Misunderstanding Gold


I am a gold bug. A gold bug is a believer in the public’s use of gold coins as the basis for a nation’s money supply. Because very few university-certified economists are gold bugs, and very few gold bugs are academic economists, there is enormous confusion on all sides regarding gold: why it is valuable, why it serves as money, why gold money is necessary for freedom, and why we don’t need a government-guaranteed gold standard in order to have a gold standard.

I begin with a recent observation by Hans Sennholz, the dean of the Austrian School of economics. He has written on all aspects of the economy, as his teacher, Ludwig von Mises, also did. He has written more than any other living Austrian School economist. Here is his recent assessment of gold as a way to attain stable money.

Money is no yardstick of prices. It is subject to man’s valuations and actions in the same way that all other economic goods are. Its subjective, as well as objective, exchange values continually fluctuate and, in turn, affect the exchange ratios of other goods at different times and to different extents. There is no true stability of money, whether it is fiat or commodity money. There is no fixed point or relationship in economic exchange. Yet, despite this inherent instability of economic value and purchasing power, man is forever searching for a dependable medium of exchange.

The precious metals have served him well throughout the ages. Because of their natural qualities and their relative scarcity, both gold and silver were dependable media of exchange. They were marketable goods that gradually gained universal acceptance and employment in exchanges. They even could be used to serve as tools of economic calculation because their quantities changed very slowly over time. This kept changes in their purchasing power at rates that could be disregarded in business accounting and bookkeeping. In this sense, we may speak of an accounting stability that permits acting man to compare the countless objects of his economic concern.

We can hope for usable price stability over the time period of accounting, but if we seek to establish a fixed-value currency, we will gain only government-issued money and monetary instability.

So, the goal of price stability is an illegitimate goal. All that we can legitimately hope for is loose predictability of those specific prices that affect us as individuals, so that we can make accurate plans for the future.

Any attempt by the government or its agent, the central bank, to attain general price stability is inherently self-defeating.

First, what matters is not some committee’s official price index, but rather specific prices as they affect acting individuals. To get the official national price index to stabilize, the planners must raise some prices, which would otherwise have fallen, and reduce some prices, which otherwise would have risen. This is beyond any committee’s ability to forecast or administer.

Second, even if politics did not intrude, which it will, the central planners of money will be forced to adjust the money supply to the committee’s central plan. The wisdom of this market-insulated bureaucracy’s central plan will not match the combined wisdom of profit-seeking, loss-avoiding forecasters and entrepreneurs in an economy that has a gold coin standard.


If you have taken my free email course on gold, "The Gold Wars," you understand the basics.

If not, then allow me to summarize.

There is a nave view of gold that teaches that the price of gold doesn’t vary. Only the value of paper money varies. Sennholz is arguing against this view. The price of every good and every service varies as conditions change: supply and demand. There is no fixed standard. There is no yardstick for money. There is no such thing as a free lunch, and there is no such thing as a measure of value. Economic value is subjective. Prices change as subjective values change.

When you buy a gold coin — which I suggest you do — you should not do so on the expectation that its price will automatically rise when the dollar falls in value. I realize that sophisticated investors say to themselves, "I know this." But when they buy gold, they often move from commodity investors to true believers. They read articles written by people with no background in economic theory or history, who become acolytes for gold. They become vulnerable to hype.

Gold bullion was an illegal investment for Americans from 1933 through 1974. This fact kept the average American from buying gold bullion coins. This reduced the demand for gold. Gold’s price did not change on international markets from 1934 to 1967. People made money buying collector gold coins from 1967 to 1974. Then gold fell by almost 50% in 1975—76. Only after September, 1976, did it soar: from $106 to $850 for one day: January 20, 1980. After that, it became a very bad investment until 2001. It was then that I began promoting gold once again.

