Monday, April 30, 2012

All That Glitters is Gold

Once upon a time the amount of currency any particular nation could produce was directly tied to its reserves of gold and other precious metals. This restricted any further production of paper money until there was an equal rise in stocks of precious metals. What this did was preserve the inherent value of money, as at any point it could be exchanged for an equal amount of gold. A unit of currency was not simply an arbitrary figure; it represented the quantity of gold that could be bought for that price.

In the intervening years this system has fallen out of favour with modern policy makers. Where governments were once restricted from increasing the money supply at a whim, currency creation is now just a matter of printing more as required. In fact, physical printing of paper currency, or minting of coins, is no longer necessary. With computers serving as the medium for large transactions, increasingly the money supply can involve as little as authorising a few additional keystrokes.

The problem with this strategy is that increasing the money supply doesn't affect real wealth; it simply causes a rise in inflation. The principle behind this is that since there has been no change in the supply of goods and services, the price of everything will go up to reflect the additional currency within the market. On an individual level, this means that the purchasing power of your money will have shrunk. To give a rudimentary example, your which bought five cheeseburgers one year, may only buy three the next, two the year after that and so on.

When taken in a national context, inflation is what deters countries from simply creating more money in order to repay debts. At least, it should act as a deterrent. If the market is suddenly flooded with a certain currency, its value will decrease. This would cause debt repayments to be worth less than the value of the loan before the increase in the money supply. To avoid this, there has been a recent trend back towards a system based on physical assets. If currency holds in itself an inherent value, it becomes more difficult to simply print more, which in turn will help control inflation.

Of course, completely returning to an asset based system would be infeasible at this point; too much has changed in the global financial landscape. However, hedging ones bets, both on an individual and a national level, by acquiring a portion of physical assets is something worth looking at. Gold offers security, but not necessarily the level of growth investors will be looking for. Property and well chosen shares will keep tabs on inflation, through the simple fact that you can't just print more of them, while providing dividends that should hold the value of your investment above inflation levels.

No comments:

Post a Comment