This week, Wall Street strategists cheered as the Dow Jones closed above 11,000 for the first time in four and a half years. As a result, many are now predicting a new all-time high, which would see the index finally exceeding its 11,750 peak first reached back in January of 2000. Do not succumb to the hype.
11,750 hardly has the same purchasing power today as it did in January of 2000. The significant inflation of the last six years (bogus CPI numbers not withstanding) has rendered any direct dollar comparisons meaningless. To get a more accurate assessment, try measuring the index in terms of something other than depreciating dollars. Historically, the best comparison is relative to gold. Back in January of 2000, with the Dow Jones at 11,750 and gold at $280 per ounce, the Dow was worth about 42 ounces of gold. Today, with the Dow at 11,000 and gold over $550 per ounce, the Dow is only worth less then 20 ounces of gold. In other words, measured in terms of gold, the Dow has actually declined in value by over 50%. To make a real new high, given the current price of gold, the Dow would have to rise above 23,000.
Some people might think that this comparison is unfair, as the price of gold has risen. However, the reality is that it is not the price of gold that has risen, but the value of the dollar that has fallen. As a result, more dollars are now required to buy an ounce of gold, the true value of which has remained constant. The same thing has happened with stocks. As the dollar loses value, more of them are required to buy the Dow Jones as well. Since 2000, both the dollar and the Dow have lost value, but the dollar’s decline has been faster. That is why the dollar price of the Dow has been rising, even as the value of both the dollar and the Dow continue to decline relative to gold.
The is very similar to the situation during the 1960’s and 1970’s, when the Dow repeatedly flirted with the 1,000 level. However, though each failed attempt was greeted with much fanfare, they were rendered meaningless by inflation. By the time the Dow finally broke through 1000 in 1982, it has lost almost 90% of its value relative to gold. It wasn’t until 1997, when the Dow broke 7,000 that the Index finally regained the equivalent value relative to gold that it had in 1966, over thirty years earlier.
Gold actually acts as an objective measure of value against which other assets may accurately be priced. Pricing assets in terms of a fiat currency can be misleading, especially during periods of rapid inflation (an excessive expansion of the supply of money and credit.) One of the many reasons politicians favor inflation is that it creates the illusion of increased wealth among the electorate. Measuring wealth in terms of gold allows voters to see through the deception and gain more realistic perspectives on their true financial situations.
I have chosen gold as the best measure of the Dow’s value for the simple reason that gold is money. Behind all the hype and rationalization, gold is bought, traded and horded for its monetary attributes. Pricing the Dow in terms of any other commodity would not yield as true a measure, as other supply and demand factors might be at work. However, pick any other commodity or asset class you wish (oil, copper, sugar, Swiss francs, condos, etc,) and the Dow has lost a considerable amount of value against it. Any way you price it, the Dow has a long way to go to make a legitimate new high.