In this paper, we analyze the value of money. We
consider both paper money and gold. We attempt to relate the supply of money
(MS) and gold to their purchasing power (PP). We demonstrate the extent to
which printing of money dilutes its value. As a store of value, the value of
money is represented by its purchasing power. We compare the ability of paper
money and gold to function as a long-term store of value. We conclude that
gold is an excellent store of value, while paper money is not. We observe
that excessive printing of paper money is the ultimate cause for the
inability of paper money to function appropriately as a store of value.
2. Data Sources
Historical monetary data is readily available on the
internet. The official source is the Federal Reserve Board. Its monetary aggregate data can
be found on its web site and is available free of charge.
The Bureau of Labor Statistics (BLS) publishes the
historical Consumer Price Index
(CPI) data. Like the Fed, it also publishes the data on its web site and
makes it freely available. For a proxy of the purchasing power of money, we
use the inverse of the consumer price index. To illustrate, if the price
index doubles, the purchasing power is halved; if the price index increases
10 times, then purchasing power of money falls 90%.
3. The Purchasing
Power of the USD
The following chart shows together the data taken
from the above two sources.
The chart visually shows the near-perfect inverse
relationship between the amount of money in circulation and its purchasing
power. It reflects the simple relationship that prices increase approximately
proportionately to money supply. Stated differently, it reflects the basic
tenet of monetarism that in the long-run, price inflation is a direct
consequence of increase to monetary inflation. It also underlies the
classical theory of "money neutrality"; whether one believes that
money is "neutral" or not is a completely different story.
Looking at the data, from January 1971 to December
2008, the U.S. money supply increased 16.8 times; this was accompanied by an
81.1% drop in purchasing power of the dollar, as implied by the
governmentally-reported CPI. Thus, the data suggests that a 17-time increase
in money supply has resulted in an approximately five-time fall in purchasing
power. We do not attempt to explain this significant gap, but mention that
the gap may be due to (1) increases in productivity, (2) over-reported money
supply, (3) under-reported CPI, (4) over-valued asset prices (stocks, bonds,
real estate), or possibly (5) a fundamental flaw in the quantity theory of
money. We would suggest, in order of significance, (3), (4), and (1) as the
most important factors explaining the gap.
4. The Purchasing
Power of Other Major Currencies
The United States is not alone in pursuing
inflationary monetary policy and steadily inflating its money supply.
Available historical exchange rate and money supply data permit similar
analyses for other major currencies. We provide a similar analysis for (1)
the British Pound, (2) the Canadian Dollar, (3) the Australian Dollar, (4)
the Japanese Yen, and (5) the Swiss Franc for the same period (1971-2008).
We chose 1971 as a starting point for three reasons.
First, prior to 1971 exchange rates were fixed, Second, pre-1971 exchange
rate data is difficult to obtain. Finally, prior to 1971 the dollar was fixed
(convertible) to gold. On the other hand, after 1971, exchange rates were
floating, data is available, and the dollar floated against gold.
In other words, we chose the post-Bretton-Woods
period. Bretton Woods is the period that characterizes the international
monetary regime between WWII and 1971. After the Second World War, only the
U.S. Dollar remained convertible to gold at a rate of US$35 per troy ounce.
During that period all other currencies were linked to the dollar at a fixed
exchange rate. On August 15, 1971, President Nixon unilaterally closed the
'gold window' to prevent foreigners from exchanging their U.S. Dollars for
Thus, he terminated the convertibility of the dollar to gold and allowed the
dollar to float against gold. This was done likely to prevent the complete
loss of the U.S. gold reserves. In turn, other currencies began to float
against the U.S. dollar. Since that historic moment, for nearly 38 years all
currencies in the world have not been backed by any tangible asset. It is an
unprecedented monetary experiment that extends to the entire world and
involves every living person.
The next three charts show similar relationships for
the British Pound, The Canadian Dollar, and the Australian Dollar.
Interestingly enough, the remaining two currencies -
the Japanese Yen and the Swiss Franc - displayed greater resilency
to monetary inflation and depreciation. This is especially true for the Swiss
Franc - the amount of Swiss Francs in circulation increased a relatively
modest 280% over the same period. The explanation may lie in the fact that
even though the Swiss Franc has not been technically (legally) convertible to
gold, the Swiss Central Bank has attempted to maintain proper gold backing of
the Franc, which in turn, had the effect of moderating inflation.
5. The Purchasing
Power of Gold
Before 1971, gold was always used as a basis for
money. It is generally accepted that gold has functioned well as a store of
value and has maintained its purchasing power for over 5000 years. So, what
can we say about the supply of gold and its purchasing power for the period
of 1971-2008? How does gold compare as a store of value (purchasing power)
against other major currencies for the same period?
For the supply of gold, we use data from the U.S.
Geological Survey (USGS) and the World Gold Council (WGC). USGS maintains
records of supply-demand statistics for a variety of minerals and metals,
going back to 1900. The WGC estimates that a total of 165,547 tonnes of gold have been mined, including 2,400 metric tonnes for 2008. Combining the two data sets, we infer
that for the period of 1971-2008, gold supply increased from 93,515 metric tonnes of gold to 165,948; thus, for the whole period,
gold supply increased by merely 78%.
For the same period and using the same CPI
statistics, the purchasing power of gold has actually increased four times.
The price of gold is up from about $38 to about $822, which corresponds to an
increase in its price of almost 22 times, while the CPI is up from about 40
to 210, or about 5 times. Thus, for the period, the
price of gold has increased about 22 times, while the price level has
increased about five times, resulting in an increase in the purchasing power
of gold of about four times; the exact increase is 310%, which corresponds to
purchasing power of a little over four times. The numbers are shown on the graph below.
So, what can we conclude from this whole analysis?
The overall conclusion is that gold is a significantly better store of value
than paper currencies. While the purchasing power of gold is up four times, the purchasing power of major currencies
is down 5-10 times, except for the Swiss Franc and
the Japanese Yen, whose depreciation is significantly less. The second column
in the table below, Change in Unit Value, shows the exact percentages.
Change in Unit Value (%)
The explanation for gold's ability to hold its
purchasing power is obvious from the first column. While the supply of gold
has not even doubled for the period, the supply of some currencies has
increased 10-20-30 times and more. For example, the supply of Australian
dollars increased 33.5 times, while the supply of Canadian Dollars is up 15.4
times. There should be no wonder why they have lost most of their value for
the period. If governments print them fast, they will depreciate rapidly - it
is as simple as that. Governments can't print gold, so they can't depreciate
its value. In the world of money, gold is still the best store of value.
It was illegal for Americans to own gold for investment purposes
since President Roosevelt signed Executive Order 6102 on April 5, 1933. It
wasn't until Dec 31, 1974 when Americans could once again own gold coins,
bars and certificates.
Mike Hewitt is the
editor of www.DollarDaze.org, a website pertaining to
commentary on the instability of the global fiat monetary system and
investment strategies on mining companies.
Disclaimer: The opinions
expressed above are not intended to be taken as investment advice. It is to
be taken as opinion only and I encourage you to complete your own due
diligence when making an investment decision.
© 2007 DollarDaze