Richard M. Salsman is president and chief market strategist of InterMarket Forecasting, which provides quantitative research and forecasts to guide the asset allocation decisions of pension sponsors, mutual funds, banks, hedge funds, and investment managers. He received his B.A. in law and economics from Bowdoin College (1981), his M.A. in economics from New York University (1988). Mr. Salsman has published numerous books and articles on capitalism, banking, the gold standard, forecasting, and investment strategy. His most famous book is “Gold and Liberty” (1995). His work has appeared in The New York Times, The Wall Street Journal, Barron’s, Forbes, Investor’s Business Daily and The National Post (Toronto). He is also a Chartered Financial Analyst.
Capitalism Magazine: For some time now the ‘gold bugs’ have been claiming that in addition to outright sales, the central banks have been holding the price of gold down by leasing gold to various sellers. Another reason, they say the price is depressed is through forward gold sales by the major gold mining companies. Would you like to comment on that? To what extent do these types of sales influence the market.”
Richard Salsman: These factors influence the gold price very little. The gold price isn’t falling because central banks are selling; central banks are selling because the gold price has been falling. Whenever the gold price falls, in any currency, it makes sense to buy financial assets. Stocks and bonds tend to move inversely with the gold price.
The volumes of gold associated with things like mining strikes in South Africa or turmoil in Russia (these were the excuses for a rising gold price in the 1970s) or central bank gold dealings or mining company forward sales — are a tiny fraction of the world stock of gold.
“Gold bugs” fail to recognize that the relevant supply of gold is not the annual increment issuing from gold mines — instead, it’s the total above-ground stock worldwide. Today this gold stock is more than 3 billion ounces. It has accumulated, of course, for centuries. The annual increment to that stock is only about 1.5%. Gold dealings of the kinds mentioned in headlines are a lesser fraction still. The total gold stock rises each year — and never falls — because unlike other commodities (excepting silver), gold is produced for purposes of accumulation, not consumption. And it’s held not for industrial use but primarily as a hedge against inflation – or it’s held less when there’s deflation.
More fundamentally, whenever an analyst cites just one side of a gold transaction, he drops context. Yes, central banks may sell gold, but for every seller, there’s a buyer. It’s not “selling alone” or “buying alone” that determines price — but buying and selling jointly. And it’s other factors that determine the intensity of buying and/or selling anything.
Capitalism Magazine: So what determines the price of gold?
Richard Salsman: The main determinant of the gold price — in any country’s currency — is the confidence (or lack thereof) markets place in the future value of each respective currency. Paper money depreciates when a central bank issues more than is demanded by holders or whenever a Treasury official advocates a drop in the foreign exchange value of paper money (thereby lowering the demand for it). Falling confidence in paper money is reflected in a rising gold price. That’s what happened in Southeast Asia in 1997-98. Rising confidence in paper money is reflected in a falling gold price. That’s been the trend in the US and UK in recent years.
Much attention is paid to a loss of confidence in paper money due to central bank over-issuance. But Treasury policy is also important in affecting demand for paper money. For example, in the US, after Clinton’s first Secretary of the Treasury, Lloyd Bentsten, verbally bashed the dollar, from 125 yen (in January 1993) to 80 yen (by May 1995), the price of gold rose from $333/oz to $410/oz (1993), reflecting rising inflation expectations. In 1994 the Fed raised interest rates by 3%, causing bond prices to fall by 35%. Those rate hikes did not “pre-empt” inflation — they ratified it.
Capitalism Magazine: So, again, how does one interpret a rising price of gold?
Richard Salsman: A rising gold price means investors are fleeing paper money for gold. As mentioned, this can result from a central bank issuing too much money, more than what’s demanded to support trade, or by a Treasury official selling dollars and saying he wants a lower foreign exchange value, a policy which lowers the demand for dollars and raised the demand for gold. Or by both policies together. A rising gold price is bearish for future inflation, interest rates, bonds, and stocks; a falling gold price is bullish, in time, for all these things. I discuss these inter-relationships in my 1995 book, Gold and Liberty.
Capitalism Magazine: But didn’t the price of gold drop significantly when it was announced that that the bank of England would sell over half of its gold reserves in the coming months?
Richard Salsman: No, not greatly. It’s true that day-to-day changes in the gold price may reflect such news. But the fundamental trend of gold prices reflect the factors I’ve named, not sales announcements. Remember, a sale announcement may just as well be seen as a “buy” announcement.
The central banks should be selling gold if its price is falling and there’s not a great chance of a return of inflation. The message sent by central banks, that they’re selling because they don’t expect a return of inflation — that, in effect, they will not reflate — is a very good sign for all but holders of gold.
What central banks should not do is announce their planned sales ahead of time — that only ensures that they’ll get a lower price. It’s sheer idiocy. It would be like Bill Gates deciding, privately, to sell half his shares in Microsoft; then, in the months prior, he tells the whole world his plan. He’d get less than he would otherwise. That would be idiocy. He should sell quietly.
The headline that screamed that England would sell “58%” of its gold was pure sensationalism. Central banks — in total — hold only about 22% of the world gold stock, down from 68% in WWII. The amount to be sold by the Bank of England is less than 2% of all central bank stocks. The gold price fell only 2.5% after the announcement. I wouldn’t call that a “greatly” drop. Gold fell more than that (3%) in the months preceding the announcement. And it fell more than 30% in the past year.
