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The following post is courtesy of Mircea Vasiu of AMarkets, a St. Vicent & the Grenadines (FSA) regulated global forex broker established in 2007.
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For thousands and thousands of years, gold was the only form of money that existed. Today, there is an intense debate if gold is money or not.
Technically speaking, it isn’t. Central banks in the 21st-century issue fiat currencies without backing them by gold or anything else. They set the interest rate based on inflation fluctuations and thus control the value of money.
But then why do central banks, private investors, governments, population, etc., struggle to get their hands on as much gold as possible?
If it is worthless as money, why bother digging it out using such an expensive process, only to store in high-security vaults, causing ongoing expenses in the process?
Short History of Gold in Financial Systems
Gold coins were part of trade for many centuries. And, a store of value too.
Fiat money replaced gold coins. In essence, fiat money refers to banknotes issued by an entity (central bank).
Initially, every holder of a banknote had the guarantee he/she can change it at the bank with its value in gold. Thus, central banks had to make sure they have enough gold in their vaults corresponding to the number of banknotes circulating. This is called a gold standard.
Apparently, banks got greedy. They quickly noticed people aren’t keen to exchange their fiat money back to gold as it was more practical (gold is heavier, difficult to transport, store, etc.).
Hence, central banks issued more fiat money than the gold held in vaults. From that moment, it was all a game of trust.
To this day, it is all about trust. Gold was part of many financial systems.
Before the U.S. Dollar became the world’s reserve currency, the British Pound enjoyed that status. In both times, countries went in and out of the gold standard.
If anything, the gold standard brings discipline (more precisely fiscal discipline) as countries and governments can’t spend beyond their means. Hence, the money doesn’t lose its value, and people’s fortunes don’t disappear overnight.
Gold in the 21st Century
Nowadays no country backs its currency with gold anymore. But yet, gold proves to maintain its main characteristic, despite the complexities of today’s financial systems.
That is a store of value. When trust in a central bank and its money is lost, no mechanism can fix it.
Virtually overnight, people lose everything because inflation eats their savings. However, gold prices rise with inflation, thus making gold a store of value.
The recent events in Argentina, Turkey, Venezuela, show what happens when trust in fiat currency is lost. The local currencies lose value in a spiral move, while people look for subterfuge in physical assets, mostly gold.
Owning gold today is easy. It can be done either physically (buying physical gold from various shops around the world, then paying for its storage) or indirectly, by owning a financial instrument.
An excellent diversification tool, owning gold takes the form of the XAUUSD pair offered by most Forex brokers, the ETF’s (Exchange Traded Funds) that track the gold mining sector or the stocks in companies involved in gold exploration and extraction.
Physical or paper gold protects savings. It did that for thousands of years and will continue to do that, despite central banks increasingly trying to diminish gold’s role.