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Gold versus fiat

As a general rule, the most successful man in life is the man who has the best information

Richard (Rick) Mills, Ahead of the Herd


May 1, 2020 ( Newswire) What exactly does it mean when pundits say that gold is a "store of value" and "hedge against inflation"? In this article we're diving deep into these questions and discussing how gold has performed over time, not only measured in US dollars but in other currencies. The latter is important, after all, since 95% of the world uses a form of currency other than the USD in their daily transactions. For holders of these currencies, the value of their money in relation to the US dollar matters as much as the gold price.

Currency fluctuations

The gold price reflects the value of gold, measured in US dollars per ounce. A buyer parts with his/ her dollars to receive either a portion of physical gold, shares in a gold ETF or shares in a gold miner's stock. When a gold buyer doesn't have US dollars, he must first present his currency for conversion to dollars. As Canadians, we know our dollar is (almost) always weaker than the greenback, so we expect to pay more, usually about 30% more, for an ounce of gold than our American cousins. (USD$1=CAD$1.40, today's exchange rate)

In the next two charts, notice how the fluctuations of different currencies versus the dollar are reflected in the price of gold denominated in those currencies. While gold increased 33% over the past year in US dollars, it did even better in Chinese renminbi/ yuan and UK pounds (the green and dark blue lines), than in the Swiss franc and Japanese yen (purple and orange lines) Why? Because strength in the franc and the yen, versus the dollar over the past year, made gold prices in those currencies fall. The opposite happened for the yuan and the pound. For the past year both have fallen against the dollar, raising the gold price in those currencies.

The following chart extends this interplay of currencies and non-dollar-denominated gold prices over the past 20 years. Here we see gold in British pounds, being the weakest viz a viz the dollar, among the charted currencies, seeing the best gains, 699%. Since September 2003, the buck nearly doubled from $1.00=GBP0.49 to its current $1.00=GBP0.81 rate of exchange. By contrast, gold in Swiss francs, seen at the bottom of the chart, only gained 294%, due to its relative strength versus the dollar.

Indeed the franc has done well as a safe-haven currency, beating the buck consistently over the past 20 years. In September 2003 it took only US$0.73 to buy one Swiss franc, in August 2011 an American would have to shell out $1.31 per franc, and today one Swiss franc costs $1.02.

Take a look at the gold price change in Canadian dollars. Our 481% gain is fairly close to the US dollar's 510%, because the CAD and USD have traded fairly closely over the past 20 years. Most of the time the Canadian dollar has been between 75 and 100 cents to the greenback (briefly reaching parity in 2010). However, this trend is in jeopardy, with the Canadian dollar's current 71 cents to the dollar testing a 16-year low of CAD$1.00=USD$0.73.

Besides comparing the value of gold in different currencies, we can also look at how gold has performed versus each currency.

Bullion dealer Voima Gold wanted to know how the gold price has done since the inception of the European Union's common currency, the euro. Their first observation was over the course of 20 years, the price of gold in euros increased 555%, (fairly close to the 501% seen in the pink line of our chart above) on April 23, 2020 hitting €51,000 euros per kg for the first time in history.

The more compelling number is how much the euro has devalued against gold.

Voima Gold found in 1999 it took one euro to buy 0.13 of a gram of gold. Today the ratio has diminished to €1=0.02 gram, meaning over the past 21 years, the euro has lost 85% of its value versus gold. Put another way, a gold dealer used to be able to buy 13 hundreds of a gram for one euro. But now, the same euro can only buy 2 hundreds of a gram. The purchasing power of the euro versus gold has fallen significantly.

To review, when the value of the dollar increases relative to other currencies, the gold price normally falls, because gold becomes more expensive in other currencies. Conversely, when the dollar drops, gold appreciates in value because it becomes cheaper in those currencies. How much gold is worth in each currency depends not only on the value of gold measured in that currency, but the value of that currency versus the US dollar, because gold is always priced in US dollars. To determine how gold has fared compared to the currency in question, you need to know how many unit(s) of currency it takes to buy a gram, or fraction of a gram. Charting that ratio over time shows how the currency has done against gold.

