I’ve long been concerned about sovereign debts and the stability of fiat currencies, frequently noting how these issues boost gold’s attractiveness. Given the significant rise in gold’s price since I first articulated these views, I wish to outline what I consider essential insights regarding gold.
I consider it an undeniable fact that gold functions as a form of money, and it is the currency least susceptible to devaluation or seizure. This inherent characteristic explains why gold has been esteemed as a monetary asset for millennia across nearly every nation, enduring while numerous other currencies have vanished.
Below is an examination of gold’s historical ability to retain its value, and the reasons it continues to do so.
Historically, all monetary systems have fallen into two categories: linked or “hard-asset-backed” currencies, and “fiat” currencies. The worth of linked, or hard-asset-backed, currencies is tied to commodities like gold or silver, which possess finite supply and global recognition. Such systems permit individuals or states to convert their paper money into gold, silver, or similar assets at a set exchange rate. Conversely, fiat currencies lack any intrinsic backing or commodity link, meaning their supply is unrestricted.
Examining historical trends across nations reveals that monetary systems operating with gold-backed money alongside excessive debt inevitably collapsed. This occurred either because national leaders upheld their pledge to back the currency with gold, resulting in debt defaults and deflationary economic downturns, or they abandoned this commitment. Breaking the gold-backing promise enabled them to generate substantial amounts of money and credit, which typically led to currency devaluation, increased inflation, and consequently, higher gold prices.
Prior to the establishment of central banks (e.g., in the U.S. in 1913), deflationary spirals were the more common outcome. However, with the advent of central banking, inflationary routes became more prevalent. Both scenarios culminated in significant debt crises, which ultimately decreased debt burdens relative to income necessary for servicing them, thus stabilizing economies at elevated price levels. This explains the long-term trend of rising prices. Notable recent instances of gold-linked monetary system failures include 1933 and 1971.
The transition from linked to fiat monetary systems occurred in 1971. Given our current reliance on fiat systems, insights gleaned from historical fiat systems during periods of excessive debt relative to the money supply required for repayment are particularly pertinent to present circumstances. In these historical instances, central bankers consistently resorted to extensive money and credit creation, typically resulting in escalating inflation and increased gold prices.
Across all such scenarios, gold performed strongly as an alternative to paper or debt-based currencies. Historically, it has demonstrated the most consistent ability to preserve purchasing power over extended durations. Consequently, gold now stands as the second-largest reserve asset held by central banks globally.
However, this does not imply that other currencies were inherently inferior wealth preservers compared to gold across all periods. The distinction lies in paper/debt currencies generating interest, whereas gold does not. Therefore, when interest rates were sufficiently high to offset the erosion in value of paper/debt monies, these offered superior returns.
The strategy of market timing, which I personally discourage, involves holding paper/debt currencies when interest rates are high enough to justify the inherent risks of default and devaluation. Conversely, when interest rates fail to sufficiently compensate for these devaluation and default risks associated with paper/debt money, then acquiring gold becomes a prudent decision.
Alternatively, one might opt to forego attempting to time these market shifts and instead consistently maintain a gold allocation. Gold, much like cash, has historically yielded a modest real return of approximately 1.2% and exhibits a negative correlation with cash. Consequently, gold and cash can be considered complementary monetary assets, valuable for maintaining liquidity in diverse economic conditions.
Moreover, gold has gained favor as a currency due to its reduced susceptibility to confiscation compared to other forms of money and assets. This is because its value is not reliant on third-party payments, and it proves more challenging for individuals or governments to seize. Its robustness against appropriation stems from its capacity for secure personal possession, unlike other monetary forms that depend on others to effect payments for their value. Furthermore, it is immune to cyber theft. Thus, gold has been the preferred asset during periods of significant confiscation risk, often arising from financial crises prompting elevated taxes or other expropriatory measures, or from economic and financial conflicts (such as sanctions) between nations.
Consequently, in eras marked by monetary/debt crises and/or conflicts that heightened confiscation threats, gold experienced substantial appreciation. More precisely, it served as the currency that maintained its value.
Therefore, gold has consistently remained the most foundational form of money, demonstrating the strongest historical performance in preserving its value relative to the cost of living over extended durations.