Is Gold a Currency?
December 8, 2012 in Forex Articles
Much has been written and discussed about gold and its nature.
- Is it a commodity?
- Is it just a hedge against inflation?
- Is it a currency?
From earliest times, gold has been valued for its lustre, durability and comparative rarity. The value of this metal in the eyes of men established its suitability as a means of monetary exchange, and for its use as a common denominator in barter deals in the earliest times, and later as coinage when organized markets developed. With rapid economic growth, it became inconvenient to transact coins, and currency notes came into being, each such note backed by gold.
Here is a picture of a 1928 currency note representing $1,000.
The inscription on the top left corner reads:
“Redeemable in gold on demand at the United States Treasury, or in gold or lawful money at any Federal Reserve Bank.”
This is an example of the gold standard, where paper currency is convertible into gold, and the total value of printed currency is backed up by equivalent reserves of gold.
After World War II, the Bretton Woods system of convertible currencies replaced the gold standard, and thereafter the medium of exchange became fiat currency instead of gold-backed paper money that was fully convertible into gold. Due to the pre-eminence of the American economy, and its trading reach across the globe, gradually the American Dollar became the most commonly accepted currency worldwide.
Was the gold standard lost?
Yes, and no.
Yes, because gold no longer served its purpose as an official store of wealth that backed the world’s money in circulation.
No, because regardless of the decision of global monetary authorities to delink it from currency, they could not delink it from value.
Gold, like centuries gone by, still commanded awe and respect from mankind as the ultimate store of wealth, in contrast to fiat currencies which had increasingly dubious value and fell by the day.
Yet, gold was something to be mined, obtained from the earth much like other metals and commodities. It also did not provide an earnings stream to the buyer, nor paid any interest, and instead cost money to hold and store. In these ways it was like a commodity. The difference was it had less use in worldwide consumption and manufacturing like the other commodities, and more as something given value by the perception of the buyer due to its rarity. So, it’s not a commodity? Let’s look at a chart of gold (the right price scale) compared to the CRB commodities index (the left price scale) over the past 10 years.
As you can see, compared to the orderly and steady rise of gold, the CRB index of commodities is much more volatile and all over the place. In fact, after mid-2008, the CRB has fallen from approx. 480 to currently 309. Gold, on the other hand, has risen from $800 to $1704 – a complete disconnect! It appears, therefore, that it would be incorrect to classify gold as a commodity.
Again, commodities tend to be far more correlated to inflation and if gold were truly a commodity, it should sync similarly with inflation. Not true, as the chart below of the Consumer Price Index (CPI) compared with gold will show.
Note the vast difference between the trends, they are almost inversely correlated. If gold were a commodity, or for that matter a hedge against inflation, the trends would move in tandem. That is not the case.
Then what makes gold tick? Here’s an instructive chart of the dollar index compared with gold.
From 1994 onwards, the dollar index and gold price are lock step in sync, only oppositely. Clearly the depreciating value of the dollar has had a profound effect on the value of gold, and in fact the two behave more like a currency pair. In my view, this is very convincing evidence that the innate nature of gold is that of a currency.
Put another way, though the economic powers-that-be officially delinked their now fiat currencies from gold, and did away with the onerous reserve requirements, they could not wish away a stark benchmark that the financial markets still hold up as a gauge of their fiat currencies – the price of gold relative to their currencies.
The gold standard is dead, long live the gold standard.
In July 2011, Republican Ron Paul asked Fed Chairman Ben Bernanke point blank, “Is gold money?”
Bernanke: “No. It’s a precious metal.”
On Paul’s reminder of the historical use of gold as money, Bernanke clarified, “It’s an asset. Would you say Treasury bills are money? I don’t think they’re money either but they’re a financial asset.”
‘Precious metal.’ ‘Financial asset.’ So much for truisms!