Gold Versus Fiat and the Mother of All Bubbles

dump the debt

Image by Friends of the Earth International via Flickr

The price of gold has recently been shooting through the roof. As of the time of this writing gold is hovering near $1870. It seems like only a short while ago when I was wondering if $1500 was near.

What’s going on with the price of gold? Is this the beginning of a mania phase in gold? Or is it really the story of the ongoing devaluation of fiat currencies and the immense growth of government debt and liabilities?

There is more to this story than a simple explanation can give. I have asked these questions many times myself, and have looked for the answers. I hope to share some of my insights with you in this post.

Is gold an investment?

Gold can be considered an investment in the following ways:

  • An investment against the drop of fiat currencies.
  • An investment in increasing demand from central banks and the far east.
  • An investment against political risk and uncertainty.

The main driver behind the price of gold in recent times is a combination of these factors and more. Consider the following trends:

The supply of gold is limited and the supply reacts only very slowly to demand, so this increasing demand is being absorbed by the metal in the form of price increases.

How is gold not an investment?

Some also like to compare the performance of gold to market indices such as the S&P 500. While this is interesting in order to see what the relative performance has been like, gold and equities are not in the same asset class. Gold is not a claim on a company’s assets and future income streams and does not return an income;  indeed, it costs money to store and insure.

Gold’s primary historic and modern role has been as money. It makes sense to compare it with other instruments that fill this role today, such as the US dollar.

Warren Buffett‘s thoughts

Squirrelers recently wrote about Warren Buffett’s views on gold; here is his summary of Warren Buffett’s main points:

If you took all the gold in the world, it would be valued around $7 trillion. This would equal about 1/3 of the value of all U.S. stocks. By comparison, the value of all farmland in the U.S. is about $2.5 trillion. You could take that farmland, add 7 Exxon Mobils to it, and have an extra $1 trillion to boot. What’s a better use of funds? You could probably do more with these alternatives to gold, versus just staring at a giant block of gold that looks nice but doesn’t actually do anything.

Warren Buffett’s argument, when phrased in this way, is probably correct, but then again, you can say the same thing about fiat by substituting a pile of US dollars for gold. The argument still holds.

This argument, while technically valid, doesn’t tell us anything meaningful about the real world. Nobody is in a position to buy all of the gold, and there would be no point in trying for the same reason that it would be pointless to try and acquire every last dollar on earth. Money derives its usefulness as a medium of exchange and as a store of value. To buy up an entire money supply and sit on it would be to defeat the purpose of the currency.

Instead, let’s look at something that does have meaning in the real world: If gold and fiat are both competing for the hearts and minds of men, then how has gold fared versus fiat currencies as a store of value?

Gold and the US Dollar

Here’s how gold has fared against the US dollar since the early 1980s:

The price of gold in USD

The value of gold was relatively stable against the USD throughout the 80s, with a decline in the late 90s and early 2000s. Since 2005 the price has clearly rocketed upwards, with this graph not fully capturing the recent surge to the $1800s and beyond as it’s based on yearly averages.

The value of the USD as measured against gold.

This chart looks at the same data in a different way. Here, we compare the USD against the price of gold, with 1982 picked as a baseline year. The value of the USD was relatively stable in the 80s, with a surge in the late 90s and early 2000s and a big drop since then.

What are some plausible explanations behind the big drop?

What we don’t see in this chart is the chaos in both the US dollar and the gold price throughout the 70s. The Bretton Woods agreement ended in 1971, ending the international convertibility of the USD into gold. This decade was marked by price controls and other measures that failed to stem the high inflation that followed. In an attempt to save the dollar, interest rates were raised to punitive levels. Can you imagine paying credit card-like interest rates on your house? That’s what the rates were like back then.

The USD/Gold ratio and the Federal Funds Rate.

The efforts were successful: inflation was tamed, the price of gold collapsed, and paper entered a new bull market that lasted until the end of the millennium. We’ve since come to an end of the paper bull market. Interest rates have been lowered to ridiculous levels, and we have become trapped in a vicious cycle of asset bubbles and recessions. The bubbles are getting bigger and bigger each time: In 2000, we had the dot com bubble, and in 2008 we had a financial implosion in the aftermath of the subprime bubble. Now, the mother of all bubbles is underway: the government sovereign debt bubble. At this point, there is nobody left to bail out the governments themselves.

