Friday, August 12, 2011

The Dollar Is More Than Worth Its Weight In Gold

The year was 1970, and I had mastered the mysteries of Money & Banking, a core course for Economics majors.  In retrospect, the Money & Banking course that I took was rather simplistic compared to what has happened since in the banking system.

In 1970, the dollar was backed by gold.  Banks controlled almost all the money.  Banks were open from 9 am to 3 pm on weekdays and until noon Saturdays.  If you wanted money, you went to the bank.

The gold that backed the dollar was stored at Fort Knox, Kentucky.  We knew the gold was there because we watched as James Bond and Pussy Galore thwarted Auric Goldfinger’s evil plan to ruin our gold.  The dollar was as good as gold.

In 1971, everything I learned about the dollar came to an end.  The United States unilaterally ended conversion of the dollar to gold.  The dollar became fiat currency—money backed only by government decree.

In 1933, President Franklin D. Roosevelt ordered the American people to surrender their gold certificates, gold bullion and gold coins to the U. S. Treasury.  They were paid $20.67 per ounce.  A year later, FDR signed the Gold Reserve Act of 1934 which priced gold at $35.00 per ounce.  The official price of gold remained at $35.00 per ounce until President Richard M. Nixon decoupled the dollar and gold on August 15, 1971.

When Kings got into trouble in the past, they called in the coins, melted them down, added an alloy, and issued new coins at the same face value.  This is known as inflation.  FDR did the kingly thing, only he did it with a pen filled with ink. 

President Nixon had little choice but to end the gold standard.  The nation’s inflation rate was rising to 6%.  If foreign governments had demanded payment in gold bullion, the gold reserve would have been drained.  There was also a fear that the Soviet Union and South Africa were sitting on huge gold reserves and would use their suspected hoards to destabilize western currencies.

The gold standard that backed the dollar from 1934 to1971 was, in reality, a fiction.  The official price of gold was arbitrarily determined by a president who was desperate to expand the money supply and stave off deflation.  That the official price of one ounce of gold remained at $35.00 through World War II and the great economic expansion of the 1950s and 1960s tells us that gold remained arbitrarily valued.  The increase in our gold reserves during the period never matched the increase in the nation’s money supply.

Even valued at today’s high price, gold would be inadequate to back even the dollar.  All of the gold ever mined is believed to be worth less than ten trillion dollars at the current market price.  Gold would have to be valued many, many, many times higher to reflect its scarcity if used to back the world money supply.

When viewed in hindsight, one can make the argument that all money is fiat money.  Money has always been worth what the king said it was.  Gold and silver bullion reserves only give the appearance of underlying value.

During the past few years, investors have been buying gold bullion and gold coins.  “Gold has never been worth zero!” is a popular ad slogan.  Investors believe that gold will only rise in value because they mistakenly believe that gold is a standard of value.

Gold is neither priced by its scarcity nor by its cost of production.  Gold pricing in today’s market differs very little from the Dutch tulip mania in the 1600s.  Gold is priced by speculators who see no end to its rise.  Gold hoarding is the latest fad, the latest asset bubble.

Gold has always mystified mankind.  It is the one metal that does not rust or tarnish.  When the Great Pyramid of Egypt is reduced to a pile of sand, the gold in Pharaoh’s tomb will be as shiny as the day it was crafted—assuming it’s still there.  Gold has an eternal quality like nothing else on Earth.

To possess gold leads to avarice.  Stories of avarice and greed abound in the Bible (Exodus), literature (Silas Marner), film (Treasure of the Sierra Madre) and history (Pizarro and the Incas).  And most people believe there is a huge treasure of gold just waiting to be discovered (Lost Dutchman mine and El Dorado.)

If history is an indicator, then it seems that one thing is certain: Just when you get ready to enjoy your gold wealth, someone takes it away.
Web links