"Gold maintains its purchasing power over long periods of
time, for example, half-century intervals."
Roy Jastram, The Golden Constant
1
In last month's column, I focused on gold's inherent
stability as a monetary numeraire. Historically, the monetary base under
gold has neither declined nor increased too rapidly. In short, it has
operated very closely to a monetarist rule.
What about gold as an inflation hedge? In this column,
I discuss the work of Roy Jastram and others who have demonstrated the
relative stability of gold in terms of its purchasing power-its ability
to maintain value and purchasing power over goods and services over the
long run. But the emphasis must be placed on the "long run." In the
short run, gold's value depends a great deal on the rate of inflation
and therefore often fails to live up to its reputation as an inflation
hedge.
The classic study on the purchasing power of gold is
The Golden Constant: The English and American Experience, 1560-1976, by
Roy W Jastram, late professor of business at the University of
California, Berkeley, The book, now out of print, examines gold as an
inflation and deflation hedge over a span of 400 years.
Two Amazing Graphs
The accompanying two charts are from Jastram's book and
updated through 1997 by the American Institute for Economic Research in
Great Barrington, Massachusetts. They tell a powerful story:
First, gold always returns to its full purchasing
power, although it may take a long time to do so; and Second, the price
of gold became more volatile as the world moved to a fiat money standard
beginning in the 1930s. Note how gold has moved up and down sharply as
the pound and the dollar have lost purchasing power since going off the
gold standard.
In my economics classes and at investment conferences,
I demonstrate the long-term value of gold by holding up a $20 St.
Gaudens double-eagle gold coin. Prior to 1933, Americans carried this
coin in their pockets as money. Back then, they could buy a tailor-made
suit for one double eagle, or $20. Today this same coin - which is worth
between $400 and $600, depending on its rarity and condition - could buy
the same tailor-made suit. Of course, the double-eagle coin has
numismatic, or rarity, value. A one-ounce gold-bullion coin, without
numismatic value, is worth only around $300 today. Gold has risen
substantially in dollar terms but has not done as well as numismatic
U.S. coins.
Gold as an Inflation Hedge
The price of gold bullion was over $800 an ounce in
1980 and has steadily declined in value for nearly two decades. Does
that mean it's not a good inflation hedge? Indeed, the record shows that
when the inflation rate is steady or declining, gold has been a poor
hedge. The yellow metal (and mining shares) typically responds best to
accelerating inflation. Over the long run, the Midas metal has held its
own, but should not be deemed an ideal or perfect hedge. In fact, U.S.
stocks have proven to be much profitable than gold as an investment.
The work of Jeremy Siegel, professor of finance at the
Wharton School of the University of Pennsylvania, has demonstrated that
U.S. stocks have far outperformed gold over the past two centuries. Like
Jastram, Siegel confirms gold's long-term stability. Yet gold can't hold
a candle to the stock market's performance. As the chart, taken from his
book, Stocks for the Long Term, shows, stocks have far outperformed
bonds, T-bills, and gold. Why? Because stocks represent higher economic
growth and productivity over the long run. Stocks have risen sharply in
the twentieth century because of a dramatic rise in the standard of
living and America's free-enterprise system.
One final note: Stocks tend to do poorly and gold
shines when price inflation accelerates. As Siegel states, "Stocks turn
out to be great long-term hedges against inflation even though they are
often poor short-term hedges." 2 Price inflation is the key
indicator: then the rate of inflation moves back up, watch out. Stocks
could flounder and gold will come back to life. In my next column, I'll
discuss the ability of gold to predict inflation and interest rates.
At the time of the original publication, Dr. Skousen
was an economist at Rollins College, Department of Economics, Winter
Park, Florida 32789, a Forbes columnist, and editor of Forecasts &
Strategies, He is also the author of Economics of a Pure Gold
Standard, 3rd edition (Foundation for Economic Education, 1996, and
was working on his own textbook, Economic Logic.
1. Roy W. Jastram, The Golden Constant: The English and
Amer-ican Experience, 1560-1976 (New York: Wiley & Sons, 1977), p.
132.
2. Jeremy J. Siegel, Stocks for the Long Run: A Guide
to Selecting Markets for Long-Term Growth (Burr Ridge, Ill.: Irwin,
1994), pp. 11-12.
Reprinted with permission from The
Freeman, a publication of The Foundation for Economic Education, Inc.,
October 1998, Vol. 48, No. 10.
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