Yet year after year, 1934 to 2006, the dollar has depreciated. Decade after decade, the Federal Reserve System has created money to buy U.S. government debt, thereby lowering the purchasing power of the dollar, as estimated in terms of various official price indexes, private and governmental.

Anyone who bought collector gold coins after 1933 or gold bullion coins in 1973 lost money most of the time. There was a brief period of high profits, from 1975 to late 1979, but the losses sustained after mid-January, 1980, were horrendous.

I repeat all this because I want readers to recognize the nature of gold. It is a hedge against serious and generally unexpected monetary inflation. But the investing public remains unfamiliar with gold. Only a few tiny companies sell gold coins. The big brokerage firms downplay gold.

Gold and silver were bubble markets, 1975—1979. They popped in January, 1980. In terms of purchasing power, gold at $600 today is the equivalent of gold at $250 in 1980. But gold peaked at $850 in 1980.

It will take unexpected and extensive monetary inflation to create a comparable boom in gold.


The case for gold is the case against government control over the money supply. It is the case against experts who invariably substitute their judgment of what is best for society in place of the decisions of individuals regarding what is best for themselves. The case for gold is the case against the civil government’s manipulation of the money supply.

Today, gold has been demonetized for everyone except central banks. Large nations’ central banks do keep some gold reserves as the legal basis of their nations’ currencies. But government bonds make up the bulk of central bank reserves: their national debt and foreign governments’ debts — mainly U.S. government debts.

The fall in value of the dollar against the euro began in January, 2002. The move upward of gold had begun in the previous quarter. People forget how long this decline of the dollar has been going on. It did not begin this year.

Gold peaked at $725 on May 12, 2006. The fall of the dollar against the euro has been attracting attention in recent months.

If you follow the monetary statistics, you are aware that the crucial statistic, the adjusted monetary base, has barely moved since February. The other monetary indicators have also fallen from their highs late in 2005.

Bernanke’s Federal Reserve has put on the monetary brakes. The fact that gold is down against the dollar since the May high is consistent with the FED’s policy. What has surprised people is the fall of the dollar against the euro.

This tells us that there is no one-to-one correlation between monetary policy and prices. At best, there is a broad correlation. Gold rose, 2001—2006. The euro rose, 2002—2006. But they did not rise in a straight line.


The dollar will decline. Of that, I am confident. At some point, it will begin to decline much faster than it is declining today. When that era comes, gold will be a fundamental investment to buy and hold. It will preserve purchasing power.

We must not be nave about gold’s potential during an era of relative monetary stability, which we are in today. The FED can shift back to inflation at any time. But Bernanke will resist this. He has bet his new career on fighting price inflation. He says that price inflation is too high. Yet the CPI, year to year, is under 2%. The Median CPI is under 3%. He will pressure the Board of Governors to accept a monetary policy that keeps all of the official price indexes under 2%.

When this monetary policy produces a recession, there will be great pressure put on him by Congress to lower interest rates to get the economy out of the doldrums. At that time, we will see how committed the FED is to Bernanke’s litany about inflation being too high. But we had better take him seriously when he says that prices are rising too much.


Because of the war, which is not going away in 2007, gold should be in everyone’s portfolio. But because recession looks increasingly likely in 2007, the case for gold as an inflation hedge looks much less relevant.

Long-term, the case for gold is the case against central banking. But central bankers have managed to gain power over money for over three centuries. Whenever they attain their goal, as they did in December, 1913, they have not surrendered this control. I do not expect them to do so in my lifetime.

As the government’s debt obligation increases, the politicians will look to the FED to buy the debt with fiat money. But, in 2006, the FED has bought almost no debt. It will take a lot of political pressure to force the FED to create a sufficient amount of fiat money to get a replay of the bubble market of 1976—1979.

Assume this when you buy gold.

December 13, 2006

Gary North [send him mail] is the author of Mises on Money. Visit http://www.garynorth.com. He is also the author of a free 19-volume series, An Economic Commentary on the Bible.

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