US government debt:

US Debt. Source:

A significant difference between the 1970s and today is that debt was much lower in the 1970s. The debt today is not as high as it was in the 1940s, but the 1940s were a time of severe consumer deprivation as much of the production was going toward planes, bombs, bullets, and stuff like that.

With Europe destroyed and much of the rest of the world embroiled in communism and dictatorships, it’s no surprise that America was the manufacturing center of the world and enjoyed prosperous times in the 50s and 60s, allowing it to grow its way out of the debt burden. Can anyone say that we’re in a similar situation today and therefore the debt doesn’t matter? I understand that there are some warmongerers out there that would like to start a new world war so that America can once again be the only one left standing. The lunacy and horror of this position cannot be overstated.

How has gold helped to preserve purchasing power?

The trouble with fiat

Two important aspects of any good money are its suitability as a medium of exchange and as a store of value. Due to national laws and trends in history, fiat is the undisputable king when it comes to its use as a medium of exchange. Walk into any store in the US and you’ll have no trouble paying in US dollars, but you might have a bit more trouble if you try to pay for something with gold or silver coins.

However, unless you spend all of your income, you’ll also be concerned with how your money performs as a store of value. How well does it keep its purchasing power compared to a day, a month, a year, and a decade from now? Fiat is good enough to hold its value in the short term, but over the years and decades its value is slowly but surely eroded away by central bank inflation.

The properties of fiat make it attractive for those looking for easy money. Lower interest rates and higher inflation reward debtors by making it cheaper to hold debt. A certain amount of credit expansion is desirable in order to fund business expansion and grow the economy, but central banks almost always go beyond the market optimum and end up inflating the currency so that they can meet the political spending requirements of the government.

The desire of debtors for cheaper money comes in direct conflict with the desire of savers for hard money that holds its value over time. Until the 1970s, it was illegal for Americans to privately own gold. In other countries, this has been true to modern times; China only legalized private ownership in 2004! Therefore, the concept of holding hard money has become downright alien and strange to many private citizens. This has been a dampening factor on demand which is slowly starting to go away.

Can’t savers simply invest in treasuries or the stock market?

The stock market is an important vehicle for long-term wealth creation. Unlike some gold bugs who believe that the stock market is nothing more than a casino, I firmly believe that the markets are the best way to build intergenerational and retirement wealth for the long term. An investment in the markets is an investment in the companies that create value and grow the economy.

However, the stock market is also highly variable in the short run. The 2000s have seen a small return, and while these may one day be looked upon as cheap times, it could be a long time indeed before it pays off. The stock markets are therefore not the best choice for short-term and medium-term savings goals. While some traders might have done better, you shouldn’t have to be a skilled trader or professional in order to eke out a good return from the markets.

As for Treasuries, current ZIRP policies have resulted in ridiculous yields. The current 5-year yield is 1.50% and the 10-year yield is 2.125%. The Billion Prices Project@MIT is showing inflation of close to 4% for the past twelve months, which isn’t far off from the official government figures. These sort of yields as well as the downside risk from future interest rate hikes have made the Treasuries next to useless.

Many have written about the relationship between the real return of Treasuries and gold, and it’s clear that so long as Treasuries give a poor return, money will seek out other avenues for the preservation of savings, such as gold.

Gold versus fiat as a store of value

Here is a chart of gold versus a collection of fiat currencies, with 1999 selected as the base year:

Gold versus fiat currencies

Nobody won this contest against gold, but the Swiss Franc and the Canadian Dollar lost the least value. The US dollar on the other hand was the worst-performing of the whole bunch.

How have other commodities performed against gold and the USD?

Gold has done a better job of keeping prices in line. What about housing prices in the US?

US housing prices, nominal and indexedEven though the bubble has burst, prices are still somewhat higher than in 2000 due to inflation. However, in terms of gold, prices have actually declined.

Of course, part of the advantage of home ownership is the immense leverage one can get with a fiat mortgage which one would not have access to if one purchased outright with gold. This is why home owners, being debtors, prefer easy money, though this is problematic because easy money inflates home prices, and home prices which rise faster than income require someone willing to be the greater fool. Eventually, there is nobody left to pass the buck to.

