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 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.