Wednesday, May 11, 2011

Gold - The Money of Kings

Gold has been used and perceived as sound money for thousands of years and for a number of reasons, but at the end of the day, its utility is quite simple. 

Gold provides an unadulterated method of account

Typically gold is thought of as the 'money of kings', whereas silver is 'poor man's gold.' Indeed, gold is the money of kings...and of central bankers around the world. Have you ever wondered why central banks continue to hold  the vast majority of gold reserves and have recently become net buyers? It's because gold is money, it's the 'currency' of last resort and an asset that has weathered the test of time. Many will argue that gold is not a good investment because its industrial uses are few and far between. I'd argue to the same point. Gold is a terrible investment and rightfully so---it's not meant to be an investment. The definition of investment goes something like this:
1. The action or process of investing money for profit or material result.
2. A thing that is worth buying because it may be profitable or useful in the future.
You can see that if gold is in fact money, then definition (1) makes no sense and if gold has few uses then definition (2) doesn't bode well for the future. Gold's objective is to preserve wealth by retaining its purchasing power against other tangible items. This doesn't mean that items priced in gold don't fluctuate, they do, but if you saved in gold you'd retain your general purchasing power. 

Prior to 1971 gold was fixed at $35/oz by the US government (and also illegal for citizens to own), which was artificially low given the amount of outstanding currency. In 1971 president Nixon abolished the gold standard and allowed the value of gold to float against the dollar. To put this into perspective, in 1971 the median home price was $25,000 and with gold fixed at $35/oz that amounted to 714 oz of gold per median home. Once the price of gold was allowed to float, it reached a high of roughly $850/oz in 1980, at which point a median sized home could be purchased for roughly $64,600 or...76 oz of gold. In this example, the purchasing power increased, but this was due to the artificial price fix by the government at $35/oz. In fact, if the price of gold had not been allowed to appreciate the United States would have been drained of all its gold reserves as foreign central banks sought to redeem their currency for gold. This is precisely why Nixon closed the gold redemption window for foreign central banks---it would have bankrupted the country. This is a gold outflow scenario and has historically bankrupted empires as there wealth is transferred abroad. Nixon sought to stop this and embark on a grand experiment that has led us to the present day---a world of floating currency, possessing no anchor.

As another example, in 2001 the price of gold reached a low for the year of $250/oz whereas a median sized home was $175,200.  That meant it cost 701 oz of gold to purchase a median sized this sounding familiar? In 2010 gold reached $1420/oz while the price of a median sized home was $221,800, which meant a home cost 156 oz of gold. Today, home prices are dropping and gold continues to rise. It is my belief  based on historical precedent that an individual will be able to buy a home outright for less than 50 oz of gold before long...

Overall, this is just scratching the surface, but the idea goes something like this: Measuring assets against other assets is a better way to measure wealth than looking at the balance in your bank account. A good video discussing the gold/asset relationship can be found at:

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