Is There Gold In the Economy’s Future?

During the great American gold rush of the late 1840s, prospectors sold their life’s possessions to dash into the Western hills of California and Nevada to search for tiny nuggets of gold. By finding a gold mine, they believed, they could guarantee themselves a lifetime of stable wealth.

Over the years, though, the value of gold itself has not always remained stable. For instance, although the precious metal was worth well over $800 an ounce in January 1980, it collapsed in value below $300 an ounce in 1999. But then, during the past decade, it soared well past $1,000 an ounce and actually surpassed $1,200 an ounce last week.

What is it about gold, though, that has created such faith in its ability to function as a storehouse of wealth? And why has its value fluctuated so dramatically during the past three decades?

Throughout Human History

Though gold is simply a compound that is mined from the earth, it is also a precious metal that has been treasured throughout human history for its shiny quality and its malleability. Because of these characteristics, it is considered an ideal compound for jewelry and other decorative, artistic, and industrial products.

The ancient Egyptians and Romans both relied on gold for such purposes. Gold also appeared prominently in the Old and New Testaments, such as in the story of the golden calf that was created by Moses’ brother Aaron, as well as in the description of the streets of Heaven as being paved with gold. More recently, governments from the United States to South Africa have issued gold coins as storehouses of wealth, and the word “gold” itself has been used to connote value and stability for everything from macadamia nuts to greeting cards.

But even though these historical precedents may explain why gold maintains its popularity in the 21st century, they cannot explain why the precious metal’s value has been so volatile during the past thirty years. Indeed, to make sense of its fluctuations in value, it is necessary to understand the volatile nature of our global system of floating currencies.

Gold as a Reserve Currency

In response to the global devastation of the Second World War, the world’s finance ministers met at the Mount Washington Hotel in Bretton Woods, New Hampshire in 1944 to develop a new monetary system. They created an interlocking network of national currencies, with each sovereign nation entrusted with the management of its own currency. Global transactions, though, were generally priced and consummated in U.S. dollars because the American economy produced 35% of the world’s economic output at the time.

Over the years, though, different nations adapted different strategies for managing the value of their respective currencies. Many empowered their national banks and government treasury departments to permit their currency values to be determined by free market traders, although they periodically attempted to influence those values through strategically timed interventions. Other nations, ranging from China to Venezuela, have at times attempted to peg their currency values to the value of the American dollar. And yet other countries, such as the members of the European Union, have planned and achieved monetary union.

Throughout the years, though, the United States dollar has maintained its role as the world’s reserve currency for global transactions. Although some business and government leaders have advocated for the adoption of a truly global reserve currency, no one has yet devised an effective mechanism for replacing the American dollar with a more stable and reliable repository of wealth.

But then where have global traders turned when the dollar itself appeared to be shaky? The answer, it seems, has always been gold.

Roller Coaster Gyrations

Indeed, the major “roller coaster” gyrations of the value of gold during the past three decades have generally reflected the health of the American economy at those times. Gold prices soared in 1980, for instance, when the American economy was reeling from a decade marked by political upheaval, a costly and debilitating war in Vietnam, energy shortages, and massive unemployment and inflation. It then plummeted in 1999 when the American economy seemed incomparably powerful, with a balanced federal government budget, record employment levels, and an internet-enabled technology boom.

Today, of course, the American economy has been weakened by a recent economic crash, a tired banking system, and a fallen housing market. Thus, once again, gold prices have soared past their all-time highs in nominal terms and towards their historical highs in real inflation adjusted terms.

And thus exists the exquisite irony that lies at the base of our contemporary monetary system: we still rely on gold as our reserve currency of last resort, even though it is simply a natural metal that originally gained prominence many millennia ago because of its shininess and malleability! Nevertheless, if you wish to attempt to predict how gold’s value may trend in the future, you’ll first need to predict how the American economy will perform during that time.