The Economic Role of Gold: A Brief Essay on How Gold Has Shaped Our Economy
Gold has significantly shaped the history of man, his economics and his over all perception of life to being a simple hunter gatherer to a man who is driven by the power of capitalism and understands the value of wealth and its possession. Gold when discovered nearly 40,000 years ago when Paleolithic man picked up a piece of rock which had gold deposits in it. Gold had never helped man develop tools of his early needs like arrows or spears or even for agricultural purposes. Being malleable, soft it did not have much use with early man. Bronze discovered about 10,000 years and silver later, were valued much more compared to gold which was discovered much earlier. A bright yellow illuminating object that may have caught the attention of early man was often traded as a valuable piece of object much later on as the system of barter did not have a place for gold nor was it used. Gold was probably used in some form as a shiny object that could have been used to some extent in jewelry and even for scaring the enemy when engaged in war. But it was only recently about 5000 years ago when the social status was devised and man divided the society into classes that he understood that this is a rare metal and thus precious and started using it in more aesthetic manners including jewelry, for worship and for trade. Gold started to be considered as a mark of royalty or power and richness and became a prerogative of the high and the powerful to be owned. Gold has always been considered to be incorruptible without blemish. In some cultures gold is synonymous to the power of the sun. The Aztecs and the Incas believed that gold came from the sun, considering it to be its sweat and excretion. The mighty and rich Egyptians considered there kings to be direct descendants of the sun and gold as the one true flesh of that king. Thus gold had a significant impact upon all these ancient empires and their cultures. The Egyptians at about 3000 BC were the first to start a monetary system entirely of gold and silver. Their power and influence across the Nile grew with the discovery of the Nubian gold mines. Exploitation of the Nubian mines lead to unimaginable wealth and the establishment of the first true great empire of the world. The Egyptians had established a system of economics and the first monetary exchange based on gold and silver and thus creating an economic order based out of currency and not barter.
Trade and the development of barter
Even since man has had the realization that he alone cannot provide for everything that he needs, he understood the importance of trade. When there was no money, people still traded using whatever they could lay their hands on. Shells, fruits, crop, and anything that was important and has some sort of value attached to it would be traded. This gave rise to a system of trade that we call as barter. Man would exchange a hunt with another for getting wine, exchange wine for clothes, and clothes for any tools that he would need. Generally the chief item of trade among the people of Asia and Europe was cattle. Cows and oxen were traded as means of exchange for goods and services rendered. This resulted in the specializations of trade and men started living in societies where each man had a role to play in the larger scheme of things. So a potter would still be able to east without knowing how to grow crops and a wine maker would have the pitchers that he needs to store his wine without having the know how. A common form of sustenance thus resulted in what we call as society. In some societies, still today, people would trade using items and not money as in coinage and paper currency. Precious metals came after cattle and started to be used as a supplementary form of exchange and then slowly took over as the primary form.
Why money was needed?
During the days when barter trade was prevalent every item would have a fixed exchange rate compared with the other items that were traded. 1 bag of rice for 2 new clothes, 20 bags of rice for a cow and so on. However in a simpler trading situation this would have been possible where the number if items on exchange were few. When the market expanded, things became complicated and more and items were started to be traded. Barter became complicated because hundreds and thousands of items now needed an exchange rate to be traded properly. This gave birth to money. When money was introduced, every item in the market had a fixed exchange rate based on a unit of currency or money.
Rise of gold as an international standard, why it was popular?
Gold has always been accepted universally. It has significant value attached to it which is why people readily accept it as a form of payment. The significance of gold as an international standard of payment rose when it was accepted internationally as a form of payment. This was during the hay days when gold standard operated as a basis of international payments. However the International Monetary Fund took gold out of the equation and ensured that it no more plays a significant role. Gold as a means of reserve in the international market fell from nearly 70% to a mere 3%.
During the years 1880 to 1914 gold formed the basis of payment internationally. All currencies were valued to a fixed amount of gold which was held in reserve. The governments would have to repay the amount of the printed currency in gold when presented. This was done to ensure that the paper currency which was in circulation has a fixed value and the governments would not print excessive amounts of paper currency and thus create cheap money in the process. The basic idea was to restore the confidence of the people on the circulated paper currency and ensure the survival of it.
