Reply To: Fall in Goldprice 1980s

January 10, 2013 at 6:56 pm #17526
jmherbener
Participant

The monetary inflation and price inflation of the 1970s led investors to buy gold as an investment hedge against further inflation. (This, by the way, is what Bernanke is trying to replicate: inflate the money stock sufficiently so that price start to rise leading people to form expectations that prices will rise further leading them to buy goods across the economy now and drive prices up now. The higher prices, he thinks, will stimulate production across the economy.)

Just like the last ten years, investors bought gold because they expect more rapid price inflation in the future. When the Fed tightens, investors may change their expectations and sell gold, popping the bubble. This is what happened in 1980. The gold price collapsed for a year and stayed at a new level for several years thereafter, higher than that of the mid-1970s but lower than that of early 1980.

The reason that price inflation was moderate for the rest of the 1980s and through the 1990s was that even though the Fed kept the money stock inflating briskly, the demand to hold money increased as well.

Bubbles can arise in any market where investors borrow credit created by banks during the process of monetary inflation, housing, autos, land, gold, and so on. These bubbles are a secondary, not primary feature of the boom-bust. The primary feature of the boom-bust is the artificial lengthening of the capital structure beyond what is supported by people’s time preferences.

For the price of gold to fall now, investors would have to lower their expectations about future price inflation in which case investors would sell gold and buy other other goods or hold more money. Of course, there are other reasons why demand for gold has been increasing and therefore, other reasons why the demand for gold might fall in the future.

We live in an age of inflation so generally, in the abstract, holding gold seems prudent. As to timing of buying and selling and portfolio allocation and so on, I render no opinion. I’m only a humble economist, not, alas, an entrepreneur.