The Dow/Gold Ratio

[Editor’s Note: The following post is by TDV contributor, Phil Champagne]

Sharelynx.com provides this interesting long term chart of the Dow measured in gold. I find this chart very interesting, although I would prefer if Sharelynx would have created two separate trend lines, one before 1913 going up at a much higher rate, and one after 1913, clearly at a much more unstable and slower growth rate.

The Dow Jones Industrial Average dates back only to the late 1800s but Sharelynx extrapolated the index to the early 1800s. Assuming this extrapolation is right, there are a lot of interesting pieces we can glean from this chart. First of all, we can clearly see the rate of growth is fairly stable except for a few occasions such as the “civil war”.

A straight line on a log scale chart means an exponential growth rate; in this case it means the Dow increased its value as measured in gold. This makes sense considering the early 1800s communication and transportation was limited to sailing boats and horse carts and a rudimentary railroad system (starting 1826), followed much later by the telegraph system. All these compared to new technological landscape of planes, trains and automobiles by the early 1900s, as well as telephones, electricity and so on. Clearly wealth was increasing in the value of companies, meanwhile the quality of life improved and the prices of very expensive items dropped such that they became affordable for everyone.

Carnegie’s method of steal production drops the price by a factor of 10, leading to cheaper, better and more railroads, facilitating a price deflation on so many items. The dreaded word: DEFLATION!!! That’s terrible!! Somebody should have called Krugman’s great grandfather back then to ring the alarms.

[Editor’s Note: See original charts here.]

Looking at the chart and focusing on the 1800s, all the bumps up and down can be attributed by one government intervention or another. The War of 1812 and its creation of the 2^nd Bank of the USA with a 20 year charter ended in 1836. There was a fierce battle between bankers and Andrew Jackson about whether or not to renew its charter. In anticipation of Jackson not renewing it, they creating a mini bubble by lowering interest rates to warn people there would be a crash if they didn’t renew it. It was not renewed and we see the crash – which would have happened anyway – with the low occurring in the early 1840s.

Then we see the panic of 1857 which was a financial panic across the USA and Europe that gets its root from the prior 5-year boom from 1852 to 1857 and which rested on widespread credit expansion with worldwide consequences. One possible explanation for this fractional reserve-fueled credit expansion might come from the modification in the Peel Banking Act of 1844 which required gold and silver reserves to back the amount of money in circulation. As we know, the more bankers can increase credit over the supply of gold and silver in reserve, the more fuel is provided to increase a bubble.

The next one is quite easy: the War Between the States. There was a myriad of ways the differences between the North and the South could have been resolved without any war, but they obviously picked the bloodiest path. Then, there was the Crime of ’73 (the Coinage Act of 1873) with silver worldwide being demonetized – no longer used for countries to cover their trade deficits. The effect of this is barely visible on this chart.

We see a few minor corrections: 1908, then around the end of WWI followed by the Depression of 1920-21 that lasted a mere 18 months because the government did what it had to do: cut expenses and let the free market determine the correct interest rate. The Federal Reserve was created in 1913 and from there we are in for a major ride.

We first start with the roaring twenties with a massive credit expansion up to the crash of 1929. Whenever we see too much of a swing in one direction, we know it has to go the other way. The rate of growth was miserable with FDR’s meddling with the economy until WW2 ends where government spending is finally significantly reduced. We get another round of a paper flood with the LBJ combo of the Vietnam War and social programs leading to a peak in the mid-1906s but then forcing Nixon to disconnect “temporarily” the dollar’s convertibility to gold. Then Volcker comes in and rescues the dollar by letting the market determine an appropriate interest rate (he didn’t set the interest rate to that level, he just let the free market be free). Excesses are cleaned up and we start again, and here we are again, going down.

As the next chart shows, clearly since the 1913 we have quite a bit more violent moves. But as I mentioned earlier, I believe a separate green trend line drawn after 1913 would have helped to illustrate the significant behavioral differences after 1913 and this line therefore would have been quite a bit more flat. But the chart would be even more negative if gold was not “demonetized” as well. If we were using gold as money just as it was in the 1800s, gold would be much more valuable today.

Much of today’s wealth is stored in CDs, Treasury notes and Money Markets, all things that are about to crash in value while gold is getting quite more attractive in this environment of sinking paper. Once this happens, the current downtrend we have seen since the early 2000s will resume much to Krugman’s chagrin who will be rushing his next article with the words bubble, gold, and bitcoin all together. [Editor's Note: Subscribers to the TDV Newsletter will already be ahead of the curve and with their money stored in forms that will generate fantastic new wealth. Click here to find out more.]

You can see that we had the Dow moving back up somewhere in the 1970s before continuing its downtrend. Expect the same with this current move up to swiftly change direction and continue down. Got Gold? Got Silver? Add some bitcoin to the pot too. I suggest you contact the folks at TDV by clicking here in order to find out how to get your gold out of dodge and to protect yourself.

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Phil Champagne is a Managing Partner at Wren Investment Group LLC, a firm that invests in real estate with equity funding from financial partners. Phil has 12 years of experience in commercial & single family investment. His knowledge of Austrian School of Economics enables his partners to navigate the real estate markets with a sound money perspective. His website can be found at http://WrenInvestment.com.

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