If it is widely accepted in exchange for other goods and services, an item or product can be said to have either subjective value, such as the pleasure it provides, or objective value. Gold is unique because it has long-held value in both of these ways. The objective value store of gold is the focus of this analysis. Gold must either maintain its rate of exchange with other goods and services or, at the very least, be expected to return to an earlier rate of exchange if it is to be used effectively as a store of value. In the time of Nebuchadnezzar, king of Babylon, who passed away in 562 BC, it is said that one ounce of gold was enough to buy 350 loaves of bread.350 loaves of bread can still be purchased with the same ounce of gold today.
The first chapter examines the very long-term purchasing power (rate of exchange with other commodities and intermediate products) of gold in the United States (1796-1997), Great Britain (1596-1997), France (1820-1997), Germany (1873-1997), and Japan (1880-1997). In other words, gold has maintained its purchasing power over the course of 2,500 years, at least in comparison to bread. In all five, gold has tended to return to its historic exchange rate with other commodities and intermediate goods over the very long term. After the 1971 end of dollar convertibility, the purchasing power of gold increased significantly in each of these nations, but it has since returned to its historical level. Gold is a good long-term hedge against price increases.
The second chapter looks at how the current gold price compares to previous levels and the fundamental supply and demand conditions for gold to figure out how much the 1971 end of the dollar’s convertibility changed the factors that determine gold’s value. The prolonged period of time that the dollar gold price had been fixed was partially to blame for the rise in gold’s purchasing power during the 1970s. The rate of exchange between gold and other commodities and intermediate goods increased after 1971 as a result of increased global demand for gold. However, the increased supply of gold from the newly mined output, increased central bank sales (real and anticipated), and forward selling have all contributed to the decline in gold’s purchasing power. However, despite the significant shifts in demand and supply, the pattern of returning to an earlier value persists.
Even though gold has been a good value store, it could be argued that other assets would have been a better value store if they allowed wealth to grow over time and the real rate of return was zero when gold was at its historical purchasing power parity. The third chapter examines the risk and rate of return of holding and trading gold in relation to paper financial assets (such as stocks and bonds) from a historical perspective.
Gold has outperformed stocks and government bonds in the United States and Britain in terms of cumulative wealth over the past century, from 1896 to 19963. Compared to other asset classes whose returns have suffered as a result of inflation, gold has performed comparatively better in France, which has tended to experience greater inflation than Britain and the United States. During this time period, severe economic and monetary crises wiped out much of the wealth that had been invested in stocks or government bonds in Germany and Japan. Between 1940 and 1949, in France, Germany, and Japan, which were undergoing massive economic upheaval and high inflation, holding gold was more effective than holding other assets for wealth preservation. Gold maintained its purchasing power throughout Germany’s economic turmoil from 1918 to 1925, which virtually wiped out the value of bonds and stocks.
During times of war, gold has not always maintained its purchasing power. This is in part due to the tendency for the prices of other commodities, which are more immediately useful for the war effort, to rise more quickly during these times. However, in times of crisis, such as occupation by a foreign power or the collapse of a monetary system, gold’s liquidity, acceptability, and portability have been particularly important. These qualities may be more important than gold’s rate of exchange with paper money in such situations. Gold has proven to be a haven on numerous occasions and in various locations due to this fact and the fact that it served as a wealth preserver during some of the darkest periods of the twentieth century.
This century’s performance of stocks and bonds shows that cumulative wealth indices rely on past luck when determining when to buy and sell an asset. When faced with the decision between purchasing gold in 1996 and selling T-bills in 1925, investors based in the United States would have received a higher total cumulative return with gold. T-bills, on the other hand, would have been the better choice if presented with exactly the same option in 1896. The third chapter compares the fortunes of US investors who traded bonds and stocks with those who bought and sold gold at random between 1896 and 1996. The United States is one of the worst-case scenarios for gold out of the five countries examined. However, when there have been periods of economic dislocation and high inflation, the value of stocks and bonds has been severely diminished in less stable economies, which includes almost every large nation except the United States and Great Britain.
According to our model, investors in gold would have earned more annually in the United States between 1896 and 1996 than investors in both long-term and short-term government bonds. However, compared to bonds, gold has a lower chance of reaching the average with a randomly selected combination of buying and selling years. As a result, a gold trader would have faced greater risk; Gold trading has been a risky but potentially lucrative activity. Equities traders would have, on average, received a higher rate of return than gold traders (with only a slightly higher chance of not making that return).
However, the fourth chapter suggests that, in addition to its value as a store of value, there are still good reasons to hold gold even when its performance is not favorable. From 1968 to 1996, there was a negative correlation between the real total returns from holding stocks and bonds and the real returns from holding gold; As a result, gold could act as a hedge in a portfolio with multiple assets. In our model, this idea of gold acting as a risk hedge is developed. When compared to buying and selling out of a pure equity portfolio between 1968 and 1996, buying and selling out of an equity portfolio that included gold would have provided, on average, a higher return with less risk.
In the end, the study of the United States, Britain, France, Germany, and Japan reveals that, despite gold’s fluctuating price, it has consistently returned to its historical purchasing power parity with other commodities and intermediate goods over the long term. Gold has proven to be an effective wealth preserver over time. Gold has also proven to be a safe haven during times of social and economic instability when the value of other assets has nearly vanished.