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The Gold Standard
For historical reasons we have added the below information
as a tool for educating investors as to the history of gold.
"We have gold because we cannot trust
governments." United States 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 those
who are forever confident in gold's stability as a source of
wealth.
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 supply and demand today. Those that are still in a love
affair with gold 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.
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
the 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.
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.
Since the dramatic rise in gold since 2008 investors and
even Central Banks have made an effort to acquire gold, this
race has been sparked by the world economic events that span
from the United States and now throughout Europe,
threatening the very foundation of the European Union. This
race for the gold has reduced the supply of gold globally
hence the dramatic rise in gold prices. Some analyst believe
that gold may reach US$2000 per ounce or more while others
sit on the sidelines as we continue onward in 2010.
Both Gold Buyers and Sellers can contact NAMC Worldwide at
646-403-9972 or
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