BERLIN – OCTOBER 21: A hostess holds a ten gram bar of gold bought from Berlin’s first Gold To Go gold bar dispenser at Galeries Lafayette on October 21, 2010 in Berlin, Germany. The company Ex Oriente Lux AG is setting up the vending machines across Europe. Customers can buy gold bars weighing between one and 250 grams with cash or a credit card. The financial turmoil of recent years has increased the worl demand for gold, which many people consider a safe investment. (Image credit: Getty Images via @daylife)
I’ve always been interested by the connection between money and the physical world we live in. With money, we are able to buy the things we need, purchase investments for the future, and lend our money to others in return for a little bit of income. Without money, we’d be reduced to barter and the double coincidence of wants: if a farmer doesn’t need my services as an engineer, then why would he sell me his eggs?
A healthy money is crucial to the life of our civilization
Money is an incredibly important tool; it’s a vital fluid in the economy that makes an advanced civilization possible. As an economy is really just millions of exchanges, so the best kinds of money have historically been chosen by the people. It’s important to remember that money is just a tool for improving exchange, as well as allowing one to save up purchasing power by producing more than they need. This excess purchasing power reflects the additional goods added to the economy, and can be redeemed in the future.
To a certain extent, money needs to reflect the underlying reality. People have traditionally chosen gold as the premier currency, as gold has some excellent properties that make it especially useful as a form of money, such as the fact that its supply grows only slowly, and it is very durable, easy to divide, and it even looks beautiful, too.
The rise of fiat versus gold
However, gold has fallen by the wayside in favour of fiat money. Fiat has some desirable properties too, such as being an incredibly easy medium in which to facilitate exchanges and commerce, and the value of fiat rests in a computer, so even if some physical notes get lost or destroyed, they can always be recreated by the bank.
The problem with fiat is that it isn’t a great means of storing long-term wealth. Because fiat is based on convention and law, rather than the physical laws of the universe, a government is always tempted to inflate the supply of the currency, so that they can use this inflated supply to acquire more of the real, physical stuff that money represents, without having to raise taxes to compensate. It’s a way to tax all holders of the fiat currency, without having to actually have them hand over any extra bills.
Because this exorbitant power is so hard to resist in the hands of populist politicians, we have seen credit bubbles get larger and larger, and countries bury themselves ever deeper in debt. There’s now a wide gap between fiat currencies and the actual physical world that they are supposed to represent, and this gap is growing larger by the day.
The return of gold
As the situation gets worse, the health and life of our world civilization is at stake. If money can no longer do its job, then producers have less of an incentive to produce, consumers will have less to consume, and life for many will stagnate or get worse. However, not everyone is willing to just stand by and watch all of this happen.
What if the pendulum has swung too far in the direction of make-believe paper instruments? Can gold return some sanity and sense to this world monetary order?
Freegold might be one way in which sanity gets restored, as we see gold take a greater place at the table as a premier store of value, while reserve currency holders lose some of the privilege of being able to export inflation that they’ve enjoyed in the past. It seems that there are some changes ahead that will lend more credence to gold regaining its proper place at the table.
Basel III and the return of gold as a Tier 1 asset
One of these changes would be the return of gold as a tier 1 asset to the banking system! The banking system would recognize physical gold as a premier reserve, marked at full market value. Indeed, there are rumours that Basel III regulators are planning to reintroduce gold as a Tier 1 asset. The re-introduction of gold into the system could help with the recapitalization of banks, as excess debt gets destroyed and worked out of the system.
When we think about whether the sky is really falling, it helps to remember that no thunderstorm lasts forever, not even the biggest hurricane. Eventually, the sun comes back out, and may it shine brightly on us all.
A quick recap
- Gold is not an investment (except as an investment in your own future and in the future role of gold). That’s what equity markets are for.
- Gold is also not a premier medium of exchange; fiat has taken over that role.
- Gold is, however, a premier store of value and means of final settlement. Those in the east have known this for thousands of years, even if some of us in the west have forgotten.
