For those who follow these things, you know that in the past few weeks the “mystery” of soaring gold prices has apparently been solved by Paul Krugman. Far from signaling that some investors are worried about the fate of the USD, Krugman thinks soaring gold prices are the natural reaction to low real interest rates.
In today’s Mises Daily I poke some holes in this chic explanation. After documenting two testable implications of his model that are way off (i.e. fail the tests), I write:
To sum up, whether we’re looking at large moves in the real interest rate over shorter periods, or fairly steady real interest rates over longer periods, there are patches using Krugman’s own data set that are at complete odds with his model. Krugman and DeLong think they solved their pesky problem of rising gold prices, but they really haven’t. They came up with a qualitative model in which sudden drops in the real interest rate lead to instantaneous upward shifts in the price of gold. Seeing this result, they declared, “Mission accomplished!” and cracked open some beers. But there are several other implications of their model that fail to match the data.
Then later I say:
I submit that Krugman, DeLong, et al., will have a hard time really understanding the market’s embrace of gold (and silver), if they try to explain its price with a model that ignores gold’s historical role as a medium of exchange.