Gold at $1,650 an ounce seems pricey to most investors simply because it costs five times more than it did a decade ago. However, $1,650 an ounce is actually a bargain if one were to price gold using the same formula that the US government used for many years. In the past, the federal government agreed to exchange gold for dollars at a fixed price of $35 per ounce. Gold's fixed price wasn't pulled out of thin air: it was established under the Bretton Woods system by dividing US gold reserves by the monetary base.
Gold reserves represent the total amount of gold the government is hoarding. The monetary base is the amount of dollars held by the public, in addition to the amount of dollars held as bank reserves.
Currently, the US government reportedly holds roughly 260 million ounces of gold. Thanks to Benny and his inkjets, the monetary base is currently flirting with the nosebleed level of $2.7 trillion. Using the government's gold price formula of yesteryear, gold's "shadow price" is roughly $10,000 an ounce ($2.7T/260 million).
The chart below tracks the market price of gold vs. what the price "should be" based on the Bretton Woods pricing method.
Contrary to popular opinion, this monetary maneuver is highly unlikely, given that a fresh flood of bonds will result in lower bond prices and rising interest rates… Oh yeah, and one helluva recession to boot!
Rising interest rates create a big problem for a country with a $15-trillion debt financed with T-bills (this isn't a 1980s debt profile). Each percentage-point rise in interest rates represents $150 billion in additional interest to pay!
What is far more likely is further expansion of the monetary base in order to keep the cost of borrowing low and the "Weekend at Bernie's" economy stumbling forward. This makes gold all the more attractive.
Will gold ultimately reach $10,000 an ounce? It may seem unlikely, but years ago it also seemed unlikely that gold would ever reach its current price. The truth is, gold's upside is only limited by the dollar's downside. While the Bretton Woods system may not give us the exact future price, it definitely tells us that the ratio of paper to gold is at remarkable highs.
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