View original document

The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.

m

1t
Ir rr©\iffiCC
n
(Q)

CC
(G)

October 12, 1979

Why Cold?
The present decade, which was dubbed at its
inception the "Soaring Seventies," ironically
is ending on just one spectacular note - the
soaring price of gold. The decade began with
gold still priced officially at $35 an ounce, but
between January and October 1979, gold's
price climbed from $220 to nearly $450 an
ounce. This 1979 increase, which ranks with
the 1933 revaluation as the sharpest goldprice rise of this century, has surprised even
jaundiced economic observers. " Gold bugs"
see the ascent as further proof of the need to
restore gold to its rightful dominance in the
international monetary system. But to many
skeptics, the 1979 experience confirms their
belief that a speculative fever, rather than
sound economic principles, rules the
peculiar market for this metal.
Few public officials can have welcomed the
return of gold to the top of the financial pages.
In principle, gold became just another commodity in the early 1970's when the u.S.
stopped pegging its price, and certainly after
1974, when the u.S. authorized private
ownership of gold again. But officials have
had difficulty maintaining their stance of
benign neglect in the face of the recent price
upsurge, especially since that upsurge can be
interpreted as an adverse verdict on the
ability of governments to contain inflation.
Officials, no less than private investors, thus
wonder about what has caused the rise in
gold prices, and what pol icy measures are
available to deal with it.

Gold's value
Gold derives value from its intrinsic usefulness, from its durability, and from its relative
scarcity. People prize it for its artistic, decorative, and industrial uses - essentially
as a consumption good. But people also
value it as an investment asset, because it can
be stored without deterioration and in
conven ient, portable, and transferable forms.
Gold's employment for both consumption
and investment purposes is illustrated by its

current uses. Of the 56 million ounces of gold
which became newly available to private
users last year, 40 million ounces went into
artistic and industrial uses (primarily jewelrymaking) and the rest went into coins, medals
and bars. Of course, diamonds, silver, art
objects and other durable goods similarly can
be used for both investment and consumption - and in many cases their prices also
have risen sharply in recent years.
As with any commodity, the price of gold
is determined by the amount demanded relative to its supply. But on the supply side, the
picture is complicated by the fact that gold
can be supplied from existing stocks as well
as from new production. Indeed, gold stocks
are many times larger than annual production, with perhaps 1.5 billion ounces in private holdings and another 1.2 billion ounces
potentially available from public holdings.
And on the demand side, fluctuations in investment demand similarly may be many
times the size of annual production or industrial demand. Consequently, gold's price
normally is determined primarily by investment considerations, being dependent on
investors' anticipations about its future value
relative to that of alternative assets.In this
respect, the gold market is more similarto the
stock market than to the market for a nondurable commodity such as wheat.
Because the total value of privately held
gold - no more than $600 billion at today's
prices - is on Iy a small fraction of the world's
total wealth, the shifting of other assets
into gold could have pronounced effects
on the price of gold. Total GN P of all noncommunist nations was roughly $8 trillion
last year, and the land and capital stock
required to produce this output was several
times greater. Alternatively, last year's gold
production - valued at about $9 billion was only a modest fraction of u.S. individuals' net savings, not to mention the
savings of individuals elsewhere. Obviously,

Orlinions e:<pressed in tflis
ci() llot
necess.arii)!
tile vi€\,'Vsof the rnanageme.nt
of the Federai Re::,er've ESaili( Sail Francisco,
crt
Reser"ve Systern.

inflationary pressures only to rise even
more spectacularly this year as U.s. inflation
accelerated again.

from either standpoint, people around the
world need shift only a small portion of their
wealth into gold - buy a few gold coins - to
bring about a drastic rise in its price. But by
the same token, even a slight decline in gold's
attractiveness can cause its price to tumble,
so that gold is also a potentially risky
investment.

