Which is Greater: The US National Debt or the World Gold Stock?

Back when Marc Hulbert wrote about my paper on the investment potential and inflation-hedging ability of precious metals, co-authored with John Zimmerman, in the New York Times, I received a number of emails criticizing the research. Many of the critics claimed that the recent increases in the price of gold constitute evidence that investors expect the US inflation rate to increase substantially in the future.

Predicting the future is somewhere between difficult and impossible. But I see strong evidence that investors do not expect an increase in the US inflation rate from the yields on nominal US Treasury securities. As of today, a ten year Treasury Note has a yield to maturity of 3.77%. If investors expect the inflation rate to accelerate any higher than that over the next ten years, they would want a higher interest rate.

So who is right: Gold investors or the Treasury security investors? It is likely there is significant overlap between the two groups. Perhaps we can get an idea of the relative importance of the two indicators by looking at the size of their respective markets.

According to Butterman and Amey (2005), available world gold stocks total approximately 122,000 metric tons. At 32,150.7 troy ounces per metric ton, that is about 3.9 billion troy ounces. Multiply that by the current $903 spot price of gold bullion and you get a value for all the available gold in the world equal to somewhere in the neighborhood of $3.5 trillion.

To get the amount of US Treasury securities on the market, first look at this report from the Federal Reserve Bank of St. Louis (see page 17) . Total US public debt is just over $9 trillion. Subtract from that the $3.958 trillion owned by the US federal government trust funds, such as the social security and medicare trust funds, and also subtract the $779 billion owned by the Federal Reserve Banks to get $4.269 trillion owned by private investors, both domestic and foreign.

Thus, we see that the net outstanding value of the US Treasury securities are somewhat greater than the world gold stock. Perhaps the investors who own these two types of assets are two mostly-separate groups with very different expectations about future US inflation. But I think a more likely explanation for the increases in gold prices over the last two years has little to do with inflation. The increases began in the fall of 2005, at the same time oil prices began to increase. This greatly increased incomes of the inhabitants of the middle east, many of who like to own gold. Likewise, the economy of India has been booming, and Indians have a strong affinity for gold jewelry.

We won't know until after the fact if inflation has increased. But I see little evidence that investors expect it to increase.