As we work and build wealth we seek ways to store that wealth. As recently as the early 1930’s that wealth could have been stored safely in U.S. dollars, as the currency itself was insured. It was backed by gold and silver. However, over the course of the 20th century the dollar lost all of its ties to gold and silver. Now the U.S. dollar is backed only by the trust that people place in its value, it is yet another fiat currency. If you want to store wealth for the long term, you need to convert some of your accumulated dollars into real money, not just currency. Accordingly, it makes sense for everyone to own gold, not as an investment, but as insurance.
Any currency is only as good as the value ordinary citizens place in its worth. Monetary history shows us that even though many currencies originate with a tie to something of real value, many eventually become fiat currencies with only the backing of the government which issues them. Unfortunately, under these circumstances governments can print as much of their currency as they desire and thus destroy the value the citizens of that nation have worked to build. On the other hand, gold, when used as money, has several important differences from fiat currencies.
First there is a limited supply of gold above ground, a limited supply below ground, and a limitation on how quickly we can extract it out of the ground. This limited supply keeps governments from simply creating more money to solve their tendency for excessive spending. While no fiat currency lasts forever, gold has been considered valuable for thousands of years. Considering its beauty and industrial potential it is likely that gold will continue to be considered valuable long after the U.S. dollar is completely devalued. These factors together make it far superior to any paper currency, allowing individuals to retain the value they have worked hard to attain.
Now we are not trying to make an argument for the gold standard, at least not in this article; however, it is important to realize the limitations of any printed currency. In uncertain times people naturally gravitate toward items of real and lasting value. Other places to store your wealth, like real estate, have real value, but they do not protect you in the same way gold does. Obviously, real estate is not portable, which makes it more difficult to protect during political upheavals, for example. If there are revolutionary movements, it is likely that assets like real estate will be seized. Also, in less dramatic times, real estate can become a significant liability due to the taxation of property. Gold is unique because it can be used as money in times of doubt due to the universal recognition of its value; and, it’s portable. Other commodities are either too difficult to use as a method of exchange, like oil, or too temporary in nature due to their ability to be consumed (wheat, corn, etc.). None of us want to be reduced to the barter system, which is one of the great fears of currency collapse. However, if we lose our trust in the currency the government issues, then need for exchange entities becomes clear. You do not need to learn to be a shoe maker to find something with universal value.
In the United States we have been very fortunate to have a stable system of government for a long time, which has allowed our citizens to enjoy tremendous prosperity. While the U.S. has been a special place, there is nothing that says it will continue to be. In fact, there are a plethora of theories which argue the decline of the U.S. system started some time ago, and we are in the midst of a long, steady fall. Before 2008, most Americans would probably consider it a silly proposition that the U.S. government could fall, but now we have certainly seen enough trouble in the financial markets to believe in the fragility of the whole system. Even if it were to collapse that does not mean that it would not reform itself in some other way. However, you should not just assume the impossibility of a financial or governmental collapse. If we have learned anything in 2008, it is that you need to prepare yourself for the things they say will never happen (the Black Swan, e.g.). Smart investors hedge their bets to make sure that they are prepared for what could come.
Gold can be valuable to you not only in a dramatic end of currency scenario, but in less dramatic events as well. During times of inflation people naturally see gold as a desirable place to house their wealth. At the core, inflation is a way in which government erodes the value of its citizens’ wealth. These citizens in turn seek a way to retain value in their assets. Gold is particularly effective in inflationary times, as it is seen as being valuable when other forms of money are not. Gold has always had value. Fiat currencies, on the other hand, are one PR nightmare away from being toilet paper.
Whenever there is instability in the world people flock to something they can trust, which in most cases is gold. As part of your asset allocation you need to consider what will happen to the assets you own if there is significant government instability either at home or abroad. The chances are that most asset classes will lose value in such a scenario, and people will seek something safe. In any market where people see significant risk, investors turn to something they see as being stable and reliable. In the market turbulence of 2008 this was treasuries. Anything containing risk was punished and investors were willing to even accept a zero yield if it was considered safe. Treasuries were safe because people believed in the stability of the U.S. government, but this may not always be the case. Our financial system is built on trust and is extraordinarily interconnected, and thus more fragile than we are all lead to believe. The bottom line is that if we stop believing in the U.S. government we will believe in gold and silver.