Why Is the Price of Gold So High?

BY busadmin  October 9, 2009 at 2:46 PM EDT

gold bars; via Flickr

Question: Why is the price of gold at a record high? And how does that affect the dollar?

Paul Solman: Gold is denominated in dollars. So if gold goes up, it means the dollar has gone down, because it takes more dollars to buy the same amount of gold. Now why would ANYONE invest in gold, you might well ask? It doesn’t pay interest. It’s a pain to store and hold. I love this exchange, cut down some for clarity and space, with Oakland, CA gold dealer Charlie Mammoser, whom I interviewed a year ago:

Charlie Mammoser: I’ve had people come in, and they say, “I want to buy 10, 20, 40 ounces of gold.” And they go get the money out of the bank, and they come, and we do the deal. And they take it away, and I tell ‘em, don’t tell anybody where you put it except one loved one. And don’t think you can hide it in the freezer, because crooks know to look there. “Oh, no, I’m gonna go put it in my safe deposit box.” [Mammoser laughed.]

If the bank goes belly-up, how do you get into your safe deposit box to get your gold that you bought to protect yourself from all this stuff?

So then I asked Mammoser: Where DO folks put their gold?

Mammoser: Well, a lot of people have safes in their own home, you know, buried into the ground, up in their attic. Or just hiding places in the house that are very unusual.

Solman: What’s the most unusual one?

Mammoser: I had a customer, he had some thousand-ounce silver bars and what he did is, he spray-painted ‘em black, and he would use ‘em as doorstops in his house. You’d walk right by it.

Okay. If gold (and silver) are such a pain to store, I ask again: Why buy them? Here was Mammoser’s answer:

Mammoser: It’s a safety hedge, against unusual political turmoil, rioting in the streets. A Jewish lady I know is a goldbug; somebody who holds gold. Her family, before World War II, had about a hundred relatives that they considered close. After World War II, there were five of them. And those five all survived because they had gold to bribe the guards to get across the border to Switzerland.

Solman: I actually know somebody who did the same thing.

Mammoser: It’s also a pure inflation hedge.

Ah, an INFLATION hedge. You think the dollar is going to lose value. Gold is denominated in dollars. So buy gold today, hold it, and sell it next year, when, if the dollar has lost value (inflation), gold’s price will be a lot higher.

And why might there BE inflation? Because of all the dollars the Federal Reserve has been creating and pushing into the banking system, dollars currently back on deposit at the Fed. But for how long? See our recent piece on this subject. Not to mention all the dollars the Fed might continue to create in the near future.

As to how the buying of gold affects the dollar, well, if you’re selling dollars to buy gold, there are more dollars on the market than there would otherwise be, right, all else equal? The greater the supply of something, all else equal, the lower the price. So buying gold with dollars to hedge against a drop in the dollar’s value would tend to drive the value of the dollar down even further.

UPDATE: In response to Friday’s post on gold and the suggestion that it is at a “record high,” an astute reader writes:

“We’re nowhere near the inflation-adjusted peak of about $2250 in 2006 dollars yet.”

My reply: True enough. Indeed, if you mean the peak of 1980 ($875/oz), here are a number of different ways to come up with a 2008 equivalent:

$875.00 from 1980 is worth: $2,286.84 using the Consumer Price Index $1,987.87 using the GDP deflator $2,757.35 using the value of consumer bundle $2,251.35 using the unskilled wage $3,389.16 using the nominal GDP per capita $4,532.20 using the relative share of GDP

(These data from the website Measuring Worth.)

But look, the high of 1980 was incredibly short-lived — a fantastic anomaly, really. Gold soon sank back to about $400/oz or less and remained in that range for the next quarter century, even as inflation advanced.

The “record high” of the moment is in nominal terms.