Why Gold Is a Currency and What Affects Gold Prices
For millennia, humanity has been captivated by gold. It’s been the subject of wars and conquests throughout the ages because of its beauty and value.
When the gold standard was removed around 50 years ago, global economies saw an increase in financial instability and escalating inflation. The gold price soared in the 1970s and again in the last 20 years, especially during the pandemic in 2020 when the precious metal set a new all-time record.
The gold standard wasn’t without its problems; yet, there has been increasing focus on a return to the gold standard in recent years.
Gold is actually a currency. Although gold is often thought of in terms of US dollars because that’s how it’s typically denominated, there is an inverse correlation between the two currencies.
- Gold has been used as some sort of currency throughout history.
- We’ve moved from using gold coins to paper assets, and seen in the larger scheme of things the move to a fiat system that isn’t backed by gold happened fairly recently.
- Since the removal of the gold standard, inflation and a dropping dollar have led to rising gold prices.
- People can use gold to diversify their portfolios and hedge against financial instability.
How come gold is a currency?
The price of gold fluctuates freely relative to other currencies such as the US dollar, the yen, and the euro. Although you can buy and sell gold and store it, it’s rarely in itself used as a method of payment. The precious metal, however, is highly liquid — you can exchange it for cash quickly.
Just like other currencies, there are times when gold moves up and when it moves down. The price is typically going up during times when other currencies are weakening, during financial instability, during financial crises, and during inflationary times.
What is the relationship between the US dollar and gold?
Seen over longer terms, the price of gold increases when the dollar weakens, as we’ve seen it over the past decades.
Up until 1971 the dollar and gold were tied together. According to the Bretton Woods system, the US government promised to exchange dollars for a fixed amount of gold. The relationship remains close; whenever investors talk about gold, they often also talk about the US dollar.
All currencies’ prices are affected by a wide range of factors beyond the US dollar and US inflation. As a global commodity, gold is affected by factors that impact the global economy and financial markets. For instance, when one country buys or sells are large amount of gold, the global price of gold will be impacted.
How can gold be used as a currency?
Since the gold standard was abandoned, the price of gold floats freely. The precious metal is a safe-haven asset that protects investment portfolios against economic uncertainty, including inflation and crises, and a rise in the gold price is often an indication of underlying financial issues in the economy.
Therefore, there are times when it’s a great idea to own gold. For instance, when the stock market is peaking or overvalued and a crash therefore is imminent.
By owning gold, you can then exchange the metal for other currencies when needed, which is easy since it is highly liquid.
By purchasing gold, investors can protect their investments. It’s a forward-looking investment — you will want to buy it before a crisis occurs because gold may already have risen quickly once a crisis hits. So investing in gold as a precaution is the best way to look at the precious metal and the best way to reap its benefits.
The bottom line
Investors should view gold as a currency but realize that it often works opposite of other currencies — like when the dollar goes down, gold usually goes up. Although there has been talk about going back to a gold standard, this has not happened yet, mostly because such a system in itself isn’t flawless
If you view gold as a currency, and trade it as one, you can protect your wealth against risks to other currencies and to financial markets. However, it’s crucial to understand that gold investing is a forward-looking strategy: If you wait to buy the precious metal once a financial crash occurs, it may be too late to save your stock portfolio and benefit from gold.
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