21 October 2009
How gold preserves its value

I am not quite sure how this came about but you know how it is: you start rootling around in the numbers and before you know it you’ve produced a table with the gold price divided by the GDP deflator for every year the 20th century. 

And then you do a graph (click to enlarge):


Now parts of this graph are easy to explain:

Why is the number for 1900 almost exactly the same as it is now?  Easy, gold preserves its value.
Why the huge upsurge in the 1970s?  Because people were scared of inflation.
But some are not so easy:
If the 1970s inflation caused an upsurge why not the Great War inflation?
What was going on in the 1930s?  Sure there was an initial upsurge after Britain abandoned the Gold Standard in 1931 but after that nothing.
Why the gradual decline after the Second World War?  I offer as a possibility that people had confidence in their currency even though it was slowly but surely losing value.  Actually, that might well explain the post-Great War decline as well.

Now, there is one big problem with this graph and that’s the GDP deflator.  It is, I presume, calculated by the government so all sorts of inaccuracies could have crept in.  I mean how has it been calculated down the decades? - that’s bound to have changed.  And who’s to say that at some point the calculators haven’t been leant on to massage the figures?

But it’s the best we’ve got.  And when it comes to being a store of value gold is the best we’ve got.

Unless I do the figures for silver…

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  1. There is no accurate way to have a GDP deflator. The composition of GDP changes dramatically over time, and there is no way to quantify it. What deflator makes sense depends significantly on what problem you are trying to solve, and these things are always artbitrary.

    Yes, there is a monetary aspect to inflation, but separating it from economic aspects is difficut, if not impossible.

    Posted by Michael Jennings on 27 October 2009 at 05:12am

  2. GDP problems aside, how would the chart look if you added the same data for the US and Germany? 70’s oil shock aside, would Germany show huge spikes post Great War and WWII? How would the chart look with gold compared to other assets over the same time period?

    Posted by cjo on 27 October 2009 at 04:44pm

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