Finally, the CPI Catches Gold
Jude Wanniski and David Gitlitz
August 19, 1997


For at least the last 20 years, supply-siders have been arguing among themselves about the correct dollar price of gold, if the government were to once again fix the dollar/gold exchange rate. Then, our David Gitlitz spotted a chart in the July 28 issue of Forbes that purports to show that since 1800, gold has held its purchasing power almost to the dollar. We can now see an end to that dispute. By a measure used by Wharton Professor Jeremy J. Siegel in his book, Stocks for the Long Run, the chart indicates that $1.00 worth of gold based upon 1800 prices will today buy $1.03 worth of the same goods. Gitlitz procured the book in order to probe Siegel’s methodology and found that for part of the series, Siegel had used the Consumer Price Index from its moment of inception in 1913, at the time of the creation of the Federal Reserve System! Eureka! The import of this discovery, as indicated by the chart plotted by Gitlitz, solves the riddle that has been baffling us, and causing Fed Chairman Alan Greenspan and former Fed Gov. Wayne Angell to agonize over the dollar/gold relationship.

How? Greenspan has testified several times before congressional banking committees that gold is the best forecaster of inflation, but that it is not perfect. The series run by Siegel and the chart plotted by Gitlitz together demonstrate beyond reasonable doubt not only that gold is about as perfect as it gets. It also shows that at the end of July the CPI has caught up with gold and crossed over into deflationary terrain.* There might be argument that the CPI itself is not a perfect indicator of inflation -- that the basket of goods it represents is not correctly weighted. But even if that were true, it wouldn’t be by more than some small amount in either direction, at least relative to the concerns that have bothered those of us, including Greenspan, who have worried about the lags of the general price level in catching up with gold. Now that the lines have crossed on the chart plotting the relationship, it arms Greenspan at the Fed with the confidence that he can argue for slight monetary ease and knock down any arguments for tightening further.

Why didn’t any of us think of this method before? Probably because nobody realized the perfect place to start the series was at the time of the Fed’s creation. Gitlitz himself says he had run across the 1913 CPI series before, but not until he saw the Siegel gold chart did he think to plot it against gold. All the debates on gold that have bedeviled supply-siders in the last 20 years have reflected different assumptions on when one inflationary ripple ended and another began. But it makes perfect sense that you can only begin in 1913, when private banking gave way to central banking. My own confusion occurred because I began to think of the dollar/gold series from 1934, when the price changed to $35 from $20.67, where it had been since the earliest days of the Republic. Doing the same, other supply-siders such as Art Laffer reckoned that the gold price now would have to be driven below $300 to guarantee zero inflation. Angell professed to be happy with $320. I argued against these perfectly reasonable economic arguments on the political grounds that the price had been so much higher since 1979 that the deflation would be far too painful for dollar debtors to absorb. Now it is clear that the CPI/gold rate has been keying off 1913, not 1934, which is why all of us have been wrong. Well, of course, if the average maturity of corporate debt was 40 years in 1913, it would be 1953 before the slight monetary inflation masked by World War I would ripple completely through the economy. Here is how David Gitlitz described it to me in a memo:

The nearly 30-year process of equilibration of the general price level with the price of gold is, for all practical purposes, complete. This chart, showing monthly movements of consumer prices and gold against a 1913 base, provides the most conclusive evidence we have yet seen that de facto price stability is a reality. It also confirms that the price level risks tend to line up on the side of deflation at below a mid-$350s range for gold. For the first time since a brief period in mid-to-late 1976, the gold price has actually dropped below the point that would indicate equilibrium with the CPI.  In July, the real value of a dollar’s worth of gold in terms of the basket of goods represented by the CPI, relative to the 1913 base, stood at $0.97. In June, they were almost exactly equal.

The chart stands as an eye-popping validation of gold’s continuing and remarkable utility as a monetary commodity whose real purchasing power remains constant over the long reaches of time, some 26 years after the collapse of Bretton Woods. It is also a ringing endorsement of the 1977 study by University of California-Berkeley economist Roy Jastram. Published under the title, “The Golden Constant,” Jastram constructed indexes of commodity prices, gold prices, and gold purchasing power from 1560 to 1976 to demonstrate that gold provided the best measure of the overall price level since Elizabethan England. Now, the circle is complete: If an ounce of gold bullion could somehow be transported back to 16th century England, it would command the same value in terms of the goods for which it would exchange as an ounce of gold purchased today at the turn of the 21st century. Describing what he called the “retrieval phenomenon,” Jastram summed up his work in this fashion: “Gold prices do not chase after commodities; commodity prices return to the index level of gold over and over. This is one of the principal findings of my study.”

*The only other time this has happened in the last several decades was in the monetary squeeze that saw gold plummet from $179 per ounce to $117, during several months of 1975-76. At that time, the Fed was starving the economy for liquidity at the same time Congress in 1975 was passing the first supply-side tax cuts -- a significant tax break for small business that Robert Mundell persuaded the House Ways & Means Committee to add to its meaningless $50 tax rebate.