Gold Prices Disprove Krugman

Gold Prices Disprove Krugman
Profile photo of Robert P. Murphy

Recently Krugman wrote an op ed ridiculing Ron Paul titled, “The Old Man and the CPI.” (In case you don’t get the reference, he’s alluding to Hemingway.) Ron Paul has responded in this video, but I want to focus on Krugman’s complains about gold bugs:

Ron Paul has been making the same prediction year after year — in fact, he’s been making this prediction at least since 1981!— and has been wrong year after year. It’s hard to think of a doctrine that has been as thoroughly refuted by events as goldbug economics. For a while gold prices did go up, although not for the reasons the goldbugs thought, but now even that has gone into reverse. So why would anyone pay money for this guy’s analysis?

This has been quite the cause for celebration among progressive economists. (I won’t link to some of the lesser lights and reward them for their smugness.) And it’s true that a simple story relating the Fed’s balance sheet to the price of gold doesn’t work out very well:

Gold vs Fed

In the chart above, total Fed assets (red line, left axis) are plotted against the price of gold (blue line, right axis). People who thought the price of gold would move in lockstep with the Fed’s QE programs were sitting pretty during QE and QE2, but then things turned around with QE3. It almost looks as if the commencement of QE3 (when the red line started stairclimbing up) was the catalyst for making gold plunge about $600 an ounce.

Nonetheless, suppose someone bought into the warnings of Ron Paul (and guys like me) when Bernanke began his unprecedented monetary inflation, back in late 2008 / early 2009, and began buying gold as a hedge. Depending on when exactly you got in, gold was selling for anywhere from $700 – $900 an ounce. It is currently about $1,100. So, that means you have made a cumulative return of about 25% – 50%. (I’m obviously just ballparking the figures.) And, you’re still sitting on a really good hedge in case things go south. We are by no means out of the woods with ~$4.5 trillion in assets on the Fed’s balance sheet.

Now what’s interesting is that in the quote above, Krugman said, “For a while gold prices did go up, although not for the reasons the goldbugs thought…”

Do you know what he means? He is referring to his earlier analysis in which he explained gold prices as moving in response to real interest rates. Based on Harold Hotelling’s analysis of exhaustible resources (which I develop here in the case of oil), Krugman argued (plausibly, I might add) that we would expect gold prices to jump upward as long-term real interest rates fall. So, Krugman thought that the goldbugs had just gotten lucky on the way up, because the Fed was expanding its balance sheet to counteract the liquidity trap into which the U.S. had fallen.

Okay fair enough. So how has Krugman’s theory held up since he advanced it? At the time, both his theory and the inflationistas’ could explain the data. We know now that the inflation-hedging story can’t handle QE3 very well, and consequently Krugman declares such people to be unscientific hacks (and also racists, if you read the link). What about Krugman’s theory in the last few years?

Gold vs TIPS


This chart plots the gold price (red line, right axis) against 20-Year Treasury Inflation-Indexed Securities (TIPS, blue line, left axis). Up until early 2014, it does a good job explaining big swings, in line with Krugman’s preferred theory: As 20-year expected real interest rates fall (from 2009 – late 2012) gold prices zoom up, and even the crash in gold prices starting in mid-2012 is kinda sorta tied to the spike in TIPS yields beginning in April 2013. The timing isn’t great, but to the naked eye the red and blue lines look like mirror images during the big moves.

However, what happened since early 2014? Gold prices have bounced around in a tight zone, even though 20-year TIPS yields dropped almost a full percentage point. Back in early 2012, when the blue line was at a comparable level, gold prices were above $1,600. And in any event, Krugman’s baseline theory says that there should be a permanent upward drift in the price of the resource, as its exhaustible supply flows into difficult-to-recover uses (like dentistry). That means that if the interest rate comes back down in 2015 to where it was in 2012, then the spot price should be higher than it had been three years earlier–certainly not $400 (25%) lower.

So since Krugman’s own theory explaining gold price movements has been refuted by the empirical evidence (see here for more), I suppose we will see a string of posts from guys like Noah Smith on Bloomberg making fun of anybody who reads Keynesians. Right?

  • Haywood Jablome

    That is the best part about being a non-thinking, liberal progressive (but I repeat myself)…you are NEVER held accountable and NEVER have to admit to mistakes. That is why they name call and bully rather than debate!

  • Haywood Jablome

    That is the best part about being a non-thinking, liberal progressive (but I repeat myself)…you are NEVER held accountable and NEVER have to admit to mistakes. That is why they name call and bully rather than debate!

Profile photo of Robert P. Murphy

Robert P. Murphy is the Senior Economist at the Institute for Energy Research, and a Senior Fellow with the Fraser Institute. He holds a PhD in economics from New York University. Murphy is the author of Choice: Cooperation, Enterprise, and Human Action (Independent Institute, 2015) as well as numerous other books and hundreds of articles.

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