However the international gold standard started to dwindle out and by 1913 the United States had about 90% of their money supply from paper money and demand deposits. However the scenario again changed after the first Great War. Post the First World War, there was a popular sentiment which wanted the old gold currency to be restored. High inflation and taxation had the entire Europe and America reeling. The United States was the first country to return back to the gold standard. This was followed by several European nations who also returned back to the gold standard. However during the First Great War the economies had been hit severely. The pressures of having run the war for years, the economies started to find the pinch and slowly started to detach themselves from the gold standard.
1934 was the year when the United States reeling under the pressures of the Great Depression, introduced the Gold Reserve Act. It practically gave a monopolistic control over possession of gold in the country to the government of United States. Private possession of gold was banned. The price of gold was sent to $35 an ounce and the dollar was devalued as well. The idea was to boost the economy by inducing production when gold was made rare in the market.
During the 1944 when most of the world was battling the Second World War, representatives of 44 allied nations met at Bretton Woods, New Hampshire, for a conference held between July 1 and July 22. Their goal was to establish an international monetary body which would ensure that there is a set monetary exchange system among nations at a pegged rate. This led to the establishment of the International Monetary Fund and the International Bank for Reconstruction and Development. Gold was at that time the dominating metal and as such was considered to be the basis of the international payment currency. At that time most of the European nations were in huge debt and they started transferring their gold to the United States. This made the US Dollar appreciate greatly. Thus in the later years the US dollar become the dominating currency. US dollar at that time was backed by Gold and an exchange rate on gold was determined which led to it becoming the preferred currency of exchange.
However major countries like France and England started selling of their US Dollar reserves and traded them for gold from the US treasury. This led to a considerable decrease in the power of the US dollar in the international market. Added to this was the considerable strain put on the US economy during the ongoing Vietnam war which lead to the then President Nixon to stop the full convertibility of the US dollar to gold. This was the trigger that upset the whole Bretton Woods system.
With the collapse of the Bretton Woods systems in USA in 1973 ordinary citizens were no longer under the ban to purchase bullion and or invest in it. The abolishment of private possession of gold completely came off in the year 1975. Similar bans were also in existence in UK and Japan which also came off in the years 1979 and 1973 respectively. The world over liberalization of the private purchase of gold lead to some countries becoming major exporters and the yellow metal. Countries like Turkey, where gold import was previously banned, saw its domestic, gold prices jump 85% following the lifting of the ban on imports.
Why the Gold Standard to some extent was advantageous
A significant reason for the Gold Standard to be successful is that it provides absolutely no chance of a hyperinflation. The reason is that gold is tied to the currency and as such until the whole stock of gold was increased additional money could not be printed. In the hindsight that is the very reason why the US economy could not come out of the great depression of 1929 rather quickly. Since the money was tied with the gold, the US government had to look for other opportunities and tried to attract the foreign investors who would bring in their investment in the form of gold. Interest rates were increased for the investors and that means higher and more prohibitive interest rates for the domestic borrowers.
Another important advantage of the gold standard is that excessive printing of cheap money can be prevented another anti inflationary method. This would ideally put the entire money in circulation into a fixed price with the gold in reserve and that evidently results in a pressure on the government to pay off the amount in gold when demanded; a deterrent for printing excess money.
All currencies of the world has been at one time of the other been formed from the base gold and silver metals. The reason that gold and silver became popular and is still valued and possessed as a means of investment is that gold and silver are the only real currency that the world has known that has survived the vagaries of millennia's of political and economic turmoil. They were of great intrinsic value unlike the paper currency and can be exchanged easily for commodities and are widely accepted. However in the last few hundred years or so, paper currency of "Fiat" currency as we call it has come into existence and has taken over. Paper currency when it first started off was attached to this base gold currency. People knew that the exchange rate was fixed and one can trade in confidence as they were backed by gold. The fact that they were later detached from gold and silver, made them lose their confidence in paper currency. Say you are trading eggs for $4 a dozen in Seattle on Monday. If the price of eggs increases to $5 a dozen on Thursday you will probably wonder whether you are dealing at the right price. It is the confidence in a paper currency that makes it work.
