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Essay 4: The Future of Gold
(1944)
As a monetary metal, gold for centuries has been the object of illusion and superstition. Yet in reality it is but a commodity like any other metal—nor is it one of the rarest. From the beginnings of time, it has been carried, like salt, by many streams to the oceans, from which it could be extracted if the price of gold justified it. Yet the very word is synonymous with riches.
Why?
In ancient times gold was used as a medium of exchange, for which its beauty, durability, malleability and relative scarcity ideally suited it. Hence its association with early monetary systems, all of which were on a "hard money" basis. As commerce grew more expansive and complex, and there arose the necessity of paper money and other credit instruments, it was believed that such instruments, to be acceptable in trade, had to be exchangeable for gold upon demand. Thus arose the correlative belief that a national currency, to have significance or "value" or "stability," had also to be identified with a measure of gold or silver. This practice was termed putting money on a gold or silver “standard."
This posed a problem, however, for there is no stability in the value of gold any more than there is in any other metal. In order to give the value of gold the appearance of constancy, therefore, the price of gold, i.e. the amount of the metal exchangeable for the monetary unit, had to be stated above its true market value so that it could not vary. For many centuries, accordingly, one or more governments have always been willing to bear the expense of maintaining the price of gold above its true value as determined in free exchange, and thus gold has been given the appearance of having a constant value. This has given rise to the superstition that gold is not only stable in value, but that it is, in fact, a criterion of value.
The practice of setting a price for gold that is above its free market value set in motion economic laws, which have actually reduced the value of gold. When an artificially high price is put upon a commodity, it causes that commodity to be over-produced, and when a commodity is in excessive supply, its units lose value commensurately. The association of gold with the monetary unit, an association intended to benefit the latter, has resulted in a benefit to gold miners, nothing more. The delusion of "gold convertibility" has, in effect, subsidized the gold mining industry for centuries and caused gross overproduction. The actual value of gold has declined accordingly, but the decline has not been manifest because some nation has always been willing to keep the price up on a peg. In short, we know the price of gold, but we can only guess at its value.
England maintained the price of gold for 600 years, from the 13th century until 1931, in which year she had to give it up, unable to afford the charade any longer. The United States then became the price pegger, but with a twist. Previously, nations on a gold standard had bought and sold gold to all comers at the fixed price. President Roosevelt was induced by his advisors, however, to exclude those within the United States from trading, and to confine buying and selling privileges to foreigners. American citizens were required to turn in their gold coins and certificates. In thus changing the rules, Roosevelt unwittingly exploded the gold standard fallacy.
Had the gold standard theory been correct, namely, that backing a monetary unit with gold convertibility gives it greater stability or acceptance than units not so backed, we would now have two dollar price levels, one for the foreigner and another for the American. This would have had to arise, since the foreigner's dollar is convertible whereas the American's is not. The fact that there is one dollar price for both demonstrates that the dollar is a power in and of itself, quite apart from any gold convertibility.
A corresponding observation is that as the dollar goes, so goes gold, and not vice versa, as the gold theorists would have had us believe. When the purchasing power of the dollar is high, that of gold is high, and when the power of the dollar declines, that of gold also declines. The purchasing power of gold, like that of the dollar, declined by nearly a third between January of 1940 and September of 1943. An ounce of gold, at $35, would have been required on the latter date to purchase the same amount of other commodities that could have been purchased for $24.50 three and a half years earlier. This in itself proves that there is no stability in the value of gold and that it has no power to uphold the unit that supports it.
In view of the fact that the purchasing power of gold is declining in America, why is it that foreigners are not withdrawing it? The reason is simple: the United States Treasury is the only market in the world for gold, and its price, despite the cheaper dollar, is still higher than its free market value. Outside of the United States there is not now, nor is there likely to be, any nation foolish enough or strong enough to burden itself by gratuitously paying a subsidy to the gold mining industry of the world. Nor will the United States pursue this folly for very much longer.
Circumstances are now compelling the realization that gold has no magic charm, no peculiar quality, no fixed value, and no special stability, but is a commodity subject to the same laws of supply and demand that determine the value of any other commodity. Its last artificial support is the dollar, and when the dollar grows too weak from inflation to hold the price of gold above its actual value, gold will be on its own. The dollar will be so reduced in purchasing power that $35 per ounce will actually be a low price for gold, and its price will rise above that figure. From that point and beyond, unless the government arbitrarily holds it for some reason, gold will move out of the Treasury and into the arts and industries. No more will flow into the Treasury, because there will be no profit to the seller at the old price. Indeed, if the government continues its present policy of selling to foreigners at $35 an ounce in the face of continuing inflation, gold will flow out to other countries, who will buy it back for a minute fraction of what they sold it to the United States Treasury for in pre-war days. The gold problem will be solved by either action or inaction, for economic laws have a way of compensating for bad statutory laws. In any event, the standard or base idea will be gone beyond recall in economic thought.
Of course, there will be some serious repercussions from the collapse of dollar support for gold. Foreign gold reserves held throughout the world are dollar reserves, nothing more and nothing less. As the dollar shrinks, these reserves shrink as well. Therefore, the inflation of the dollar is undermining gold reserves and the credit they support all over the world. The nation with the premier unit that makes the price and market for gold cannot go through inflation without affecting all nations. That is why our inflation is international inflation, the first such instance in the world's long experience with inflation.
The Federal Reserve Board and the Bank of International Settlements have estimated monetary gold reserves outside of the Unites States at $7 billion, and the Bank of International Settlements estimates $2.5 billion in unrecorded holdings of exchange funds and government accounts outside of the United States. The National City Bank estimates $2 billion of newly mined gold. Thus a total of $11.5 billion is estimated as the world holdings outside of the United States. If the dollar has lost 30 per cent, therefore (there is no definite index in view of the black markets), these hoards have already shrunk to about $8 billion in actual purchasing power. For the Unites States to make its own hoard maintain its Federal Reserve Bank reserve illusion, the price will have to be raised to many times its present artificial price.
Some indication of the extent to which gold has been excluded from industrial uses by the pegged price policy can be seen from the figures for production and industrial consumption in the United States during the period 1937 to 1941. In the latter year, consumption was only about 15 per cent of production, and this was far above average for the period. These figures only reflect United States production and consumption. When we consider that the United States produces only about one-eighth of the world's gold, but undoubtedly uses more for industrial purposes than the rest of the world combined, we can see how greatly current production exceeds current industrial demand.
The picture is all the more startling if we consider the tremendous accumulation that exists. The best available figures show that throughout the world, in government treasuries, stabilization funds, central bank reserves, and private hoards, there are nearly a billion ounces, all of which must, sooner or later, be dumped on the industrial market. On the basis of approximately one million ounces for industrial consumption in the United States in 1941, and assuming double this amount for world consumption, it would take five hundred years to consume the existing supply. Of course, this is no criterion for the probable rate of consumption when price support ends. There are many known uses for gold for which the price has always been prohibitive, and changing technology will continue to find new uses.
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