The Case For Gold

My original article, The Case for Gold, has been revised to reflect my reading of The New Case for Gold by James Rickards published in 2016 and The Power of Gold - The History of an Obsession by Peter L. Bernstein, originally published in 2000.

Gold is a metal found in the earth as nuggets or grains in rocks, in veins and other deposits. Today, gold is extracted from the earth by substantial investment in capital equipment, development of costly mines and ore processing plants and the hard labor of men. Gold is chemically inert and the most malleable and ductile pure metal known. It has a bright yellow color and luster considered attractive by most people, which it maintains without oxidizing in air or water. Gold has been a highly sought-after precious metal for coinage, jewelry, and other arts and served as a symbol of wealth and store of value since the beginning of recorded history. It is believed that virtually all of the gold ever discovered or mined is controlled by persons, organizations or governments in today’s world.

According to the Greek historian Herodotus, the Lydians were the first people to create coins made out of gold and silver in about 635 B.C. Lydia was located in what is now western Turkey. King Croesus of Lydia created the first bimetallic coinage system, gold coins for large transactions like foreign trade and silver coins for small transactions. Croesus set the first value ratio of gold to silver at 10 to 1. The value of ratio of gold to silver has been controversial throughout history and changed as the relative supply of gold and silver evolved through new discoveries and mining of deposits all over the world.

In The Power of Gold Bernstein reviews the evolution of role of gold in cultures throughout the world throughout history. What is clearly illustrated is that gold has been used as a store of value, used to showcase one's wealth, used for a variety of religious purposes and used as a medium exchange in virtually every culture known to man. Depending on the time, place and circumstances of the people, empire or nation gold was deployed in a manner that benefited the leadership class. However, Bernstein illustrates clearly that acquisition of large amounts of gold and silver doesn't necessarily mean a people, empire or nation becomes rich and stays rich over the long term. The story of Spain's exploitation of the gold and silver resources of Peru and Mexico is one of the highlights of the book. If one spends far more than one's income it doesn't matter how much income one has, you still go bankrupt. Despite its massive gold and silver exploitation of the America's, Spain was never able to become a rich and powerful nation for an extended period of time. What is also clear is that the interaction between monetary and fiscal policies with social issues is far more complex and has potentially long lasting impacts that are not immediately understood.

As Bernstein reaches the 1800's in his book the story of gold as the international monetary standard becomes more familiar. He describes that gold rushes that occurred in California, Australia, Russia, South Africa and the Klondike and puts them in context of the events of the day. Bernstein does a great job of explaining how the leading nations of the day competed with one another, helped one another, attempted to manage their economies within the context of the industrial revolution and the development of the United States as a major industrialized nation. One of the most interesting aspects of the book is Bernstein's discussion of the continuing arbitrage between the value of gold, silver, paper currencies and bank notes that circulated as money around the world. Those of us in the technology driven world of the 21rst century should appreciate that fast moving markets were not invented in the past 20 years. Whenever there has been an opportunity to gain financial benefit by trading money people have acted quickly to gain that benefit.

The modern story of how the world monetary system evolved into its present status begins with the impact of World War I on Europe. The destruction and havoc caused by World War I created a combination of conditions that lead to the Great Depression, the rise of Nazi Germany and World War II and then the recovery from World War II and everything that has happened since then. After reading several books that have covered this subject I believe the world has never fully recovered from the political, economic and monetary impact of World War I. My parents were born after World War I and have departed this earth, but the impact of the series of events that began in World War I has never stopped. I am sure it is difficult for many people to believe that events which have occurred over such a long period of time are connected but when you read and fully appreciate the story the linkages become clear.

Decisions taken by the Bank England, the government of France and many others lead to the series of disasters that followed World War I. Bernstein, a Keynesian economist, is critical of many of the decisions of the leadership of the Bank of England after the close of World War I. His primary criticism relates to the Bank's effort to restore the international gold standard in the aftermath of the war. England made the decision to protect the value of its money at the expense of slowing down their economy and creating unemployment. Winston Churchill was the ultimate decision maker. After reading The Power of Gold and other books which have covered this period, I am not sure what the right decision should have been. One can always look at past decisions and criticize them knowing what has happened. But no one knows what would have happened if there had been different decisions. What is clear is that the English debated the issue intensely before deciding what action to take. What is also clear is that government monetary decisions can never be separated from the overall political and economic environment. What is fair and right for one person can be devastating economically to another.