Why gold has been a popular method of savings
In the 1920's if you wanted to buy a new pair of trousers you needed probably $10. Whether you spend that using a $10 printed currency note or use a $10 worth of gold coin it was irrelevant. In 2011 if you want to buy a trouser, that same $10 gold coin will buy you the pair of trousers but the $10 printed note will be useless. The reason is gold has an intrinsic value. To a large extent the prices of gold and for that matter even silver has not seen a downward spiral even during the greatest of depressions. Sometimes though the price of gold has certainly swayed but the same can be said of all precious materials and other commodities. During the Gold Decree the price of gild was fixed at 35 dollars to an ounce. Even the purchase price before that was fixed at a little over 20 dollars. In both these cases the price was set by the government of US and not due to market dynamics. During the last great depression even when most of the stocks took a beating and some more than 70%, gold stocks increased to over 400% and gave dividends to their investors. The two largest gold producing mines in USA and Canada managed to do this which speaks volumes about the persistence and strength of gold in any market situation. Thus people have always preferred gold as a mode of savings. It is like saving their money securely which is not going to devalue over time and waiting till the investment weather is good for further diversification of the portfolio.
Another reason why gold is a good investment option is the diversity that it brings to the overall portfolio. An investment expert will never ask you to put all your money in a single stock or investment option because of the inherent risks that it brings to the portfolio. A diversification is required to spread the risks. Gold being a hard currency gives more intrinsic value to your portfolios and credibility to it.
A significant disadvantage of gold is that it does not give dividends and the price of gold during an inflationary process is what provides the increase in the investment. It is more of the safety and stability of the investment which encourages buying gold. The remarkable nature of both gold and silver.to hold their prices and remain steady even though there is a considerable price deflation all around means that when you invest in gold your investment though not necessarily going to provide an immediate return, will provide a considerable gain of wealth when your compare the prices after some time.
The comparative price of gold to other commodities in the market has always been better. The Dow Jones Industrial Average has always been competitive with the price of gold. Even during a depression, when the prices of all commodities have gone down, the price of gold which may not have increased to more than what you had paid for it in the first place, the comparative price is more than what other commodities are. This can be further explained using a small example. Imagine that today you have purchased 20 ounce of gold (this is just a comparison). If you wish to purchase a car, only about 10 ounce will buy you a luxurious sedan. However another few years of waiting and the same sedan can be bought for only 15 ounce of gold. This is because of the price of gold which has gone up significantly compared to the other products in the market.
One aspect of investing in gold, silver, platinum and palladium the main four precious metals that you can buy, is the storage costs that you need to take into consideration. Physically buying gold and storing them a location that is under your control is not advisable because of the inherent risks of it. As such when you open a holding account online or with a bank they will offer you the storage options at a nominal cost. When investing precious metals, the cost of storage is also to be taken into consideration. Any cost which is prohibitive for storage must be considered against the inherent gains that the holding will provide after a period of time. An estimated storage costs for holding gold is 0.015% from 1 to 49,999 gold grams stored in at London, Zurich or Hong Kong. The costs also include the insurance coverage against theft for the investment.
Comparatively the regular basic savings and other investments options would appear more attractive as they don't require storage costs, but the fact remains that their volatility in a negative market situation works to their disadvantage. A soft currency investment option is never a hard currency and lacks the intrinsic value that hard currency like gold, silver, palladium or platinum has. Thus when markets crash the inherent depreciates overnight and people lose their life's savings. Gold on the other hand is a reserve currency which is accepted under any market situation and as such a better option.