The role of inflation

Inflation is the rate at which prices within a basket of goods or services (called the consumer price index or CPI) rise or fall. When a currency falls, the ability of that unit of money to purchase goods and services weakens, ie., it takes more units of currency to buy the same basket of goods as before it weakened. The more a currency falls, the less you can buy with it because its purchasing power decreases. We call this devaluation/ loss of purchasing power.

Casey Research founder Doug Casey believes we often put the cart before the horse when thinking about inflation. The renowned investor, author and speaker states,

"Inflation" occurs when the creation of currency outruns the creation of real wealth it can bid for... It isn't caused by price increases; rather, it causes price increases.

Inflation is not caused by the butcher, the baker, or the auto maker, although they usually get blamed. On the contrary, by producing real wealth, they fight the effects of inflation. Inflation is the work of government alone, since government alone controls the creation of currency.

Indeed, governments in fiat economies can literally print paper money "out of thin air," something impossible to do with a gold-backed currency. (it is often said, "the Fed can't print gold" (or silver)". When gold goes up or down it is not inherently losing value; what has changed is the value of paper money, the fiat dollar. When you buy gold to resist inflation, ie., rising prices that eat away your savings by reducing your purchasing power, it's called a hedge against inflation.

It's interesting to look at the purchasing power of gold versus a country's currency. Voima Gold examined the purchasing power of gold versus the euro to store value in Finland, Germany and Italy, countries seen as representative of consumer prices in the Eurozone. Assuming a current interest rate of 0%, and subtracting 1% a year for inflation, means euros lose about 1% of their purchasing power per year in those countries.

Gold on the other hand has increased 39% over the past 12 months. Subtracting 1% inflation leaves an increased purchasing power of 38%. Even accounting for years when the gold price didn't rise as much, or even fell, the chart below reveals gold's extraordinary purchasing power. Voima Gold states,

First and foremost, you can see gold's purchasing power has increased in the eurozone since 1999. This means that the price of gold has outpaced consumer prices. From the index number you can see that gold's purchasing power, on average, has increased by a staggering 350% (450 - 100) over 20 years. The gold price can be volatile, at times, but over longer periods of time it preserves its purchasing power, with the benefit that it doesn't have any counterparty risk, so it withstands every crisis.

One could do the same calculation (a country's interest rate minus inflation) with different currencies, to see how inflation erodes purchasing power over time.

Using this handy inflation calculator, we find for example,

  • At an average annual inflation rate of 1.89%, the purchasing power of £100 in 1999 equals £150.85 today.
  • The purchasing power of 100 Chinese yuan in 1994 equals ¥231.07 in 2020. The average annual inflation rate between these periods was 3.27%.
  • At an average annual inflation rate of 4.92%, the purchasing power of 100 South African rand in 1999 equals R287.96 today. 

Gold and purchasing power

A 1999 €100 (Euro) is equivalent in purchasing power to about €142.45 in 2020, a difference of €42.45 over 21 years. Turn this around and what it means is it takes €142.45 today to buy the same basket of goods it took €100 to buy in 1999. Consider...

"Over the course of 20 years, the price of gold in euros has increased by 555%. From a historic perspective the euro is a young currency, but already lost 85% of its value against gold. This reveals the instability of fiat money."

Investors with less risk appetite often divert their extra cash into bonds, banking on the yields they will receive. However, compared to gold, bonds have done extremely poorly over the past two decades. In the chart below, see gold gaining 510% versus yields on 2-, 10- and 30-year Treasuries losing a respective 95%, 88% and 78%.

Reasons to be bullish

The US national debt in November surpassed $23 trillion. Driven by Congressional borrowing, it rose 5.6% up to Q3 2019, compared to the same period in 2018, against nominal GDP of just 3.7%. In other words, debt was outrunning economic growth.

Excess debt is a brake on aggregate demand. Consider: over the last 13 years, global debt has increased by $128 trillion, but GDP has only risen by $27 trillion. ie. countries borrowed five times more than their economies produced.

