Gold and Oil: A Tale of Two Commodities

By Contention News

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Gold broke $1,930 an ounce this week, its highest level ever. This follows weeks of record inflows to gold-related exchange traded funds (ETFs), and comes alongside silver’s biggest weekly gain in four decades.

Oil also advanced last week, but prices remain depressed -- the fracking industry now faces “extinction.”

Solving the puzzle of how metals can be gaining while the production of the most crucial commodity of our times can “peak without ever making money in the aggregate” unlocks important insights into how our global system works at its core. 

Money and the world of commodities

To repeat: money exists to circulate commodities. [1] Anything can serve as money as long as there is a stable relationship between the value of money at large and the world of commodities it circulates. The best way to do this: pick a representative commodity to serve as money. [2] Metals have low carrying costs and are easily divisible, so most epochs have settled on gold or some other metal for this purpose.

Since 1973, however, the world money system has not relied upon a representative commodity. Instead it has relied upon the United States to use political and military means to keep commodity prices stable. [3] The easiest way to keep prices steady: pin them down. Prices and profits serve as the signal for action: higher commodity prices = higher input costs = squeezed margins. 

Politicians don’t have to worry about the monetary system, they just have to think about corporate earnings. 

Oil prices and economic crisis

This worked for most of the world’s commodities save one: petroleum. The oil crises of the 1970s prompted a multi-year inflation crisis and economic “stagflation.” The United States responded with the Carter Doctrine, which defined the free flow of oil in the Persian Gulf region as a matter of U.S. national interest, justifying persistent military presence in the region and strategic alliances with key oil-producing states to keep prices low.

This system broke down between 2003 and 2008, with oil prices spiking more than $120 a barrel over that period. What caused the spike? The most likely causes:

• unanticipated popular resistance to the U.S. intervention in Iraq 

• accelerating energy demand from China’s rapid economic development

• significant financial speculation [4]

This price rise reached crisis levels in 2008 immediately prior to the Great Recession. Correlation isn’t causation, but it isn’t out of line to think that rising fuel and other commodity costs might have prompted an uptick in mortgage defaults. The same goes for investors selling off previously iron-clad securities as prices in general grew unstable. 

Fracking provides a crucial response to this kind of crisis. Not profitable under normal conditions, rising prices draw investment into the sector, bringing on new supply, driving prices down again. Companies borrow big to get started and go bust quickly, but executives get their golden parachutes, creditors get their settlements, attorneys make killer fees, and large firms gobble up all the abandoned assets. Only oil workers, royalty owners, and taxpayers lose.

Gold’s moment today 

Now a new crisis from outside the energy sector has destroyed demand and plummeted prices. [5] Central bank “money printing” in response should be inflationary, and thus the rise in gold prices, according to conventional economic wisdom.

Except that conventional wisdom is actually backwards. The money supply does not determine prices, commodity production determines how much money you need. If production goes up or production costs get bid upwards, [6] you need more money. Money gets pulled out of savings, banks increase lending, and the supply and velocity of money goes up.

Simply pouring more money into a depressed market, on the other hand, drives that cash into savings. This oversupplies money markets, driving down interest rates. As real rates — interest minus expected inflation — dip into negative territory, gold’s zero yield becomes a better bet than anything else. That’s how you end up with low oil prices, a collapsing fracking industry, and rising gold values. 

But now U.S. political failure is putting the whole dollar system into question over and on top of this. The result: investment flowing out of the dollar and into the yuan and the Euro. Without a clear alternative to the dollar as “world money,” gold is even more attractive as an asset. If rising demand in countries outside the United States drives up oil costs, price instability could make it even better. 

The puzzle still has pieces that have yet to be placed, but the image is clear: a fragile system is coming to an end, and when it falls who has the gold will rule. 

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Notes

[1] Much of the analysis here is inspired by collective study of The Value of Money by Prabhat Patnaik

[2] Any advances in the productive forces at large will shift the marginal value of all commodities, the money commodity included. Industrialization, for example, allowed the same amount of labor-power to produce a larger quantity of commodities, lowering the marginal value of each. Industrialization did the same for gold production, shifting its relative value to the world of commodities in the same way.

[3] The recent right-wing coup in Bolivia represents an example of this strategy. The United States could not tolerate an independent government controlling a significant supply of lithium. Even if Tesla buys its lithium in Australia, the prospect of an anti-colonial government controlling enough supply to boost prices — especially in alliance with China — not only impacts the automotive industry, it actually poses a risk for the whole monetary system. 

[4] Another way of putting this: the falling rate of profit produced rampant financialization which collided with class struggle against imperialist occupation and Western hegemony to destabilize commodity exchange on a fundamental level. 

[5] The crisis is internal to capitalism, not exogenous, the result of rampant deforestation and imperialist supply chains. See Rob Wallace et al. “COVID-19 and the Circuits of Capital.”

[6] Bid upwards by class struggle — workers fighting for higher wages, peasants demanding fairer prices for their outputs, colonized countries taking charge of their resources, etc.