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AMERICAN INSTITUTE for ECONOMIC RESEARCH
www.aier.org
Vol. LXXVII, No. 3, February 15, 2010
Gold and the Dollar
The global rise in the gold price may indicate that investors expect higher rates of general
price inflation not only in the U.S. but around the world.
by Kerry A. Lynch, Senior Fellow
G
old bullion closed in London at
$1,212.50 per ounce December
2, the highest P.M. fix ever. While
the price has since dropped back
to about $1,000, it has still nearly
doubled in three years. And just
since October 2008, it has increased
by 50 percent.
This upswing has been attributed
to various factors. Primarily, investors are said to be worried about
the uncertain consequences of the
financial and economic upheavals
of the past year, and the extraordinary policy responses they have
produced. Analysts also have cited
the role of the dollar.
The impact of fluctuating
exchange rates on the gold price is
illustrated in Chart 1, which shows an
index of the price of gold in terms of
the five major currencies. The price
of gold in euros, yen, and Swiss francs
has increased by about 40 percent
since October 2008, when the financial
crisis erupted. But its price in terms of
dollars and pounds has increased even
more. The difference reflects the falling exchange value of the dollar and
pound during this period. (The gap
has shrunk since December, because
the dollar has strengthened, especially
against the euro.)
More notably, however, the price
of gold has increased in terms of all
these currencies. This suggests there
is more than exchange-rate fluctuations at work. Indeed, many observers have seen the global increase
in the gold price as an indication
that investors have been providing
against an acceleration of the loss
of purchasing power of all paper
money, not just the dollar. That is,
they have come to expect higher
rates of general price inflation here
and abroad.
Still, the gold price has increased
most against the dollar. Moreover,
the diverging trends of the dollar, other currencies, and gold are
not new. The gold price has been
increasing since 2001. And during
the decade since then, the dollar
has lost a quarter to a third of its
exchange value against the euro, the
Swiss Franc, and the yen. (See charts
on next page.) Many factors could
be driving these trends, but if they
reflect changes in confidence and
expectations, the message seems to be
that investors have more confidence
in gold, and perhaps other currencies, than they do in the dollar.
There is ample reason to be
concerned about the dollar. Paper
currencies have value only as long
as people retain confidence in them.
Right now, the list of problems that
could eventually trigger a loss of
confidence in the dollar seems long
indeed. The monetary and fiscal
policies followed by the U.S. government over the past decade, and
especially the past year, boil down
Chart 1: Index of the Price of Gold in Selected Currencies
(October 2008=100)
Pounds
Euros
Dollars
Yen
Swiss Francs
180
170
160
150
140
130
120
Note: Monthly average data.
Oct-2008
Jan-2009
Apr-2009
Jul-2009
Oct-2009
110
100
Jan-2010
Inside this report The new credit card law that goes into effect this month is supposedly designed to protect consumers. But no law can
change the cost of doing business, writes Research Fellow Polina Vlasenko. As a result, responsible credit card borrowers
may face higher costs. See back page.
Also Kevin T. McGrath provides a tax season checklist. See Ask the Expert on page 3.
Research Reports, February 15, 2010
Indexes of the Price of Gold and the Euro
(January 2001=100)
450
Price of Gold in Dollars
400
Price of Gold in Euros
350
300
Euros per Dollar
250
200
150
100
50
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
Indexes of the Price of Gold and the Pound
(January 2001=100)
0
2010
450
Price of Gold in Dollars
400
Price of Gold in Pounds
350
300
Pounds per Dollar
250
200
150
100
50
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
Indexes of the Price of Gold and the Swiss Franc
(January 2001=100)
0
2010
450
Price of Gold in Dollars
400
Price of Gold in Francs
350
300
Pounds per Francs
250
200
150
100
50
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
Indexes of the Price of Gold and the Yen
(January 2001=100)
0
2010
450
Price of Gold in Dollars
400
Price of Gold in Yen
350
300
Yen per Dollar
250
200
150
100
50
1999
2
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
0
2010
to this: running large deficits and
printing more money. The deficit
is now at a once-unthinkable level,
even as spending on entitlements
is poised to soar. Yet policy makers
seem unable to wean themselves off
of debt as the all-purpose solution to
every fiscal and economic problem.
It’s far from clear, however, that
other currencies can be expected to
hold up better than the dollar in the
long run. The euro is often cited as a
potential challenger to the dollar as
the world’s reserve currency, but it
faces major pressures. It has existed
for only a decade, and even before
the financial crisis some economists
questioned its long-term prospects.
