People often whisper conspiratorially about the age-old
U.S. practice of fixing the gold price at $42.22. "They're just trying
to keep gold down," is a complaint I've heard more than a few times. But
in this post I'll show that the monetary authorities have sound reasons for
keeping the price of gold at $42.22.
Below, I've charted out the history of the U.S.'s
official gold price. As you can see, the $42.22 price has been maintained
since 1973, an odd-seeming state of affairs given that gold is currently
hovering at around $1225. The practice of setting an archaic price for the
yellow metal looks even stranger when we consider that central banks all over
the world have adopted the habit of using the market price of gold to value
their gold reserves.
U.S. official gold price, 1900 to 2018
US Monetary Gold
To understand what is at stake, let's start with a few
stylized facts about U.S. monetary gold:
- Central banks that keep gold on their
balance sheet tend to hold physical gold. But the U.S. Federal Reserve doesn't actually hold physical metal. Instead, it owns gold certificates.
- The Fed registers the value of these
gold certificates on its books at $11 billion (see screenshot below). It
has used this same number for decades.
- These certificates have been issued to
the Fed by the U.S. Treasury, a different branch of the Federal
government. (To learn about why and when the Treasury issued them, read
my old posts on the topic)
- To "back" these certificates,
the Treasury in turn holds physical gold. According to the September 30,
2018 Status Report of U.S. Government Gold Reserve, the U.S. Treasury currently records 261,498,926 fine troy
ounces of gold in reserves.
- The Fed's Treasury gold certificates
are quite odd. They do not provide the Fed with a claim on a fixed weight
of gold held at the Treasury. Rather, they provide the Fed with a claim
on $11 billion dollars worth of gold. It would be as if your coat check
tag constituted a claim on $40 worth of coat, rather than the coat
itself.
How many ounces of gold does the $11 billion claim
entitle the Fed to? That depends on the price of gold that is used in the
calculation.
Gold certificates on the Federal Reserve's balance sheet
At the official price of $42.22, the Fed's $11 billion in
gold certificates lay claim to 261 million ounces of gold held at the U.S.
Treasury ($11,000,000,000/$42.22). So pretty much every bit of the
261,498,927 ounces held at the Treasury is the property of the Fed.
We can now start to see some of the complications
involved in marking the official gold price to market. Setting the official
price at today's level of $1225 per ounce, the Fed's $11 billion worth of
gold certificates would constitute a claim on just 9 million ounces of the
yellow metal ($11,000,000,000/$1225). That is, of the 261,498,927 ounces held
at the Treasury, just 3.4% would now be earmarked to satisfy the Fed's gold
certificates. This would deprive the Fed of 96.6% of the ounces that had
previously been stored on its behalf. The remaining 252 million or so ounces
of gold would henceforth constitute the property of the U.S. Treasury.
The Fed and The Treasury
But who cares, you ask? Sure, changes to the official
price of gold may alter the effective owner of the U.S.'s gold stash. But
given that the Fed and the Treasury are arms of the same U.S. government, it
seems irrelevant which of them owns the 261,498,927 ounces.
There is some truth to this. However, economists
generally believe that if a central bank is to set an independent monetary
policy, it needs to be capable of operating at an arm's length from the
government. An independent (i.e. technocratic) monetary policy is generally
believed to be preferable to one that is set by politicians, who may be
willing to take risks with inflation in order to enjoy short-term political
gain.
If the Fed is to set monetary policy independently of
political interference, it must have a large base of assets under its
control. This base of assets will allow it to repurchase currency in a manner
that reinforces its monetary policy targets, specifically its chosen path for
the purchasing power of the dollar. Without its own base of assets, the Fed
may have no choice but to depend on the goodwill of those in power to provide
ongoing resources.
And that is probably why the U.S.'s statutory price of
gold stays fixed at a decades-old level of $42.22. The consensus that
independent central banking is a good thing (because it keeps a lid on
inflation) dictates that the Fed have plenty of ammo. If the official gold
price stays at $42.22, the Fed can lay claim to the full 261,498,927 ounces
held by the Treasury. If the price is increased, the Fed gets only a sliver
of that, the Treasury laying claim to the rest. And with fewer resources, the
Fed's has less control over the purchasing power of currency.
When I hear people complain about the baffling $42.22
gold price, it makes be think of G.K. Chesterton's old
adage about fences. Before tearing down a fence
that seems to serve no purpose, first go away and think. Once you have seen
the use of the fence, you may not want to destroy it anymore. It may very
well be that the old price of $42.22 is the best official price for gold.
This blog post is a guest post on BullionStar's Blog
by the renowned blogger JP Koning who will be
writing about monetary economics, central banking and gold. BullionStar does
not endorse or oppose the opinions presented but encourages a healthy debate.
