$20 In Gold Is Not What It Used To Be.

It’s not known for sure where the concept that an ounce of gold could always buy a nice businessman’s suit came from, but the analogy is used today by many who want to paint a positive picture for gold.  The premise of the story is used to reveal the fact that the dollar has lost 95%-98% of its purchasing power since the creation of the Federal Reserve in 1913.

The typical story goes something like this:

“In the early 1900’s an ounce of gold was worth $20.00 and could buy a nice men’s suit. During that time an ounce of gold was worth $20. Today an ounce of gold is worth around $960.00 and can still buy a very nice men’s suit whereas $20 might get you a necktie.”

But how much of the story is fact, and how much is fiction?  Are we really comparing apples to apples when we use this analogy of the price of a businessman’s suit and the price of an ounce of gold both then and now?

There’s the assumption that the $20 cash just sat there earning nothing. Is this what a person did back in the beginning of the 20th century? Who in their right mind would do this?  Would you do it today?  Today’s investor is always trying to have their money earn more money.  In the 20’s, they did the same.

The parable assumes that people did in fact take the $20 and put it under their mattress.

My grandmother was from that era and one of those who feared losing money. When she passed away in the 90’s, we found some old birthday cards that she had received with the $10’s and $20’s still stuck in the card. But she probably didn’t want to lose money in the stock market, so kept it from her husband who liked to dabble. Her husband, my grandfather, like many in the 20th century, did like to play the stock market or put their money in bonds or a bank where it could earn interest.

They called it the roaring 20’s for a reason and the stock market was doing well and so were the banks.

But the stock market crashed in 1929 and the thousands of banks failed soon thereafter.  In 1933, gold was even confiscated.

So stocks, bonds, dollars and gold all had their problems, but for the sake of argument, let’s ignore the various problems of that era and deal with what’s happened since that time with gold, bonds and stocks.

While it is true that the purchasing power of gold in and of itself has kept pace with inflation over the years, the dollar in and of itself has not.  But the dollar does offer the investor something that gold doesn’t, and that is interest.

Gold does not offer the investor any interest while the dollar that is put in the bank offers the depositor a return on their deposit. Bonds and some stocks offer interest (dividends) as well.

The bank offered a depositor interest on their savings account and this is what normal people did back in the 1920’s. This accumulated interest is what the price of an ounce of gold should be compared to today.

So to do apples to apples historical comparison, one has to measure the value of one investment that they held at that point in time versus the other based on what a rational, reasonable investor would do.

Naturally, you would agree, a rational investor would not put the $20 under their mattress back in the 1920’s just as they wouldn’t today (emphasis on the word rational here).  On a side note, I’ll also leave out of this analysis the fact that the businessman’s suit bought in the 20’s, today would be rather old and musty and more than likely didn’t retain its purchasing power and I’ll also leave out the fact that those folks who put their dollars under the mattress back then would get a decent amount for them today from collectors if they were kept in good condition.

The Historic Analysis of Gold vs. the Dollar

Since we already know the price of gold today, we need to go back and calculate the interest paid on dollars and bonds from that period of time to today.  I’ve also included a comparison to stocks.

I picked the year 1929 to do my calculation.  Gold was priced about $20 an ounce1 then and had been holding steady at that price for years.

The dollar had not yet depreciated by 60% with the revaluing of gold to $35 an ounce in 1934, so in a sense, I’m allowing for the fact that the price of gold was artificially moved higher and the dollar was knocked down a peg or two. This depreciation of the dollar didn’t help most as they were not allowed to own gold at the time. It only helped the government and the Federal Reserve, but that’s a story for another time.

So to find the interest earned from 1929 to 2008, I turned to this2 website and used the “short term”3 rates as my guide.4 Keep in mind I’m not using CD rates5 which have actually averaged 1.1% higher than short term rates over the last 10 years, but I did analyze long term bond rates6

Compounding the data, the $20 would have grown to $393.86 in the short-term asset account and $1,904.23 in the long-term asset (at a term of one year’s account) by the year 2008.7 The Dow Jones Average would have returned you $562 (before dividends).8

These figures you can then compare to the current price of gold at $981.751

You can see from this analysis that the gold price historically fits somewhere between a short term savings account and a long term “one year bond” account. Gold has performed 42% better than the DOW during this time-frame.

So if someone put all their money each year into short-term asset accounts, they wouldn’t be able to buy the same businessman’s suit as they could if they had put it in gold, but they’d still be able to buy a decent suit at Men’s Warehouse but not what $981 could buy you at Brooks Brothers.

Either way, it’s a bit of a false conclusion comparing what a $20 ounce of gold can buy in 1929 versus what $20 cash can buy today. There has been a benefit of compounding interest one has received on that $20 put in the bank over the years.  There is also the fact that the dollar still had gold backing for 42 years of this analysis until Nixon took the U.S. off the gold standard.

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Posted by Eric on Jun 2 2009 Filed under MONEY. You can follow any responses to this entry through the RSS 2.0. You can leave a response or trackback to this entry