21. How to Evaluate the New Price of Gold

(L’Opinion, October 30, 1952)

It is perhaps to abuse the patience of readers of this journal to speak to them again about the price of gold. However, it is not needless to recall again how the problem presents itself from the point of view of economic logic. That is what I shall try to do here, while excusing myself in advance for the rather austere character of these considerations.

When gold serves as a monetary standard and the paper in circulation is freely convertible into metal, the rate of exchange of gold against commodities establishes itself in the simplest manner. Any increase in the production of gold sold to the bank of issue automatically increases the amount of paper money. By a well-known process, this increase tends to raise the level of prices of merchandise. In other words, the purchasing power of gold, like that of the convertible paper, decreases.

On the contrary, when the production of merchandise increases at a more rapid rate than the increase in the production of gold, we see a decline in the general level of prices, that is, a rise in the purchasing power of gold.

These formulae that contain what is wrongly called the quantitative theory of money, appear obsolete today to a great number of economists, who are startled by its mere mention. I believe, however, that they have been confirmed by the entire history of prices in the nineteenth and the beginning of the twentieth centuries.

Besides, they were confirmed when the formidable influx of merchandises in the world markets, after 1930, brought about what is called “the great depression.” The interpretation of this crisis, far from being a sort of mystery, is, on the contrary, most simple and conforms perfectly to the data of economic experience.

It is quite different when the paper in circulation is no longer convertible into gold, but constitutes itself the monetary standard. Gold, whether coined or not, has henceforth a variable price in paper money, like that of merchandise. It has itself become a commodity that may be bought and is sold in the market, like any other commodity.

As for commodities, their prices are no longer in relation to the gold produced, but in relation to the paper money issued. There is no longer any relation between the production of gold and the prices of commodities. Another relation arises, between the issue of paper money and the price of merchandises, gold included.

This accounts for the lack of equilibrium which we note today and to which is added a supplementary imbalance. While the price of commodities expressed in dollars in the United States has practically doubled, that of the gold sold at the Treasury has remained the same. Why? Because we are dealing with a single buyer, a monopolist who arbitrarily fixes the price of gold, all, or nearly all, the other outlets having been closed by the prohibition of the free sale. There results this paradoxical consequence that the same weight of gold, transformed into dollars by the Treasury, can now buy only half of what it bought formerly. The purchasing power of gold has been practically reduced by half, exactly as if the amount of gold produced annually in the world had been greatly increased, whereas it has remained identically the same.

When it is proposed to increase the price of gold expressed in dollars, we propose, in reality to bring the purchasing power of gold closer to what it would have been if gold, instead of paper money, had been increased in quantity. In other words, one tries to come closer to what might have been if the paper money in circulation had evidenced an increase in the production of gold, which, in fact, has not been the case.

One can imagine another procedure which, on the contrary, would consist in bringing the price of merchandises closer to what it would have been if the production of gold had continued to remain stable in the face of a rapidly increasing amount of commodities. This is the phenomenon we witnessed between 1875 and 1895, a long period of continuous decline in prices. In this case, in order that the prices of commodities might meet the rising purchasing power of gold, it would evidently be necessary that the level of prices be lowered to a point where this increased purchasing power would be sufficient to restore the equilibrium.

However, this last solution, the one which consists in allowing all the prices to fall, meets with violent opposition, withal justified, on the part of all governments. This is the phenomenon we have witnessed since 1929, which in economic history is called by the name “great depression.” Such a decline in prices carries with it a dangerous reduction in economic activity, unemployment, and loss of earnings so fatal to the well-being of the most impoverished classes, that no one can think for a moment of deliberately accepting a policy that would lead to it.

There is, therefore, no other way of constituting a solid base for the paper money and an international monetary standard, than that which consists in adjusting the value of gold to the new value of the dollar in merchandise. The point is, in fact, to recreate a new unity of prices in gold, having no reference to the old unity.

How can we solve the problem?

On the one hand, the production of gold having remained the same, there is no reason that its real purchasing power should have varied since 1940. An ounce of gold continues to be worth the same quantity of merchandise and of services as in 1940. (There are even reasons to believe that it is worth more, given the enormous increase of commodities.) However, at the same time, the amount of paper dollars in circulation has increased in such a way that one dollar buys only half the merchandise and services which it bought in 1940. Therefore, a paper dollar does not represent more than half the gold it represented formerly. If one wishes to render it convertible into gold, one must fix its price in gold at half of its former price—and, consequently double the price of thirty-five dollars per ounce, which amounts to fixing the dollar at 1/70th instead of l/35th of an ounce.

This calculation, one may say, is rather rough. I only give it in order to show concretely the reasoning by which one arrives at the inevitable conclusion that the price of the gold in dollars must be increased.

One may present the problem under another form and ask by how much the physical quantity of monetized gold should have been increased to cause the doubling of prices which we have seen. As this physical increase is not possible, it suffices, in order to obtain the same result, to multiply by a certain coefficient the value, expressed in dollars, of the existing gold.

Can we base ourselves on previous experiences? Can we calculate what should have been the increase in the quantity of gold so that the purchasing power of the dollar would fall to its present level and, in consequence, apply this percentage of increase to the quantity of gold existing today?

The only example that we have is the considerable increase in the quantity of gold produced after 1900, which had for effect the important rise of world prices between 1900 and 1912. But it is dangerous to lean upon historic precedents in a matter in which all the circumstances, technical, financial, psychological, have undergone changes as profound as those we have witnessed since the First World War.

Another example is the devaluation of the dollar in 1933. There is no doubt that this devaluation, so criticized and attacked still today, in the United States, has however had the result of arresting the depression of 1929 and setting this great country back on the road to prosperity. The devaluation at that time was 35 per cent. It certainly helped to control the decline of prices and restore to the American economy its power of expansion.

In any case, and whatever may be the methods adopted to arrive at how much one should devalue the dollar, or, more exactly, what weight in gold one should assign to the new dollar, there will necessarily be some uncertainty and chance in this operation.

It is understood, under these conditions, that responsible governments hesitate and fear the hazards in all such decisions.

It remains no less true, however, that the present situation is contrary to all monetary logic and that it tends to perpetuate the insecurity in international commerce, and the lack of equilibrium in the balances of payments, with all the grave inconveniences which this lack of equilibrium entails.

There is more. If, as many signs indicate, the entire world is headed toward a period of decline in prices, the only way that we can see to prevent this decline from becoming catastrophic is precisely by increasing the production of gold to a point where it will suffice to sustain the prices at the level where the results of the war and the universal creation of paper money have unfortunately brought them.