The US initially established the price of gold at $19.75 per troy ounce in the Coinage Act of 1792. Gold was used for $10, $5 and $2.50 coins. Silver was used for coins from half dismes (nickels) to one dollar. In 1834 the price was raised to $20.67. In 1873 the US Congress passed the Coinage Act. "which listed the listed the various the denominations of gold and silver coins to be minted by the US Treasury" going forward. The silver dollar was not included in the list of coins. Silver coins were limited to small denominations. The US was no longer on a gold and silver standard. The US was on the gold standard. The US maintained the official dollar value of gold for almost a century until Franklin D. Roosevelt signed Presidential Executive Order 6102 on April 5, 1933 confiscating all gold held by US citizens for other than industrial, professional or artistic uses. FDR called in all US held gold at a value of $20.67. The Gold Reserve Act was passed by Congress on January 30, 1934 establishing the official price of gold at $35 per ounce, a 40 percent devaluation of the US dollar. These two actions were the first two major events in the long term destruction of the value of the US dollar in gold terms and demonstrated that the US government will confiscate the wealth of its citizens to achieve its political objectives. While most US citizens are taught that FDR was a heroic figure and a great President in combating the effects of the Great Depression and World War II, the reality is that he was responsible for the confiscation of gold and a massive devaluation of the dollar. Did the Congress pass legislation that violated the principles of the US Constitution? Did Roosevelt make good decisions or bad decisions? It all depends on your perspective. One cannot separate monetary policy from politics.

In July 1944, in preparation for the end of World War II, the allied nations established the Bretton Woods systems of monetary management that was based on the US dollar as the world reserve currency. Since the US dollar was freely convertible into gold at $35 per ounce the world currency system was essentially on the gold standard. The US dollar was as good as gold. Bernstein describes the dynamics of the global economy in the post war era. As the destroyed economies of Europe and Japan were rebuilt, the US gold hoard which has been accumulated during World War II began to shrink quickly. Within 20 years after the end of the war it was clear that the fixed currency exchange rate must be changed. It was also clear that the common interests on World War II allies were diverging. Charles de Gaulle, President of France in the 1960s, led the charge of those that wanted to exchange their US dollars for gold. It appears de Gaulle's motivations were in many respects political rather than monetary, again illustrating that it is impossible to separate monetary policy from politics.

During the 1960’s the US government spent excessively on the Viet Nam war and established and expanded a number of entitlement programs for its citizens. Under President Johnson on March 18, 1968 the United States law regarding gold backed money was changed. The new law eliminated any requirement that the US dollar be backed by gold. Fearing devaluation of the dollar European interests demanded to exchange their US dollars for gold. In August 1971 President Nixon shut the gold window and unilaterally refused to exchange gold for dollars the final act of destruction of our constitutional requirement for money based on gold and silver coin. In 1972 the official price of gold was changed to $38 per troy ounce and the price was further adjusted to $42.22 in 1973, the official gold price that exists today. President Ford signed a bill legalizing the ownership of gold effective December 31, 1974 allowing individuals to profit from trading gold and protect themselves from future devaluation of the US dollar by owning gold.

During the thirty-nine years since the ban on gold ownership was lifted, the US government and the Federal Reserve have devalued the US dollar to the current market price of approximately $1300 per ounce. Gold reached a market high in excess of $1900 in 2011. The US dollar has lost more than 95 percent of its value since the early 1970’s. An ounce of gold hasn’t physically changed during this period. What has changed is that the US government has acted irresponsibly in its stewardship of our nation’s monetary and fiscal policy. Both Democrats and Republicans have been responsible for the government actions that date back to FDR, but accelerated when our Congress would not restrain themselves by spending our nation’s wealth on both guns and butter beginning in the 1960’s.

The Power of Gold was initially published in 2000 after gold had gone through a bull and bear market cycle relative as measured by US dollars. Gold reached a high of $850 in January 1980 and had a long decline to a low of about $255 in early 2001. It is clear from Bernstein's views expressed in the book that he is a Keynesian and doesn't believe gold should have a monetary role in modern times. He looks at the gold bull market top in 1980 and subsequent decline until the date of publication of his book as vindication for his views. Unfortunately, the world didn't end at the time he wrote the book. Politicians the world over continue to want to spend far more money than they collect in tax revenue. Like the kings of ancient times that debased their coinage, current governments don't want to be fiscally and monetarily responsible. Leaders always have other objectives beyond maintaining sound money. During times of conflict when governments have manufactured fiat paper money at will to achieve their national objectives, gold has been the medium of exchange used to acquire critically needed goods and raw materials. One can go anywhere in the world and exchange gold for any kind of paper money. In some cultures direct ownership of gold jewelry and objects continues to be a fundamental measure and storehouse of wealth.

