Gold Is Not What You Think It Is

Updated: May 17



The term “gold bug” has been popularised in recent decades as a reference to ardent fans of gold investment. The almost imperceptible flaw in gold bugs’ thinking is that gold should be considered an investment. It should not. Gold has only ever been a currency and that is all it can ever be, jewellery and some industrial uses aside.

"They tended to react badly"

We take for granted that bits of paper (bank notes) and electronic records in computer chips (bank deposits) have value to such an extent that it is impossible to imagine it any other way. Article one, section 10, of the United States Constitution states that “no State shall… coin Money; emit Bills of Credit; make any Thing but gold and silver Coin a Tender in Payment of Debts”.


In other words, the Founding Fathers were against fiat currency, currency that is backed by only a promise rather than precious metal. Why was this?


They were aware that, throughout history, every single state-controlled fiat currency system had ultimately failed. The temptation to create money out of nothing could never be resisted, leading to the corruption of politicians and the elite and unsustainable wealth disparity between rich and poor.


George Washington had noted in 1787 that “paper money has had the effect to ruin commerce, oppress the honest, and open the door to every species of fraud and injustice”. Later, in 1798, Thomas Jefferson wrote that the federal government has no power “of making paper money or anything else a legal tender”, and he advocated a constitutional amendment to enforce this principle by denying the federal government the power to borrow.


In days gone by money or, as it is also known, IOUs, developed naturally in the market. The best medium for these IOUs was gold coins as they were difficult to fake. (Gold is heavy, sufficiently scarce, expensive to extract and impossible to synthesise.) However, governments soon took control, often by guaranteeing the quality and purity of the coins. As they outspent their revenues, they found ways to counterfeit the currency by reducing the amount of gold in the coins, hoping their subjects would not discover the fraud. But the people always did, and they tended to react badly.


For money to be considered legal tender it must have a maker (person that will make the payment), a payee (person that will receive the payment), an amount to be paid, and a due date. Dollar bills used to state that the bearer would be paid on demand. In 1963 these words were removed.


By the same token, the creation of bank deposits involves even less work than notes and coins. To create bank deposits, a bank simply needs to find someone to lend to, then punches a number into a computer. Alakazam! A bank deposit from thin air!


When President Nixon closed the gold window in 1971, refusing, as promised under the Bretton Woods Agreement, to exchange dollars for one thirty-fifth of an ounce of gold (there was not enough gold in the coffers), the stage was set for massive and unconstrained monetary expansion. Under Bretton Woods, credit as a percentage of GDP had been maintained at around 150%. From 1980 to 2012, it rose from 162% to 353%. The last 40 years have been one huge, credit-fuelled party.


The only way that the US – and other Anglo-Saxon governments for that matter – is going to get itself out of its debt hole, is by inflating its way out. In a best-case scenario, this only entails sharply rising interest rates and substantial dollar depreciation; in the worst case, a loss of confidence in banking systems and, assuming it is not outlawed, gold over $10,000 per ounce.


We may well have entered a period in which paper currencies are debased, first by goods and services inflation then, when economies go into recession as they inevitably will, by monetary inflation.


In such an environment it may be a good idea to have an allocation to gold. As an alternative form of cash, not as an investment.


Published in What Investment





The views expressed in this communication are those of Peter Elston at the time of writing and are subject to change without notice. They do not constitute investment advice and whilst all reasonable efforts have been used to ensure the accuracy of the information contained in this communication, the reliability, completeness or accuracy of the content cannot be guaranteed. This communication provides information for professional use only and should not be relied upon by retail investors as the sole basis for investment.

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