David Levenstein: A Historical Perspective of Gold and Currencies

JOHANNESBURG – As gold continues to make new record highs, there are many analysts scratching their temples trying to understand what is going on. And, as I have mentioned many times in the past, many of these analysts are stock brokers, financial advisors, accountants and other geniuses. Some of them even have a string of academic qualifications behind their name. But, what has this got to with the gold. The answer is absolutely nothing. And, this is one of the problems facing individuals who are interested in investing in precious metals, in particular gold and silver.

Most of these individuals rely to a large extent on the advice given to them by their financial advisors. This is certainly the case in South Africa. Or they watch and listen to the commentators on main stream media. While many of these analysts are brilliant when it comes to evaluating stocks, most of them have no knowledge about the actual physical markets for gold and especially silver. In South Africa, practically every single one these “experts,” have denigrated gold as an investment since the price was less than $300. However, they have yet to understand that investing in gold mining shares and accumulating the physical metal is not the same thing. And, yes, I agree, South African gold mining shares have been miserable performers in the current gold bull market. But, in their confused state, these analysts have failed to make the important distinction between gold mining shares and the reason why someone would want to buy physical gold. And, the majority of these advisors are only familiar with the modern day fiat currency system with some vague understanding of gold. Yet, it is these individuals who proffer advice on investing in gold. If you break your leg, do you go to the nearest library and ask the librarian on duty to help you by looking up the relevant procedure from some medical journal? Or do you go to your doctor? The same applies with investing in precious metals. If you want to know more, go the people who are the experts in this field and not someone who has no idea of what is going on. When it comes to understanding gold it is important to have a knowledge and understanding of money.

The emergence of money was perhaps one of the most important events in the history of mankind.  Historically many different goods have been used as money including beads, shells, tobacco, copper and sugar etc. Without money there was no medium of exchange and thus the only way people could trade with one another was through a system of barter. However, it was not a practical means of trade because some goods were more widely demanded than others and some were more divisible into smaller units without the loss of value. Some were also more easily transported than others.

But, over centuries gold and silver emerged as the two commodities that offered the best solution. Both these precious metals were uniquely marketable in that they had worldwide acceptance. This allowed for much easier trade transactions, both domestically and internationally, something we now take for granted. And, over the years, silver was used for smaller transactions while gold was used for larger transactions. Then, gold and silver were minted into coins, for smaller, day-to-day transactions, and into large bars for bigger transactions.

As these coins and bars gained wider acceptance, there were other problems such as the supply of money and of course the problem of “fractional reserve banking.” In simple terms this came about by banks that were the custodians of gold on behalf of clients. They simply printed more warehouse receipts than the actual quantity of gold that they held. While these pseudo receipts were nothing more than counterfeit documents, governments gave banks their approval. These banks were simply using the gold reserves of their depositors to create new money. And, of course, this new money increased the economy’s supply of money without the country having to increase their holdings of gold. 

For many years, the world adopted a gold standard or a form thereof. It must be emphasized that gold was not selected arbitrarily by governments to be the monetary standard. Gold had developed for many centuries on the free market as the best money; as the commodity providing the most stable and desirable monetary medium. From 1815 to 1914 the world was on a gold standard, which meant that each national currency (the dollar, pound, franc, etc.) was merely a name for a certain weight of gold. The US dollar was defined as 1/20 of an ounce of gold, the pound ¼ an ounce of gold, and so on. This international gold standard meant that the benefits of having one money medium were extended throughout the world, thus facilitating freedom of trade, investment, and travel throughout that trading and monetary area. But, with the advent of World War I this system broke down, The system itself did not break down, but in order to pay for this disastrous war, governments had to inflate their own supply of money which meant that it was impossible for the warring governments to keep their pledges of seeing that all paper money was redeemable in gold, and so they went off the gold standard.

Then, from 1926 to 1931 the world returned to a gold standard. While the US continued to redeem dollars for gold, England and the other countries of the West returned to somewhat of a pseudo gold standard. British pounds and other currencies were not payable in gold coins, but only in large sized bars, suitable only for international transactions. This prevented the citizens of Britain and other European countries from using gold in their daily life, and this allowed for a wider degree of paper and bank inflation. Furthermore, Britain redeemed pounds not merely in gold, but also in dollars while other countries redeemed their currencies not in gold but in pounds. As sterling balances piled up in France and the US, and when France attempted to cash in its sterling balances for gold, Britain went off the gold standard.

The world was back to the monetary chaos of World War I. International economic and monetary warfare raged between currencies as they devalued against one another. This was followed by exchange controls, and trade barriers until eventually international trade and investment came to a virtual standstill. Sound familiar?

Then, a new international monetary system emerged at a monetary conference held at Bretton Woods in 1944. And, the world returned to another gold exchange standard which lasted from 1945 to 1968. This gold standard was much the same as gold exchange standard of 1920 but now the dollar had taken over from the pound. The other difference was that the dollar was no longer redeemable in gold to American citizens but it was redeemable to foreign governments and their central banks. Under the Bretton Woods system the US pyramided dollars on top of gold while other governments held dollars as their basic reserve. And, since the US had a huge stock pile of gold at the time there was plenty of room to create more dollars. And, as the US government embarked on its post war policy of continual monetary expansion, a policy that it has pursued ever since, by the early 1950’s the continuing US inflation began to worry other nations. While the US was expanding money and credit, many of the major European governments (Germany, Switzerland, France, and Italy) pursued a more “hard currency” approach. By the late 1950’s these countries as well as Japan were getting even more concerned about being forced to pile up dollars that had then become increasingly overvalued.   But, Europe still had the option of redeeming dollars for gold at $35 an ounce, and, this is exactly what they did for almost two decades until the US gold stock pile had dwindled from some $20 billion to $9 billion. And, as US dollars kept inflating on a gold stock pile that was gradually declining the system began to unravel in 1968.

As European central banks threatened to redeem as much of their dollars for gold as possible, in August 1971, President Nixon, declared that the US would no longer be part of the gold standard and for the first time in American history, the dollar became a totally fiat currency without the backing of gold in any shape or form. As the dollar declined in value and the West German mark, the Swiss Franc, and the Japanese yen, all soared higher against the dollar, Friedmanite economists hailed this as the monetary ideal. And, since the US went off the gold standard and established the Friedmanite fluctuating rate system of currencies in March 1973, the entire world has suffered some of the worst bouts of inflation in its history. And, in their scorn of gold, Keynesians and Friedmanites, each devoted to the fiat monetary system, predicted that when fiat money was established, the market price of gold would fall to about $8 an ounce.

We are currently in the midst of another monetary crisis brought on by many of the same reasons that brought on previous disasters. While I do not know how this crisis is going to be resolved, I do know that it has the potential to be the worst we have ever experienced. And, the higher gold prices are merely reflecting the deteriorating situation with global currencies. Unfortunately, it seems that this global monetary crisis is only going to get worse before it gets better.



The break above $1440 an ounce has set gold up to test $1480 and then $1500 in the short-term. However, the longer-term picture suggests that gold is head to $1600.

About the author

 David Levenstein began trading silver through the LME in 1980, over the years he has dealt with gold, silver, platinum and palladium. He has traded and invested in bullion, bullion coins, mining shares, exchange traded funds, as well as futures for his personal account as well as for clients. www.lakeshoretrading.co.za

Information contained herein has been obtained from sources believed to be reliable, but there is no guarantee as to completeness or accuracy. Any opinions expressed herein are statements of our judgment as of this date and are subject to change without notice.


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