The global financial crisis of 2008 and the COVID-19 pandemic both spurred debt creation and raised question marks about the stability of our financial system. Is the biggest economic experiment of all time coming to an end after 50 years? Do dollars and other fiat currencies still work as a store of value, or should we be looking at gold and bitcoin as alternatives?
In 1912, financier J.P. Morgan stated in his testimony before Congress, “Gold is money. Everything else is credit”. This statement rings especially true today. Now, at the start of 2021, the coronavirus pandemic still holds a tight grip on the world, especially in America, Europe, Brazil, Mexico, and India. There have been more than 110 million cases and a coronavirus-related death toll exceeding 2.5 million people globally. Thankfully, vaccines are catching up and giving people hope that they will be able to return to normal life soon. But the financial and economic consequences of the pandemic will be with us for much longer than the pandemic itself. In 2008, during the global financial crisis, it was the financial sector that needed a bailout; just over a decade later, it’s the whole economy. Worldwide, more than US$10T has been invested in keeping the economy alive and people in their jobs. Just days after his inauguration in January 2021, President Joe Biden unveiled a new US$1.9T stimulus package for the economy consisting of higher stimuli payments, tax credits, enhanced unemployment aid, rental assistance, and food stamps.
Gold as a store of value is checking all the right boxes. With U.S. money supply growing by more than 20% in 2020 alone
Governments around the world are on a desperate spending spree and, in the process, adding massively to their debt. Government debt in the USA alone is surpassing US$27T and, as a percentage to GDP, it’s expected to rise above 110% in 2021. This means the accumulated debt of the government is exceeding the economic capability of the country. The only countries of high economic importance where debt levels are exceeding this ratio are Japan (still working on their lost decade) and Italy, the problem child of the European Union. But government debt is only one factor. To calculate the total debt of an economy, you need to add consumer debt – from mortgages and car leases to credit card debt and corporate debt – to the equation. Since the 1970s, the growth of total debt is exceeding economic growth, but the global financial crisis and the coronavirus pandemic are accelerating debt creation beyond all means.
Where is all this money coming from? Credit. Credit is magically created by the fractional reserve banking system, central banks who are financing government deficits, and the lending activity of the private banking sector. By the end of 2020, global debt exceeded global GDP by a breathtaking 350%. To properly understand the significance of this number, as well as gain perspective on the importance of gold, we need to take a step back and understand the ascent of money.
At its core, money needs to fulfil four basic functions: be a medium of exchange, a measure of value, a standard of deferred payment, and a store of value. If it is fulfilling these basic functions, nearly anything can be money; seashells, precious metal coins, a printed piece of paper, bitcoins, etc. The common forms of money today – printed paper and plastic cards – have no intrinsic value. It is fiat money, that is, it’s created by the government as an informal acknowledged debt in the form of an IOU.
While gold has fascinated humankind for 5,000 years, it hasn’t always been the base of the monetary system. Many countries experimented with a gold or silver standard in history, whereby the currency was based on a fixed quantity of either gold or silver. After WW1 and WW2, the world order changed and the hegemony of the U.S. dollar began. All major currencies have since been pegged to the U.S. dollar, and the U.S. dollar to gold. As the United States was printing more money to finance its budget deficit and to ramp up the Vietnam War, it started to experience a dwindling outflow of gold. At the same time, other nations were converting their local currency into U.S. dollars to exchange into gold. In 1971, Richard Nixon, U.S. president at the time, stopped that process unilaterally by suspending the convertibility of U.S. dollars into gold (“Nixon-Shock”). Shortly after, the international monetary system embarked on the biggest economic experiment in history: a system of free-floating currencies without any base or anchoring, with gold being a relic of the past.
Since then, credit-fuelled growth has become a success model, but only because the nominal value of money is often mistaken for its purchasing power – which is its real value. Classic economic theory claims that money is neutral or an illusion, a “veil on the real economy”. Additionally, the quantitative theory of money teaches us that money only affects prices and has no real effect on the economy. In the hamster wheel of our consumerist economy model, a moderate rate of inflation spurs consumption and stimulates economic growth. It’s no secret that US$100 today will get you less than it would have 10 or 20 years ago, but just how much has the purchasing power of the U.S. dollar decreased over the years? Between 1913 and today, the U.S. dollar has lost more than 96% of its purchasing power. This is inherent to fiat currencies, disqualifying them as money in the long-term as they are not able to store value.
Since the 1970s, the monetary dams have weakened and then broken, and now the rising tide of credit is rushing down on the real economy. Gold’s purchasing power, on the other hand, has remained remarkably stable over the past almost-500 years, at least until the end of the Bretton Woods system in 1971. Professor Roy Jastram performed an in-depth examination of the purchasing power of gold from 1560 in England and from 1800 in the U.S. (an analysis later updated by Jill Leyland). Jastram and Leyland concluded that gold as well as silver had protected investors’ purchasing power for centuries.
The Bank of America put a price tag of US$3,000 on gold in 2020, while the majority of other banks are now forecasting gold to trade between US$2,000-US$2,400 in the medium term. Gold as a store of value is checking all the right boxes. With U.S. money supply growing by more than 20% in 2020 alone, we have to wonder: is it that the price of gold is rising or that the value of the dollar is decreasing? Considering all of these factors, Lana Del Ray’s famous line, “Nothing is more gorgeous than a hundred-dollar bill,” now couldn’t feel further from the truth . Give me some old-fashioned gold instead, because my trust in governments is limited.