Why gold? It is a simple question. We all like gold. It is shiny, bright and it looks good on women as well as on man. It is appropriate for all occasions and will never let you down. We can garnish it or ingot it, we can paint with it and even drink it! Poets said that gold is eternal and it would seem to be. Almost all gold ever extracted is still in circulation today. But money? Yuck! Paper is real money, not gold. And in a sense, sadly, it is.
However, this is not as it was before. Before the reign of paper, before politicians figured out that they could manufacture money out of thin air and take the entire world for a ride, there was gold. Undisputed. Unparalleled. Ever present. Ever in demand. Gold was money. And humans prospered.
Forests have been toppled and rivers of ink dried in a futile attempt to bring gold back. It is not our intent to repeat this feat. Our humble goal is to remind you that all the old arguments for gold are today in much more demand than you can possibly fathom. As the world spins down into monetary oblivion enveloped in a storm of fiat proportions, only gold remains a safe harbor and this is good.
We are not attempting to convince anybody. Those convinced do not need more convincing and those unconvinced will remain so. Until it is too late. Then, and only then, they may remember they read about gold in an obscure corner of the internet. Then, and only then, they may turn to gold for economic salvation, and gold will be there, waiting. We will be waiting with it.
WHY GOLD
If you are to remember something from this lesson, remember this: Gold was chosen by the free market. It put gold through a ruthless evolutionary battery of tests lasting thousands of years to see if it would survive. It did. It did survive better than any other form of money for two main reasons:
- It worked
- It kept everybody honest (specially governments)
And that’s IT! Everything else is just argumentation from either people with vested interests or academicians up there, on top of their ivory towers. Our humble job is to expose you to their arguments so that you may make your very own decision. We can only hope you will side with us.
AN ULTRA-SHORT HISTORY OF GOLD
Oversimplifying, we can split Gold’s history into roughly 6 periods. They are:
Gold as commodity
In the beginning gold was a commodity without monetary value. Gold was sought and accumulated mostly for its decorative properties.
Gold as money
Over time, gold began to be used as a means of exchange (money). It was always used by weight in different shapes or forms or as gold dust. Different civilizations had different standards, but they all agreed that Gold and Silver were the preferred means to pay for goods and services. Eventually, gold was coined which simplified its measurement and therefore exchange.
Paper money is born
Many people realized that carrying gold with them was a problem. Gold is heavy and easy to spot therefore easy to rob. Warehouses appeared for the storage of gold and in return they issued gold receipts, redeemable on demand. Over time, these gold receipts begun to be used as gold, since they were literally “as good as gold”. All a receipt holder had to do is to go to a Warehouse and exchange the receipt for gold. Therefore, people realized, it was easier to exchange those paper receipts than gold and so paper money was born.
For as long as warehouses provided full redemptions of receipts, gold acted as stable and honest money. The economy grew. Natural economic cycles of boom and bust (excluding man-made catastrophes such as wars) were exceedingly short and shallow. Gold was a sturdy store of value. In many cases, mild deflations set in allowing people to reap many benefits.
Eventually, warehouses realized that they could issue more receipts than the gold they actually had in their vaults. This was so because only a small fraction of people would ever bother in redeeming receipts for gold. For as long as the illusion of redeemability could be maintained, warehouse receipts could be issued for loan and loan interests kept. When banks lost their trust, people would demand gold. When full redemption was impossible, banks went bankrupt. However, banks were private and bankruptcies did not have massive impacts on economic endeavors.
The “classic” gold standard
Eventually, governments got into the game.
Governments issued “notes” which were redeemable in gold coins at any bank. The original “paper money” (Francs, Dollars, Dinars, Marks, etc.) were defined in terms of a specific weight of Gold. This weight was then redeemable in gold coins. These coins were actual money that people used in their daily lives. Furthermore, as each note was related to a specific weight of gold, their “exchange rate” was fixed. If the dollar was defined as 1/20 of a gold ounce and pound sterling as ¼, their exchange rate would be 1 pound sterling to 5 dollars.
Why would governments issue notes?
Because as with any paper money, the person who spends it first, spends it at face value. For any government, printing notes was cheap, far cheaper than obtain its theoretical value in gold and then spend it. Of course, for second, third, fourth…etc. spenders; the gold equivalent of paper money would decrease until it would reach the ratio between number of notes and weight stored in national banks.
The calculation is simple. If UK issues 400 notes and the national bank had 100 gold ounces, each not would be worth ¼ ounce. However, if the bank would print another 100 notes (reaching a total of 500 notes), then each not would be worth 1/5 of an ounce. The trick was to print and not let people know so that they could spend the new notes as ¼ gold ounces instead at their true value of 1/5 gold ounces.
