What the Federal Reserve is really about these days


The Return of the Gold Bugs:

The run-up in prices above $500 an ounce
seems driven by investors and speculators.
Take your price of which anxiety is
likely motivating them.

By Robert J. Samuelson
December 12, 2005


The price of gold passed $500 an ounce last week, its highest level
since the late 1980s. This is either an ominous development -- or it
isn't. You can make the case that higher gold prices (up 23 percent
from 2004's average) warn of worsening inflation. Gold has long
served as an inflation hedge, and when U.S. inflation reached double-
digit levels in the late 1970s, gold hit a record high of about $850
in early 1980. But you can also argue that the present run-up has
little to do with inflation and mostly reflects that old economic
standby: the law of supply and demand.

It's precisely because gold has so much history that we still watch
its price. In his illuminating book "The Power of Gold," Peter
Bernstein notes that "Egyptians were casting gold bars as money as
early as 4000 B.C." Later in Europe, gold enabled kings to pay
armies and bribe rivals. In 1511, Spain's King Ferdinand exhorted
his conquistadors: "Get gold, humanely if possible, but at all
hazards, get gold."

If you'd lived a century ago, gold would have been the basis of your
money. Great Britain dominated the global gold standard; its
currency, the pound, was freely convertible into gold. So were many
other monies. In the United States, about $610 million of gold coin
in 1900 constituted nearly 30 percent of America's currency. All the
rest -- paper notes and silver -- could be exchanged freely for
gold, notes economist Michael Bordo of Rutgers University. But the
gold standard's very rigidity led to its collapse in the Great
Depression. Too little gold fostered banking and currency crises. On
April 5, 1933, President Franklin D. Roosevelt ordered Americans to
surrender their gold coin; the country effectively went on a paper-
money standard.

Even stripped of its role as money, gold retains an economic
mystique. About 85 percent of annual consumption goes for jewelry
and, to a much lesser extent, other commercial uses, mainly
electronics and dental work. But the recent price run-up seems
driven by the remaining 15 percent: investors, speculators and
hoarders. These include commodity funds, hedge funds and wealthy
individuals. Especially in Asia and the Middle East, the rich hoard
gold bars. In the first nine months of 2005, the investment and
speculative demand for gold rose a perky 62 percent, reports the
World Gold Council, an industry group.

Except for the belief that gold will go higher, just what motivates
these buyers isn't clear. Take your pick of anxiety, says analyst
Philip Newman of GFMS, a consulting firm: inflation, financial
crisis, terrorism, general global disorder. Because holding gold can
be an alternative to holding dollars, rising American inflation and
a falling dollar on foreign-exchange markets are often cited as
reasons for higher gold prices. But the dollar has recently
strengthened on foreign-exchange markets, and the evidence of
increasing inflation is thin. True, oil temporarily made it worse.
But excluding erratic food and energy prices, inflation has remained
at about 2.5 percent since early 2004. Perhaps gold buyers glimpse
dangers not apparent in the statistics.

Or maybe the real culprit is true scarcity. Copper is now selling
for about $2 a pound, up from about 70 cents four years ago. At $60
a barrel, oil has doubled since late 2003. In each case, global
demand -- influenced heavily by China and India -- has squeezed
available supplies. Gold could be the same. After the 1980 peak,
gold prices went on a two-decade slide that bottomed in 2001 at an
average of $271. Low prices discouraged exploration and the opening
of new mines. In 2004, global mine production dropped 5 percent or
128 metric tons, the largest absolute decline in 71 years, according
to Newmont Mining Corp., the world's biggest gold producer.

Meanwhile, growing wealth in India, China and the Middle East has
revived jewelry demand; that's up 12 percent this year after a 5
percent increase in 2004. Jewelry is often more than adornment; it's
also a store of wealth. Consider India. "For thousands of years,
[gold jewelry] has been a means of savings," says George Milling-
Stanley of the World Gold Council. "Seventy percent or more of
consumption is among the rural population. They don't have access to
banks, stocks or bonds. They don't trust government or paper

Higher demand collides with constricted supplies; wham, prices rise.
That stimulates more speculative demand, but it also enlarges supply
by causing past investors in bars or jewelry to sell and take
profits. Governments also have large gold stocks; their sales and
purchases influence prices, too.

Though new mines often require a decade to bring into production,
supply could ultimately overtake demand. Or prosperity in India and
China might multiply by many times the world's gold bugs. They may
regard gold as a more trustworthy form of saving than any currency,
even though gold investments don't pay interest or dividends.
Whatever happens, the fears and anxieties that give gold its
speculative appeal could intensify or dissipate. Gold is an unending
mystery, because its value lies less in what it does for us (it is
not like sugar, copper or oil) and more in what it symbolizes. It is
almost as unfathomable as the human drama itself.