The US budget deficit this year is expected to reach nearly $4 trillion, after Congress pumped about $2.5 trillion into the economy to stem the bleeding from coronavirus lockdowns.

The predicted $3.6 trillion spending shortfall amounts to 17.7% of GDP, nearly double the 2007-09 Great Recession, when the deficit never reached even 10% of GDP. But guess what? The government doesn't have the money; the gap will have to be bridged through borrowing or printing money. No doubt much of it will be financed, pushing the national debt to a new record high. According to, it has already reached $24.3 trillion.

Well before supply chain disruptions and industrial demand destruction owing to covid-19, US manufacturing was slowing. The IHS Markit manufacturing PMI in January fell to a three-month low - from 52.4 in December to 51.7; any reading below 50 indicates poor economic conditions.

We said there would be more interest rate cuts, beyond the three last year, to deal with the looming threat of the coronavirus which in February was mostly confined to China.

In March the central bank obliged, first cutting the federal funds rate by half a percentage point, then slashing it by another full percentage point, taking the Fed's benchmark for short-term lending down to near 0%.

We also pointed out the spread between 2- and 10-year Treasury yields, which in February was the flattest since November. A yield curve inversion, when short-term yields push higher than long-term yields, is a predictable recession indicator. Right again. The covid crisis is threatening to spin the global economy into the steepest, and worst recession since World War II.

On March 9 the entire US yield curve fell below 1% for the first time ever. When real interest rates (interest rate minus inflation) "go negative" (ie. below 0%) investors usually flock to gold.

While lowering interest rates, the Fed also introduced a number of stimulus measures aimed at keeping credit rolling through the financial system. A new round of quantitative easing, $700 billion in asset purchases, was changed to "unlimited". The Fed also announced a $300 billion credit program for businesses and consumers. That was followed by a $2.3 trillion lending program announced on April 6, whereby the Fed can purchase up to $600 billion in loans, buy downgraded corporate bonds, and purchase $500 billion in bonds from state and municipal governments.

The trends we identified as affecting gold prior to coronavirus, are still in play, but the worsening economic fall-out has meant their effects are magnified, resulting in even higher gold prices. We are talking about low interest rates, quantitative easing, debt, GDP, declines in manufacturing and retail spending.

First, global GDP is anticipated to slide 3% this year, triple the slowdown in economic activity during the Great Recession.

The forced closure of businesses across the United States, and the sudden surge in unemployment, is expected to contract US GDP by 30%, at an annualized rate in the second quarter, and 5% overall in 2020.

That is huge.

In an earlier article we showed the close relationship between debt-to-GDP ratios and gold:

As the crisis continues to prevent businesses from opening, and people from getting out from their homes and spending money in the economy again, GDP will continue to stagnate, or fall.

According to Bloomberg Economics' GDP tracker, we were already in recession in March.

That's the first part of a rising debt-to-GDP ratio - a fall in GDP. The second part is an increase in debt.

It's been estimated that a fresh round of quantitative easing to deal with the covid crisis could increase the central bank's balance sheet from an already-record $4.7 trillion to $9-10 trillion.

The longer stimulus measures continue, including a creeping expansion of the Fed's balance sheet and negative real interest rates (interest rates minus inflation) which are always bullish for gold, we see no reason to doubt that gold will keep climbing.

In a recent column, Frank Holmes, CEO of US Global Investors, mentions a Bloomberg commodity strategist who observes that the price of gold appears to be seeking to revert to its long-term mean relative to the S&P 500 Index. This would suggest that we could see a new record high, driven largely by excessive money printing. (currently equal to US$2,800 gold - Rick)

"Unprecedented global monetary stimulus is a worthy catalyst for the per-ounce price of gold to revert to its long-term mean vs. the S&P 500 Index, in our view," McGlone explains.

