April 22nd, 2013
05:18 PM ET

Will gold lose its glitter?

By Global Pubic Square staff

We've been watching one of the world's key economic indices collapse. It dropped 13 percent in two days. Over the last two years, it's down 20 percent. And here's the strangest part – this might be very good news for the global economy.

What is it that has been falling? Gold. For much of the last decade, the whole world has been on a gilded shopping spree. Hedge funds poured money into it; Indians and Chinese hoarded it; you could even find ATMs dispensing gold. To give you a sense of the hysteria, consider that if you had invested about $100 in gold in 2001, it would be worth $700 in 2011 – a seven-fold increase, a stunning return.

So: why the sell off last week – and what does it mean?

One theory goes that prices fell because of a slowdown in China and India. But consumers there are actually taking advantage of the drop in prices to buy more gold. Another theory runs that the recent drop is simply a market correction. That's fair – look at a graph of gold prices over the last 30 years: the 20 percent drop follows a 700 percent rise.

But what is it that precipitated the fall? There does seem to be a method to the market's madness.

Investors like gold because they see it as a hedge against inflation. They also think it's a safe haven in a climate of uncertainty. The strongest proponents of gold – goldbugs they're sometimes called – believe that central banks have been pumping money into the global economy for decades and that this will make money worthless. The only safe investment, in this view, is gold, which has been valued for thousands of years and exists in limited supply. (The total amount of gold in the world would actually fit into two large swimming pools.)

But gold prices are falling and that's probably because neither of the doomsday scenarios seems likely – high inflation or a total economic collapse.

Consider the first: inflation. There was an interesting chart in the IMF's latest World Economic Outlook. It looks at the change in inflation and unemployment during recessions. In the 1970s inflation fell along with a rise in unemployment. That's the usual pattern. The same happened in the recessions of the 1980s, 90s, and early 2000s. But that correlation changed with the most recent financial crisis: this time, steep jumps in unemployment with very little impact on inflation.

Part of the reason why this happened is that central banks have taken on an unusually activist role in the last few years. The Federal Reserve, the ECB, and other central banks have pumped vast sums of money into the global financial system. Under normal market circumstances that could lead to hyperinflation. But in the current scenario – slow growth and wage deflation in the rich countries – it has actually led to stability. U.S. inflation has held roughly steady at 2 percent, lower than the global average. This is a significant policy success. And what it means is that despite the usual risk of inflation, governments still have room to be aggressive in stimulating growth: good news for the economy – if we'll take it.

Human beings love gold. We covet it beyond all rationality. And that's fine, if we want to use it for jewelry. But as an investment, the market is telling us to be cautious, which is very good news.

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soundoff (5 Responses)
  1. sand

    the reson why the gold standard got disgarded and international trade has increased every year in the world was that after word war 2 they found out that this way the liklyhood of wars was less and this way they could promote peace globaly.

    April 22, 2013 at 7:10 pm | Reply
  2. matslats

    It is completely negligent of you not to mention the fraud and manipulation in the gold market, as detailed by GATA for many years. 99% of gold is actually not metal, but claims on metal, which can never be delivered. The gold price can be manipulated down when banks sell more claims on the existing metal. It is very important to manipulate the gold price down if you want to make the dollar appear more than worthless.
    Not mentioning this activity makes this article propaganda not journalism.

    April 23, 2013 at 5:50 am | Reply
  3. rightospeak

    Nonsense and propaganda. You guys are not smart enough to even have the facts straight. A very fine toga in a Roman empire did cost about one once of gold. In the Persian Empire a soldier was paid coins of gold and silver which amout to about $2000 ( I did the calculation myself given the exact amount of gold in the coins ) a month. A fine suit in 1800s was about one once of gold and so it is today.
    Because of all the printing of the fiat money any half intelligent person would know that the value of gold is going to go up. We unfortunately may not have much gold left if we can not give back to Germany their gold now, which they requested.

    April 23, 2013 at 9:10 am | Reply
  4. j. von hettlingen

    Gold is linked to myths, fairy tales, stories and atrocities throughout history that it will never lose its shine. In the West, people buy gold more likely as an investment, but in Eastern cultures gold can be turned into coveted objects, that people want to touch and admire. The rise in gold prices from 2001 to 2011 can be explained that the demand for gold came from China and India, the two emerging economies and speculation by investors in the West.

    April 23, 2013 at 11:30 am | Reply
  5. deniz boro

    This whole article and comments is a proof of how far away is the Western financial world and Eastern financial worl is from each other.
    Look at how some Christian church knives created the concept of bankingin the Middle Ages. The Muslim world is creating another banking system now. Interest on money is against these people. This banking system markets interest-free money. Hence they sell "profit shares" or "gold".
    If this group collects gold cheap than the aftermath is quite clear. But not much different than the traditional banking.
    It rises no alarm as a normal concentrated money movement or sitipulation in the money market. However, in the current economic balance of the world and markets in general, it may take a nasty turn.

    April 25, 2013 at 6:40 pm | Reply

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