Will Gold Prices Plunge Like in 1980?

A look at the parallels, as well the differences, between the end of gold's last bull market and today...

ARE PEOPLE Buying Gold making a big mistake? Is history repeating itself? asks Bill Bonner in the Daily Reckoning. 

The New York Times suggests it is:

As it was in 1980, could it be again in 2012?

The 1980 presidential election was fought by a Democratic incumbent weakened by a poor economy amid worries that the United States had lost its ability to compete in the world. Gold prices had risen to unprecedented levels as the election approached, and the Republican nominee hinted he might propose a return to a gold standard.

That Republican, Ronald Reagan, won the election and soon appointed a commission to study the role of gold in monetary systems. To gold bugs, it appeared to be the best chance in decades to move the country toward gold and away from what they like to call "fiat money," a currency anchored by nothing more than government dictates.

Last month, Newt Gingrich, seeking to widen his support in the days leading up to the South Carolina primary, promised that he would appoint a new gold commission. "Part of our approach ought to be to re-establish something Ronald Reagan did in 1981 and that is to have a commission on gold to look at the whole concept of how do we get back to hard money," he said in a speech.

No, dear reader, history is not repeating itself. The NYT is wrong...about everything. Well, almost everything. It understands that gold is a threat to its big advertisers...and most of its readers (who don't own any gold). It is also a threat to most economists — who have built their careers on not understanding how a real economy actually works...and whose income and whose professional status now depend on a gold-free, centrally-planned economy.

So, to prove that gold is a 'barbarous relic' and that gold bugs walk on four legs, they merely put the question to economists.

The University of Chicago last month asked a panel of 40 economists, including former advisers to both Democratic and Republican presidents, if they agreed that "price-stability and employment outcomes would be better for the average American" if the Dollar's value were tied to gold. Every one of them disagreed, some with more than a little incredulity that such a question was worthy of discussion.

"Why tie to gold?" asked [the very witty] Richard Thaler, a University of Chicago professor. "Why not 1982 Bordeaux?"

"Eesh," responded Austan Goolsbee, a Chicago colleague and former adviser to President Obama. "Has it come to this?"

The Times goes on to report that "even economists with some sympathy to gold opposed the idea" of a gold-backed Dollar. And Mr. Ben Bernanke, former professor of economics at Princeton, says he doesn't think gold is money.

Oh yeah, replied Congressman Ron Paul, then why do central banks hold gold...and not things such as '82 Bordeaux or diamonds?

Mr. Bernanke replied that it was just a matter of "tradition."

Yes, he's right...it is a matter of tradition, like marriage...like property rights...like government...like murder...like teenagers who moon adults out of car windows...or like drivers who give each other the finger.

Traditions become traditions because people keep doing them. And they keep doing them for reasons that aren't likely to go away. Times change. Conditions change. Human nature doesn't.

But let us go back to the New York Times' silly notion that we are about to relive the period following 1980. What seems to have triggered the idea was Newt Gingrich's proposal to study the idea of going back on the gold standard. Every right thinking person in the country — the Times implies — knows the idea is foolish. And the price of the yellow metal is sure to fall, as it did after the Reagan election, when people realize how foolish it is.

But gold didn't fall after '80 because the Reagan administration didn't put it back in the monetary system. It fell because Paul Volcker made it unnecessary. Instead of printing money, Volcker tightened up...taking out some of the money that was already there. And he did it under conditions that were not merely unlike those of today...but almost the exact opposite.

Then, the US was still a creditor to the rest of the world, not a debtor.

Then, the US was still running positive trade balances, not losing money every month.

Then, US stocks were at bargain levels...selling for 5 to 8 times earnings; today, they're twice as expensive.

Then, US bonds were cheap too...with yields for US Treasury debt as high as 18%, or nearly SIX TIMES as high as today's long bonds.

Then, US households had debt of only 60% or 70% of their disposable income, not 120% like today.

Then, the Fed was determined to stifle inflation; now it is determined to cause it.

Then, the federal government's debt was less than 40% of GDP. Now, it's over 100%.

Then, even in today's inflation adjusted terms, the US government ran a deficit of $197 billion. Today, the deficit is $1.1 trillion.

Then, stocks had been going down for the previous 14 years; bonds had been going down for at least 31 years. Now, stocks and bonds have been going up, generally, for the last 30 years.

This final point is not just a detail. It's the heart of the matter. With bonds at a 30-year low, Paul Volcker could squeeze inflation...begin a 3-decade period of rising bonds (with falling interest rates)...and an 18-year bust in the gold market.

Will that happen again? Impossible!

What kind of strange history would it be if it could repeat itself...from totally different initial conditions? Could Napoleon march on Moscow...if he had started out in Chicago rather than Paris? Could Liz Taylor have married Richard Burton twice if she'd died in a traffic accident after her first marriage?

Can gold now repeat its path of '80-'98, even though today's situation is almost the opposite in every way?

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