For ages, the price of gold and the price of oil have held at the same ratio. An ounce of gold divided by a barrel of oil, both things priced in dollars, has always been 15, plus or minus about 3. Back before the United States went off the gold standard, in 1971, and the so-called “oil shock” of 1973, gold was steady at $35 and oil at circa $3. Ratio, about 12. When gold and oil both rocketed skyward in the 1970s, the near-to-15 ratio held. As it did throughout the 1980s and 1990s, when gold and oil both tumbled and stayed low. Pick a time, any time. Mid-1996? Gold at $385, oil at $20.5, ratio just over 15.
Gold and oil zoomed upward in the 2000s through the Great Recession, zigzagging together. Then a vagary came. In mid-2014, oil took a major fall and stabilized low, while gold took a little fall and held there. For a few years, the ratio was pushing 30, with gold around $1300 and oil at $45.
The closing of this ahistorical variance is coming to pass at this moment. Gold is tanking a little, testing below $1300, and oil has kicked up over the last few months, to the low $70s. The current ratio is about 18.
In the 1970s, Berkeley business professor Roy Jastram referred to the gold-oil price correspondence as part of a “golden constant.” This particular relative price almost never changes. But why?
Gold is the world’s preferred form of final money. It’s the place people go when they want money but would rather not hold it in currency. The world’s dominant currency is the dollar. Therefore, as David P. Goldman has long said, the price of gold is an index of worldwide confidence in the dollar.
Oil, in contrast, does not appear to be everybody’s final money, or even money at all. It’s a commodity we have got to have to motor around this world of ours in cars and trucks.
Yet geological restrictions define its supply, as in gold; and you can divide oil up into little units and ship them separately without losing any of the nature of the product, as in gold; and in the form it is traded (crude), it does not degrade, as in gold; and the price ratio holds. Oil, whatever its role in the daily activities of the global economy, sports a price that is a proxy for that worldwide vote on the value of the dollar, the price of gold.
It is a global consensus that oil is a little high in the 70s, and gold in the 12/1300s. Therefore, there is a global consensus that the dollar is not quite good enough. This means that investment capital is not deployed as deeply as it could be in real enterprises. The result is opportunity left untaken, less enterprise, less work and production, less exchange, slower growth, and less economic flourishing among humanity at large than there naturally would be.
For the few years when the gold-oil ratio was un-sustained, it was possible, if improper, to wave off the price of gold as a reflection of the preoccupations of “gold bugs,” of cranks who bet against the economy. Here lay one of the great effects of the gold/oil golden constant when it had held prior to 2014. Everyone cared about the price of oil, the general view being that the higher the price, the more the economy is out of whack. By extension, everyone felt the same way about gold. The golden constant involving oil forced us to take the price of gold seriously.
The improvement in oil production methods (fracking etc.) appeared, after 2014, to break the geological hold on oil, and the golden constant with it. As of now, that was a temporary break. We can be sure the numerator and the denominator of the golden constant will fall in tandem, and in the context of a resurgence of economic opportunity, when we once again let desire for doing real things in the economy roll. Government’s part is to get unobtrusive, via low tax rates, spare regulation, free trade, spending restraint, and permitting the provision of good sound money that people love to use.