Gold as boom and bust damper
As governments began to print and spend, cycles of boom and bust would set in. Consider this hypothetical example. When the country of Inflationland prints notes, prices go up because of the extra notes in circulation (inflation). Inflationland’s goods and services become more expensive, but imports retain their pre-inflation prices (since are not affected by it) and are hence preferred by its population. Hence imports increase and exports decrease. But imports need to be paid in gold since other countries do not accept Inflationland notes, only gold. This means that Inflationland starts to loose gold rapidly. When this happens, Inflationland’s notes become less and less redeemable in gold at the fix rate. If this would to continue, Inflationland’s notes would not be redeemable in gold and hence nobody would accept them. Result? Inflationland would go bankrupt. So, to prevent this process, Inflationland suddenly decreases the amount of notes in circulation to revert back to the original note-to-gold ratio. In this manner, prices would go down, but in the process a bust was created.
A warning
This period was called the “classic” gold standard. Most people referring to it do not fully understand its mechanisms and point to this period as the proof that a “gold standard” is not viable. When faced with this kind of nonsense, we need to keep reminding people that it was gold that prevented this process from getting completely out of control, not gold that created booms and busts. Boom and bust cycles were created by governments printing un-backed notes.
Bretton-Woods agreement
After WWII, the USA arguably became the most powerful economic force on the planet. Furthermore, all Allied countries and Axis ones were completely devastated and bankrupted. They were forced to accept the “New World Order” imposed by USA. Why exactly did the USA impose the views it did is still shrouded in mystery. We know their declared intentions, their “economic security” concept which stated in short that a global market is a safer market. For our purposes, these ultimate intentions are irrelevant. What is relevant is that the USA imposed a kind of a “gold standard” where gold was more-or-less irrelevant.
The agreement in theory
This agreement stated that only USA Dollars will be defined against gold, at a fixed rate of 1/35 of a gold ounce. All other countries would define their currencies against the dollar. USA Dollars became irredeemable, except for countries and Central Banks. No private citizen from any country was able to redeem USA Dollars for gold by any mechanism. The stated theoretical goal of the agreement was to provide backing to currencies whose countries lacked gold (i.e. they were bankrupt). At the same time, it was understood among those who were in the know, that no USA gold was to be redeemed beyond minor transactions between countries and Central Banks. USA’s gold was to stay in USA. Period.
The agreement in practice
This agreement functioned in this way. The Dollar operated as gold for all countries except the USA. They could create as many Dollars as they wanted, while all the other countries would be forced to increase their dollar savings as “reserves” should they intended to print currency since they had a fixed ratio against the dollar.
This created a widely unfair advantage for USA. This was so because as the USA began to print (i.e. inflate the Dollar), prices would increase and therefore imports would increase. These imports were paid in Dollars which were saved by other countries in order to be able to print more of their own currency. Under the previous gold standard, gold would be demanded for printed dollars and that would put a stop to their printing. However, in the new system, dollars simply left the USA and accumulated elsewhere, which had the effect of maintaining a low inflation in USA.
The other countries, should they inflate, would see their prices raise and imports increase. Then, they would be requested to exchange their currency for Dollars (the new “gold” standard), since other countries did not accept any other currency than their own or Dollars. As a consequence of this, countries inflating their currencies (an always in-favor sport for politicians) were forced to seek more Dollars as “reserves” to redeem their currency spent on imports. Yet another benefit for USA, since their Dollars were now widely in demand outside the USA.
The death of gold as money
Sooner or later countries realized that the Dollar had depreciated enormously and begun to demand redemption in gold as per the agreement. In the beginning the USA satisfied those demands but eventually it realized that gold redemption was a trend, not a one-time affair. Furthermore, the USA was in need of massive monetary expansion (i.e. printing) since they were involved in the Vietnam War and the gold standard was an impediment to this process. In August 15, 1971, President Nixon closed the so-called “gold window”. No more gold redemption of any kind will be allowed. This ended gold’s use as money, which returned to its pure commodity status.
Post-Script
Gold had been serving humanity for thousands of years. Politicians destroyed its value as money by governmental intimidation and brute force. We are now sitting in a world of “dirty float”, where there is no gold to anchor currencies. They float against each other based on nothing. This is absolutely correct. The value of one currency against the other (the exchange rate) is purely, 100% subjective. As such, any comparison is impossible. In a sense, we have returned to a bartering situation where in order to trade (internationally) it is necessary to know the price of your merchandise in all tradable currencies as it was explained in the lesson Real Money For A Real Economy. The destruction of gold as money has brought us back to bartering, albeit at much more sophisticated level. You can thank the politicians for this travesty.
Note: please see the Glossary if you are unfamiliar with certain words.
Continue to Gold is a shiny beacon of hope - Part 2
