Originally posted Tuesday, November 06, 2012
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A key issue in restoring the gold standard is the determination of the new definitional price of the currency in gold. If the price is set too high it will cause some level of inflationary surge. If the price is set too low, as it was by Winston Churchill, serving as chancellor of the exchequer of Great Britain in 1925, it will cause deflation and unemployment.
Gold Vault, New York Federal Reserve Bank, image courtesy of Wikipedia
As set forth in The True Gold Standard, by Lehrman Institute founder and chairman Lewis E. Lehrman, the only safe mechanism is to set a convertibility date no more than several years in the future, allow the markets to arbitrage to the appropriate price, and there fix the dollar’s definition, subject only to a final expert review to rule out the possibility of a price that would induce nominal wage deflation.
A recent article, “An Argument For Gold ‘Value’ of $1100” in StopAlerts.com, a service of QVM Group LLC (with which the website is not affiliated), published in SeekingAlpha, contained many astute observations demonstrating why a market-generated valuation is the practical and safe mechanism:
Today, the price of gold is over $1,700. Could it be “worth” far less. “Yes”, by certain quantitative approaches, and absolutely “No” according to the “faithful” .
Price and value are not the same thing. Prices tend to vary more often and more significantly than value, but how to get at value. Price discovery is easy. Value discovery is not.
But What Is Gold “Worth”?
The problem with the question is that there are no internals for gold on which to make a valuation. There are no revenues, no profits, no dividends, and therefore no price-to-sales, no price-to-earnings, and no yield. That makes rationally selecting a value quite difficult.
There are those who are chartists who extend trends, but trends continue until they don’t.
There are the faithful, who reference thousands of years of use of gold as a medium of exchange, and who see it as the solution to the ever expanding fiat currency base of the world; or who simply believe in it.
We get the crisis bit, but are not sure about inflation correlation. We can’t make the leap of pure faith. We want to find something more tangible to avoid simply accepting and taking whatever the market asks for gold at the moment.
All asset prices overshoot and undershoot value. The question is how can we possibly guesstimate when a price is over or under valued.
CPI Doesn’t Work
We reviewed the price of gold from 1968 through September 2012 (45 years) and found that gold far outstripped inflation. Gold was up almost 50 times, while the US “all items” CPI was up less than 7 times over that period.
What Make Sense Logically?
Call us doubting Thomas, or preferably that we are from the Show Me state of Missouri, but either way; we have an intellectual need to be able to relate the price of gold to something other than blind faith in the yellow metal.
The fact that gold has been money in the past; the fact that paper money in our lifetimes has been pegged to gold; the fact that the stock of currency printed and circulating continues to grow unabated; the fact that is currency alternative use is much greater than its jewelry or industrial use; and the fact that a significant portion of the jewelry use is a quasi investment versus decoration decision, tells us that the logical basis of valuing gold is to find its equivalent in terms of currency in circulation.
What Is The Currency In Circulation “Value”of Gold?
Our logic would say that if we add up all the world’s currencies in circulation and convert them all to their US Dollar value, and then divide that sum by the total number of ounces of gold that are estimated to be above ground at this time; then that is the paper money value of gold.
That number is about $1,100.
If that is true, then gold is either in a major overshoot at the moment, or currency in circulation is about to explode up by about 50%.
Both of those ideas seem plausible, but it should give some pause to see how far ahead of present currency in circulation the price of gold is. Price and value are not the same thing.
It is technically impossible to know, absent allowing the markets to determine the appropriate price, what the true “value” of the dollar relative to gold should be. Yet the mechanism for determining the convertibility price is well understood and the logical approach presented by StopAlerts astutely references many of the mechanisms which the markets will employ in making a correct, and even elegant, determination.
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