The US dollar is not a meter nor a yardstick

It’s very easy to see gold exploding in terms of USD and point out that the parabolic rise in gold must mean that gold is in a bubble. I readily concede that any market is susceptible to the very human emotions of greed and exuberance, and gold is no exception. I acknowledge that there are probably many players in the market hoping to ride this side of the curve while the good times last.

I also concede that there may be a political sea change in the US and the ship may be turned around in the other direction; rising yields and lowered spending would remove much of the drive behind the gold price.

However, many people fall into the trap of looking at the USD as if it was some fixed ruler of measurement. We look at the gold price in 2000, and the gold price in 2010, and imagine that gold is the only variable that changed while the USD remained more or less constant. This is not the case. What if much of the story behind the rise in gold and other commodities is really the story of the fall of the US dollar?

A gold standard is not the solution

Some people have called for a return of a government-run gold standard, like what existed before 1971 or the classical standard that existed before the Great Depression.

These ideas are not only undesirable, but they are also unlikely to happen in today’s political environment.

The government shouldn’t be in the process of determining winners or losers — it should only be there to preserve law and rights and ensure freedom of choice. Enforcing a gold standard would only be choosing winners and losers by mandate just like any other scheme.

We don’t have government-mandated social networking standards or government-mandated web browser standards, and this is a good thing: giving one option a monopoly over the others destroys innovation and free choice.

What will truly keep the central banks and governments in check would be to free up the monetary systems and allow people free choice in which money they prefer to use. It has been said that gold is a barbarous relic, and it has also been compared to a cross of crucifixion. Many of these problems came about due to manipulation and monopoly privilege, just like many of the problems of fiat today are due to manipulation.

The truly barbarous system is the breaking down of the world into separate fiat regimes where one currency enjoys monopoly privileges to the expense of others. This restriction of free choice gives central banks free reign to destroy the currency all in the name of short term political gain. One day, history will look back upon this system and sadly shake her head with shame.

My thoughts

Gold has enjoyed a strong run up, and like anything else is subject to pullbacks and corrections along the way. The wall of support behind gold is the exploding debt, mess of regulations and tax regimes, and huge levels of spending by government. Until this changes, gold will continue to be the alternative asset of choice.

A lot of this talk of sovereign debt bubbles and economic woes sounds very doom & gloom, and I think many gold bugs downright fantasize of a Mad Max scenario, or perhaps a Wild West scenario where the economy collapses and we return to a frontier style of living. I don’t buy it, though. Even if the dollar does collapse, many currencies have collapsed in the past without complete destruction of society, including in the US itself.

If the government continues on its current path then times will get harder, however, humans are great at adapting, especially in response to pain. I believe that the outcome of the mother of all bubbles will be a healthier economic and monetary order. Today is a great time to be alive in the grand scheme of things; we have access to an unbelievable amount of information and technology in ways that people only a few decades ago could only have dreamed of, and the trend here is only forwards and upwards. There is light at the end of the tunnel, and my belief is that the lessons of these times will not be forgotten.

Further reads

The Return to Honest Money (FOFOA)
Money: A Semi Fictional Fable (The Daily Capitalist)
Fed Secretly Lends 16 Trillion Dollars (Hope to Prosper)
The Great Credit Contraction And How To Use Gold As Money (Run to Gold via Invest It Wisely)
The Story of Gold, How We Got Here and What No one Told You (The Wise Buck)

Data sources
So, reader, what are your thoughts? Is gold in a bubble? Is the government doing the right thing to get the economy back on track? Or, do you believe that this story is only beginning?


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  1. says

    Really good thought provoking post.
    Gold is a bubble but like the bubble it is very profitable until it pops and it is obviously difficult to say when that might happen. I believe we’ll be shocked when over a very short period of time interest rates shoot up sharply, raising the opportunity cost of holding gold. People will rush to the exits to get out of gold and bonds. Then maybe the asset du jour will be the U.S. dollar.
    If this unfolds it will be devastating but this is what happens when price controls are in effect. For a long time the pressures have been building as the Federal Reserve has been holding the price of money – short term interest rates – below market levels.
    It is interesting that much of this started, as shown in your graphs, when the Greenspan Fed started manipulating the Fed Funds rate, i.e. the price of short-term money, in response to every little jiggle in the economy. It is detrimental in personal finance to meet every little shortfall by whipping out the credit card. This is true at the national level as well. By not understanding this the policy makers have put us on a path to making our fiat money worthless.
    Sadly, it doesn’t look like its going to change. There is no turning around arrogance. In fact, after speeding us towards the cliff they proudly point out that they tamped on the brakes.

