No less an authority than Mohamed El-Erian, former CEO of the $2 trillion bond giant PIMCO, has now said in the Financial Times that we should pay attention to the rise in the gold price above $2,700, up around 40% over the past year. El-Erian is a former advisor to President Obama and perennial bond bull, so his change of view is akin to a stopped clock suddenly registering a new time. We should pay attention when this happens. In a world of fiat currencies and unreliable governments, gold or its equivalent is the only sound monetary basis. Let us hope that after almost a century of monetary folly, world leaders are re-learning this lesson.

Central banks in the 2010s thought they had solved the problem of inflation. First Fed chairman Ben Bernanke redefined the appropriate inflation target as 2% per annum rather than zero, despite even the Humphrey-Hawkins Full Employment Act of 1978, the liberal-wish-list Act that governs the Fed’s actions, requiring the Fed to promote “price stability.” In the long run, prices that rise by 2% per annum are not stable; they double every 35 years; in a century, prevailing prices will be eight times those of today. A road with a persistent moderate 2% slope is not flat; if you carry on far enough along such a road you will eventually die of oxygen starvation. A road that undulates up and down but eventually returns to the same altitude is flat in the long run. Such a long-term-flat monetary road was provided by the Gold Standard, with moderate fluctuations caused by trends in the gold supply; it is not what the Fed is currently offering us.

Bernanke’s excuse for the Fed’s 2% inflation target was that deflation was economically ruinous. There are two things wrong with that argument. First and less important, since 1996 the Bureau of Labor Statistics has engaged in a spurious “hedonic” adjustment of price indices which credits them with every increase in computer power, even though such increases have sharply diminishing marginal returns in welfare. Thus, “MS Word” of 2024 is nothing like 1 billion times as capable as the MS Word of 1996, as it should be from the increase in chip power; it is barely twice as capable, if that. Thus, all the consumer price indexes are artificially suppressed by about 0.8%-1% per annum — check a grocery bill from 20 years ago if you don’t believe me – and a reported inflation of zero is a true inflation of 0.8-1%.

Second, the historical record does not bear Bernanke out. He cites the 1880s, the one sustained period of deflation in U.S. history, when prices fell by about 20% in 1873-94, before new gold discoveries in South Africa and the Yukon caused them to rise again. Certainly, farmers in the U.S. West had a hard time in the late 1880s and early 1890s, causing the rise in the Populist movement. However, apart from drought the main cause of their plight was technological change, notably refrigerated transportation and long-distance railroads worldwide. These brought new competition for European markets from Argentina and Australia and lower farm prices, difficult to deal with for farmers with mortgages.

However, farmers’ plight in the 1880s was offset by the increased prosperity of factory workers, whose fixed wages increased steadily in value, so they saw a rise of 25% in real wages over the period. That is why strike activity increased around that time, to block employer wage cuts. By the end of the period, U.S. factory workers were the world’s best paid, despite wage-cutting competition from immigrants. (British workers were not so lucky, because of the country’s foolish unilateral free trade policies.) Bernanke’s irrational fear of inflation and the artificially low interest rates it produced (negative in real terms) were a grotesque subsidy to billionaires who could borrow cheaply and invest in inflating assets, at the expense of everyone else most especially the laboring classes without significant assets or cheap borrowing capacity.

The situation is made worse by the fact that, even with its 2% target, the Fed quite often misses that target and does not seek to claw back the substantial amounts of additional inflation it permits through those misses. With both political parties in the United States demanding lower interest rates, it seems almost certain that this folly will be perpetuated, so we will be treated to a further cycle of negative real interest rates followed by soaring inflation, with inflationary expectations then set at a permanently higher level, as they were with each cycle in 1965-80.

This column has frequently written of the fine performance as Fed chairman of the late Paul Volcker in 1979-87, who pushed short term rates above 20% and thereby conquered inflation that had been running at double digit levels. However, this praise must be tempered with a sense of reality. Volcker is no longer with us; his Chairmanship lasted only eight years, he was removed by a White House staff who resented the discipline he had imposed and, despite his example and continued wise presence for several decades, no subsequent Fed chairman made any attempt to copy him. The idea of “Volckerizing” the Fed, so that we can get the benefits of permanently low inflation and sound monetary policy without returning to a Gold Standard, is a nice one but it won’t work; the temptations on politicians and leftist economists to undermine any such regime are just too strong.

The Fed could reassert its claim to be serious about inflation (and fulfil its legislatively-imposed mandate) by revising its inflation target to zero and making a long-term commitment to keep inflation at that average rate, tightening policy sufficiently to bring prices back to their original level every time a burst of inflation occurred. That would cause massive squawking from inflation-seeking politicians wishing to run perpetual budget deficits, but it would restore the health of the U.S. economy by making real returns to savers and costs to borrowers positive. We would then be on a monetary road that undulated but was over the very long-term flat. Savers and investors would be able to plan for their retirements and other long-term needs in the confident expectation that the money they saved would in retirement be worth about the same as it is today.

Even more important, savers and investors would not be taxed on non-existent profits; interest of 4% taxed at 35% in a period of 2% suffers tax of 1.4% on an increase in real wealth of only 2%, i.e. a true tax rate of 70%. For inflation only a little higher, the true tax rate quickly rises above 100%. To the extent that the government benefits fiscally from inflationary erosion of its accumulated debt, it does so by stealing from all its provident citizens. My Great-Aunt Nan, of whom I have previously written, found her income and wealth reduced by 90% during her 25-year retirement after 1947, and almost all of that represented the British government’s hidden theft through inflation and income tax on nominal returns.

Fortunately, a solution exists. It is the same one adopted by the Roman Empire and its successor in Byzantium to repair the inflation caused by Emperor Diocletian (285-305). At Diocletian’s order they minted a new gold coin, the solidus, of high gold purity (about 23 carats) and a standard weight of 1/72 of a Roman pound. With the new coin minted in bulk under Constantine (306-337), inflation was conquered. It is more remarkable that Byzantium continued to issue the solidus, in the same weight and fineness, until it was debased by the Emperor Nicephorus Phocas (963-969) with the only change being the replacement of the Latin inscription with a Greek one in the early 9th century. The solidus thus lasted more than three times as long as Isaac Newton’s classical Gold Standard (1717-1914, interrupted in 1797-1821) and longer than any Chinese or other equivalent.

Americans will scoff at the possibility of a return to the Gold Standard, and claim that an inflation target of zero, duly authorized by congressional legislation or even a Constitutional amendment, would do just as well. However, the Biden administration’s foolish and intemperate imposition of sanctions on Russia in 2022, in particular its seizure of $600 billion in Russian dollar reserves, may have removed the freedom to continue with the fiat dollar as a global reserve currency. The inexorable 40% gold price rise, which is unlinked to any current economic conditions or the level of interest rates, appears to be caused by an attempt by the central banks of major powers, particularly China and India, to replace the dollars in their reserves with gold holdings. Such gold holdings are not subject to foolish U.S. monetary policy and can be sold on the private international market without reference to President Biden or any of his possibly even more witless successors.

If the world reverts in this way to an effective Gold Standard, no solemn declarations by Presidents, Congresses or Federal Reserve Chairmen that the U.S. inflation target is zero will have any effect; the matter will have been taken out of their hands. In that case, minting a suitably authorized high-purity gold solidus, abolishing the Fed and returning to the Gold Standard will be the only way to go. Alas, such is the fly-by-night nature of democratic regimes, a new U.S. solidus is most unlikely to last the 650 years of the original.

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(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)