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Gibson's Paradox and the Gold Boom

Recently Paul Krugman has been worrying at the question of whether the high real price of gold right now reflects fear of an inflationary future or rather something else, and coming up with the conclusion that the real price of gold is high not because expected inflation is high but because the long-term real interest rate is low:

Golden Spikes  NYTimes com

FRED Graph  St Louis Fed

On this interpretation gold is and always has been a super Treasury bond: a very long duration asset that is or at least is perceived to be "safe" in the sense that its price does not trade at a discount (due to risk and default premia) from a Treasury bond of the same duration but instead trades at a premium.

I was going to note that Robert Barsky and Larry Summers had made this argument twenty-five years ago, but Tyler Cowen beat me to it. Under a gold standard, you see, the real price of gold is simply the inverse of the price level, and real interest rates are essentially nominal interest rates--so that to say that the real price of gold is high when interest rates are low is to say that the price level is low when nominal interest rates are low:

Robert B. Barsky and Lawrence H. Summers (1988), "Gibson's Paradox and the Gold Standard", Journal of Political Economy

[A]s emphasized by Keynes (1930)… between 1730 and 1930 the British console yield exhibited close comovement with the wholesale price index alongside an essentially zero correlation with the inflation rate. Keynes referred to the strong positive correlation between nominal interest rates and the price level, which he called Gibson's Paradox, as "one of the most completely established empirical facts in the whole field of quantitative economics…. [Irving] Fisher… attempted to resolve the Gibson Paradox by combining his [Fisher effect] relation between nominal rates and expected inflation with the hypothesis that inflationary expetatios were formed as a long distributed lag on past inflation…. Shiller and Siegel reported that movements in nominal rates during that period seem to be attributable to variation in real rates rather than the inflation premium…. Friedman and Schwartz conclude "the Gibsonian Paradox remains an empirical phenomenon without a theoretical explanation".

This paper contributes a new element…. [Under] a metallic standard… the general price level is the reciprocal of the price of gold…. Since gold is a durable asset, its price is sensitive to the long-term interest rate…. [O]ur mechanism… relies on the allocation of gold between monetary and non monetary uses…

Basically, gold pays no dividends or interest. It is thus expensive to hold in your portfolio when real interest rates are high, and cheap to hold it in your portfolio when real interest rates are low. When interest rates are high, you have to be pretty confident that gold is going to rise in price in order to hold it in your portfolio--which means that when interest rates are high you sell gold unless you think the price of gold is low.