THE ECONOMY: NEW FEARS OVER INFLATION : Greenspan Uses Gold as Hedge for Future Interest Rate Hikes
Despite strange talk by Federal Reserve Board Chairman Alan Greenspan, the price of gold doesn’t have much, if anything, to do with the U.S. economy, or with the rate of inflation.
So it’s a mystery why the Fed chairman told Congress in testimony last week that gold “has shown a consistent lead on inflation expectations and has been over the years a reasonably good indicator of inflation.”
In fact, the record of the last decade shows no such thing. While U.S. inflation in the 1980s averaged 4.7% a year, the price of gold seesawed violently and declined 3.4% a year on average.
Why did Greenspan, who knows that record, declare that he uses the gold price as a guide in making interest rate policy? Fed chairmen don’t explain their statements, but it just may be that Greenspan is using gold as a stalking horse, a handy cover allowing him to exert a moderating influence on the strengthening economy. To that end, he’s been using small hikes in short-term interest rates and a lot of scare talk about gold and industrial commodities, such as nickel, aluminum and copper.
Some price inflation is showing up in those commodities, the National Assn. of Purchasing Management reported Tuesday. But even there, professional “hedge funds” pouring vast pools of investment into commodities may be distorting the markets. To the extent that speculative buying of commodity futures, rather than real industrial demand, has pushed up metals prices, those prices are subject to downdraft.
In other words, there may be less than meets the eye in inflation statistics.
What really is happening with gold is that there is an increased worldwide demand for it in jewelry, especially in developing countries.
Jewelry demand has risen to more than 80 million ounces, from 27 million a decade ago. Global consumption has outrun new gold production for the last four years, with the shortfall being made up from gold scrap, sales by central banks and other means. Yet there seems to be no shortage of the yellow metal.
Through most of the unprecedented rise in jewelry demand, the price of gold has been declining. Even today, with production all but shut down in the former Soviet Union, the price remains less than $400 an ounce. Leading analyst Ian MacDonald of Credit Suisse doesn’t expect gold to “go screaming up.” But he does predict it will go above $400, from about $382 now.
The story on gold these days, unlike in the 1970s, has little to do with hedging against U.S. inflation and a lot to do with purchases of jewelry in China, says analyst Vahid Fathi of Kemper Securities.
There is new wealth in a rapidly growing economy in China and a desire to buy something that might hold its value amid inflation running 15% a year. Chinese purchases now account for almost 14% of global jewelry sales.
The tradition in India is that even poor farmers buy gold jewelry for dowries. Now there is more cash circulating in India’s economy and farmers are buying more jewelry. That reflection of rising living standards is occurring in many developing countries, where people have always valued gold for its stability.
In Turkey, a gold exchange has opened in Istanbul to draw hoarded gold out of households and into circulation, boosting the economy.
In any event, gold fever in Shanghai and Bombay has little to do with the U.S. economy. Even the gold jewelry sold there is different from the trinkets in U.S. stores. Bracelets and rings typically are 24-karat, pure gold and priced on their gold content.
But in U.S. jewelry stores, the price of 14-karat bracelets and rings reflects the jeweler’s art and the merchant’s markup; it is far beyond the gold value.
Anyway, gold is not much of an investment, paying no interest or dividends and as likely to fall in value as go up. Investment manager Kenneth Fisher of Fisher Investments in Woodside, Calif., predicts a long downward trend for gold’s price, based on increased production and a leveling off in demand. He is also skeptical of most high-flying metals prices, reckoning that inflation pressures will remain low in a world where economic efficiency is improving.
And the possibility that gold might fall is a further hint that Greenspan sees it as a useful scapegoat for action he may have to take to control the economy. If the price of gold goes up, the Fed chairman can use that fact as an excuse to raise short-term interest rates. If it goes down, that may persuade the markets to bring bond rates back down gain.
Greenspan’s motive is clear and commendable: He wants to prevent inflation from seeping into the economy and influencing wages, cost-of-living adjustments for Medicare and labor union contracts and the assumptions businesses make about investment returns.
Inflation, like carbon monoxide, is insidious and deadly. Global investors have been jumpy lately because they detect something in the air. That’s why stocks and bonds are falling. But, like Greenspan’s reference to the price of gold, it may only be a false alarm.
