"Everything you need to know about gold"
GOLD HAS LOTS OF POTENTIAL DOWNSIDE
Over the past year, the price of gold has made repeated attempts to move higher. Looking at a one-year price history of GLD in the chart (source) below, there is a series of progressively lower highs which seems to indicate staunch resistance to higher gold prices…
ONCE MORE WITH FEELING
“…try it one more time with feeling
Chairman take it from the top
This one is the big one Jay so give
it everything you got
(You can) make believe your makin’ me
believe each word you say
Let’s try it once more with feeling
and we’ll call it a day”
(original lyrics by Kris Kristofferson)
NOTHING CHANGES AT THE FED
The statement may sound obvious given that Jerome Powell has been nominated to continue his reign as head of the world’s most visible central bank. Some might think this is a good thing; and will allow the Fed to steer a course that will bring our economy back from the living dead.
Yes, even gold is subject to inflation.
Most gold bugs think that a gold standard will solve our inflation problems. While it is true that gold acts as a restraint on governments and central banks desire to create and control money, it does not mean that inflation cannot happen just because gold is the money used.
WHAT GOLD IS NOT
After reading recent articles by others and listening to what continues to pass as ‘fundamentals for gold’, I think it might be helpful to restate, and elaborate on, two specific things which gold is not…
GOLD IS CHEAPER NOW
Most investors and others who follow the gold market are aware that gold peaked in January 1980 at $850 oz.
Gold is currently priced at $1772 oz., somewhat lower than its peak in August 2020 at $2060 oz. In either case, the gold price has increased considerably since 1980.
After forty years, though, one might be inclined to ask in all sincerity “Is that all there is?”
The question has merit. In inflation-adjusted terms, gold is actually cheaper today at $1772 oz. by twenty-three percent compared to it’s high in January 1980 at $850 oz.
Sure; $100,000 Bitcoin is possible; but is it realistic? Is a potential gain of sixty-six percent worth the risk of losing a similar amount or more?
VIDEO GAMES AND BITCOIN
After spending the better part of a day at the game arcade with two of my sons and a couple of my grandchildren, and amidst all the ringing bells and flashing lights, I found time for some brief reflection.
There seemed to be a huge disparity between the reflected scores and the accomplishments of the various participants.
For example, why is 200 points a “good” score in one game and 1000 points a “bad” score in another game?
We could ask similar questions, I suppose, about the scoring variations in organized sports, too.
Then, I thought about Bitcoin. What makes investors think Bitcoin is worth $60,000? And why is its price so much higher than other cryptocurrencies?
GOLD FACTS AND FUNDAMENTALS…
After the gold price reached a high of $850 oz. in 1980, its price began a long decline that lasted over twenty years. But the decline was not just characterized by its lower price, which eventually bottomed around $250 oz.
More noteworthy was the lack of interest in the yellow metal, which continued for almost twenty-five years.
INFLATION OR DEFLATION
The debate continues but not much has been said that clarifies the issue for ordinary investors. What follows in this article should help.
Inflation is the debasement of money by government and central banks. The Federal Reserve and all central banks practice inflation by expanding the supply of money and credit continuously and intentionally.
This debasement of the money results in effects that are harmful and unpredictable. One of these effects of inflation is an unquantifiable loss of purchasing power in the money itself.
“Gold going nowhere” seems to be a reasonable description of recent price action in the metals markets.
Below is a daily chart of GLD for the past year…
An understanding of the relationship between between the gold price and inflation requires historical observation and factual understanding. Below are three specific statements that are rooted in historical fact…
1) GOLD IS REAL MONEY
Lots of things have been used as money during five thousand years of recorded history. Only gold has stood the test of time. It has earned its role as real money because it is the only thing which meets the three specific criteria for money: a measure of value, a medium of exchange, and a store of value.
Gold is and has been easily incorporated into recognizable forms and amounts for use within various standards of weight and measure. Also, gold is scarce, malleable, indestructible and beautiful.
2) PAPER CURRENCIES ARE SUBSTITUTES FOR REAL MONEY
Gold is also original money. It is the original measure of value for everything else.
A medium of exchange needs to be portable, which gold certainly is. Gold is and has been easily incorporated into recognizable forms and amounts for use within various standards of weight and measure.
