God bless Peter Bernstein, may he rest in peace. No one else could make arcane and seemingly dull topics (e.g. the history of gold or of statistics) so fascinating and accessible. In 2009, the year of Bernstein’s death, the celebrated academic economist Niall Ferguson published a bestseller, “The Ascent of Money: A Financial History of the World.” In my humble opinion, it was a dud. But this book, “The Power of Gold: The History of an Obsession,” first published in 2000, is the real financial history of the world for the layman. It is brilliant, penetrating, concise, and convincing.
There is much to commend about this book. And there is a lot that it covers. Allow me to distill it down to half-a-dozen central highlights, although that is a rather arbitrary number.
First, why gold? What is it about this element that has made it such an enduring part of the world’s monetary system, regardless of time period, location, or economic system? Bernstein explains that gold, alone among natural elements, shares the following characteristics: 1) it is universal (gold has been discovered on every continent other than Antarctica); 2) it is enduring (gold never rusts or tarnishes); 3) it is malleable (gold can easily be crafted into almost any imaginable shape); and 4) it is extremely dense (an equivalent monetary weight for gold in silver is enormous).
In some historical circumstances gold was easily obtained (e.g. the chunks of pure gold in the river Pactolus or at Sutter’s mill), but historically gold is difficult to produce. For example, “To produce one ounce of fine gold [in South Africa in the late 1990s] requires thirty-eight man-hours, 1400 gallons of water, electricity to run a large house for ten days, 282 to 565 cubic feet of air under straining pressure, and quantities of chemicals including cyanide, acids, lead, borax, and lime.” Such efforts are justified because gold is…well, gold. “Unlike other forms of money,” the author writes, “gold has never lost its poetic quality. It has always been both sacred and profane.”
Second, gold has always been a store of value (i.e. used for adornment and as treasure), but it hasn’t always been “money.” Bernstein writes that gold-as-money was born in Lydia, in present-day Turkey, the home city of the fabled Midas, around 650 BC. Croesus, the Lydian leader who was defeated by Cyrus in the Persian Wars, provided the central innovation of gold coinage. For the first time in history coins of equal size, weight, and value were minted by a central government and accepted far-and-wide in the Eastern Mediterranean. Eventually, the Lydian style of uniform gold coinage was adopted by other governments, including the Byzantine empire, which introduced the famed bezant, “the Dollar of the Middle Ages,” whose stability and intrinsic value “has never been equaled or even approached by any other currency,” including the modern US dollar, according to one scholar cited by Bernstein.
Third, the author compares and contrasts the two great ages of gold discovery. Between 1492 and 1600 the stock of silver and gold in Europe is estimated to have grown fivefold, yet the primary producer (or extractor) of New World specie, Spain, did not benefit long term. Rather, “Spain acted like a poor man who makes a great windfall at the gambling tables but comes to believe that the money is his destiny rather than a nonrecurring event,” freely spending fortunes on luxury goods produced around Europe rather than investing in domestic economic development. Spain was really just a bridge for gold and silver to get to Europe and Asia, where trade flowed in a one-way direction. “Asia turned out to be a sponge for gold and silver,” according to the author. The Asians traded silks and spices for gold, which they did not spend but rather refactored into adornments, thus depleting Europe’s stock of specie.
Worse yet for Spain, 1492 also marked the beginning of the expulsion of the Jews and Moors, the country’s primary merchant classes. (The Spanish empire went on to declare bankruptcy in 1576, 1596, 1607, 1627 and 1647.) As New World specie continued to pump into the European economy via Spain, prices began to rise steadily resulting in various schemes to debase the currency, including Henry VIII’s “Great Debasement” of 1542-1547. Monetarist economists like Milton Friedman (and plain common sense) would suggest that the new specie caused this so-called “Price Revolution of the 16th Century,” but Bernstein suggests the opposite may be the case. That is, it was the extreme demand for specie that drove the extensive exploration and seizing of gold.
As dramatic as the New World specie conquests were, they were dwarfed by the gold discoveries in California, Australia, the Klondike, and South Africa in the late 19th century. A few numbers make the point dramatically. The New World discoveries in the 1500s about doubled global gold production to 7 tons a year. By 1860, with Californian, Australian and Russian production in full swing, world production was 275 tons a year, a forty-fold increase! And that was before the discoveries in South Africa and the perfection of the cyanide method of efficiently separating gold from ore. Whereas California gold production peaked at 95 tons in 1853, South Africa peaked at 120 tons in 1898. So didn’t all this new gold produce inflation? Why was there not a corresponding “Price Revolution of the 19th Century”? Bernstein cites a few reasons: 1) wars during the 1500s were long lasting and total in nature, unlike the late 1800s, which only experienced a few intense wars of short duration (US Civil War, Franco-Prussian War, Crimean War); 2) economic productivity during the industrial revolution absorbed much of the money (consumption of energy in the US alone grew from 3 trillion BTUs in 1800 to 7,322 trillion BTUs in 1900); and 3) massive amounts of gold were hoarded by a new global entity, government central banks, in support of a new international monetary system, the gold standard.