Finally, history shows that more than 80% of the time, the gold price does not fall when central banks announce or make large sales — it rises. My interpretation of this fact is that markets worry when central banks sell the one form of money in the world that is still objective and which maintains a stable in purchasing power.
Gold gives value to paper money that it wouldn’t otherwise have; paper doesn’t do that for gold.
Capitalism Magazine: Are falling gold prices a warning of a coming deflation?
Richard Salsman: It’s not a “warning of a coming deflation.” I would say that it IS deflation.
I trust the gold price to tell me the state of paper money far better than does the government’s bogus inflation statistics like CPI. And mild deflations are bullish for the economy and financial assets generally.
The gold price has great forecasting power. A falling gold price is an advance and open invitation (not a “warning,” which implies a negative) to buy dollar-denominated securities.
Capitalism Magazine: So deflation is good?
Richard Salsman: Yes. The effect on the economy of a deflation — of a higher value of money — is bullish. On average, since 1971, the U.S. economy has grown three times as fast in the year after the gold price falls than in the year after it rises.
The only reason people have come to associate deflation with bad times is that they’ve been trained in schools to believe that’s what happened in the 1930s. Not so. Prices did fall precipitously, but only as a result of depositor runs on banks caused by threatened inflation. Depositors sought cash and gold starting in 1931-32 because FDR had hinted, even while campaigning, that he would take the US off the gold standard, or else devalue. He did; that was a financial catastrophe.
Capitalism Magazine: If the economy does poorly, will this be due to deflation?
Richard Salsman: If the economy doesn’t do well in the coming years it won’t be because the gold price is falling and we have deflation. It will be because the Fed raises interest rates, on the bogus theory that an economy that “grows too fast” and “lowers the unemployment rate too far” accelerates inflation.
Greenspan tends to believe, with all Keynesians, that producing things and hiring people causes inflation. That’s a long, long way from his essays in Capitalism: The Unknown Ideal. I explained and refuted this bogus theory (based on “the Phillips Curve”) in an article titled The Cross and the Curve (The Intellectual Activist in 1997).
Notice which economies have done worst in recent years: Southeast Asia, Russia, and Brazil. But they didn’t deflate — they hyper-inflated. That is, they devalued their currencies. And their local-currency gold prices sky-rocketed.
Even in Japan, stagnant for a decade, the problem has not been deflation. Japan has deflated far LESS than did the US and UK. What Japan needs is more and steadier deflation. But Japan needs other things too — policies that stop treating stock market gains as a “bubble” and a tax policy which is not punitive toward savers, investors, and producers.
Capitalism Magazine: I take it you’re not a “gold bug”?
Richard Salsman: I’m not — emphatically not. I find that most of them are an utter disgrace to scientific procedure, economic analysis and the virtues of gold. They give gold a bad name.
A gold bug is someone who buys gold on faith, not facts, who believes the world’s coming to an end and that the gold price will sky-rocket.
I’m no “gold bug,” and I urge others not to fall for their scare tactics and rationalizations.
Many “gold bugs” are still trying to recover from their purchases of gold at $800/oz in 1980 (they predicted then, as did Pepperdine economist George Reisman, that the price would go as high as $4000/oz). When the gold price doesn’t rise or falls, gold bugs blame minuscule dealings in the gold market. Hence their rationalizations. For all his virtues, the late Jim Blanchard did, unfortunately, shade toward being a gold bug. He is often called “the first gold bug.”
Capitalism Magazine: Do “gold bugs” damage gold’s reputation more than Keynesians do?
Richard Salsman: I don’t know which group does more damage.
The Keynesians, we know, always dismiss gold as a “barbarous relic.” But they’re a dying breed. Their criticisms have been irrelevant. More gold has been mined, stored, and invested in, since Keynes, than before him.
Today, the subjectivist gold bugs are probably the main impediment to rational gold analysis.
Capitalism Magazine: Isn’t that much like the manner in which libertarians and conservatives – trying to defend capitalism on an altruist base – do more damage to capitalism than liberals who oppose capitalism because it’s based on selfishness and the profit motive?
Richard Salsman: Absolutely.
In the case of the “gold bugs,” they keep saying the gold price will skyrocket because fiat paper money — and the world — will go to Hell.
When the gold price falls, the anti-gold pundits claim gold’s irrelevant, because it defied the wild speculations of gold bugs.
Capitalism Magazine: What about the great Austrian economist Ludwig Von Mises who wrote that fiat paper money would eventually become worthless?
Richard Salsman: Many gold bugs cite Mises, who wrote that all fiat paper monies end up in complete dissolution and worthlessness. But “end-up” is a quite ambiguous date to attach to any forecast; people can crack-up and go broke waiting for the exact “end up.”
We’ve had paper money for nearly three decades now, and although the dollar almost dissolved in the crisis of 1978-80, the dollar’s value has risen enormously (vs. gold) since then. The stock market (S&P 500) has risen from 160 in 1983 to 1340 in 1999. That’s an annual appreciation of 14%. There were only a few bad years in that stretch.
That’s an awful lot of wealth creation for a bug to miss.
Capitalism Magazine: Thanks, Richard. It’s rare to get both a free-market perspective AND an optimistic interpretation of modern-day economic events.
Richard Salsman: I have neither a predilection toward pessimism or optimism. Instead, I try to look at facts objectively.
Today, the economic news is generally good – but, of course, our lives would be far better still if we were moving more aggressively toward full, laissez-faire capitalism.
