What Makes Gold A Currency?
For people to enjoy the benefits of commerce, the economic system absolutely requires a widely accepted standard unit of value that makes it possible for anyone to compare the value of a day's work with the price of a box of Cheerios, a Ralph Lauren dress or a BMW
Z4. Gold and silver played that standardization role in countless cultures for at least 4,000 years. In advanced systems, like the Roman Empire, tradable precious metal usually took the form of coins; these were marked with official imprints attesting to their weight and purity.
Eventually, technology ushered in the far more convenient paper currencies with which we are familiar; these of course could be
printed as needed by the regulating authority, creating the potential for some serious conflicts of interest. To minimize such abuse and assure the acceptability of currencies, until the early 1970s all major modern paper currencies accepted and exchanged within the global banking system were undergird by an enforceable gold exchange ratio.
As recounted above, President Nixon, to prevent a run on the Treasury, put an end to the Dollar's gold convertibility in 1971. The other world currencies quickly followed suit. How has that worked out? Well, the proud British Pound Sterling that was once worth a pound of silver changes hands today at US $1.63.
History is littered with the ashes of currencies that have crashed and burned. Without exception, their failures stemmed from abuse by their sponsors. A list of the 20th century's standout currency disasters is headed by the German Mark. Backed by gold until the beginning of WWI, it was replaced by a paper Mark so that war costs and, later, war debts could be managed. After just 5 short years it took 1 billion paper marks to equal 1 original Gold Mark! That's not just inflation, of course, it's hyperinflation.
In our digital age, government currency sponsors don't need clumsy printing presses; a central bank can conjure unlimited
quantities of non-convertible currency with a committee meeting and a few taps on a keyboard. Recently, America has been
tapping un-backed currency into existence at a $1 trillion annual rate. The temptation to increase the supply here and in Europe
seems to have become irresistible, so overwhelming are the credit problems that have built up.
That's where gold comes in. News flash... you can't print gold! It is the only reliable unit of exchange that cannot be increased by government fiat. That's what makes it attractive. It is the standard against which competing paper currencies can be measured and either kept honest or discounted by the marketplace as necessary. One commentator said it very well:
Gold is real money... paper currencies are derivatives of it.
Investment Conclusions
Economic context An often unnoticed part of our responsibility as managers of retirement savings for real people is to keep their asset mix appropriate to the global economic context in which the investments are held. The two most compelling forces affecting that context, and shaping the outlook for this young century are:
a) The sovereign debt crisis in Europe, Japan and the US, and how the governing authorities choose to manage it
b) The extraordinary GDP growth of the less developed economies, whether it is sustainable and how the forces of global trade
eventually play out.
From our study of these forces, we think it is a fair generalization that in the Developed World:
a) Growth is stagnating under the mounting sovereign debt burden; so far, the only political response with any traction seems to be extraordinarily loose monetary policy.
b) The national balance sheets are rapidly deteriorating as governments continue to choose currency debasement as their policy default option.