Economic and business cycles and financial panics occur on a regular basis because of the greed and emotions of men. The financial community tries to present itself to the rest of us as a group of highly analytical people that have the education, skills and experience to manage all aspects of our money. Unfortunately, this group has proven throughout history that they are collectively driven by greed, emotion and a quest for power and their analytical capabilities are set aside when no longer convenient in the context of personal or collective objectives. When a time of financial excess occurs and a recession, depression or panic results we must allow the cycle of greed and emotion to run its course without compromising our financial system or our money. We must endure the negatives in the same manner we enjoyed the positives of our economic, financial and monetary system.

At the end of his book, Bernstein shows his true Keynesian colors as he uses a variety of examples to support his opinion that gold should never be the foundation of our monetary system because of it imperfections when used as money or the foundation for paper money. However, it appears that deep inside Bernstein knew he was or might be wrong. After making his case against gold he provides several views by respected individuals that have the opposite perspective. He states that in March 1997, Robert Mundell, then a future Nobel Laureate in Economics, predicted that "Gold will be part of the international monetary system in the twenty-first century." Bernstein states that "Gold may again serve as the ultimate hedge in chaotic conditions. Its return to its traditional role as universal money is unlikely, however, unless the time should come when the dollar, the euro, and the yen have all failed to function as acceptable means of payment across international borders." Based on the fiat money printing in the US, Europe and Japan in the past decade, Bernstein may have anticipated the future more than 10 years ago.

The Constitution of the United States dictates in Article 1 Section 10. No State shall… make any Thing but gold and silver Coin a Tender in Payment of Debts… Our founding fathers were very familiar with paper currencies and knew that all governments that were not constrained by a physical gold standard would eventually abuse their fiat currency to support their own political objectives. Our founding fathers have been proven to be correct. However, it remains to be seen what ultimate outcome of our current monetary path will be.

Our national expenditures continue to outpace our income. The debt and long term obligations of the US government continue to grow. Our collective desire to consume exceeds our collective productivity, work ethic and ability to compete in world markets. Our collective desire to be the world’s police force and nation builder allows our military industrial complex to consume larger and larger amounts of our nation’s wealth. Our collective desire to experience the good life has overwhelmed our national income and savings. The increasing price of gold over time is the best measure of the US government’s level of financial irresponsibility. The US government is on a path to bankrupting our nation due to its and the citizens of the US unwillingness to make hard choices and act in a financially responsible manner.

The future level of debt, government financial guarantees, debt to gross domestic product ratio, and annual deficits envisioned by the Obama administration are unsustainable. Eventually, the US will need to return to the rational thinking of our founding fathers and live by the law of the land, the US Constitution. Gold will need to take its place again as the core of our monetary system. I don’t know what the price of gold will be when the people of the US finally understand what has happened to our nations finances. However, don’t be surprised in the price of an ounce of gold in the years ahead doesn’t reach $3,000, $5,000 or even $10,000 before the US turns the corner and begins living within its means.

The citizens of the United States badly need the discipline of a gold standard to be restored at the core of our monetary system so we can rediscover how to build a strong, vibrant and disciplined nation. However, as Bernstein illustrates very well in The Power of Gold, one never knows what the future will bring when politics, economics and monetary policies collide.

In The New Case for Gold James Rickards brings the story of gold up to date and looks into the future. He makes the case that the world financial system continues to have gold as its core asset but the political and financial leaders don't want to acknowledge the truth. They want to control the actions of everyone by making us totally dependent on electronic money that they control. The fact that China, Russia and other developing nations are rapidly acquiring hundreds of tons gold is proof of the importance of gold as the core financial system asset of any nation. Rickards explains how the US Federal Reserve would be essentially insolvent without its gold reserves. He explains why the world financial system will have another crisis at some point in the years head. Rickards makes the case why gold should be part of everyone's net worth (ten percent is his target). He also explains why the US dollar value of gold is likely to reach $10,000 per ounce at some point and maybe much higher. After a few years of decline in the dollar value of gold, Rickards states that is likely that gold has completed its price retracement from its bull market highs and is ready to move higher again in US dollar terms.

We should all remember that gold is real money. It can be converted into any currency and has buying power anywhere in the world at any time.