Many writers who discuss gold have said that it is the only real money and that every investor should measure his/her net worth in gold, not U.S. dollars or any other national currency.
However, one often hears in response that what really matters is the purchasing power of investments, not their dollar value. So presumably, even measuring assets in gold is not good enough…because it doesn’t take into account the purchasing power of gold.
I often think that this latter view is completely wrongheaded because…what really matters is how much stuff you can buy with the yield from your investments, not how much you can buy with their capital gains. I agree with Keith Weiner on this point.
Nevertheless, the question “what is the purchasing power of gold?” is an interesting one. We know that gold retains its value over the long-run. But if we want to maximize our ability to buy consumer goods, how big is the short-term risk to holding gold?
In order to figure this out, I tried to find a list of gold bullion prices going back to 1913, which I ended up finding here. Then I looked for a chart of the purchasing power of the dollar going back to the same year, which I found here.
When you put the information from these two pages together, it tells you the story of gold’s purchasing power throughout the 20th and 21st centuries.
The Purchasing Power of Gold From 1913 to Today.
- 1913: Paper dollars can be redeemed for gold at the official price of $20.67/oz. However, gold bullion produced by private mints can be sold on the open market for only $18.92/oz. So physical gold trades at a discount below paper dollars. This provides an incentive for gold owners to keep their metal in the bank instead of selling it to private individuals to be hoarded in safes or vaults.
- 1933: The dollar has fallen to about 80 cents of it’s 1913 value. Meanwhile, gold bullion is trading at around $26.33/oz, a premium over its paper value of $20.67. This provides an incentive for depositors to withdraw their gold from the bank and sell it on the open market. If we measure the purchasing power of gold for this time period using 1913 dollars, we get 26.33 X 0.8 = $21.06, around a 5% increase in purchasing power from 1913-1934.
- 1934: The official price is raised to $35/oz. so that physical gold will no longer trade at a premium over dollars.
- 1970: The dollar has fallen to about 25 cents of its 1913 value. Meanwhile, gold bullion is trading on the open market at around $36.02/oz. So it is once again trading at a premium over its official price of $35/oz. This is despite the fact that the gold price has been suppressed for years by the London Gold Pool, an unsustainable attempt by world governments to manipulate gold prices (this attempt has only recently been given up on, in 1968). The purchasing power of gold at this time is $36.02 X 0.25 = $9.00 measured in 1913 dollars. That’s a fall of over 50% compared to 1913 – 1933.
- 1971: The U.S. Government stops redeeming dollars for gold and governments all over the world stop trying to manipulate the gold price. Theoretically, this allows the dollar to fall – and the price of gold to rise – without limit.
- 1980: After nine years of rising inflation, the dollar has become worth only around 15 cents of its 1913 value and 60 cents of its 1971 value. The price of gold is $615/oz. So gold’s purchasing power is 615 X 0.25 = $92.25/oz. in 1913 dollars. That’s an increase of over 350% since the period 1913-1933 and over 800% since 1970. Meanwhile, The real interest rate on the 10-year bond (the nominal interest rate on the 10-year bond minus the rate of inflation) goes from -5% to +7% as the U.S. government raises the Federal Funds Rate to prevent the dollar from collapsing. This succeeds in stabilizing the dollar, and both interest rates and the gold price start falling once again.
- 1989: The real rate on the 10-year Treasury has fallen to +4.2%
- 1990: Gold bullion trades at $383.51 and the dollar is worth around ten cents of it’s 1913 value. So gold’s purchasing power is $38.35 in 1913 dollars. That’s a fall in purchasing power of a little over 50% in ten years and an increase of over 100% since 1913.
- 2000: The dollar has fallen to just seven cents of its 1913 value, and the real rate on the 10-year Treasury has fallen to 3.26%. Gold bullion is trading at around $279.11 and has a purchasing power of $19.53 in 1913 dollars. This is a a 50% decline in ten years, an almost 80% decline in 20 years, and only slightly above where it had been originally in 1913.
- Today (November 2nd, 2016): The dollar is worth about 5 cents of what it was in 1913 and the real rate on the 10-year bond is around 0%. Gold is trading at 1,296.99/oz., with a purchasing power of $64.85 in 1913 dollars. An increase of over 200% since 2000 and over 200% since 1913.
If gold continues to go up until it reaches it’s previous high in purchasing power, it will increase by another 50% before it tops out. If it falls back to its previous low established in 2000, it will fall by a little over 66%.
However, gold previously topped out when the real interest rate on the 10-year bond went from -5% to +7%. It is now around 0% and falling. So it looks like there’s still a lot of room for it to go up.