Gold Tops $3,000
Despite efforts to rein in government debt, gold prices keep rising—suggesting investors aren’t buying the promises of fiscal responsibility.
The price of gold recently surpassed $3,000 per ounce for the first time in history. For perspective, gold was around $1,185 per ounce in 2013 and just $265 per ounce in 2000. The price has increased more than tenfold in the last 25 years and is up even more in foreign currency terms, owing to the strength of the dollar. Yet the average portfolio has a negligible amount of gold in it, despite it performing similarly to stocks over time.
Gold is often thought of as an inflation hedge, but that idea doesn't always hold up. In 2022, when inflation peaked, gold prices fell. Over the last year, as inflation moderated, gold prices rose. Our experience with gold as an inflation hedge comes from the 1970s, when inflation was high and rising. Gold performed well throughout the decade and exploded higher in 1980. When then-Chairman of the Federal Reserve Paul Volcker cranked interest rates higher to stop the inflation, gold went down and stayed down throughout the disinflationary '80s and '90s. However, gold's relationship with inflation isn't consistent.
Gold is most correlated with budget deficits—when government deficits grow, gold prices tend to rise. This happened during President Barack Obama's first term, when massive government spending sent gold soaring. When the Republican opposition succeeded in slowing spending, and the deficits dropped to about 2 percent of gross domestic product, gold prices stagnated. Gold also rose slightly from the 2000 lows after 9/11, during the deficit-inducing global war on terror.
Gold benefits from rising deficits because it is an option on debt monetization. When government debt becomes unsustainable, and the supply of bonds issued overwhelms the amount demanded, interest rates rise to a point that is intolerable. In response, the government may cap interest rates to prevent borrowing costs from spiraling out of control. This practice, known as yield curve control, requires printing vast amounts of money to buy government bonds—often leading to inflation and rising gold prices.
In this context, "intolerable" means that interest payments on the national debt become such a large part of the budget that they cause debt and deficits to spiral out of control. Over the past two years, interest payments have surged from just over $300 billion in 2018 to $1.1 trillion today. If interest rates had risen by just two more percentage points, the federal government would have been effectively insolvent. This could have forced policymakers to cap interest rates—which, in turn, could have triggered unlimited money printing and runaway hyperinflation. Treasury Secretary Scott Bessent, therefore, has identified the debt as a national security issue. This is why the stated goals of the Department of Government Efficiency (DOGE) are so important. If we can cut $1 trillion in waste, reform entitlements, rethink defense spending, and bring interest rates down, we can refinance the debt at lower rates and solve this crisis.
What's alarming is that even with these efforts to reduce the debt, the price of gold keeps heading higher. This indicates that perhaps the financial markets don't believe that DOGE's deficit-cutting efforts will be successful in the long run, which is not unreasonable—the instinct of politicians is to spend, and DOGE has already made some missteps in its first few months.
Perhaps the financial markets believe that DOGE will fail. Another possibility is that China, as well as many other foreign central banks, continue to buy gold as a result of sanctions against Russia, though they have slowed down recently. Cash held in an overseas bank can be seized—gold held within sovereign borders cannot. Since the beginning of the war in Ukraine, foreign governments have been busy "diversifying their reserves" into gold, causing upward pressure on the price.
The U.S. remains the largest holder of gold in the world, with 4,582 tons of it in Fort Knox—allegedly. This gold is worth $800 billion at today's prices, which would only fund government spending for about a month and a half. The U.S. dollar has not been backed by gold since 1971, when President Richard Nixon suspended the convertibility of dollars into gold and made private ownership of gold legal. There are currently about $22 trillion dollars in existence. In order to return to a gold standard, we'd either have to acquire a large amount of gold, or more likely, revalue gold higher so that it equals the supply of money.
Gold tends to rise when governments mismanage finances and fall when they act responsibly. That is why the government has historically been hostile to gold, even confiscating it in the past—it is the one "release valve" in the markets that allows people to protect themselves from financial mismanagement at the federal level. If gold keeps climbing despite efforts to cut the deficit, it suggests the markets have little faith in those efforts—and that should concern all of us.