    • says

      Hi DIY Investor,

      Great point in referring to the existing scheme as a price control! Communism may have fallen but it seems that we haven’t learned the lesson, and we’re still repeating the same mistakes over and over. What price control can be greater than controlling the price of money?

      I would be happy to see the walls come down and for people to have more choice in their currencies. Ultimately the ability to have that choice may be what saves the U.S. economy from disaster.

  2. says

    I don’t think gold is in a bubble yet. You make a good point that if the dollar collapses and disappears, society will go on. How true. And gold will still be around and worth something in the new currency as well.

    • says

      Exactly. Gold, being a fundamental element of this universe, has survived the rise and fall of civilizations and will continue to do so in the future. Far from being a barbarous relic, it is the most honest money we know, since until we have the technology to reap it from seawater or stuff like that (which will still cost energy), it simply cannot be intervened with nor inflated, which keeps credit bubbles in check and avoids capital consumption which even a gold-backed government monopoly currency cannot do, as it’s not the real thing.

    • says

      I hope so, too. Gold would play a fundamental role, I believe, but the most important idea is simply to remove the monopoly privileges and allow people to choose and transact freely. Even gold shouldn’t be privileged — letting people choose voluntarily results in the most freedom and no special privileges for any entrenched interests.

  3. says

    This is an awesome post Kevin.

    Back when gold was $700, I remember someone asking me if it would hit $1,00 and I thought no way. Boy, was I wrong. I thought we would be in a strong recovery by now and stocks would be back where they were before the Financial Crisis of 2008. But, a lot of misguided easing and stimulus, plus poor leadership from our government has really hammered the dollar and our markets. No one has the courage to be honest with America and make the hard choices that are right for the country. I hope that changes soon.

    • says

      Hi Bret,

      I hope it changes through the peaceful spread of ideas and not through violence. Sadly, too many interests have much to lose if things move to a better state of affairs, and they are resisting every step of the way.

  4. says

    Wow..I’m loving all the charts. It certainly does look like gold is a big bubble about to pop but when and how is still TBD. As you said, this largely depends on when the US will get their act together.

    Great article.

    • says

      Well everything is a bubble if you give it enough time. Do you believe we’ll see a big boost in the USD? It’s possible, but are they willing to kill the economy through high interest rates? Sometimes the patient gets so addicted to the drugs that withdrawal results in death.

      I don’t believe a reset is such a bad thing though overall, so long as we end the monopoly and restore monetary freedom to the people.

  5. Frank says

    Epic indeed! For the time being, one can make a pretty good profit from trading with gold. Whether it’s a bubble, it probably is, but I don’t see it blowing in the next few years.

    • says

      We could see a few more years of declining yields on Treasuries and negative returns… which would place more upwards pressure on gold. Will be interesting to see how it continues to play out.

  6. says

    Even as a semi-tepid gold bug, I hope it doesn’t come to a gold standard, as determined by a central bank. In that case, I suspect that the peasants will be the ones to get the shaft of arbitrary valuation. Let the government get out of the money lending business, and the markets generally come up with a system of trust and money. Whether its monetary metals, or bitcoins, or land units, or seasteading timeshares, it doesn’t really matter. Good post, Kevin.

    • says

      Agreed, 101. The only standard I want is a standard of openness and free choice. No more of this obfuscated banking system with legal privileges and price fixing.

  7. wilfredo says


    • says

      Will be interesting to see where it goes. Could we see $30,000 gold at some point? I don’t know. I think in real terms it won’t be vastly upwards of where it is today, because this is also a story of falling currencies.

  8. Rose Jackson says

    Gold is one of the precious metals which has been used as currency everywhere in the world. Investing in gold is the safest investment of all. This has been proved from time to time in the history of mankind. The prices of gold have always appreciated, defying the scenario of economic instability.


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