"The editors don't agree with your claim that gold is a
best indicator of inflationary expectations and economic stability."
-Dan Hinson, Managing Editor, The Wall Street Journal
1
This column developed out of a running debate I've had
with the editors of the Wall Street Journal and the New York Times. In
the financial news, the Times highlights the price of oil as the best
indicator of commodity prices and inflationary expectations. The front
page of the Wall Street Journal publishes nine prices and indices,
including oil and the Dow Jones Commodity Spot Index, to reflect
activity in the financial markets. But neither the Times nor the Journal
highlights the price of gold as an important barometer of inflation or
monetary stability. Apparently they believe that oil and the commodity
spot index are better indicators.
Gold Is Watched Carefully
Despite these misgivings by the establishment media,
gold is not ignored. It is well known that members of the Federal
Reserve Board and other central banks monitor the price of gold
carefully and consider it a good estimate of inflationary expectations.
Moreover, some financial observers and economists are convinced that
central banks may intervene from time to time to maintain a steady gold
price. According to this view, a rising gold price is undesirable
because it suggests increased inflationary expectations and a potential
monetary crisis (such as a run on the dollar). Thus, when the price of
gold moves up "too much," central banks sell gold. At the same time, a
falling gold price is undesirable because it may imply deflation and
recession. When gold falls below a certain price, central banks buy or
simply stop selling.
How long central bank interventionism can last is
anyone's guess. But eventually the market will reassert itself, just as
it does whenever a form of price-fixing occurs, and gold prices will
start rising again.
A Test to Find the Best Indicator
Are the Times and the Journal right in highlighting oil
and commodities in general rather than gold as a barometer of
inflationary expectations? Are they justified in their antigold bias?
To test this theory, I constructed a simple econometric
model to test how well gold, oil, and the Dow Jones Commodity Spot Index
have anticipated changes in the Consumer Price Index (CPI) since 1970.
In each case, I developed a least--squares regression analysis, testing
the CPI against gold, oil, and the Dow Jones Commodity Spot Index for
each year with a one-year time lag. (I thank Professor
John List, economist at the University of Central
Florida, for helping me develop this econometric model.) Even though the
CPI has come under criticism as a measure of price inflation, I have
selected it as a simple, consistent measure of price inflation.
The question to answer: Do changes in either of these
commodity prices anticipate a rise or fall in the Consumer Price Index?
At first I tested to see if any of these three
commodity prices predicted changes in the CPI on a monthly basis since
1970. For example, did the change in the price of oil in January
anticipate the change in the CPI in February? No Commodity a Good
Short-Term Indicator
The results were discouraging. It is clear that none of
the commodity prices- oil, gold, or the commodity spot index-were able
to anticipate changes in the CPI from one month to the next. R-squared
was 0.02 or less for each test, indicating no correlation at all. As a
short-term indicator, gold, oil, and the commodity spot index are all
lousy predictors of next month's CPL
Gold Turns Out to Be the Best
However, the results were much better when we tested
average annual commodity prices as a predictor of the following year's
CPI since 1970. All three commodity prices showed predictable power over
the long term (one year). However, it is clear from the regressions that
gold was the best indicator of inflationary expectations (R-squared,
0.42), followed closely by the Dow Jones Commodity Spot Index
(R-squared, 0.37), and oil was a distant third (R-squared, 0.18). In
fact, it could be determined that oil was a poor indicator of
inflationary expectations as measured by the CPI. This view falls in
line with the work of energy economist Douglas Bohi, whose historical
work concludes that oil has far less impact on the world economies than
most economists believe. 2
Gold as a Measure of Price Inflation
Historically, we can see how gold has significantly
anticipated the rise and fall in purchasing power. When the world went
off the gold exchange standard in 1971, the price of gold rose sharply
from $35 an ounce to $200 an ounce, reflecting the sharp rise in
commodity and consumer prices in 1973-74. Then gold suddenly topped out
in 1975, about the same time the CPI rate started dropping. When
consumer price inflation started moving up again, reaching 14 percent in
1979 - 80, gold moved in sympathy, rising from $100 an ounce in 1976 to
$850 an ounce in January 1980. The long disinflationary era of the 1980s
and 1990s saw a declining trend in both consumer price inflation and the
gold price, although that trend may be changing again soon.
In short, it appears that the price of gold does a good
job of reflecting the inflationary environment as measured by the
Consumer Price Index. It is certainly a better indicator than the crude
oil price.
Research by the late Professor Roy Jastram (University
of California at Berkeley) suggests that gold maintains its purchasing
power over the centuries. After investigating the purchasing power of
gold over the past 300 years, Jastram concluded that, despite major
inflations and deflations, "Nevertheless, gold maintains its purchasing
power over long periods of time, for example, half-century intervals. "
3 Based on the above new evidence, wouldn't it be appropriate
for the New York Times and the Wall Street Journal to add gold to their
summaries of the financial markets?
At the time of the original publication, Dr. Skousen
was an economist at Rollins College, Department of Economics, Winter
Park, Florida 32789, and editor of Forecasts & Strategies, one of
the largest investment newsletters in the country. The third edition
of his book Economics
of a Pure Gold Standard has recently been published by FEE.
1. Private correspondence, April 14, 1995. 1 first
raised this issue in MY column, "What's Missing from This Picture?" (The
Freeman , August 1994). This column was reprinted in The Lustre of Gold
(Irvington-on-Hudson, N.Y.: Foundation for Economic Education, 1995).
2. Douglas R. Bohi, "On the macroeconomic effects of
energy price shocks," Resources and Energy 13 (1991), pp. 146-162. See
also my column, The Freeman (August 1994), pp. 457-458.
3. Roy Jastram, The Golden Constant (New York: John
Wiley & Sons, 1977), p. 132.
Reprinted with permission from The
Freeman, a publication of The Foundation for Economic Education, Inc.,
February 1997, Vol. 47, No. 2.
Yourname@libertyhaven.com