Gold crash vs. hyperinflation
Gold is one commodity that has always been looked with confidence by the investors. An interesting fact about gold is that there is not much of it in the market. As such if paper money becomes obsolete tomorrow and the only mode of accepted payment becomes gold or silver, then we the people who does not possess gold but only electronic balances of money, will have no where to go. If we rush to buy gold all the gold and silver and other precious metals would have been gone. So basically all our huge savings, investments and bonds will have vanished. A printed paper currency which is being produced in much quantity as required by the economy cannot be relied and the only thing that will matter when paper money fails is what you have in intrinsic value that is gold. One of my colleagues had once said me, "gold at $1000 a once, this is not a price one should invest into something." However the fact remains that it is not the price at the end of the day that counts, but the intrinsic value that you possess. Paper money in itself does not worth anything; gold does. Thus when paper money will become defunct, the only things that will remain of value are the precious metals.
Irrespective of that, gold prices have also suffered a price deviation. In recent years as during the depression of 2008, when commodity prices were going down and the real estate and financial markets crashed, people started to sell off their investment and hoard up the dollars. Even the price of the yellow metal, which was otherwise so popular, also went down. People started to sell of their gold investment and realize the investment in cash. This resulted in gold prices falling by about 30 percent in November of 2008 from the March 2008 price of $1000 per ounce.
A real possibility of gold crash could be if and when there is a sudden increase in the supply of gold in the market. Due to inherent rules of a demand and supply of any commodity in the market which drives the price of it, gold prices can severely depreciate if there is a significant rise of the supply of gold in the market. However for the last few decades there has not been a single discovery of a gold deposit that is easily accessible in an area where there is no conflict or political instability to encourage an increase of gold supply into the market. It is unlikely something of that sort happening in the near future.
There has been no dearth of speculation as to where the price of gold will reach in the next few years. The internet is abuzz with speculations and predictions. Some people have predicted a $3000 value per ounce for the precious metal not something that is entirely impossible. Other market experts have even predicted a $10,000 value of the yellow metal. However, it is any body's guess to predict which way gold prices are going to go.
Again some schools of opinion say that anything that is being traded and is consistently rising in price has the tendency to correct itself out at one point of time. Just like in a share market which has hundreds and thousands of companies listed and their shares traded. Evidently the shares being traded are only limited in numbers and the company's cannot keep adding more and more shares as they are being traded. Thus sooner rather than later a situation will arrive when the shares of the company's will rise to a level that no one will be able to invest in them. However nothing can simply go on increasing indefinitely and as such price will stall at one point of time. There will be a price fall after that. As soon as prices start to fall, people who have invested their life's savings will want to cash out and escape the tumbling share market. What follow is more sellers in the market than buyers. Prices will tumble and values will get eroded overnight. A once booming market will then be followed by a recession. Recession will follow simply because there will be less money in circulation. People who have lost their savings will have but no option but to hold on to what they have and thus the market will have significantly less demand for goods and services.
Hyperinflation has its own effects on the economy. A simple explanation of hyperinflation is when there is a large increase of money in the market which is not supported by the GDP of a country that means more purchasing power than can be supplied with the availability of goods and services, hyperinflation sets in such conditions. One way to explain a situation like this is by giving an example. Say there is a massive crop failure. Consumers need the goods but they are unable to buy it because of the minimal amount in supply. Thus the prices of the goods are going to go up.
In the modern world, governments of the world has the power to print money as they wish and that has been possible because of the absence of a pegged exchange rate to an object of intrinsic value. Thus in order to correct the problem of job cuts and to revive the economy, governments are spending billions of dollars. One would imagine that this would come from taxes but in an economy which is already reeling with absence of jobs and there is no real inkling of hope that jobs are getting back in drones, increased taxes will only add to the misery. Thus governments are resorting to other forms of funding which is to print more money. Indirectly they are also fuelling the inflationary forces.
