Gold opened 2008 with a bang. The price of the yellow metal soared to all-time nominal highs, surpassing $900 per ounce. "So what?" you may ask. "Unless one works for a mining company or a jeweler, gold is a trivial or nonexistent factor in one's life." True. But do you use dollars for your money? If so, then you ought to be concerned about the rising price of gold.
Gold is sometimes known as an inflation barometer. I prefer to characterize it as the most reliable indicator of confidence in our currency. When confidence in the U.S. dollar is high and people desire to hold dollars, then the price of gold is low in dollar terms. Conversely, when confidence in the dollar is low and people's desire to hold dollars has ebbed, then price of gold is high in dollar terms.
Why is gold a reliable monetary indicator? Historically, gold emerged as the preferred choice of money in countries around the world. Because of the painful hyperinflation of the Continental currency during the Revolutionary War, our Founding Fathers made the U.S. dollar a fixed quantity of gold. Indeed, that was the case for most of our history; thus, the saying as late as the mid-1900s that "the dollar is as good as gold."
From our everyday perspective, in which we habitually express economic value in terms of dollars, gold appears to fluctuate greatly in value. This, however, is an illusion, comparable to the illusion that the sun orbits the earth. If we change our frame of reference from the dollar to gold, we note that gold has maintained roughly the same purchasing power for centuries, and it is paper money that fluctuates wildly in value. Federal Reserve Notes, for example, have less than 5 percent of the purchasing power they had when introduced in 1914; yet, in not too many years, we will look back longingly on paying "only" three Federal Reserve Notes for a gallon of gas.
The price of gold is telling us in no uncertain terms that confidence in the dollar is falling. As explained in my "Anatomy of a Financial Crisis" commentary (see Part I and Part II in River Cities' Reader Issue 665, January 2-8, 2008), U.S. policymakers decided to sacrifice the dollar to keep the financial markets from grinding to a halt. Even before that crisis emerged, the demise of the Federal Reserve Note could be foretold. Americans are drowning in debt. Individuals and corporations hold record amounts of debt, but the greatest debtor of all is Uncle Sam. Only the naïve would think that Uncle Sam can indefinitely finance his $9 trillion of officially acknowledged debt, his other trillions of off-budget debt, and the tens of trillions of unfunded liabilities for Medicare, Social Security, etc. The only viable political option is to have the Fed inflate the money supply, thereby reducing the exchange value of each currency unit, and repay creditors with cheapened dollars.
Our overall financial weakness, the vigorous economic growth in other countries, and the consequent ongoing shrinkage of the U.S. share of global Gross Domestic Product mean that the dollar's days as the global reserve currency are numbered. The price of gold will rise even higher as this process unfolds.
In addition to the overwhelming economic factors working against our fiat dollar, there are geopolitical factors, too. Although the rest of the world loves to criticize the United States, they like the stability of a Pax Americana. If the United States can maintain order in the world, global business benefits. On the other hand, when the United States appears to be losing control, confidence in our currency swoons in lockstep with confidence in our power.
The last time the price of gold exceeded $800 per ounce, Iran had taken American hostages, the Soviets had invaded Afghanistan, and the United States appeared impotent. By contrast, seven years ago - in the aftermath of the dissolution of the Soviet Union and Communist Bloc, and before 9/11 - the United States was regarded as the unchallenged, largely benevolent superpower; confidence in our currency was very high; and gold sold for less than $300 per ounce. Now, with the assassination of Benazir Bhutto threatening to unravel nuclear-armed Pakistan, Russia and China acting to spite and discomfit us any way they can, and tensions with Iran mounting, there is diminishing confidence in the United States' ability to maintain a peaceful global order. Consequently, investors around the world are exchanging dollars for gold.
The current high price of gold indicates that these are challenging times for our country, both economically and geopolitically. If the two major parties cannot set aside their endless bickering and unite to address the major challenges facing our country, the dollar will sink more and gold will continue to rise.
Mark W. Hendrickson is a faculty member, economist, and contributing scholar with the Center for Vision & Values at Grove City College.
