Investing in Gold: A Safeguard Against a Crashing Dollar?

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By guest writer Kumarpal Shah

There is a lot of conflicting investment advice out there, and sometimes it is hard to know which approach to take. One way to cut through some of the differing opinions is to look at history, and see what insights you can glean. Though past history is no guarantee of future results, it is often instructive. When it comes to the matter of gold vs. the US dollar, here is what history can tell us.

Gold as a Currency

Every economy that wants to move beyond using barter for exchanging goods and services needs to have some form of currency, a standardized medium for exchange. This medium of exchange needs to be generally accepted, recognizable, and portable in terms of size and weight.

As explained in ‘Are Digital Currencies the Future of Finance?‘, for thousands of years, in numerous civilizations around the world, gold and silver have been used for currencies. Ancient civilizations in Rome and Egypt used gold, and the Bible has numerous references to the use of gold and other metals. Gold coins have been a recognized form of currency across the ages.

The Gold Standard

In 1787, the US constitution included a section which specified that gold and silver would be used as legal tender in the country. The US used paper currency backed by gold reserves. After World War II, the Bretton-Woods accord was an international agreement that tied the US dollar to the value of gold, while other international currencies were tied to the US dollar.

Leaving the Gold Standard

In 1971, President Richard Nixon officially ended the use of the gold standard in the United States. The US dollar was decoupled from gold. Since other currencies had been indirectly tied to the value of gold through the US dollar, this meant that other currencies were also decoupled from gold at the same time. The US dollar and others are now known as “fiat currencies”. They are not backed by gold or other tangible assets, but merely by faith in the government and its laws and institutions.

The Supply of Dollars Increases

As long as the US dollar (and associated currencies) were tied to the gold standard, there was a limit on how many dollars could be issued. There is a finite global supply of gold, which increases relatively slowly. That put a constraint on the US money supply.

However by leaving the gold standard, the U.S. government became able to print as much currency as it wanted to issue. The constraints were gone, and the supply of dollars released into the international markets increased. This also enabled the government to take on more debt, since the country could create as many dollars as the economy could absorb.

Dollars Vs. Gold Since Abandoning the Gold Standard

Since 1971, the value of gold in US dollars has risen by 4,400 percent. During the same time period, the consumer price index has increased by about 500 percent. This means that a fixed amount of gold purchased in 1971 would now buy several times more real goods and services than it did then. The value of the dollar has decreased due to printing more currency, while the real purchasing power of gold has gone up.

Investing in Gold: A possible hedge against the next financial crisis

As the dollar has declined and gold has risen, the imbalance between the two has grown. Given the Fed’s current policy of low interest rates and quantitative easing, along with the continually increasing national debt, it seems that this imbalance will continue to grow.

As US dollars continue to be printed in increasing numbers, and the national debt continues to balloon as it has been, some people foresee disaster scenarios for the dollar. Rather than achieving an equilibrium position against gold, the value of the dollar could plummet due to oversupply, excessive debt, and loss of faith in the US government.

While there is no way to be sure what will happen in the future, gold is a useful investment. If such a scenario comes about, then those who had invested in gold would be protected from the resulting financial disaster.

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