Fourth, few authors do a better job explaining the classic gold standard than Bernstein does here. His main argument, echoed by many others, is that the gold standard was a symptom and not a cause of the tremendous economic expansion and relative stability of the pre-World War I global economy. Indeed, he writes that it was “…a system whose simplicity and elegance was unmatched in the history of money.” Built on experience and without any written rules, much like the British government, the gold standard nevertheless “developed all the trappings of a full-fledged religion: shared beliefs, high priests, strict codes of behavior, creed, and faith.” Moreover, it became something of a national status symbol, or as the great economist and historian Joseph Schumpeter put it, “a symbol of sound practice and a badge of honor and decency.” In this system, all national currencies adhering to gold, nearly 50 at its height, “were just names for particular weights of gold.”
Or as Bernstein succinctly puts it, “The gold discoveries in California and Australia and the Comstock Lode in Nevada, the appetite of Indians for silver, the American Civil War, and Germany’s overwhelming ambition to be a great power in effect backed the world into [a gold standard] that no one had anticipated and that many people were reluctant to accept. Once in place, however, the system displayed remarkable durability for the next half-century.”
The system worked only because all participants were committed to making it work, regardless of the domestic implications. If a national currency began to depreciate against its pegged value to gold, the primary response was to raise domestic interest rates to attract foreign investments, which would strengthen the currency but tend to produce subdued business activity, leading to higher unemployment. The high unemployment would keep wages in check, which would keep price increases in check, which would tend to strengthen the foreign exchange value of currency even more. Bernstein writes that the “system is singularly simple and effective – just so long as you ignore and/or are impervious to the human dimensions of the policy leading to unemployment and falling wages.”
Fifth, there is the tragic story of the interwar period and the Great Depression, and gold’s central role in it. Bernstein notes that the catastrophe of World War I obliterated many of the pre-war social, economic, and political norms. But that “…one paramount feature of the prewar era rose triumphantly from the ashes: gold.” National governments hastened to restore gold convertibility as soon as possible (England returned to gold in 1819, 4 years after the defeat of Napoleon and once price levels had returned to 1798 levels; it took England 7 years after WWI to return to gold and even then prices were still double what they had been in 1914). The essentialness of the gold standard became embedded in many people’s minds, Bernstein writes. In the words of Montagu Norman, Governor of the Bank of England from 1920 to 1944, a gold reserve and gold standard “were as necessary, and as dangerous to do without, as a police force and a tax collector.”
They all failed to realize that the gold standard was the symptom of their pre-war prosperity, not the cause of it. Or as the author expresses, “The notion that gold would make everything come out all right was a notion that was upside down; gold would make everything come out all right only when everything was all right in the first place.” The post-war world was “no right” in many respects necessary for a smoothly functioning gold standard. No longer was a national commitment to upholding the currency price of gold a foregone conclusion. Labor groups began to flex their political muscle against monetary policy moves certain to increase unemployment. And gone were the pre-war years of international cooperation as disputes over reparations, war debts, and national minorities undermined efforts at cross-border economic policy collaboration. Under such conditions, the prevailing gold standard was doomed to fail, especially if hit with an economic shock such as that experienced in 1929. The knee-jerk contractionary monetary and fiscal policies prescribed by the gold standard (raise interest rates and taxes while cutting government spending) turned a mild recession into a global economic catastrophe.
Roughly two-thirds of US banks folded as the Fed refused to inject liquidity into the markets for fears of destabilizing the dollar price in gold. In January 1934, FDR dropped his “bombshell” message that would raise the convertibility rate of gold to the dollar from $20.67 set in 1900 to $35.00, a 69% increase, but one that would last for 37 years. This jump in the price of gold led to a “golden avalanche” as gold production soared. By WWII, 60% of the world’s monetary gold was in the US, weighing some 15,000 tons (in contrast to the Inca ruler Atahualpa’s “Chamber of Gold” of some 6 tons in the 16th century).
Finally, there is the story of “gold unhinged,” a period in the post-Bretton Woods years when gold climbed to heights of value that would make Spain’s Philip II blanche. After over thirty years of being pegged at $35 an ounce, gold was allowed to float in 1971. The US Treasury tried to adjust the price to the low $40s as inflation raged across the industrialized world, but the price of gold continued to rise steadily, almost unbelievably. By 1980, an ounce of gold peak at $850 – an annual price increase of 30% from 1968 to 1980, a period when the inflation rate averaged 7.5%. Up to that point, the best 12-year stretch for the stock market was 19%/year from 1949 to 1961. By 1981, the US gold stock had dropped from 75% of global totals in 1949 to just 25%. But this was gold’s high water mark – for a time. In 1980 the price of gold and the Dow Jones Industrial Average (DJIA) were nearly equal: 850. By 1999, gold was trading for $300 an ounce while the DJIA stood at 10,000.
This book, again published in 2000, seems to end on the note of “the death of gold.” That “barbarous relic,” as Keynes famously called it, had finally been buried. Or had it? The price of gold has risen steadily throughout the 2000s, peaking at roughly $1,700/ounce in 2011 and 2012. Today, the price of gold closed at $1,187.30. Perhaps reports of the death of gold have been greatly exaggerated after all.
In closing, Bernstein takes a rather dim view of his subject. “Disappointment, disillusion, and defeat have overcome everyone in this history who was so blinded in the pursuit of a hoard of gold that they could not comprehend the difference between a useless metal and real wealth,” he writes. I’m rather surprised he would be so cynical after chronicling so well the overwhelming power of this mysterious element. What other tangible “thing” has had such a dramatic impact on human society across time and place? He also writes “Where gold is involved, dreams seldom come true.” And perhaps that is a better way of putting it.
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