"We have gold because we cannot trust governments." President Herbert Hoover's statement in 1933 to Franklin D. Roosevelt foresaw one of the most draconian events in U.S. financial history: the Emergency Banking Act occurred that same year, forcing all Americans to convert their gold coins, bullion and certificates into U.S. dollars. While the Act successfully stopped the outflow of gold during the Great Depression, it did not change the conviction of gold bugs, those who are forever confident in gold's stability as a source of wealth.
Tutorial: Commodity
Investing
Before investing in gold, you must
understand its history - a history that, like that of no asset class, has a
unique influence on its own demand and supply today. Gold bugs still cling to a past
when gold was king. But gold's past includes also a fall, which must be
understood to properly assess its future.
A
Love Affair That Has Lasted 5,000 Years
For 5,000 years, gold's combination
of luster, malleability, density and scarcity has captivated humankind like no
other metal. According to Peter Bernstein's book "The Power of Gold: The History
of Obsession", gold is so dense that one ton of it can be packed into a cubic
foot.
At the start of this obsession, gold was used solely for worship. A
trip to any of the world's ancient sacred sites demonstrates this. Today, gold's
most popular use in the manufacture of jewelry.
Around 700 B.C., gold was made
into coins for the first time, enhancing its usability as a monetary unit:
before this, gold, in its use as money, had to be weighed and checked for
purity when settling trades.
Gold coins, however, were not a
perfect solution since a common practice for centuries to come was to clip these
slightly irregular coins to accumulate enough gold that could be melted down
into bullion. But in 1696,
the Great Recoinage in England introduced a technology that automated the
production of coins, and put an end to clipping.
Since it could not
always rely on additional supplies from the earth, the supply of gold expanded
only through deflation, trade,
pillage or debasement.
The
discovery of America in the 15th century brought the first great gold rush.
Spain's plunder of treasures from the New World raised Europe's supply of gold
five-fold in the 16th century. Subsequent gold rushes in the Americas, Australia
and South Africa took place in the 19th century.
Europe's introduction of
paper money occurred in the 16th century, with the use of debt instruments
issued by private parties. While gold coins and bullion continued to dominate
the monetary system of Europe, it was not until the 18th century that paper
money began to dominate. The struggle between paper money and gold would
eventually result in the introduction of a gold
standard.
The
Rise of the Gold Standard
The gold standard is a monetary
system in which paper money is freely convertible into a fixed amount of gold.
In other words, in such a monetary system gold backs the value of money. Between
1696 and 1812, the development and formalization of the gold standard began as
the introduction of paper money posed some problems. (Learn more in What Is
Money?)
In 1797,
due to too much credit being created with paper money, the Restriction
Bill in England suspended the
conversion of notes into gold. Also, constant supply imbalances between gold and
silver created tremendous stress to England's economy. A gold standard was
needed to instill the necessary controls on money.
By 1821, England became the
first country to officially adopt a gold standard. The century's dramatic
increase in global trade and production brought large discoveries of gold, which
helped the gold standard remain intact well into the next century. As all trade
imbalances between nations were settled with gold, governments had strong
incentive to stockpile gold for more difficult times. Those stockpiles still
exist today.
The
international gold standard emerged in 1871 following the adoption of it by
Germany. By 1900, the majority of the developed nations were linked to the gold
standard. Ironically, the U.S. was one of the last countries to join. (A strong
silver lobby prevented gold from being the sole monetary standard within the
U.S. throughout the 19th century.)
From 1871 to 1914, the gold standard
was at its pinnacle. During this period near-ideal political conditions existed
in the world. Governments worked very well together to make the system work, but
this all changed forever with the outbreak of the Great War in 1914.
The
Fall of the Gold Standard
With the Great War, political
alliances changed, international indebtedness increased and government finances
deteriorated. While the gold standard was not suspended, it was in limbo during
the war, demonstrating its inability to hold through both good and bad times.
This created a lack of confidence in the gold standard that only exacerbated
economic difficulties. It became increasingly apparent that the world needed
something more flexible on which to base its global economy.
At the same
time, a desire to return to the idyllic years of the gold standard remained
strong among nations. As the gold supply continued to fall behind the growth of
the global economy, the British pound sterling and U.S. dollar became the global
reserve currencies. Smaller countries began holding more of these currencies
instead of gold. The
result was an accentuated consolidation of gold into the hands of a few
large nations.
The stock market crash of 1929 was only one of the
world's post-war difficulties. The pound and the French franc were horribly
misaligned with other currencies; war debts and repatriations were still
stifling Germany; commodity prices were collapsing; and banks were overextended.
Many countries tried to protect their gold stock by raising interest rates to
entice investors to keep their deposits intact rather than convert them into
gold. These higher interest rates only made things worse for the global economy,
and finally, in 1931, the gold standard in England was suspended, leaving only
the U.S. and France with large gold reserves.
Then in 1934, the U.S.
government revalued gold from $20.67/oz to $35.00/oz, raising the amount of
paper money it took to buy one ounce, to help improve its economy. As other
nations could convert their existing gold holdings into more U.S dollars, a dramatic
devaluation of the dollar
instantly took place. This higher price for gold increased the conversion of
gold into U.S. dollars effectively allowing the U.S. to corner the gold market.
Gold production soared so that by 1939 there was enough in the world to replace
all global currency in circulation.
As World War II was coming to an end,
the leading western powers met to put together the Bretton
Woods Agreement, which would be the framework for the global currency
markets until 1971. At the end of WWII, the U.S. had 75% of the world's monetary
gold, and the dollar was the only currency still backed directly by gold.
But as the world rebuilt itself
after WWII, the U.S. saw its gold reserves steadily drop as money flowed out to
help war-torn nations as well as to pay for its own high demand for imports. The
high inflationary environment of the late 1960s sucked out the last bit of air
from the gold standard. (Learn more in An
Introduction To The International Monetary Fund.)
In 1968, a
gold pool (which dominated gold supply), which included the U.S and a number of
European nations stopped selling gold on the London market, allowing the market
to freely determine the price of gold. From 1968 to 1971, only central banks
could trade with the U.S. at $35/oz. Finally, in 1971, even this bit of gold
convertibility died. Gold was free at last. There was no further reason for
central banks to hold it.
Source: World Gold Council |
Millet
Bobin
Manager-Sales
Email: Mil...@QuantumAMC.com
| Mobile No: 9821528887
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