Gold Tells the Tale of Dollar’s Health

The late Hall of Fame football coach Bill Walsh used to say that the quarterback’s footwork often told the tale of the games. If Walsh lacked access to the scoreboard, highlights and game statistics, he could tell which team did well by watching the quarterback’s footwork to the exclusion of everything else.

In trying to divine the direction of the U.S. economy we have a similarly useful signal, though one disregarded by most in the economic commentariat. The signal is the dollar price of gold (NYSE:GLD). If an individual were in a cave with no access to any kind of outside information other than the direction of the gold price, this person could reliably forecast the health of the economy, along with the direction of the stock market.

Over the last ten years the price of an ounce of gold has risen 595%, and over that same time frame the S&P 500 (NYSE:SPY) has gone up a paltry 2.9%. That’s right: If investors had purchased a scarce metal with very limited industrial uses ten years ago they would have wildly outperformed an index loaded with America’s most promising companies.

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The last ten years are not unique. In the 1970s gold rose 1,355%, while the S&P essentially went flat over the same decade with a return of 16%. Conversely, in the 1980s gold fell 52% and the S&P zoomed upward by 222%. In the 1990s gold’s decline continued by 29% and the S&P roared, up 314% for the decade.

Gold (NYSE:GLD) is a great predictor of our economic health because as the most constant, objective measure of value in existence, its price is the single best measure of the value of the most important price in the world: the U.S. dollar. Put simply, a fall in the price of gold signals a strengthening dollar, and a rise in the yellow metal signals a weakening one.

Looked at in stock market terms, when investors commit capital to companies they are buying future income streams. So when dollar policy favors weakness, as it did in the 1970s and the last ten years, the value of the income streams investors are buying similarly declines. On the other hand, when dollar policy tilts toward strength, as it did in the 1980s and 1990s, the income streams investors are purchasing rise in value, thus serving as a lure for investment capital that will be better protected by virtue of sound dollar policy.

Considered in economic terms, when the dollar is weakening investors don’t just sit back and do nothing. Instead they seek to protect their money from the devaluation through investment in hard, commoditized assets least vulnerable to devaluation. The sad economic implications of such a scenario are elementary but largely ignored by economists seemingly trained to ignore the value of the dollar.

In short, when the dollar is in decline limited capital tends to flow toward hard assets such as gold, land and rare art that already exist, and away from the stock and bond income streams that will fund the creation of wealth that doesn’t yet exist. Currency devaluation at its core is a blast to our economic past at the certain expense of our economic future.

When we devalue the dollar investment must necessarily become defensive, whereas investment that authors our advancement tends to be intrepid and offensive. Gold always tells this tale because it’s once again the single best market measure of the true health of the dollar.

Looking back to the 1970s and our most recent decade through the prism of the gold price, what’s perhaps mysterious becomes more explainable. The dollar fell substantially in both instances. Its fall easily foretold a rush into the defensive assets of yesterday, and as economies going backward are tautologically capital repellents, the investment necessary to author our advancement necessarily dried up. To put it plainly, there are no companies and no jobs without investment first, and policies of dollar weakness have made the U.S. a bad place to commit growth capital over the last ten years.

Nine individuals are presently vying for the Republican Party’s presidential nomination with an eye on unseating President Obama in 2012. Voters will surely judge them in a number of policy areas, but none are more important than their stance on the dollar. Indeed, absent improved dollar policy that tilts toward strength and stability, the economic portion of their presidencies will almost certainly fall short.

John Tamny is editor of RealClearMarkets and Forbes Opinions, a senior economic adviser to H.C. Wainwright Economics, and a senior economic adviser to Toreador Research and Trading.

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