly speaking, Mr. Tamny is not fully correct in the sense that changes in the price of gold are not perfectly indicative of macro-economic conditions; gold, now a global safe haven in a time of extraordinary uncertainty and consequent market volatility, is itself subject to that volatility (viz., gold has recently fallen from $1900 to $1600 per ounce — this is not indicative of a sudden dramatic improvement in the economic outlook, and is instead due to institutional money flows wary of a European collapse). But as he indicates, the long run historical record makes it unambiguously clear that gold is an excellent indicator of the health of the economy (that is to say, the dollar price of gold, as an inverse indicator of U.S. economic health and monetary stability), has been a consistent statistic in the fiat-money regime), and a reliable parameter describing the relative merits of current economic policy.
The 1970s, like the 2000s, were a time of inflation in the supply of money and bank-created credit, the result of which was a decline in the trade-weighted value of the dollar. In the 1970s this dollar weakness manifested itself in consumer price increases and high interest rates, while in the 2000s the result was a bubble in housing and asset prices, but in each case the value of U.S. corporate equity stagnated. In the 1980s and 1990s, however, the dollar price of gold fell as U.S. corporate equity values soared. This dollar-gold relationship does indeed illustrate an important and, in the long run, predictive indicator of the U.S. economy in a fiat-money world: the macro-economy can, as a thought construct, be “modelled” as a two-good economy, gold and corporate equity. When investors prefer to hold gold, by definition they do not want to hold claims on risky assets that are valued based on the present value of their future cash flows. Conversely when, as in the 1980s and 1990s, U.S. equity markets are vibrant, investors are voting with their dollars and placing bets on those risky future cash flows, and hence demand for gold declines in relative terms. Or as Mr. Tamny says, investors will bet on risk-taking corporate America, and on its bountiful record of productivity, innovation, and invention, during times of monetary stability (as evinced by a quiescent dollar price of gold). Conversely, during periods of monetary upheaval, investor flight to gold, and away from risk-taking corporate America, results in the bid-up of the dollar-price of gold.
The astute observer may object to this formulation by noting that for several years prior to the fall 2007 stock market peak (as expressed in the Dow Jones and S&P 500 index averages), U.S. equities rose alongside the rise in the dollar price of gold. This can happen for a time in a credit-induced bubble brought on by easy monetary policy, but of course in the fullness of time asset bubbles burst, belying their falsity. One way to “correct” for this occurrence is to analyze the ratio of the S&P 500 (or equivalent index) as compared to the dollar price of gold (in the denominator); this gives a precise reading of the “real” equity gains in an economy, as opposed to those nominally driven by an increasing money supply. By 1979, for example, the gold price had risen so dramatically against a choppy U.S. equity market, that the Dow/gold ratio had reverted to near parity of 1:1, versus the 28:1 achieved in 1966 at the Dow’s first crossing of 1000. It was a perfect summary of a moribund investment climate all across the 1970s in relative terms, and this ratio’s growth across the ensuing 20 years comported well with a renewed faith in investment in the U.S.
In a fiat money world, no indicator is ”perfect”, as seen in gold’s recent drop due to global volatility in hot money flows. But in a world in which there is no monetary anchor, the trend of the Dow Jones Industrial Average/gold price or S&P 500/gold price ratios, as seen over time, is an excellent indicator of the vibrancy and health of U.S. capital markets. And in turn, a dynamic market for U.S. equities, aided by investor certainty in the future value of the U.S. currency, is a near-perfect indicator of an equally vibrant future for the U.S. economy — and by extension, that of the world.
The furies unleashed in the monetary policy debates of 1896 have now been fully resurrected in the torpor of the current era. One can certainly empathize with Mr. Bryan’s concern for the indebted and hard-pressed farmers of his time, but his calls for inflationism were no better a remedy then than they have been in the modern world at the behest of Messrs. Greenspan and Bernanke. Instead, a return to a golden anchor for the U.S. dollar would electrify the global investment community, and induce an effective recapitalization of the U.S. economy, and with it the entire world in short order.
For information on Alhambra Investment Partners’ money management services and global portfolio approach to capital preservation, John Chapman can be reached at john.chapman@alhambrapartners.com.
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