The ever-changing yardstick
The following is excerpted from a commentary originally posted at www.speculative-investor.com on 3rd February 2013.
To illustrate the difficulty of measuring performance in terms of the US dollar, today we are presenting three inflation-adjusted (IA) gold charts. Our method of inflation adjustment was outlined in the December-2010 article posted HERE.
First, we present the long-term monthly chart that we normally use to show gold’s ‘real’ performance. This chart puts historical prices into current (in this case, December-2012) dollar terms, which means that prices from past times are adjusted upward to reflect the estimated decline in the dollar’s purchasing power from the past time to the present. For example, we calculate that the January-1980 gold price of $722 is the equivalent of around $3100 in current dollar terms. This means that by our calculations it takes more than four dollars today to buy what one dollar would have bought in January-1980, or, to put it another way, the US$ has lost more than 75% of its purchasing power since January of 1980.
Note that our chart uses monthly closing prices for gold. For example, the 1980 high of around $3100/oz shown on the chart is the current-dollar equivalent of $722, the monthly close in January of that year. Had we used intra-day prices then our chart would show a 1980 high of around $3600, since $3600 is roughly the current-dollar equivalent of the January-1980 intra-day high of $850.
Next, here’s the long-term monthly gold chart in terms of January-1980 dollars. In January-1980 dollars, today’s gold price is around $400/oz.
Last, here’s the long-term monthly gold chart in terms of 1959 dollars. In terms of a 1959 dollar, today’s gold price would be around $250/oz. That the gold price in current dollar terms is about $1650/oz means that it now takes about $6.60 to buy what $1 would have bought in 1959.
The above charts look identical. The only difference is the scale on the Y-axis. This illustrates the problem of measuring performance in terms of a ‘yardstick’ that is constantly changing (shrinking).
A related point worth explaining is that if there hadn’t been any depreciation of the US$ from 1959 through to today, that is, if the dollar had the same purchasing power today as it had in 1959, then the gold price would not now be $250/oz (our calculation of the current gold price in 1959 dollar terms). It would probably still be around $35/oz. The increase from the $35/oz price of 1959 to today’s price in 1959 dollar terms of $250/oz constitutes a large real gain. This real gain stems mainly from the long-term economy-weakening costs of currency depreciation.
As we’ve argued many times in the past, if all that happened due to monetary inflation was a reduction in the purchasing power of the currency then monetary inflation wouldn’t be a big deal. Who cares if all prices rise uniformly across the economy? Everyone will have to spend more money, but they will also have more money to spend.
The problem isn’t so much that prices rise in response to monetary inflation. The problem is that due to the way money makes its way into the economy, prices rise non-uniformly and interest rates are distorted. This causes some people, businesses and economic sectors to benefit at the expense of others. It also leads to investment booms. Each large-scale investment boom, in turn, leads to a vast wastage of resources and eventually an economy-wide bust. In short, monetary inflation causes the boom-bust cycle.
As the economy oscillates between boom and bust, a long-term effect is that capital gets allocated less efficiently and the rate of economic progress slows. In addition, the more aggressive the efforts of the central planners to alleviate the pain caused by the bursting of an inflation-fueled boom by creating even more inflation, the greater the economic oscillations and the slower the long-term rate of real economic progress are apt to become. There is no doubt that the central monetary planners became far more aggressive in their efforts to manipulate the economy after the monetary system was ‘cut loose’ from its golden anchor in 1971, the result being booms and busts of greater magnitude and a pronounced slowdown in the rate of real economic progress.
The long-term decline in the rate of economic progress stemming from the more aggressive and more regular use of the monetary inflation policy-tool has had important side effects. One of these side effects is an increasing propensity to save in terms of something with money-like attributes that can’t be debased by the policy-makers. That’s why gold is in a very long-term upward trend in REAL terms. It’s also why analysts who try to calculate a fair value for gold by only considering changes in the supply of money and the supply of gold tend to be too pessimistic about gold’s prospects.
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