The US dollar’s alive and well. Photo by Jessica Hromas/Getty Images.
Gold’s been a hot topic with many investors in recent months—and, quite often, a source of fear. Not because its price is way down from 2011’s highs, but because they see its long-term appreciation as a sign of the dollar’s devaluation—and they fear we’re on the road to Weimar as a result.
Good news: That’s a rather misguided interpretation of gold’s rise, and our currency is far more stable than some give it credit for. Ultimately, stock investors needn’t fret the dollar’s demise.
Gold’s long-term rise is rooted in nothing more than normal market forces. After it began trading freely for the first time when post-Bretton Woods controls were finally dropped in March 1973, it jumped quickly as investors engaged in the normal process of price discovery. Before then, the government had fixed the price of gold well below market value in order to maintain a partial gold reserve. And in order to increase the money supply over time—necessary in a growing, wealth-creating economy—the government had to continuously devalue gold. Moving to a free-floating dollar wasn’t a currency devaluation, but a gold revaluation.
Since then, gold’s experienced normal commodity-like volatility. It shot up in the late 1970s but fell, on balance, through the 80s and 90s—with lots of wiggles along the way. Its strong run since 2001 erased some memories of that 1990s crash, but recent years still saw quite volatile gold. During 2008, for example, gold fell right along with stocks, and current prices are about 27% below the September 6, 2011 high. But they’re still well above early 1973 to 1974 levels, hence the dollar devaluation jitters.
But the size of our economy and our total wealth is greater now than in the early 70s, too. GDP has grown from $4.9 trillion in 1973 to $13.5 trillion (measured in constant 2005 dollars) today. US household net worth went from $4.5 trillion in 1973 to over $70 trillion today. Over time, the money supply’s grown in sympathy.
Gold’s long-term rise is a fully expected consequence of this. Supply is limited—it tends to increase about 1% annually. There are currently about 170,000 tons outstanding, and much of that is held as central bank reserves globally. The amount trading on open markets—whether through ETFs or for jewelry, dental implants, limited industrial use or personal collections—is quite small. But the amount of money chasing this finite commodity has grown astronomically, whether measured in terms of household net worth or the money supply. Whenever you have an increasing amount of money chasing a finite good, the price can rise if demand increases. Sometimes a lot! That’s how the economics of supply and demand work. Said another way, gold’s annualized rise over time—small though it has been—is a very healthy side effect of rising wealth and just what you’d expect from a commodity. A volatile path to basically inflation-like returns over the very, very long-term—and that includes a 20-year period when gold’s price fell while consumer prices rose.
The trend of increasing wealth is even more pronounced if you look globally. According to Credit Suisse, from 2000 through 2012, global household wealth about doubled and sits at nearly $223 trillion.I Much of that increase comes from Emerging Asia, where gold has cultural value as a display of wealth—as more folks pass through higher income brackets, they buy more and more gold. In fact, gold demand in India is so strong, the government often caps imports in order to keep its current account deficit in check.
So gold’s price—high or low—is a function of largely limited supply and often fickle global demand. And due to gold’s limited physical uses, that demand is largely driven by investor sentiment, which is far removed from the US dollar—gold’s price, whether higher or lower, tells us next to nothing about the strength of our currency.
What, then, does tell us about the US dollar’s health? For one, while inflation can be variable in the short term, over time, it’s annualized about 3%—a tame side effect of economic growth, not a sign of dollar devaluation. Our economic output, adjusted for inflation, is at all-time highs and still growing. And, perhaps most tellingly, US assets are in demand globally. Our Treasury markets are the world’s deepest and most liquid, and nations worldwide see US bonds as the most stable store of value there is—foreign demand is high and rising. Ditto for foreign demand in US real estate and infrastructure projects. When wealthy Chinese folks move their money out of their home country to shield it from their meddlesome, seizure-happy government, many choose to buy homes here—they covet the strength of our financial system and our iron-clad property rights. Japan’s national pension fund, in an effort to diversify away from low-yielding (and, lately, increasingly volatile) Japanese bonds, is eyeing several US infrastructure developments. As long as dollar-denominated assets remain in high demand as long-term stores of value, that’s a good sign the dollar is highly valued, not devalued.
Simply put, if the dollar had truly devalued over time, it likely wouldn’t be the world’s reserve currency of choice—a status it likely doesn’t lose any time soon, given its many advantages over peers. China’s often touted as a potential threat, but Chinese markets are in their infancy, and the yuan has far to go before it will be anywhere near close to a viable alternative—China needs a free, developed financial system with market-set interest rates and a free-floating currency. And that currency will need to prove itself stable over time. That’s decades away, if it ever happens—so many unknown variables will arise in the interim. Case in point, less than 10 years ago, many thought the euro would displace the dollar. One PIIGS crisis and a few bailouts later, and there’s nary a whisper. The dollar, meanwhile, shines brightly.
Even if the dollar did lose its status as the sole global reserve currency, that’s not necessarily a negative. The British pound has fared just fine over time (misguided adventures in fixed European exchange rates notwithstanding) even though its days as the world’s premier currency are long gone. If, in the long run, more reserve currencies rose alongside the dollar, it could even be a positive for markets—more diversification and more choice are good, not bad. Wider adoption of other currencies needn’t be the dollar’s loss—this isn’t a zero sum game. There’s no reason multiple currencies can’t share the fun.
For stock investors, that’s good news—fears of a falsehood are bullish, and the dollar’s demise is overwhelmingly likely a false fear. That dollar dread’s resurfacing—and that folks see gold’s rise as a sign of US weakness, not US and global strength over time—tells us there are still pockets of skepticism throughout the marketplace. That’s just one more sign we’re far from the euphoria that typically marks bull market peaks—and, thus, one more sign this bull has room to run.
I Source: Credit Suisse Global Wealth Databook 2012.