Why is gold falling?

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    I am being asked by my Keynsian friends the following:

    “I am curious as to your rational behind the plunge in gold value. This doesn’t seem to fit the inflation prediction model that I have been hearing touted or the idea of security in the gold standard model. Although I admit it doesn’t completely crush it either.

    To me this is a further chink in the Austrian business model and it’s inability to be an accurate or predictive economic model (from what people have been saying since about 2006 we should have seen run away inflation on a monumental scale by this point in time).

    It also shows me that gold is not a good standard as it is just as prone to speculative bubbles as any other commodity.

    http://www.reuters.com/article/2013/04/15/us-markets-precious-idUSBRE93E0FI20130415 (It has fallen around $500 per ounce since its peak in 2011.)”


    And a follow up statement by another kenysian….

    “Obviously gold is subject to speculation, just like any other commodity – a big hole in the theory of those supporting GS. But I think the main reason the gold standard is such a fail is because it automatically hamstrings a nation’s economy. You are placing a cap on how much money can be in your system due to the scarcity, which limits the rate of growth of the economy.”


    Why is it falling? I am not entirely sure. I heard one explanation being that the Chinese economy is slowing and they are the second largest buyer of gold. Not sure

    But, I will take on the part about speculation and stunting growth.

    The point of the Keynesian theory is to level out the supposed boom and bust cycle inherent in the free market. The validity of the idea that business cycles are a feature of the free market and not of government controlled economies is pretty flimsy as you have probably learned in these courses.


    Speculation is an interesting discussion. Keynes’s prescription for control economies was for governments to save during the booms and spend during the busts thereby leveling out the cycles he believed to be inherent in the free market. Austrians on the other hand believe that sharp booms and deep, prolonged busts are, in fact, the result of government meddling. Now, in theory, Keynes prescription might work…sort of. What would be the point? when there is a surplus of goods and general prosperity for whatever reason, government soaks up purchasing power and then releases it during the bad times. The goal for Keynes is to have price stability across goods and services, the ability to prop up the labor market during a bust and things like that.

    What does that have to do with speculators. Speculators are doing the EXACT thing that Keynes wants government to do. During booms in one market, speculators buy up cheap surplus goods, wait for demand to increase in relation to supply and then they release those goods onto the market when the price goes up. If they are buying more goods when prices are low, this increases those prices. if they put those goods onto the market when prices are higher, then it lowers prices. Speculators are speculating on what? the future price of a good on the market. In other words, if they think prices will soon spike, they will buy now raising prices some now with the anticipation of selling them at a higher price and lowering the price then. They are leveling prices not perpetually increasing them. (search “Speculation in Man Economy and State http://mises.org/Books/mespm.PDF)

    So, why should government not do what I just said the market does? Well there is the calculation problem from Mises. Basically, no one person or small group of people is capable of calculating how the millions of units of millions of different goods and services are best distributed in the economy to fit the demands of every person. But even if there were some computer program that could provide this instant answer, Hayek explained that there would still be a knowledge problem. The amount of information that would need to be gathered from every person would be too ridiculous to think about gathering and even if you could manage to gather all the information need, you can still not compare the subjective value between individual and, by the time all this information was gathered, the values scales of individuals would have changed.

    Thus, it is better to leave the leveling of prices over time to thousands and thousands of individuals who specialize in one or a few markets who are putting their own cash or businesses at risk rather than to a small committee in government disconnected from the markets and the incentives provided by profit and loss.

    Limiting Growth

    This argument is pretty much a complete misunderstanding of economics. The argument goes something like this. If there is a limit to the amount of money, then as more goods are available to more people money is spread thinner and thinner through the economy. With less and less money spread around, prices would have to fall. If people see falling prices, they will wait to make purchases. If prices continue to fall, people will continue to wait. No one will buy anything, money will stop flowing through the economy and the entire economy will collapse. I assume you are using this website on your personal computer. But, even with general inflation, computer prices have fallen about every year. So why did you buy a computer (say… this year)? Because you still valued the services of your computer over the course of this year more than the money you would have buy waiting until next year to buy one. This would be the case for most goods and services. People are not going to perpetually wait to buy food, clothes, the next iPhone, a car, a house, etc, if they value the use of that item now more than the money saved by waiting. Yes, if there is a fixed amount of money then prices will fall, but that is not necessarily a bad thing and it is not going to collapse the economy.

    Yes, prices will fall and this will also lead to more savings. But savings, in the form of savings accounts (the type in a non fractional reserve system) and investments. this money will just go right back into the economy in the form of capital investment. It doesnt sit idle in someones mattress. Keynesians want consumption now. Austrians are looking at a long term picture where there is investment in capital, an extension of the capital structure, and greater long term growth in production.