An increasing price of gold can be attributed to a bubble that is being created because of the gold mania that we are currently experiencing. Some speculators are expecting gold prices to touch $5000 an ounce and every body seems to be coming out with a speculation of their own and the internet is abuzz these days. We are currently seeing the same kind of mania that we had before the economy took a down turn when the real estate markets crashed. Why would the gold price be a mania, you ask? Gold is in a relatively fixed amount of production. It is one metal that has a limited supply and the production is also limited based on the availability of the gold mines around the world. However contrary to the supply demand is ever increasing. We all know that gold has an intrinsic value and is along with other precious metals like silver, palladium or platinum is readily accepted world wide and is treated as a reserve currency. Even if all Fiat currencies fails to become confetti and the banks fail around the globe the real possession value of gold is not going to fail and it will continue to be accepted. Thus the understandable urge to possess gold as a reserve asset. However the supply of gold is not going to increase to the demand of the consumers and thus the prices will continue to be pushed beyond the limits of a common man. The same way when the property prices went on into a dizzying height and pushed the real consumers out of the market due to the influx of speculators and then crashed miserably when defaults started happening similarly gold prices will stall at a point. If it starts to go down as the market starts to correct itself, we can see a recession setting in or at least a bear market.
An improving job market and a strengthening dollar can see a correction in the gold prices as has been seen in the first quarter of the year. As per a report from the Bureau of Labor Statistics non farm payrolls have increased by 216,000 which is higher than the consensus expectation of 185,000. This immediately saw dip in the gold prices with investors cashing in on the yellow metal and migrating to stocks instead.
Investment in Gold via Dollar Cost Averaging
Since the intrinsic value of gold is never challenged and the fact remains that it is a true reserve currency to the world, an investment in gold at any point (unless it is going over the roof and is due to correct itself imminently) is a safe method to store your net values. One way to ensure that the value of gold your investing is averaged out and represents a lower end of the price rise is to employ a method of Dollar Cost averaging. You invest a fixed amount of money periodically over a fixed period of time. This in a rising gold price market initially will bring in more gold than the later investments. The benefits of this system is that over a period of time when the markets fluctuate, your investment is going to be marginalized and you will suffer less than if you had invested the entire amount in one go.
A lot of brokerage firms will offer this service using an automated debit system from your bank. That way you don't have to actually do the transactions manually and have to remember yourself to make the payment every time it is due. Else you can manually make the payment.
Purchasing Gold using Value Averaging
Gold has been one of the many and by and large a popular method of storing assets and values. It is one of the few precious metals which are rare and have an intrinsic value attached to it because of its rarity. This is what makes it more susceptible to fall back to when there is a market crash as we saw in 2008. Real estate was another such market but when the real estate market crashed devaluing values held in such assets, people had to fall back on the time tested yellow metal for salvation.
A lot of people have experimented using the Dollar Cost averaging and the Value Averaging methods of investing in the yellow metal. While we have discussed abut dollar cost averaging in the previous chapter, we will discuss about value averaging here. Value averaging is somewhat similar to dollar cost averaging, in terms of the over all approach of investing on a monthly basis. However it differs to the former by the fact that the investment is directly in proportion to the fluctuations that the investment has had in between the two investment dates. Say a person has invested in some stocks to the tune of $5000. He has set an amount of $100 for the investment to grow by the next month when the next investment date is. Say on the day the additional investment is to be made; the total price of his investment has increased to $5057. That means he has to make an additional investment of only $43 to raise his total investment to $5100. Similar to a dollar cost averaging method, in a market where the prices are increasing, one has to buy fewer shares and more when the prices are going down. The value wise difference between the two methods has not been too much in a same period of price fluctuations. This method can be gainfully used in the manner of investment into Gold. When the price is lower amount invested will buy more quantities of gold then when the price is higher. However over a reasonable period of time the cost of gold acquired will be marginalized reflecting a lower price.
Ways to invest in Gold and Silver
Gold can be purchased either as a physical holding of bullion, coins or jewelry or a stock held at a secured vault holding some where else. A lot of registered gold firms sell gold coins and bullion accepts applications. Ensure before investing in gold through one of these companies, to check with the better business bureau and find out more about the company and its background.
Find the current price of gold and silver over the phone and find out everything that you need to know before placing the order. Once you are satisfied place the order and confirm it when it is verified by either phone or email. Once the order is verified, make the payment using a wire transfer to check payment and wait for the confirmation of the purchase being made.
Rajib Mukherjee is a freelance article writer from India, specializing on technical, finance, travel, internet and internet technology related content.
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