The 16 euro countries each face different fiscal policies, economic conditions, and political pressures. The
global downturn has underscored
these differences.
Three of the member countries,
Greece, Spain, and Ireland, are running budget deficits of 10 percent or
higher. Greece’s situation is so precarious that Fitch Ratings recently
downgraded the country’s debt to
BBB+. If Greece defaulted, how
would the European Central Bank
respond? And will the bank be able
to maintain confidence in the euro
if member countries continue to run
large deficits?
As for the Swiss franc, it exists in
the shadow of the euro. Switzerland
is not a member of the European
Union. But the franc closely tracks
the euro, and the Swiss economy is
closely intertwined with Europe’s
economy. If the euro began to crack,
the franc could become a safe haven;
but it seems just as likely that investors
would flee to the dollar or gold.
There’s another reason to be
cautious about viewing the weakness of the dollar against gold and
other currencies as a clear sign of its
future path. Namely, the outcome of
the last gold rush of the late 1970s.
The price of gold peaked in January
1980, briefly topping $800. This
marked the end of a bull market
that had begun in the early 1970s,
amid warnings that the U.S. gov-
Research Reports, February 15, 2010
ernment was pursuing unsustainable policies that had the potential to
lead to high price inflation.
Economic conditions were indeed terrible in the 1970s and 1980s.
There were two severe recessions
in 1980-82, the unemployment rate
rose higher than it is today, and
price inflation hit double digits.
But this turbulence was followed
by a remarkable turnaround. Price
inflation fell from 13 percent in 1981
to 3 percent in 1983. The economy
expanded for nearly 20 years, except
for one mild recession in 1990-91.
The dollar strengthened against
other currencies in the early 1980s,
and by 1982 the gold price had
fallen back to $320.
Few people foresaw the prosperity of the 1980s and 1990s. This is
partly because predictions about the
future long-term trends of economic
activity, price inflation, exchange
rates, and the gold price amount
to predictions of the future actions
of the policy makers concerned, a
very hazardous exercise at best. Few
predicted the changes that followed
the appointment of Paul Volcker as
Federal Reserve Board chairman
and the election of Ronald Reagan.
The current crop of policy makers do not inspire confidence, but
they or their successors may yet
surprise us.
Beyond concerns about the future
of paper currencies, the recent
increase in the gold price apparently
reflects speculative buying. That
is, people are buying gold simply
because its price has been going up.
These people will probably tire of
gold if the price levels off or drops
(even temporarily). Investment
demand for gold has already been
somewhat offset by a sharp drop in
global demand for jewelry, because
of the high price and the economic
downturn.
On the supply side, the picture
is mixed. Sales of gold scrap have
soared. But mine production, which
has been falling for years, has yet to
increase much, partly because of rising costs and a lack of financial capital. And the world’s central banks
have cut back on gold sales. They
sold large quantities over the past
decade, but the financial crisis seems
to have renewed central bankers’
appreciation for gold as a store of
value. Whether the high price may
tempt them to become sellers again
remains to be seen.
We have no way of determining
how all of these forces of supply
and demand will combine to affect
the gold price, and neither does
anyone else. In other words, we
have no way of knowing how long
the bull market in gold will last.
We do think that current concerns
about the risks of future inflating
are well-grounded, and that the
global system of paper currencies
is more vulnerable to a loss of confidence now than at any time since
the 1970s. But accurately predicting specifically how and when an
inflationary scenario might play out
is no easier now than it was then. It
isn’t certainty that drives investors
to gold, it’s uncertainty.
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Ask the Expert
2009 Tax Update
W
hen preparing your 2009 tax
return, consider some of the following tax items.
• Unemployment compensation
amounts over $2,400 still taxable.
• $3,500 to $4,500 received under “cash
for clunkers” not taxable.
• Deduction of sales tax on new vehicles
purchased between February 17 and
December 31, 2009. Purchase price
limit of $49,500.
• For 2009, a one-year reprieve from
taking required minimum distributions
from retirement accounts.
• Making work pay credit: Based on 6.2
percent of earned income, up to $400
per person ($800 joint return). Phase
out with AGI over 75k (150k joint)
• First-time home buyer credit: Expanded
for contracts through April 30, 2010
(closing by June 30, 2010). Up to $8,000.
• Long-time home buyer credit: Up to
$6,500. Must have lived in prior home
for at least five years.
