Gold versus the money supply

Alasdair Macleod – 15 July 2013

In a recent article I introduced the concept of allowing for the increased quantity of aboveground gold and the expansion of the quantity of dollar currency over time when trying to value gold. The purpose of this article is to explain why such an obvious adjustment is rarely contemplated and why it should be applied.

The reason no one adjusts the dollar quantity is we want to think of the dollar as having a constant value when we buy assets or goods. We describe prices of goods as rising or falling, and never the currency falling or rising. When we construct an index of house prices or stocks we do not take into account the debasement of the currency.

Except in times of price hyperinflation we are generally unaware of the corruption of economic calculation due to changes in the money quantity. The problem of valuing gold is however different, because gold remains the principal rival to fiat currency. It is therefore logical to adjust the gold/dollar exchange rate by both an appropriate measure of dollars and by the accumulating quantity of above-ground gold when making price comparisons over time.

The dollar, as the internationally-accepted fiat currency, is a good proxy for all the others, and the need to incorporate changes in the quantity of money has become urgent since the banking crisis, because the quantity of dollars has expanded rapidly.

If this argument is accepted, we have to decide what monetary measure is most appropriate. The approach I have taken is to add up the money-supply components that would be convertible into gold if full convertibility was the case. This amounts to cash, checking accounts and savings accounts, as well as the excess reserves held at the Fed. It is Austrian, or True Money Supply plus excess reserves, and it can be seen from the chart below that the US dollar on this measure is already in hyperinflation, because its quantity is growing substantially faster than its exponential trend, represented by the dotted line.


The fact that the US dollar is hyper-inflating adds extra urgency to the case for adjusting the dollar price of gold to reflect monetary inflation. This leads us to the second chart, covering the price of gold rebased to January 2000, when the price was $283.

Gold adjusted for $ expansion

Since 2000 the quantity of above-ground gold stocks has increased from about 126,000 tonnes to 159,000 tonnes today, and the dollar component from $2.92 trillion to $11.3 trillion. Therefore, measured in January-2000 dollars the gold price today is under $400 at today’s price of $1,200. So instead of the gold/dollar exchange rate nominally rising by 324%, in real terms it has only risen by 39% in thirteen years.

For anyone trying to value gold as a hedge against banking and currency risks this knowledge is crucial. In real terms gold is at the level it was in April 2006, and below the levels seen during the banking crisis, yet the dollar on our measure is hyper-inflating.

Almost no one accounts for monetary inflation when evaluating the gold/dollar price, despite increasingly unstable monetary conditions. This is a mistake that will only be recognised by most people when prices eventually reflect today’s monetary inflation; but it offers a tremendous opportunity for those who understand the true relationship between gold and fiat currencies.

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Alasdair started his career as a stockbroker in 1970 on the London Stock Exchange. In those days, trainees learned everything: from making the tea, to corporate finance, to evaluating and dealing in equities and bonds. They learned rapidly through experience about things as diverse as mining shares and general economics. It was excellent training, and within nine years Alasdair had risen to become senior partner of his firm. Subsequently, Alasdair held positions at director level in investment management, and worked as a mutual fund manager. He also worked at a bank in Guernsey as an executive director. For most of his 40 years in the finance industry, Alasdair has been de-mystifying macro-economic events for his investing clients. The accumulation of this experience has convinced him that unsound monetary policies are the most destructive weapon governments use against the common man. Accordingly, his mission is to educate and inform the public in layman’s terms what governments do with money and how to protect themselves from the consequences.

9 thoughts on “Gold versus the money supply”

  1. Great article. Would be helpful to see this same chart for poor man’s gold as well for comparison sake as well.

  2. Gold is money, better than ever now that it trades in real-time and the liquidity it lacked during FIXED value systems is no longer an obstacle.

  3. Expanding the theoretical argument – would miners be allowed to cover the capital requirements for the proposed expansion of above-ground gold in bullion or would they need to provide the dollars ? Spot the fly in the ointment !

  4. The essay makes a lot of sense. – – Except that costs such as labor, materials $ supplies, transportation, etc., are priced in dollars, so that’s what most all suppliers understand and accept.

    I agree that is not the way finances should work, but that the way finances function.

  5. To play the devil’s advocate; There are a quadrillion dollars sitting in a computer somewhere and the “right hands” [Powers that b]can unleash them at any time with a few strokes of the keys. The dollars already “unleashed” are sitting in banks. What is the difference? These dollars are all latent and not being used to accelerate inflation…errr. to hyperinflation. This is, as I see it, the reason gold is flat lined. Willie

  6. If there is indeed a quadrillion dollars sitting in a computer then the price of gold is one quadrillion divided by 5.6 to 6 billion ounces of gold. Not a small number at all. If we assume 6 billion ounces then we have $166,666.66 an ounce or 3 to 6 times that if we count silver bullion and coin and discount the silver that was consumed by industrial processes. Of course paper silver and gold would be discounted altogether. Given this kind of pricing it would pay to be in on the ground floor with the real deal.

  7. To most people the paper gold market may have troubled the insight to physical metals’s value. In the long run it doesn’t make sense to have one price for two categories.
    I think the Fed recently did grave its own grave by allowing the gold-price to below 1200$. That really started the buying wave to empty the PM-market.
    In the Plunge Protection Team the Fed permanently is supporting the Dow’s price level. Why didn’t they care to stabilize the gold-price at a constant level of say 1700$? That might have kept the tiger in its cave…

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