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Gold Is Our Safeguard Against the Barbarians

The commentary below is for the benefit of our readers from opinion makers and writers not associated with Euro Pacific. We do not guarantee the accuracy and completeness of third-party authored content. Opinions expressed are those of the writer, and may or may not reflect those held by Euro Pacific, or its CEO, Peter Schiff.
Valentin Petkantchin
February 23, 2011

Gold hit fresh highs against the dollar recently, trading at well over $1,400/oz last December, from under $300/oz ten years ago. The metal’s mounting value is hooked directly to its economic role as a stable alternative to paper currencies. Its rise should tell us something about the health of the global monetary system. Unfortunately, monetary authorities around the world still broadly misunderstand and even dismiss gold's role. How else to explain their recent policies?

Lenin committed a similar error when, according to Khrushchev, he claimed “the day would come when gold would serve to coat the walls and floors of public toilets.” And John Maynard Keynes, the monetary guru of so many of today’s central bankers and politicians, once dubbed it a “barbarous relic.”

Yet today, having been unpegged completely from the world monetary system, gold is neither relic nor toilet tile. In modern societies based on advanced specialization and division of labor, the yellow metal is actually more important than ever, precisely because the paper value of goods and services is ever-more dependent on the whims of an elite few.

So for those businesses and households that need some stable means of exchange and  store of value, governments’ paper-based monetary and financial system is unsuitable. Gold, on the other hand, is a much-needed safeguard against the barbarism of monetary authorities.

In the pre-1971 US, before the closing of the “gold window,” gold acted as the citizens' safety valve against the Fed's inflationary expansion of the money supply. But, rather than face the economic consequences of inflation created during the previous decades, Washington instead decided to put an end to the dollar’s convertibility to gold – and thus eradicated the one check on its own monetary expansion. As a consequence, the US dollar has lost nearly 82% of its purchasing power since that time.

In this post-gold era, every currency has been subject to manipulation and devaluation. Today’s economic players must therefore take into account major exchange-rate risks between all the world's non-trivial paper currencies. These currencies survive through the compulsion of legal tender laws, but they have lost many advantages of traditional money.

Households and businesses still need a reliable means of storing value. In the lead up to financial crisis, many had turned to financial markets to preserve their wealth, but here too, monetary inflation’s infection is evident in the boom-and-bust cycles of stock exchanges, as Keynes's foe Friedrich Hayek had explained.

With each bubble, monetary authorities create more inflation that, over time, erodes the very legitimacy on which paper currencies depend. In this type of environment, consisting of successive bubbles in which the valuation of various financial assets is distorted by inflation, gold has naturally become a refuge. At present, the inflationary rush in the US is serving to finance government debt, and goes by the name of “quantitative easing.”

Inflation has been so far at the origin of the rise in the price of gold. This rise is linked primarily to the ability of the yellow metal to hold value better than paper currencies.

The following chart illustrates the decline of the main paper currencies in comparison to gold over the last decade:

Source: World Gold Council; calculations by the author.

Clearly, some currencies are performing better than others, but they are all headed in the same direction. If the monetary authorities continue on this path, each currency will eventually succumb to a crisis of confidence – and then collapse. This slow-motion destruction of the international monetary system is creating a huge need to find a stable substitute unit for savings and global trade. In response, gold appears to be spontaneously recovering its monetary role, as it has often done in the history of human civilization.

Unlike the housing bubble, which was a historically abnormal boom in home prices, this gold rally is really a restoration of the historical norm. Rather than coating the walls of public toilets, gold is regaining recognition as the ultimate safeguard against the barbarous era of fiat currencies – and soon you may even buy groceries with it.

Valentin Petkantchinis an Associate Researcher at the Institut Économique Molinari (www.institutmolinari.org). He holds a PhD in Economics from the University of Aix-Marseille III (France) and is the author of numerous scientific publications and research papers.

Please note: Valentin Petkantchin and Institut Economique Molinari are not affiliated with Euro Pacific Capital.