A Consistent Bet Against Inflation
Even though gold is not typically used as a direct form of payment, individuals and central banks buy gold to protect their purchasing power in the event of inflation. Understanding inflation is best done when looking at your yearly cost of living. The price of goods and services can gradually rise every year driven by increased demand, technological changes or increases in production costs. Central Banks can also induce inflation by lowering interest rates and by expanding the money supply. Governments tend to fight economic slowdowns with more money-printing, which reduces the value of paper currencies around the globe. Whatever the causes, inflation erodes a consumer's purchasing power.
Historically, gold bullion holds its value in times of inflation, market volatility and uncertainty. Fiat currencies are printed at the will of any central bank, and over time, lose value to inflation. Gold, however, exists in a limited amount, and governments have no ability to depreciate its value. This gives gold a significant competitive advantage over the paper currencies and explains its gradual rise in price over many centuries.
When Gold Assets are Good for Individual Currencies
Over the past century, gold has outperformed all major currencies. Gold is held in reserve by central banks around the globe. Central banks typically hold gold as part of their foreign exchange reserves because it is a highly liquid, historically safe asset. Gold is an accepted medium of exchange between two countries. A nation can build up its gold reserves without relying too much on external purchases that would have to be paid for in foreign exchange. And in times of emergencies, counties can sell off some of their gold to decrease their national debt and boost their balance sheets.
Countries that have large gold assets will benefit if gold prices rise. As fiat currencies lose their value, the price of gold typically increases, offsetting the loss in purchasing power. Fluctuating currencies create economic uncertainty and instability. Price increases in gold can strengthen a nation’s currency because the gold they hold is factored into their “current accounts.” The combined value of gold and currency is more stable than the value of currency alone. A stable currency gives businesses a measurable trajectory to better plan for the future which encourages investment and economic activity.
