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Will a Return to the Gold Standard Push Gold to the Stratosphere?
“A gold standard system has a specific purpose: To achieve, as closely as possible in an imperfect world, the Classical ideal of a currency that is stable in value, neutral, free of government manipulation, precise in its definition, and which can serve as a universal standard of value, in much the manner in which kilograms or meters serve as standards of weights and measures.”
– Nathan Lewis and Steve Forbes, in “Gold: The Monetary Polaris” (2013)
Right now, the U.S. dollar is strong and gold is weak. It wasn’t always that way. In the century since the Federal Reserve was born, gold has outperformed the dollar 50-to-1. (Gold was $20.67 per ounce then.)
Most of the world went off the gold standard in 1931, in the depths of the Depression. Britain abandoned gold on September 19, 1931. Japan followed suit on December 11, 1931. Many other nations established exchange controls to prevent the hemorrhage of gold. The United States under Herbert Hoover held on to the gold standard, but Franklin Roosevelt not only abandoned gold but forced the confiscation of private gold held by Americans soon after his inauguration. Then, in January, 1934, he raised the price of gold to $35 per ounce, devaluing the dollar by 41%. After World War II, when the dollar became the world’s strongest currency, other governments could swap dollars for gold (although American citizens couldn’t).
As the dollar lost its competitive advantage in the 1960s, President Lyndon B. Johnson removed silver from our coins in July, 1965 and President Richard M. Nixon closed the gold window in August of 1971.
After 1971, U.S. money supply took off (from under $1 trillion to over $12 trillion) without gold backing.
There has been no semblance of a gold standard since 1971. Now, currencies simply “float.” Imagine if miles, inches, kilometers, pounds and gravity were allowed to have floating values. If you can imagine that, you can see why a world without a monetary standard is so unpredictable that investors bet trillions of dollars per day on the currency markets, dwarfing trading volume on the world’s great stock markets.
A Return to a Gold Standard could Send Gold Prices to $50,000 or Higher
Several scholars and economists have proposed a return to the gold standard – even though most of the mainstream economists are dead set against a return to what John Maynard Keynes called that “barbarous relic.” In this case, I believe the mainstream economists will prevail. A return to the gold standard at this far remove might be such a shock to the world’s economic system that it might not recover. The levels of debt are now so high that the meager amount of gold in our national vaults would not begin to cover those debts at a price anywhere below $50,000 per Troy ounce of gold – almost 50 times the current price level.
The United States, for instance, has more central bank gold than any other nation, by a long shot – about 264 million Troy ounces. With M2 money supply currently at $12.2 trillion, it would take a gold price of $46,200 to back our money supply. In addition, with a national debt of around $19 trillion, the “clearing price” of gold (that price at which we could exchange gold for maturing Treasury bonds) would be over $70,000. If gold were to back both our money supply and our debt, gold’s price would be $117,735/oz.
And that’s for the country with the most gold. The situation would be far worse in Europe, Asia and in the Third World, which is just beginning to be rich enough to add some gold to their central bank coffers.
For practical reasons alone, America and the world will not return to the gold standard in the foreseeable future. But we as private investors have the opportunity to create our own “gold standard” at home, but exchanging the gradually eroding value of various paper currencies for a growing cache of gold at home.
The Erosion of All Paper Money Since 1913
The headlines tell you gold is at a six-year low, but even if gold fell to $1,034 it would still be worth 50 times what it was worth a century ago – in terms of the world’s strongest currency in the last century, the U.S. dollar – but nearly all other currencies have either died (gone to “money heaven”) or they have been absorbed into another type of currency (such as the “euro,” which replaced a dozen or more currencies).
The German mark was mighty in 1914, trading at four marks per dollar, but the old German mark died in World War I and the hyper-inflation of 1923. Prices in Germany were growing by nearly 30,000% per month by late 1923. Prices in some other war-ravaged areas were rising by triple digits at that time. The destruction of the German mark wiped out an entire generation’s savings before it was fully repudiated.