In another column, Sprott Senior Portfolio Manager John Hathaway speculates on whether investors will return to stocks and bonds when the market returns to some semblance of normal. He concludes that equities are unlikely to see a bounce and that (low) bond yields will continue to be impaired by inflation. This leaves major upside for gold, especially considering that gold prices are currently less than 2011's $1,900/oz peak, despite the combined balance sheets of the Fed and the European Central Bank more than double what they were in 2011 ($11.4 trillion vs ~$5.5 trillion):

Despite the solid price gains achieved by gold in the past two years, there is much more upside to come as investors gradually give up on repeated equity market bottom fishing and the hope of a return to financial market normalcy. A full reversal to the previous complacency cannot take place following a brief crash. The mood change will more likely become pervasive after grueling stretches of disappointing returns from previously successful investment strategies.

Looking forward, bonds may no longer be able to play the safe haven role they traditionally filled to balance equity risk. The vacuum could be filled in part by increased gold exposure for all classes of investors. Sovereign credit liquidity injections are likely to remain significant and permanent. The bond market has become socialized. Owning Treasury bonds of any duration could become akin to parking Treasury bills, with little upside and considerable risk of impairment through inflation. Gold is the antidote to the fixed-income investor's dilemma.

Gold is also the logical response to fear.

Heightened global tensions such as terrorist attacks, border skirmishes, coups, protests and pandemics, scare investors into shifting their funds to precious metals.

Nowadays the only people and institutions who own physical gold are central banks and those who distrust the monetary system - people who see gold as a hedge against inflation and want to own it as insurance against some calamity (eg. banking system collapse, war), when getting access to cash is difficult or impossible, and paper currencies plummet in value.

Most people think such an event is so unlikely, they disregard the idea of owning gold or returning to the "barbarous relic", as economist John Maynard Keynes referred to the gold standard in his 1924 book, suggesting gold had outlived its usefulness.

In reality there are many instances in history of how gold came to the rescue of states on the verge of collapse, and a number of frankly terrifying scenarios that could destroy the meaning and value of today's money in a heartbeat.

Russian roulette

Toby Ord's new book ‘The Precipice' should be required reading for anyone with a passing interest in apocalyptic visions or dystopian futures in which gold as a currency could play a pivotal, even life and death role.

Ord, a moral philospher, argues that humanity is notoriously bad at anticipating potential catastrophes, both those that could abruptly end the human race (like a comet strike), and events that lead to the collapse of civilization, and a prehistorical existence, such as nuclear war or an ultra-infectious pandemic.

One of very few academics working in existential risk assessments, Ord believes all the naturally occurring risks, including coronaviruses, do not amount to the man-made risks presented by nuclear war or global warming.

Now is a period when if the right decisions are made, primarily concerning the slowing of climate change and preventing nuclear war, humanity will flourish. "I put the existential risk this century at around one in six," he writes in his book, recently reviewed by The Guardian:

If we make the wrong ones, he maintains that we could well go the way of the dodo and the dinosaurs, exiting the planet for good.

In other words, the 21st century is effectively one giant game of Russian roulette.

The risk is more like one in three if we ignore threats represented by advances in areas like biotech and artificial intelligence. Other vulnerabilities, as we've seen with covid-19, include "just in time" supply chains stocked with limited goods, and overdependence on the Internet and satellites.

There are now stacks of evidence proving that the Chinese government undertook pernicious measures to conceal the coronavirus outbreak in Wuhan. They included destruction of virus samples, suppression of information, and delaying lockdown of a city of 11 million, allowing the virus to spread throughout China and worldwide, through airline travel during the Chinese Spring Festival, the largest annual migration of holiday travelers on earth.

In February, when stock markets started reacting to the spread of the coronavirus in Asia, from China to Japan, South Korea and Iran, Donald Trump saw it not as a time to gird against a possible pandemic, but a time to gamble, to roll the dice.

When testing kits from the Centers for Disease Control failed, due to faulty reagents, the White House could have insisted the Centers for Disease Control use a functioning test the World Health Organization offered the US to conduct widespread testing - a measure that worked extremely well in China and South Korea in slowing the spread of the virus. They didn't accept the free offer.

The administration promised millions of test kits would be available, which turned out to be a lie. Not until March 31 was a new test from Abbott Laboratories announced, finally enabling the thousands of tests per day required.

