Gold Price and the Return of the Gold Standard Debate

There are a rising number of articles that debate the possibility of returning to the gold standard. I think this scenario has little chance of coming true as it will take away many of the powers the central banks have and won’t necessarily reduce the speculation in the currency markets (a whole subject for a different article).

According to one article, the money manager that was interviewed calculated the new gold price benchmark under a theoretical gold standard and came up with $10,000; he made this calculation by dividing the U.S. Monetary Base to the gold reserves of the Federal Reserve. Let’s call this figure the gold price standard.

The talks of returning to the gold standard are partly due to the increase in the currency risk in the past few years. But I suspect that the sharp increase in gold price in the past three years is also one of the factors that helped push the gold standard agenda to center stage.

So the question here is whether the sharp increase in gold price is a sign that we are closer today than say three years ago from returning to gold standard. Does the gold price is far away from the gold price standard? There are many ways to tackle these questions, I will use one:

In the chart below is the development of the gold price standard and the actual gold price during the past decade (between 2000 and 2011).

Gold Price and U.S Monetary base to Gold Reserve 2000-2011 October 26 2011

The chart also shows that the price of gold adapted to the surge in the monetary base in recent years as gold price climbed very sharply along with the steep increase in the monetary base (QE1 and QE2). But it does show that the gold price under the theoretical gold standard reaches the $10,000 mark. This mark seems very high compared with the current gold price which is only well under the $2,000 mark. But is it such a huge gap that should make us concern that gold price could continue to shoot up? Actually, there were times in which the ratio of the gold price standard to the actual gold price was much higher:

The last chart shows the development of the ratio of the gold price standard to the actual gold price during the years 2000 and 2011.

 

RATIO OF U.S Monetary base to Gold Reserve TO Gold Price  2000-2011 October 26 2011

The chart clearly shows that there were times in the past such in 2001 when the ratio of the gold price standard to the actual gold price was much higher than it is today. This servers as an indicators that the connection between the actual gold price and the gold price standard was much looser in the past than it is today.

This means, that in historical terms the current gold price isn’t that far off the gold price standard, and just because the gold price is very high doesn’t mean there is a cause to think that the return of the gold standard is right around the corner.

For further reading:

 

Lior Cohen, M.A. commodities analyst and blogger at Trading NRG.