Gold Model — Reader Response

Here’s a thoughtful email I received in response to my gold model:

I read your piece on your gold model and thought it was very good – really dead on. I think, however, you have the relationship somewhat backwards on two counts.

First, the dollar derives its value from its relationship to gold. So instead of the dollar price of an ounce of gold, it should be thought of as the gold price of a single dollar. (For instance, the current of gold price of single US dollar is presently about 1/1345th of an ounce of gold)

Second, on this basis, the relationship is somewhat clearer: when the purchasing power of an ounce of gold rises (i.e., when an ounce of gold commands more dollars) interest rates will be low; and, when the purchasing power of a an ounce of gold falls (i.e., when gold commands fewer dollars the interest rate will be high.

In the days of the gold standard, this meant when prices, denominated in gold backed money, fell, interest rates fell – for instance, during periods of depressions. This would also be the period when the purchasing power of gold backed money was at its highest.

When prices, denominated in gold backed money rose, interest rates also rose – for instances during periods of rapid expansion. This would have been the period when the purchasing power of gold backed money was at its lowest.

Under the gold standard, the purchasing power of money fell during expansions, or what is the same thing, prices rose. And, interest rates rose with prices. The purchasing power of money rose during depressions, or what is the same thing, prices fell. And interest rates fell with prices.

So, what you have shown is that the Gibson Paradox continues to work even in the absence of gold backed money. It did not disappear. It expresses itself through national currencies and thus reveal the underlying state of the real economy through this operation.

When the “dollar price” of gold is rising, it is likely that we are in a depression in the real economy. Hence, real interest rates should be at their lowest. And, when the “dollar price” of gold is falling, it is likely we are in a period of expansion. Hence, interest rates should be at their highest.

Both the movement of gold prices and interest rates are determined by the expansion or contraction of the real economy, and by an inverse relation between them. When the real economy is expanding, gold prices will fall and interest rates will be higher. When the real economy is contracting, gold prices will rise, and interest rates will be lower.

What rising gold prices are telling us today, and for the last decade, is that we are in a depression in the real economy – one that has lasted about a decade at present, and shows no signs of ending as yet. Layered over this real economy depression has been two monetary recessions – the first in 2001, and the present one; with, one period of monetary expansion between them.

Posted by on October 9th, 2010 at 4:50 pm


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