Gold Series Part 1: Why do People Buy Gold?

By Edwin Tucker

Sandwiched between mercury and platinum on the periodic table, gold is just another element occurring naturally in the earth’s crust. This shiny yellow metal differs from its peers in that it has a powerful effect on human beings. The search for gold has consumed untold resources and countless lives. Often dubbed the currency of kings, entire nations have been sent to war over this treasure. Once acquired, protection from theft becomes an owner’s main concern. While gold might be seen as many things, it is most simply money.

The next logical question may be: what is money?  In order for something to function as money it must be all of the following:

  • A medium of exchange
  • A unit of account
  • A store of value

Throughout recorded history many things have been used as money. At times raw commodities served the purpose. In colonial America cotton and tobacco were periodically treated as currency. The biggest problem with these alternative sources is that they are subject to spoiling or rotting and can easily be tainted causing them to unexpectedly lose value. Modern money, still made of cotton, is subject to a different set of perils.

If you are to survey ten random citizens asking each “What is money?” you will likely find that nearly 100% of them reach for their wallet to display a paper copy of their national currency. Whether it is Yen, Euro, Dollar or any other modern note, this is where their understanding of the subject ends.

The dollar for example is issued by The Federal Reserve and is acceptable tender for tax liabilities. This creates the basis for trade and valuation. The Fed was created in 1913 and most citizens have no idea that this private institution is owned by a group of private banks. The Fed was given the power to create and issue currency on behalf of the nation. The nation was told that this authority would carefully govern the money supply through its network of reserve banks eliminating bank runs and economic volatility. The nation had just experienced the San Francisco earthquake of 1906 and the financial crisis of 1907.

The earthquake and massive fires that followed caused a great amount of destruction in San Francisco. Much of this destruction was indemnified by British insurers causing a tremendous amount of capital to flow across the Atlantic. In 1907 The Bank of England, another private institution, raised rates fiercely in response to these capital flows. This action lured capital away pushing the United States into recession. In the wake of these events congress formed The National Monetary Commission who recommended the creation of a central bank.

Initially the Fed created an amount of currency that was worth 1/20th of an ounce of gold.  In 1933 president Franklin D Roosevelt issued executive order number 6102 demanding that all citizens turn their privately held gold over to the government. Failure to comply with this order carried the threat of up to a $10,000 fine and imprisonment. In the weeks preceding the order many wealthy, well-connected citizens moved their gold overseas. The average citizen followed the order and turned in their gold.

Once the gold of the citizens had been confiscated by the government it was revalued to reflect a conversion rate of $35 to each ounce.  Now the government had more ounces and could create more currency denominated by those ounces. This newly-minted money could be used to accomplish the goals of the government including redistributing some of the money to secure votes before elections.

After World War II the US claimed to have more than 22,200 tons of gold. Since the beginning of recorded history there have been approximately 160,000 tons of gold mined and most of that gold still exists above ground in some form. To put things into perspective, all of that gold would fill roughly two Olympic swimming pools. One nation controlling nearly 15% of the world supply creates a superpower that can only be defeated from the inside.

As World War II drew to a close leaders from all 44 allied nations met at The Mount Washington Hotel in Bretton Woods, NH. The purpose of this meeting was to form a monetary system that would govern the post-war world. This system established many entities that we still know today including The World Bank and the IMF. Due to its dominance in the war effort and vast gold reserves the US dollar would be chosen to anchor this new system. Member nations would be required to maintain an exchange rate with the dollar which in turn would always be convertible into gold at a rate of $35 to one ounce.

The security created by the combination of post-war peace and a stable monetary system would somehow not be enough for the United States. Eventually the true nature of politicians and their insatiable quest for power would put pressure on the most important part of this system. John F. Kennedy’s New Frontier program was the beginning. Lyndon B. Johnson followed with The Great Society.  These well intentioned efforts stressed the US Treasury as tax revenues were not sufficiently available to fully fund the new entitlements.  The US began creating slightly more currency through bond issuances in order to cover these budget gaps. Along comes the first need for defense in the form of a shadow conflict with communism disguised as a freedom fight in Vietnam. Debt is issued to finance this conflict and soon the US is secretly running deficits financed with the same currency that is pegged to gold at $35 per ounce.

As young Americans die fighting and protestors dominate the nightly news, another entirely different war begins to rage. The newly printed excess dollars created to finance US expenditures began to make their way through the world markets. Savvy international traders would gather these excess dollars and return them to the Gold Exchange Window requesting ounces at the $35:1oz conversion rate established in Bretton Woods. By the summer of 1971 the United States was in serious financial trouble. The nation’s leaders were not able to stop spending on handouts and war.  Foreigners were raiding the nation’s gold supply at an alarming rate. On August 15, 1971 Richard Nixon slammed the gold exchange window shut thus ending international convertibility. The US dollar was now officially a fiat currency created by government decree and backed by nothing.

We may never truly know how much gold was lost due to the reckless and irresponsible behavior of power-hungry politicians lacking foresight. We do however know that the US government officially claims to own 8,133 tones. While this still represents 5% of the world’s known supply it is a far cry from the spoils of victory controlled after World War II.

As we approach the 40th anniversary of Nixon’s decree the exchange-window politicians seem to have learned little from past events. In 2010 the US government spent a record $1,500,000,000,000 more than it took in through treasury revenues.  Astonishingly the balance was funded by arranging for the Fed to electronically mint dollars which would then be used to purchase excess bonds. This behavior is not likely to subside as recent headlines detail intense fighting on cuts of a mere $40,000,000,000, or less than 1% of annual expenditures. This is not a political issue; it is a series of economic facts caused by choices that have already been made.

Many respected figures claim that gold is a barbarous relic. It pays no dividend and in fact creates negative cash flow as ownership is fraught with storage problems. While these accusations and others might be true we must never lose sight of gold’s true purpose. This metal is a sound currency that provides safety when elected leaders are knowingly or unknowingly destroying the medium of exchange that the nation’s citizens blindly trust.

See also: Gold Series Part II: How To Own Gold?