These shifting gold-price trends reflect changing sentiments about national currencies.
Prior to the 1970's, the purchasing powers
of individual national currer.tcieswere linked,
at least loosely, through the mechanism of
fixed exchange rates. The dollar served as
a widely accepted and fairly stable international asset. Gold's utility as an investment
was accordingly limited, particularly as itwas
linked to the dollarfor mostofthat period. But
then, with the acceleration and divergence of
national inflation rates, fixed exchange rates
became impossible to maintain any longer.
As a result, the purchasing powers of alternative currencies have often diverged sharply
and unpredictably. However, thecoRsider.,
able ups and downs in currency values of the
1 973-79 period have made investment in any
single national currency a risky endeavor.
Not surprisingly, then, gold has increased in
attractiveness as a hedge against the
uncertain prospects for individual currencies,
as well as against currencies collectively. For
th is reason, gold has been especially sensitive
to the inflation outlook, its price rising or
falling with the waxing or waning of inflation
fears.

Why would individuals want to invest in
gold? Partly, they use gold as protection
against losses on other investments. Traditionally, people throughout the world have
held gold against panics, wars, and other
upheavals that have often sharply degraded
the value of stocks and other financial assets.
More recently, many investors have found
that holding gold reduces the risk that their
wealth will be eroded by an unforeseen
acceleration in inflation. This insurance
characteristic has made gold attractive as an
investment asset even in periods when its
purchasing power was declining in terms of
commodities.
Recently, of course, gold's purcha,sing power
has been rising, making it a very attractive
(although still risky) hedge against inflation.
This has not always been true; indeed, for
most of the post-World War II period, gold's
price was pegged to the dollar, and its
purchasing power declined with inflation.
Investment in virtually any other asset stocks, silver, oreven savings bonds - would
have yielded a higher return during that
period. Since 1971, however, gold has risen
faster in price than have commodities generally, despite sharp short-term price fluctuations which brought losses to some gold
investors.

Nonetheless, we can detect differences
between the situation in 1 977-78 and the
situation this year. Much of the 1 977-78 runup in gold prices can be attributed to U.S.
inflation and the resulting decline in the value
of the dollar, especially against "harder" currencies such as the Swiss franc. The dollar
price of gold rose 68 percent over that twoyear period - butthe dollar price of the Swiss
franc and the yen each rose about 50 percent,
while the dollar price of the mark increased
23 percent. These currencies - if not quite
lias good as gold" - were at least considerably superior to the dollar as inflation hedges.

Gold's rise
Still, gold's upward march has been neither
steady nor uninterrupted (see chart). Gold
prices surged in 1 971 , roughly in line with
the first devaluation of the dollar, and they
accelerated further in 1973 and 1 974, with
the rise of world inflation and the adoption
of floating exchange rates. But gold prices
then fell nearly one-third in the 1 975-76
period, with the temporary weakening of

In 1979, however, the situation apparently
has changed drastically. Since last January,
gold has risen more than 80 percent against
the dollar - and by nearly as much against
the yen, the mark and the Swiss franc, reflect2

ing a shift in inflation prospects throughout
the entire industrial world. Inflation has
speeded up in Germany, Japan and Switzerland, brought about (at least in Germany and
Switzerland) by a monetary acceleration
which was caused in part by their heavy
market intervention in support of the dollar.
Also, around midyear, fears of further
inflation were fanned by the sharp increase in
oil prices announced atthattime. Altogether,
the upsurge in gold prices reflects the
perception by investors that the inflation
prospects of the major industrial countries are
more closely
and adversely - linked than
they had been previously.

Swiss fianc, putting further pressure on the
dollar.

Gold - and policy

Thus, in the last analysis, effective antiinflation pol icies are likely to be the most
effective gold policy in the period ahead. The
tighter monetary-policy package adopted last
weekend has promising implications on this
score; indeed, gold's price fell to $375 an
ounce this Monday from last week's peak of
$444 an ounce. There are also signs that
monetary policy is tightening abroad as well.
These developments suggest that, with the
containment of inflation pressures, gold's
price could continue to fall as it did in -197576, because investors then would feel more
secu re in putti ng thei r money back into other
assets.