"We just twiddled our thumbs as the coronavirus waltzed in," William Hanage, a Harvard epidemiologist, wrote.

Worse, the President downplayed requests by states for more resources to combat the virus, including badly hit New York. Not until Trump signed into law a $2 trillion economic stimulus package, and was (temporarily) convinced of extending social distancing measures, was he able to see the advantages of an aggressive approach to the worsening pandemic, ie., a marvelous political opportunity for himself to get re-elected.

Yet Trump's mis-placed narcissism and controlling impulse is only partly to blame for Washington's bungled response to the coronavirus. As Ord writes, "even when experts estimate a significant probability for an unprecedented event [like an engineered pathogen], we have great difficulty believing it until we see it."

Skepticism gives way to apathy, a reluctance to plan, and a failure to fund. The Guardian states,

Yet like so many aspects of existential threat, the idea of an engineered pathogen seems too sci-fi, too far-fetched, to grab our attention for long. The international body charged with policing bioweapons is the Biological Weapons Convention. Its annual budget is just €1.4m (£1.2m). As Ord points out with due derision, that sum is less than the turnover of the average McDonald's restaurant.

If that's food for thought, Ord has another gastronomic comparison that's even harder to swallow. While he's not sure exactly how much the world invests in measuring existential risk, he's confident, he writes, that we spend "more on ice-cream every year than on ensuring that the technologies we develop don't destroy us".


Getting back to the topic at hand, gold and its value in other currencies, we note that gold is on the cusp of breaking all-time highs (of $1,900/oz) and has already done so in virtually every other currency.

We have shown that over time, gold is a store of value because it is not subject to the inflationary pressures fiat currencies are. Since 1913, the US dollar has lost 96% of its value. Over the last 20 years, inflation in the US hasn't been bad, but it has still eaten away 57% of the dollar's purchasing power. This means that even though stocks have done extremely well, having your money tied up in dollars means it takes over 50% more dollars to buy the same basket of goods as 20 years ago. Nobody mentions this when bragging about their ROI from stock market gains.

Bonds are a much worse investment compared to gold, with yields on the benchmark 2 year, 10-year and 30-year US Treasury bonds sinking between 78% and 95% over the same period. An investor who bought gold in 1999 and still holds it today, would have realized a 510% gain.

The coronavirus has lit a fire under gold prices, which have burned past $1,700 an ounce and stayed there for the better part of a week.

All the bullish factors for gold are in place: a "black swan" event that has created huge fear and uncertainty, imploding global stocks and sending traders/ investors flocking to the safety of havens like the US dollar, US Treasuries and precious metals. The demand for Treasuries has pushed up their prices, causing their yields to fall to new lows. Negative real yields (yields minus inflation) are bullish for gold, and we expect yields to remain negative for some time, as central banks are forced to keep interest rates low to encourage lending.

And then there's debt. We've been able to draw a very straight line between debt-to-GDP ratios and gold prices. Gold rises proportionally to debt. As long as governments are wrangling the coronavirus, we fully expect national debt piles to keep growing. Indeed the political pressure on governments to help the most vulnerable in society, for fear not only of losing power, but in some countries, extreme social unrest, is bound to keep the stimulus taps gushing.

The following from CNBC, 2020.04.30;

"Consumer expenditures, which comprise 67% of total GDP, plunged 7.6% in the quarter as all nonessential stores were closed and the cornerstone of the U.S. economy was taken almost completely out of commission...The count of all goods and services produced in the U.S. shows that even though the first quarter saw only two weeks of shutdown, the impact was pronounced and set the stage for a second-quarter picture will be the worst in the post-World War II era.

"The upshot is this was already an economic catastrophe within two weeks of the lockdowns going into effect. The second quarter will be far worse." Paul Ashworth, chief U.S. economist at Capital Economics

Consider what a $10 trillion, and counting, Fed balance sheet will do to the debt-to-GDP ratio.

Despite broad-based market volatility, we at believe now is an unbelievably good time to be investing in precious metals, in all currencies.

Richard (Rick) Mills

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