Hyper-inflation during and after World War II was just as bad. In late 1944, prices were doubling every four days in Greece, reaching a monthly inflation rate of 13,800% in October, 1944. Hungary suffered 207% daily price rises during the month of July, 1946. Prices doubled every 15 hours. The percentage increase in prices in that single month almost defy comprehension, rising by 41,900,000,000,000,000%!
The United States also suffered temporary sieges of inflation under the gold standard during the War of Independence (1775-1781), the War of 1812 (1812-1815), the Civil War (1861-65) and World War I (1917-18, the years of U.S. involvement, as this chart shows, but overall prices were stable under gold.
America’s worst experience with inflation came during the War of Independence, when the Continental Congress printed the “Continental,” a paper currency backed only by their “faith and good intentions.” Those cheap-looking pasteboards were not backed by gold or silver, so they were printed by the millions. Merchants demanded more and more Continentals for the same amount of goods. Before long, General Washington complained that “a wagonload of currency will hardly purchase a wagonload of provisions.”
By the end of the Revolutionary War, the Continental was worthless. Because of this early experience with hyper-inflation, the phrase “not worth a Continental” became a common way to describe anything with no real value. That’s one reason why the drafters of the U.S. Constitution wrote gold and silver into our nation’s founding document: “No State shall… make any Thing but gold and silver Coin a tender in Payment of Debts” (Article I, Section 10). This is why the first American coins, under the Coinage Act of 1792, were composed of gold and silver, with only the 1-cent and half-cent coins to be made of copper.
Under the gold standard for most of the period 1792 to 1914, price levels were remarkably stable:
Since the end of the U.S. gold standard in 1934, the U.S. dollar’s purchasing power has fallen sharply.
During the 125 years that America existed as a Republic without a central bank (1789 to 1914), there was only one brief period when America went off the gold standard, staring in the War Between the States, when President Lincoln printed “Greenbacks,” unbacked by gold or silver (the Confederate states printed their own fiat currency). The gold standard was not fully restored until 1878, after which the dollar held its value, until the birth of the Federal Reserve System in 1914. After that, the dollar began to tumble.
Since the birth of the Fed, the Consumer Price Index (CPI) has risen 23-fold and gold has risen 52-fold. If you turn these numbers around, the dollar has lost 98% of its value to gold and it has lost nearly 96% of its buying power. In the last 50 years, the dollar has lost 86% of its buying power and gold is up 3,000%.
The birth of the Federal Reserve coincided with the birth of the Internal Revenue Service (IRS), which lifted the top U.S. tax rate to 70% within five years of its founding. This resulted in an expanding central government, in part to fund America’s involvement in World War I. This caused double-digit inflation.
Inflation Rates during the Federal Reserve’s First Few Years in Office
Inflation is low today, but over the last century, the Consumer Price Index is up 2,254% and gold is up over 50-fold. Here is where gold and the CPI stood (annual averages) 25, 50, 75 and 100 years ago:
And here’s how gold and inflation have gained over those last 25, 50, 75 and 100 years:
When this new Millennia began 15 years ago, gold traded under $300 an ounce. In almost any historical perspective (except for the last four years), gold has badly beaten the dollar, and gold will likely beat the dollar going forward (in part due to QE). The only problem is, we don’t know when gold might recover.
Gold is currently in a resting period, but that does not negate its long-term value as a currency hedge. In a balanced portfolio, gold is preferable to cash or long-term bonds as a currency hedge – a hedge against either inflation or deflation, currency debasement, quantitative easing or central bank manipulation. As a rare earth element that is virtually indestructible, it contains all the qualities of true money. Paper fails all those tests: It can easily be debased by the printing press and it is often a tool of political manipulation, while gold is beholden to no man or government. Its intrinsic value has been honored for centuries.
We don’t need to rely on governments to establish a gold standard – they probably won’t – but we can create our own gold standard by owning a portion of our assets denominated in gold rather than paper.
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