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Gold and the Barbarians

Article published in The Wall Street Journal on January 26, 2010.

Gold has hit fresh highs against the dollar recently, trading at well over $1,400 per troy ounce in the last month, from under $300 per troy ounce 10 years ago. The metal’s mounting value is hooked directly to its economic role as a stable alternative to paper currencies, and its rise should tell us something about the health of the global monetary system. Unfortunately monetary authorities around the world still broadly misunderstand and even dismiss gold’s role. How else to explain their recent policies?

Lenin committed a similar error when, according to Khrushchev, he said « the day would come when gold would serve to coat the walls and floors of public toilets. » And John Maynard Keynes, the monetary guru of so many of today’s central bankers and politicians, once dubbed it a « barbarous relic. » Yet today, having been unpegged completely from the world monetary system, gold is neither relic nor toilet tile; it is more important than ever, and precisely because the paper value of goods and services is ever-more dependent on the whims of an elite few. So for those businesses and households that need some stable means of storing value, governments’ paper-based monetary and financial system is unsuitable. Gold, on the other hand, is a much-needed safeguard against the barbarism of monetary authorities.

Historically, the international monetary system, imposed after World War II by the Bretton Woods agreements, gave the dollar a central role. It was considered « as good as gold » because it was the only currency that maintained a link with the yellow metal. Gold thus acted as economic actors’ safety valve against American monetary authorities’ abuse of inflationary expansion.

But after these authorities spent the better part of a decade using their printing presses to finance the Vietnam War and a raft of new social programs, President Richard Nixon in 1971 put an end to the dollar’s convertibility to gold. So rather than end inflationary monetary growth and face the economic consequences, Washington instead decided to eradicate the one check on its own monetary expansion. As the nearby figure illustrates, the U.S. dollar has lost nearly 82% of its purchasing power since that time.

The 40 years since then have exposed the international system to inflationary U.S. monetary growth, as well as to various manipulations of other paper currencies, such as the Chinese yuan. Today’s economic players must therefore take into account major exchange-rate risks between all the world’s non-trivial paper currencies. Those paper currencies survive because of governments’ interventions to ensure that they are legal tender, and despite their continual loss of purchasing power.

But households and businesses still need a reliable means of storing value. They turned to financial markets to preserve their wealth, but here too, monetary inflation’s infection is evident in the boom and bust cycles of stock exchanges, as Keynes’s foe Friedrich Hayek explained. And with each bubble, monetary authorities create more inflation that, over time, erodes the very moral capital on which paper currencies depend. At present, this inflationary rush in the U.S. is serving to finance governments’ debt, and goes by the name of « quantitative easing. »

So it should be no surprise that inflation—which is often confused with one of its consequences, namely a rise in consumer prices—leads to rising gold prices. Today’s gold price should serve as a warning to monetary authorities that if they continue down their inflationary path, sooner or later they will mete out death to their paper currencies. Gold will probably never coat the walls of public toilets, but it could one day be used to buy groceries.

Mr. Petkantchin is an associate researcher at the Institut économique Molinari.


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