Cumberland Advisors Market Commentary – Clams Or Gold Responses
We received several comments from readers concerning some of the key points in our recent commentary “Clams or Gold.” Below is an abbreviated version of the questions, to which responses are then supplied.
Comment: You may have seriously misled readers because both the purity of the official gold bullion and measurement of ounces have remained constant, or at least they have been for the period of your nineteen-year study. As both the quantity and quality of gold have remained constant over these nineteen years, it is not that gold has inflated by nine percent, but those pesky fiat currencies, i.e. the USD in this case, have lost value by nine percent per year.
Reply: The issue here is not the measurement, quality, or purity of gold. The evidence suggests that other forces besides the value of the dollar have affected the price of gold more over time. Data show that the dollar has not inflated to the same degree that the price of gold has changed. Moreover, since we are looking at only the dollar price of gold, the movement in the price can’t be due to fiat currency value changes. Gold is scarce and people want it. (Note that 52% of all gold mined is used for jewelry.) Gold is priced in a world market, but we are not looking at the price of gold in other currencies, just in dollars. So the main point is that the price of gold is and has been more unstable than the value of the dollar. More detail to illustrate this point is contained below.
Comment: Consider that the cost of postage has increased by 9.2 percent over a 44-year period. Housing, oil, land, etc. also cost more. These are generally more difficult to quantify, but the energy in a barrel of oil today, i.e. BTUs, is probably the same as say in 1970 when oil was about $2 per barrel; now it is $60. Have oil, gold, or land, postage, etc. become unstable or are fiat currencies unstable? Perhaps I misunderstood the main point in the article, but my 10,000 fiat dollars that bought a brand-new car in 1989 will not even come close to buying a new car today. It is the fiat currency that has lost value, not the car, gold, land, haircut, etc.
Reply: What we need to look at here is the nominal value of certain goods compared to their real value and adjust for the fact that not only have prices changed over time but also our incomes have changed as has the quality of the goods we consume. In the case of oil, the main demand in the US is for gasoline, which cost about 36 cents per gallon in 1970, as compared with a national average price today of about $2.80. But clearly we cannot compare the nominal price of a gallon of gas in 1970 with the nominal price today, when we know that supplies (and incomes) then were not nearly what they are today. We all know about OPEC and how it has artificially manipulated oil prices over time. The point is that oil is a commodity, and both its real and nominal prices have changed due to shifts in supply and demand conditions. Oil’s nominal price has also been influenced by both politics and inflation (the main inflationary period in the US being in the 1970s).
The following chart shows the inflation-adjusted history of gasoline prices versus the nominal price in 2015 terms. You will notice that the real price of gasoline hit a low in 1998. Interestingly, in the 1930s, gas prices in inflation-adjusted terms were not much different from what they are now; but note that movement in inflation-adjusted prices doesn’t always mirror the upward movement in nominal prices that began in the ’70s.
On top of variations in barrel prices, US gasoline prices have been significantly impacted over time by the imposition of both state and federal taxes, which are also implicitly reflected in the above chart. The federal tax on gasoline has been flat since 1993 at 18.3 cents per gallon, but state and local gasoline taxes have increased steadily. (Pennsylvania now has the highest in the country at an average of 77.10 cents per gallon. The lowest is Alaska, with an average tax of 32.74 cents per gallon.)
One last point is that the demand for gasoline is a derived demand, in that we don’t want to keep gasoline in our garage; we demand it for travel. Therefore, we need to consider what the cost per mile is when we think about gasoline prices. We know that fuel economy has increased significantly, putting downward pressure on our travel costs. The average car in 1970 got 13.5 miles per gallon, whereas today the average is 23.6 miles per gallon. So we are getting much more work done with a barrel of oil today than we did in 1970.
Let us consider a different example by posing the question, what would a quality TV cost you today and what would it have cost you in 1954 in today’s dollars? In 2017 a 55-inch LG TV had a list price of $2300, or a price per square inch of $1.78. In 1954, the best TV you could get was a 21-inch Westinghouse for $495, which in today’s dollars is $11,875, or a price per square inch of $110.20. Put another way, if you were to use 1954 dollars to buy today’s LG TV, it would be substantially cheaper than the 21-inch TV. The Westinghouse cost $495, while today’s LG TV would cost $241.  Clearly there would be no demand for that Westinghouse TV today, and there are both quality and size differences that make true comparisons difficult. But the point is that goods change, quality increases, and real costs can decline. We could clearly pull out similar comparisons of today’s cars versus yesterdays.
This makes the gold comparison interesting because there are no quality issues associated with gold. As a reader pointed out, a bar produced today is virtually indistinguishable from one produced in 1920. But as I argued above, gold’s price has been much more variable and has increased much more than our rate of inflation. The chart below shows the nominal and inflation-adjusted price of gold in 2018 dollars. The chart demonstrates that the real price of gold, when we net out the influence of inflation, is not only volatile but also that volatility is not due to variations in fiat currencies, including the US dollar. Note too that since the financial crisis there has been very little difference between the nominal and inflation-adjusted prices, suggesting that something besides inflation is driving the price of gold.
Comment: Economists should start talking about “Net Worth,” not GDP, and how much nations’ and individuals’ “Net Worth” are changing. The reason this world is in such an economic mess is that we only look at GDP, the credit side of the ledger.
Reply: GDP is not a nominal measure but a real measure of our economy’s output. As such it is a very relevant measure of what is being produced and can be compared over time to assess real growth, productivity, and how well the economy is doing. Moreover, it focuses on domestic production and not total production, which is captured in gross national product, GNP. If the main criterion for assessing our economy is how people’s net worth is increasing, then that is a whole different issue. The difference is wealth versus output. One is a stock, and the other is a flow. I might also add that wealth measures don’t help us understand employment or what segments are contributing to growth and employment.
Comment: I also question your argument about the unsustainability of gold mining. The price of gold can be inflated to match GDP, Net Worth, etc. A constant quantity of gold could also be inflated to mirror the world aggregate GDP, Net Worth, etc.
Reply: The statement about the unsustainability of gold mining is related to available information about the real current mining and resource costs involved in extracting an increasingly scarce commodity versus what miners can sell the gold for. The comment about sustainability reflects the calculation that the real costs of extraction will exceed the real value of the gold mined after adjusting for price changes.
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