Gold was stored in warehouses and the owners were issued receipts which reflected ownership and title to the gold on deposit. The receipts were bearer instruments that were negotiable for trade and exchange. Some consider these negotiable receipts to be a precursor to our modern checking system.
3) INFLATION IS CAUSED BY GOVERNMENT
One thing that should be clear from history is that governments destroy money. Inflation is the debasement of money by government. It is practiced intentionally by governments and central banks.
The effects of inflation are volatile and unpredictable. The Federal Reserve Bank of The United States has managed to destroy the purchasing power of the U.S. dollar little by little over the past century. The result is a dollar that is worth ninety-nine percent less than in 1913.
MORE ALWAYS EQUALS LESS
When the Fed began its grand experiment, the price of gold was fixed and convertible at the rate of $20.67 per ounce. This fixed rate of exchange was supposed to act as a restraint on government to keep them from creating excess dollars to meet their spending needs.
Here is a historical example of how inflation was practiced with gold before the invention of the printing press and the advent of paper currencies…
“Early ruling monarchs would ‘clip’ small pieces of the coins they accumulated through taxes and other levies against their subjects.
The clipped pieces were melted down and fabricated into new coins. All of the coins were then returned to circulation. And all were assumed to be equal in value. As the process evolved, and more and more clipped coins showed up in circulation, people became more outwardly suspicious and concerned. Thus, the ruling powers began altering/reducing the precious metal content of the coins. This lowered the cost to fabricate and issue new coins. No need to clip the coins anymore.” (see Inflation – What It Is, What It Isn’t, And Who’s Responsible For It)
From the above example it is not hard to see how anything used as money could be altered in some way to satisfy the spending habits of government. But a process such as this was cumbersome and inconvenient.
Enter: Paper Money
With the advent of the printing press and continued improvements to the mechanics of replicating words and numbers in easily recognizable fashion, paper money became the “next big thing.”
At first, people viewed the new ‘money’ with skepticism. Coins with precious metal content continued to circulate alongside the new paper money. Hence, it was necessary, at least initially, for government to maintain a link of some kind between money of known value vs. money of no value in order to encourage its use.
Eventually, that link was severed; partially at first, then completely. And it was done by fiat (a decree or order of government).
Not only does our money today have no intrinsic value, it is inflated and debased continually through subtle and more sophisticated ways such as fractional-reserve banking and credit expansion.
Government causes inflation by expanding the supply of money and credit. And that expansion of the money supply cheapens the value of all the money. Which is exactly why the US dollar continues to lose purchasing power.
EFFECTS OF INFLATION
The ongoing expansion of the supply of money and credit by governments and central banks IS inflation.
This intentional debasement of money leads to a gradual loss in purchasing power of the US dollar.
The loss in purchasing power results in higher prices over time for most goods and services.(see “A Loaf Of Bread, A Gallon Of Gas, An Ounce Of Gold” Revisited)
The loss in purchasing power and subsequent higher prices are the effects of inflation.
GOLD AND THE US DOLLAR
A declining U.S. dollar means a higher gold price. A stable or strengthening U.S. dollar results in a stable or lower gold price.
In other words, over time, a higher gold price is correlated inversely to the US dollar’s loss in purchasing power.
When the gold price peaked last August at $2060 oz., it was one hundred times higher than its original fixed US dollar price of $20.67 oz. a century ago. That indicates almost exactly the ninety-nine percent decline in US dollar purchasing power mentioned earlier and is indicative that gold is a store of value.
If you think the current effects of inflation are understated, that would mean the potential for a higher gold price is implied. Except…
The effects of inflation are unpredictable. And a higher gold price is predicated on seeing the actual price increases first.
The gold price doesn’t go up because people expect inflation to get worse. It only goes up to reflect the loss in US dollar purchasing power that has already occurred.
Furthermore, it can take years for the gold price to reflect any subsequent loss in purchasing power (1980-2011; 2011-2021).
Kelsey Williams is the author of two books: INFLATION, WHAT IT IS, WHAT IT ISN’T, AND WHO’S RESPONSIBLE FOR IT and ALL HAIL THE FED!