Famous economist Kenneth Rogoff weighs in on the surge in the price of gold. It’s nice to have a dispassionate view…
SAN FRANCISCO – It has never been easy to have a rational
conversation about the value of gold. Lately, with gold prices up more
than 300% over the last decade, it is harder than ever. Just last
December, fellow economists Martin Feldstein and Nouriel Roubini each
penned op-eds bravely questioning bullish market sentiment, sensibly
pointing out gold’s risks.
Wouldn’t you know it? Since their articles appeared, the price of
gold has moved up still further. Gold prices even hit a record-high
$1,300 recently. Last December, many gold bugs were arguing that the
price was inevitably headed for $2,000. Now, emboldened by continuing
appreciation, some are suggesting that gold could be headed even higher
One successful gold investor recently explained to me that stock
prices languished for a more than a decade before the Dow Jones index
crossed the 1,000 mark in the early 1980’s. Since then, the index has
climbed above 10,000. Now that gold has crossed the magic $1,000
barrier, why can’t it increase ten-fold, too?
Admittedly, getting to a much higher price for gold is not quite the
leap of imagination that it seems. After adjusting for inflation,
today’s price is nowhere near the all-time high of January 1980. Back
then, gold hit $850, or well over $2,000 in today’s dollars. But January
1980 was arguably a “freak peak” during a period of heightened
geo-political instability. At $1,300, today’s price is probably more
than double very long-term, inflation-adjusted, average gold prices. So
what could justify another huge increase in gold prices from here?
One answer, of course, is a complete collapse of the US dollar. With
soaring deficits, and a rudderless fiscal policy, one does wonder
whether a populist administration might recklessly turn to the printing
press. And if you are really worried about that, gold might indeed be
the most reliable hedge.
Sure, some might argue that inflation-indexed bonds offer a better
and more direct inflation hedge than gold. But gold bugs are right to
worry about whether the government will honor its commitments under more
extreme circumstances. In fact, as Carmen Reinhart and I discuss in our
recent book on the history of financial crises, This Time is Different,
cash-strapped governments will often forcibly convert indexed debt to
non-indexed debt, precisely so that its value might be inflated away.
Even the United States abrogated indexation clauses in bond contracts
during the Great Depression of the 1930’s. So it can happen anywhere.
Even so, the fact that very high inflation is possible does not make
it probable, so one should be cautious in arguing that higher gold
prices are being driven by inflation expectations. Some have argued
instead that gold’s long upward march has been partly driven by the
development of new financial instruments that make it easier to trade
and speculate in gold.
There is probably some slight truth – and also a certain degree of
irony – to this argument. After all, medieval alchemists engaged in what
we now consider an absurd search for ways to transform base metals into
gold. Wouldn’t it be paradoxical, then, if financial alchemy could make
an ingot of gold worth dramatically more?
In my view, the most powerful argument to justify today’s high price
of gold is the dramatic emergence of Asia, Latin America, and the Middle
East into the global economy. As legions of new consumers gain
purchasing power, demand inevitably rises, driving up the price of
At the same time, emerging-market central banks need to accumulate
gold reserves, which they still hold in far lower proportion than do
rich-country central banks. With the euro looking less appetizing as a
diversification play away from the dollar, gold’s appeal has naturally
So, yes, there are solid fundamentals that arguably support today’s
higher gold price, although it is far more debatable whether and to what
extent they will continue to support higher prices in the future.
Indeed, another critical fundamental factor that has been sustaining
high gold prices might prove far more ephemeral than globalization. Gold
prices are extremely sensitive to global interest-rate movements. After
all, gold pays no interest and even costs something to store. Today,
with interest rates near or at record lows in many countries, it is
relatively cheap to speculate in gold instead of investing in bonds. But
if real interest rates rise significantly, as well they might someday,
gold prices could plummet.
Most economic research suggests that gold prices are very difficult
to predict over the short to medium term, with the odds of gains and
losses being roughly in balance. It is therefore dangerous to
extrapolate from short-term trends. Yes, gold has had a great run, but
so, too, did worldwide housing prices until a couple of years ago.
If you are a high-net-worth investor, a sovereign wealth fund, or a
central bank, it makes perfect sense to hold a modest proportion of your
portfolio in gold as a hedge against extreme events. But, despite
gold’s heightened allure in the wake of an extraordinary run-up in its
price, it remains a very risky bet for most of us.
Of course, such considerations might have little influence on prices.
What was true for the alchemists of yore remains true today: gold and
reason are often difficult to reconcile.
Kenneth Rogoff is Professor of Economics and Public Policy at Harvard University, and was formerly chief economist at the IMF.