• American opportunity credit: Expands
the Hope Education credit to $2,500
to cover four years of post-secondary
education expenses. It also allows a tax
refund of up to 40 percent.
• Personal energy property credit: Nonrefundable credit covers 30 percent of
costs for smaller energy-efficient home
improvements. Limited to combined
total of $1,500 for 2009 and 2010.
• Residential energy credit: 30 percent of
costs for certain energy-efficient properties placed in service before 2016.
—Kevin T. McGrath, CPA,
is a tax partner with BST Advisors, LLC.
To submit questions for future columns, email
[email protected]. For guidance on specific
situations, consult your lawyer or financial advisor.
3
Research Reports, February 15, 2010
Will the New Credit Card Rules Help?
The new law claims to protect consumers, but responsible borrowers may face higher
interest rates and fees as an unintended consequence.
by Polina Vlasenko, Research Fellow
M
ost provisions of the credit
compensate for the risks they repMany credit cards have increased
card law (the Credit CARD
resent. To recapture this revenue,
their interest rates in anticipation
Act) signed last year will take effect
credit card companies will introduce
of the new law. Now might be a
February 22. The law is supposed
changes that affect all borrowers,
good time to call your credit card
to protect consumers from “unfair”
both responsible and risky ones.
and inquire about the terms of your
credit practices, but it may have
The heart of the problem is that
account. Since interest rates are
unintended consequences, such as
it is difficult to determine beforehand
usually variable, calculated as the
raising fees for everyone.
whether a given person is a risky
Prime Rate plus a margin, be sure to
The law limits a credit card issuor a responsible borrower. This is
ask what the margin is—the lower
ers’ ability to raise interest rates. Its
not a major problem if lenders can
the better. Today the prime rate is
supporters apparently consider high
raise the interest rate as soon as they
3.25 percent. So even with a high
and varying interest rates
margin, the interest rate
The heart of the problem is that it is dif- will seem reasonable. But
to be an unfair, or at least
an undesirable, practice.
ficult to determine beforehand whether over the next few years,
But there is a reason why
the prime rate could easa given person is a risky or a responsible ily rise to 7 or 8 percent.
credit cards carry high
interest rates. And no law borrower.
Even credit card users
will make it go away.
who carry no balance will
Credit cards provide loans that
get information that a borrower is
be affected by the changes. Credit
are convenient for borrowers and
higher-risk (when he or she makes
card companies may introduce or
risky for lenders. A credit card with
a late payment, for example). Until
increase annual fees and reduce
a $5,500 credit limit allows the bornow, this is what credit card compabonus features such as rebates or airrower to get a loan of $5,000 on the
nies have done. They gave cards to
line miles. They may also increase
spot—for any purpose and without
almost anyone, and later raised the
the merchant fees. Some merchants
answering any questions. No other
rates and fees on those who turned
will pass on this cost to consumers
financial product allows people to
out to be bad credit risks.
by raising prices. Others, espedo this.
The new rules make this “try
cially small local stores, may stop
These loans are unsecured. This
and see” approach impossible. But
accepting credit cards or require a
means that should a borrower
the creditworthiness of a borrower
substantial minimum purchase to
default, the lender cannot seize any
cannot be perfectly determined
use them.
property for repayment. The loan
before credit is issued, even with
Be prepared that you might need
also can be repaid at any time, makthe information provided by credit
to pay cash for small purchases in
ing it difficult for lenders to estimate
reports.
the future.
the flow of interest payments. And
Lenders cannot distinguish bad
credit card balances can be comborrowers from good ones with a
pletely discharged in bankruptcy.
sufficient degree of certainty, and
It is no surprise that lenders
they will not be able to link interest
$1,300
charge high interest rates for these
rates to the behavior of individual
risky loans. They charge especially
borrowers. Instead, they will charge
$1,076.25
$1,200
high rates to borrowers who show
the same average interest rates to
signs of being bad credit risks—
everyone.
$1,100
namely, those who pay late or
To make matters worse, since the
$1,000
exceed their credit limit.
law makes it difficult to raise interThe law does nothing to change
est rates, initial rates will be high.
$900
the risk associated with credit card
Responsible borrowers will face
$800
loans. It only limits the ability of
higher interest rates and fees under
Feb-2009
Jun-2009
Oct-2009
Feb-2010
credit card companies to collect
the new rules than they would have
Price of gold, February 11, 2010, London PM fix.
revenue from risky borrowers to
otherwise.
gold corner
4
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