More importantly, recent events have shown
that gold's rise is a symptom, not a cause, of
the uncertainty and pessimism about future
economic conditions that at other times have
led to fluctuations in land values, in stock
prices, and in exchange rates. Investors have
learned, often painfully, to switch among a
variety of assets in response to their changing
perceptions of the future state of the national
and international economies. As a result, we
have experienced frequent and often precipitous changes in the prices of such assets.

Public officials feel pressured to "do something" about gold - understandably so, in
view"df'its high visibility and past monetary
role. Increased gold sales by the U.S. and the
International Monetary Fund could help
dampen the rise in gold prices. But even if
sales were (say) doubled, they would remain
small compared to the stock now in private
hands, and thus, would be unlikely to reverse
the upward price trend. Indeed, expanded
sales cou Id backfi re if they were perceived as
a substitute for tighter domestic economic
policies. Again, any attempt to restrict private
purchases of gold could also backfire,
because investors might then turn back to
"strong" currencies such as the mark and

Charles Pigott

300

200

1 00

Consumer prices
(1 967=1 00)

.,

.-._._0

.--------------.----------Gold

price ($)

35
1950

1955

1965

1960
3

1970

1975

1979

.LSI:II.:I
U018U!4seM 4eln • uo8aJO• epei\ClN o4ePI
•
•
!!eMeH • e!uJol!1e:> • euozp'v' • e>jsel'v'

Jrdr
(\J)

'l!l2::>
'O:lSp U2J ues
:I
ZSl 'ON
OIVd
:I! lVISOd's'n
llVW SSV1::>
IS}!I:I

BANKING DATA-TWELfTH fEDERAL
RESERVE
DISTRICT
(Dollar amounts in millions)

Selected
Assets liabilities
and
largeCommercial
Banks
Loans (gross, adjusted) and investments*
Loans (gross, adjusted) - total#
Commercial and industrial
Real estate
Loans to individuals
Securities loans
U.s. Treasury securities*
Other securities*
Demand deposits
total #
Demand deposits - adjusted
Savings deposits - total
Time deposits - total#
Individuals, part. & corp.
(Large negotiable CD's)

WeeklyAverages
of Daily Figures
MemberBankReserve
Position

Amount
Outstanding

Change from
year ago @
Dollar
Percent

Change
from

9/26/79

9/19/79

133,731
110,550
31,673
40,619
22,673
2,219
7,643
15,538
42,785
30,182
30,078
54,743
46,424
20,541

-

-

-

-

NA
NA

+
+
+

+
+
+

Weekended

Weekended

9/26/79

9/19/79

Excess Reserves (+ )/Deficiency (-)
Borrowings
Net free reserves (+ )/Net borrowed( -)

1
15
16

+
+
+
+

+ 18,663
+ 18,069
+ 4,359
+ 8,300

135
243
203
128
97
49
44
64
1,633
155
165
576
583
203

16.22
19.54
15.96
25.68
NA
NA

1,404
1,998
2,590
834
644
6,881
8,525
1,081

- 15.52
+ 14.76
+ 6.44
+ 2.84
2.10
+ 14.38
+ 22.49
+ 5.55

Comparable
year-ago period

68
226
158

66
86
20

Federal
Funds Seven
Large
Banks
Net interbank transactions
[Purchases (+ )/Sales (-)J
Net, U.s. Securities dealer transactions
[Loans (+ )/Borrowings (-)J

-

453
77

+

562

-

234

+ 503

947

* Excludes trading account securities.
# Includes items not shown separately.
@ Historical
dataarenot strictlycomparable to changes thereporting
due
in
panel;however,
adjustments

havebeenappliedto 1978datato remove muchaspossible effects thechanges coverage.
as
the
of
in
In
addition,for some
items,historical
dataarenotavailable to definitional
due
changes.