Golden Spikes, by Paul Krugman, in NY Times: As some readers may have guessed, I’m having some fun thinking about gold price economics — nothing like a good intellectual puzzle to keep you occupied while the world collapses. Anyway, some people have asked about previous gold price fluctuations, and in particular whether my low-interest-rate story can fit with the last time gold soared.
So, here’s the history since the gold peg ended (deflating by the CPI):
Now, the end of the 70s was a time of high interest rates, whereas the current environment is one of low rates. But that’s a comparison of nominal rates; what about real rates, which are what the model says should matter?
Bear in mind that what we want are expected real rates looking forward, not ex-post rates based on past inflation and bond yields. And unfortunately, there weren’t any inflation-protected securities three decades ago, so we can’t get a direct read on market real interest rates. But there are other indicators of inflation expectations. Here’s one easy comparison (yes, it’s one-year inflation expectations versus 10-year bond yields; so sue me):
So the late 70s were a time of high rates but very high inflation expectations, so that real rates were arguably zero or negative, just as they are today.
And this also suggests that many people misread that 70s experience; because high gold prices then were associated with high inflation, gold has come to be taken as an inflation indicator, whereas it’s actually a low real rates indicator. Last time those low real rates had a lot to do with inflation, but this time they’re taking place in a deflationary or at least disinflationary environment.
One other observation: obviously, people who bought gold at the peak of the last spike got badly burned. As I pointed out from the beginning, the fact that there’s a fundamentals-based story that could explain high prices doesn’t mean that there can’t be a bubble too.
Update: I should reiterate that Barsky and Summers basically did this analysis 25 years ago, in a paper that weirdly never crossed my desk, with differences in modeling strategy that make no difference to the fundamental insight. And while most of their paper was concerned with the gold-standard era correlation between interest rates and the price level, they had the right analysis of the late-70s spike too. DeLong gets it in a nutshell:
On this interpretation gold is and always has been a super Treasury bond: a very long duration asset that is or at least is perceived to be “safe” in the sense that its price does not trade at a discount (due to risk and default premia) from a Treasury bond of the same duration but instead trades at a premium.
And this means that it is deeply, deeply wrong to think of rising gold prices when bond yields are low as some kind of symptom of monetary excess.