    But besides all of that, at least around here, people are not calling for a gold standard as most Keynesians believe it to be. When Keynesians decry a gold standard, they are talking about a government decree stating gold is the only valid currency. What most free market austrians advocate is competing currencies and it would eliminate this argument all together. If the amount of one form of money (say gold) become too low to be practical for use in the market, then the market will, basically on its own, begin using other currencies like silver, copper, bitcoin, whatever comes along. It is not that the dollar should be replaced with gold, but that we should let the market take over issuing of currency.

    Of course, they can say that the dollar isnt prone to wide fluctuations because they are using the dollar as their ruler. if you measure a ruler using itself it will always look straight.

    I probably did alot of straying from the target on this post. Feel free to ask some questions that get me a little more focused ;).


    The argument of your Keynesian friend is illogical. He is saying that the volatility in the dollar price of gold, which is not money, is due to the vagaries of the valuation people make of gold but not the value they make of the dollar, which is money. But if the value of money cannot be the source of the volatility of the prices of goods, then in a gold standard, i.e., when gold coins are money, the valuation of gold coins cannot be the source of volatility in the prices of goods either.

    As to the “prediction” that the Fed’s expansionary monetary policy in the wake of the crisis would cause price inflation, the jury is still out. The Austrian theory of money explains that the purchasing power of money is determined by the Total Stock of money and the Total Demand to hold money, just as the price of any other good is determined. The money stock in our economy is money proper (i.e., Federal Reserve Notes printed by the Fed) plus money substitutes (i.e., on demand, at par redemption claims for money proper) issued by banks and other financial institutions. In the wake of the crisis, the Fed bought assets from banks and paid with reserves (cash and demand deposits at the Fed). In normal times, the banks would issue a multiple of fiduciary media on top of their reserves. But instead, banks have held excess reserves. Thus, the money stock has not expanded as some anticipated it might. Moreover, the demand for money has increased, as it often does during a downturn. This has moderated the reduction of money’s purchasing power. The jury is still out on whether the potential for monetary inflation in the form of excess reserves in the banks and a reduction of money demand will yet result in a significant monetary inflation when economic normality returns. That it hasn’t happened yet may be a strike against the historical acumen of those who predicted it would, but it doesn’t bear at all on the efficacy of the theory of money held by Austrians.

    Finally, the claim that the economy cannot reach its highest production potential without continuous monetary inflation, which cannot occur under the gold standard, is both theoretically dubious and historically false. The fastest sustained period of economic growth in American history was during the latter part of the 19th century under the classic gold standard. The basic theoretical problem with this claim is that production depends not on prices of output, but on the spread between output prices and input prices. Such price spreads depend not at all on total spending in the economy.


    Question 1: You wrote “The jury is still out on whether the potential for monetary inflation in the form of excess reserves in the banks and a reduction of money demand will yet result in a significant monetary inflation when economic normality returns. ” If economic normalcy returns why would there even be a doubt as to whether or not we would see massive price increases?

    Question 2: If the dollar collapses and as a result, interest rates rise, would this not put downward pressure on gold or would gold spike because the interest rate spike is based on the weakness of fiat currencies?


    1. There is doubt because the Fed can invoke policy to eliminate the potential for fiduciary issue. The most obvious case would be to raise the required reserve ratio to convert excess reserves into required reserves.

    2. If investors see gold as a hedge against price inflation, then a dollar collapse is bullish for gold. Rising interest rates, under your scenario, are necessary to compensate for price inflation. The higher rates, then, do not imply higher real returns and thus, are not bearish for gold.


    Gary North just had an article on this but I can’t link to it because it is on his membership site. But he keeps saying that gold is not a hedge against recession. Rather it is a safe haven when there is an expectation of mass(not just 2%) inflation.

    His point in the article is that he seeing recession coming and that is why gold is falling. However he also says that the Fed is likely to start pumping more money into the system. This isn’t the first time gold has fallen when the expectation of recession has risen. He thinks that the Fed is likely to allow mass inflation but NOT hyperinflation. It is important to make that distinction.


    When the fear of recession hit in 2008, the FED tripled the money supplied and averted recession (to be hit harder in the future).

    With the FED already printing $85 billion a month, what are they going to do now? Print to mass inflation without going to hyperinflation?


    The Fed tripled the monetary base:


    It did this by buying securities from banks. Banks, in turn, have held most of this additional monetary base as reserves:


    Most of this increase in reserves is nothing more than checking account balances that banks hold at the Federal Reserve.

    As a consequence of most of the increase in the monetary base being held by banks as reserves, the money stock has increased relatively modestly:


    Even this increase in the money stock has not generated much price inflation, because the demand to hold money increased in the wake of the financial crisis:


    None of these monetary shenanigans by the Fed has averted recession:


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