Hey FG,
A lot of people are becoming aware of the global governments’ currency abuses, or what I like to call Scamflation. Many are calling for a return to the Gold Standard, but this doesn’t seem practical to me. My understanding is that there is only a couple of trillion dollars in physical gold in the world, which wouldn’t support the global GDPs of the world’s economies.
Hopefully, the new Basel III standards will help to curb fiat abuses, which harm responsible savers and investors.
Hi Bret,
I don’t believe we will ever return to a arbitrarily fixed price of gold, which is what a gold standard is. Gold will continue to gain importance in the global monetary system, but its price will remain free and floating.
Also, you are quite right that at the current price, there wouldn’t be enough gold. Given that the supply of gold cannot be expanded to make up the gap, what does the law of supply and demand say should happen to the price of gold in order to support the GDPs?
Let me know if this makes sense.
When I say return to a gold standard, I was thinking more along the lines of gold and silver certificates, instead of a fixed price for gold. Back in the day, paper money was redeemable for gold or silver, which limited the money supply.
As for the supply and demand of gold, I don’t believe gold is considerably more valuable, based on the world’s economies. I believe it’s just a shiny metal and not inherently more valuable than paper, unless you want to make jewelry. With 7 billion people living on the planet, gold is no longer a practical representation of the global economies.
Hi Bret,
Thanks for sharing your thoughts.
In my view, a gold standard, even based on official exchange of certificates, is doomed to fail because politicians cannot resist the temptation to reduce the value of those paper certificates by expanding their supply beyond what the reserves can allow. We’ve already been down this road before, and it didn’t work. I simply don’t see this as ever happening.
Instead, I see gold acting as more of a counterweight with a floating free-market price. There’s no need to make gold legal tender as a medium of exchange; simply reducing confiscatory taxation would be enough, and governments around the world are already doing this as they recognize gold’s valuable role as a currency, and not simply as a commodity.
As gold regains its role in the monetary system, it gains more value because it becomes more valuable as a final store of value, free from counter-party risk and default. Nothing has inherent value, but gold, unlike fiat, has the very important property of being supply-stable and a means of final possession of wealth. Gold existing in a vacuum is not valuable, it’s the properties of gold and its high utility as a permanent store of value that makes it valuable in people’s subjective evaluations.
In my view, 7 billion people living in a modern world only make this function all the more important. Gold as a store of value is simply a link to this physical plane, and the more stuff there is in the physical plane, the more valuable gold becomes. Gold today is more valuable than gold from 5000 years ago, because the world is so much richer today!
Fiat is a great medium of exchange (I’d rather carry around a few bills than a few coins in my wallet), but as a store of value, it’s a failure and it always has been a failure. It’s been proven to be a terrible way of preserving wealth, and the emphasis on fiat has lead to a great deal of profligacy and capital misallocation in the world today. Maybe fiat was the best alternative when Nixon took the US off the gold standard and essentially told the rest of the world to F off, but the existing monetary order is starting to come to an end.
The way this will end, as I see it, will not be in a return to the gold standard, but rather, there will no longer be the demand to accumulate trillions in paper reserves as there were before. WIthout the same demand for fiat savings, fiat will be forced to compete with “hard money” like gold, and without there needing to be a gold standard in place. It will be harder for politicians to use the inflation tax when there’s less demand for dollars in aggregate. Politicians can only inflate to the extent that there’s demand!
I am not as good as others at the exposition of this concept; I recommend reading this post as an introduction.
What does this mean for someone, personally? I personally aim for 10% – 20% in precious metals, because I believe that the current game is coming to an end. I don’t know when it’s going to come, and there can always be surprises which change the course of events, which is why I’m not going all-in. For me, this range is enough for me to feel that at least I’ve prepared for things to come. Worst case, if they manage to kick the can down the road again, I’m sure a rising stock market will be compensation for the loss of value in precious metals.