Money is debt, gold is money

“In numerous years following the [civil] war, the Federal Government ran a heavy surplus. [But] it could not pay off its debt, retire its securities, because to do so meant there would be no bonds to back the national bank notes. To pay off the debt was to destroy the money supply.”

John Kenneth Galbraith

In the investing world, you can take a three-month view, a three-year view or a 30-year view. One person looking at one asset class might have a different forecast depending on the time horizon he is considering. In this article, I will look at gold through a 30-year lens.

I believe that structural forces will support gold and other hard assets over the long term. While current forces may be bearish for gold in the intermediate term, there are a number of underlying currents that demand a strategic allocation to the metal (either bullion or via an ETF such as (GLD), (IAU) or (SGOL)). While the sophisticated gold investor is already familiar with these concepts, I think it is important to re-introduce them to a broader audience who may have zero allocation to gold, other precious metals (e.g. silver (SLV) or a basket (GLTR)) of hard assets in their portfolio.

The Origins of Money

Throughout history, money always has held an important position as a unit of accounting, a store of value and a means to pay taxes and facilitate transactions, thus creating massive efficiencies within an economy. Initially, transactions were directly conducted via barter, later, every imaginable item was used for money, like obsidian (volcanic glass), shells or cows. Later, money was directly issued by kings and governments without any debt. Today, nearly all money (except coins) is created by private central banks and loaned to the governments and charged with interest in exchange for government bonds, creating perpetually growing public debt.

Many historians suggest that fractional reserve banking and private money creation started when gold owners stored bullion within the vaults of goldsmiths for safe keeping. As proof of deposit, goldsmiths issued paper receipts – gold certificates – that could be redeemed in exchange for gold. Seeing an easier way to transact, when buying goods and services, gold owners would simply hand over gold receipts as forms of payment instead of redeeming for gold and delivering the metal.

Eventually, enough people were doing this that some enterprising goldsmiths, who noticed that the gold in their vaults was rarely reclaimed, started lending (with interest) more paper receipts than there were specific gold deposits. After making these loans, more paper was in circulation than gold in the vaults, resulting in an early example of expanding money supply and credit growth. Of course, any goldsmith that manufactured receipts far in excess of gold reserves risked a run on deposits and existing receipt holders may have experienced a loss of exchange value.

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