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Can bitcoin replace gold as a store of wealth in the face of inflation and times of uncertainty?
-The history of gold as a hedge against inflation
-The history of gold as a safe haven
-The brief history of Bitcoin
– Arguments for and against cryptos
By Greg Peel
This is the second in FNArena’s series on cryptocurrencies. A link to Part 1 is provided at the bottom.
Since ancient times, gold has been considered an indicator of wealth and power. The earliest currencies were gold and silver coins, their value being determined by their actual metal content.
The key to using precious metals as currency is their scarcity. They were a store of wealth because they were difficult and expensive to find and operate.
Eventually, coins of precious metals were replaced by coins of lesser metals and banknotes, which were supported by the issuer’s holdings of these metals. Gold was the main store of wealth, and the value of a currency reflected the extent of gold holdings.
In recent centuries, as economies grew across the world, gold backing for a currency was a business again. At the end of World War II, America and its allies came together in a meeting in Bretton Woods where it was agreed that the currencies would indeed be backed by gold. At the time, the United States held two-thirds of the world’s gold. The US dollar has become the world’s reserve currency.
At the time, gold was US $ 35 an ounce.
Economic growth has come from business cycles, and with every recession, from tax expenditures, funded by money printing. Since currencies were backed by gold, money printing led to gold outflows to other economies. The United States became the most powerful economy in the world after World War II, but by the 1960s and 1970s the defeated powers of Germany and Japan had quickly started to catch up.
The tipping point came in 1971 when, amid other heavy spending programs, the United States was bleeding money to fund the Vietnam War. Then President Nixon made the unilateral decision to end the Bretton Woods agreement. From then on, the reserve currency would only be supported by the US economy, and the currency would effectively become a âpromissory noteâ of the US government. Other countries had no choice but to do the same.
The decoupling of currencies from gold has sown the seed for today’s cryptocurrencies. In the meantime, it simply required the growth of digital technology.
Gold as a hedge against inflation
Printing money adds to the supply of that currency and thus devalues ââthat currency. It goes without saying, mathematically, that the more a currency is devalued, the more it takes to buy the same pint of milk, the same family car and the same ounce of gold. The more money consumers need to buy the same items, the more wages have to increase to cover this loss in purchasing power.
In the 1970s, central banks had no mandate to control inflation.
The post-war American economic boom led to increased demand for oil, which made the United States dependent on imports from Arab oil producers. Money printing devalued dollars received by oil producers. Dissatisfied with the situation, in 1973, these oil producers (OPEC) imposed an embargo on exports to the United States and other countries. If inflation wasn’t already becoming a problem, it certainly was now. The price of oil has skyrocketed as domestic supply has failed to meet demand.
The inflationary shock also caused the price of gold in US dollars to skyrocket. OPEC ended its oil embargo in 1974, but without central bank control, inflation is a difficult beast to contain once it is out of the cage.
The price of gold in US dollars has increased accordingly.
Just when it looked like things couldn’t get worse, the Iranian revolution of 1979 put an end to the world’s largest oil producer. The price of oil skyrocketed again and the price of gold again reacted accordingly. Having become “parabolic” in the late 1970s, the price of gold in US dollars reached US $ 850 per ounce, compared to US $ 180 per ounce just five years earlier.
The inflation rate in the United States has climbed to double digits (as has also been the case in Australia).
Back then, the US Federal Reserve funds rate was 13% (compared to zero effective today). To cap the upward spiral of inflation and the resulting recession, Fed Chairman Paul Volker raised the funds rate to 20%. The US CPI peaked in March 1980 at 14.8%. Three years later, it was back at 2.6%.
Markets that become âparabolicâ tend to end with an explosive top. At the same time that Volker steps in to curb inflation, the Hunt brothers try to seize the money market. They missed. The price of silver has collapsed. The price of gold now had many reasons to collapse as well.
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