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Gold has no official monetary role, but central banks and individuals hold it for good reason. It serves as a store of value, a means of investment diversification, and protection from economic or political crises.
The history of fiat currencies is that they lose more and more of their purchasing power over time, and many eventually become worthless. Their decrease in value has sometimes been accompanied by increasingly severe restrictions on personal economic freedom culminating in seizures of assets and de jure and de facto defaults on promises by desperate governments.
Because a limited amount of gold exists in the world and paper money can be created without limit, gold is the ultimate protection against the debasement of currencies.
Gold’s tendency to hold its value is evident in the chart below, which shows the purchasing power of gold and the dollar since 1792. Even in 2001, when gold was $250 an ounce, its purchasing power was close to what it was in 1792. Since 2001, the buying power of gold has increased further and is now in the upper part of the range recorded throughout U.S. history.
Click to enlarge chart.
The most fundamental reason to hold gold is to obtain protection for a portion of one’s wealth against the possibility of serious economic, monetary, and political disruptions that lead to a breakdown of payment and credit mechanisms based on fiat currency.
In addition, the price of gold tends to fluctuate very differently than the prices of other financial assets. This suggests that gold can also serve as a viable form of “portfolio insurance” – potentially reducing swings in the value of the portfolio without reducing investment returns. But the primary reason to hold gold is not to make money, but to have money in any and all circumstances.
This article has been adapted from "How to Own Gold" in the September issue of the Economic Bulletin, available free to subscribers or $2 for non-subscribers.
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