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Holding precious metals in the form of Gold Bullion, Silver Bullion, Gold Coins, and Silver Coins as a form of investment has been the preferred choice among serious investors for many years. The general superiority of these metals as a means by which to store one's wealth has also well established. But as economic turbulence increases, it behooves one to understand the underlying mechanisms responsible for having elevated these assets to a desired level. Having such knowledge in these times allows the individual to make better informed investment decisions, mitigate loss, and in many cases, make a profit.
The Transition from Precious Metals to Fiat Money as a Medium of Exchange
The evolution of money – that is, any standardized medium of exchange – has been a long and detailed one. Numerous types of objects, known collectively as “proto-money”, were used as early as 100,000 years ago to facilitate trade in several civilizations. Over time, the introduction of coins and paper money standardized these means of commerce. While there is much more to this story, what is of particular concern to the modern investor is the popularization among prominent global economies of the fiat currency.
In preparation for the global economic repercussions of World War II, representatives from the allied nations met in Bretton Woods, New Hampshire to establish procedures and institutions for dealing with international economic relations. The major results of this three-week meeting were
- The establishment of the International Monetary Fund (IMF)
- The adoption of a gold-based and essentially fixed exchange rate for each of the countries in attendance.
Each nation participated in this system for over twenty-five years, until August of 1971 when the United States terminated convertibility of the Dollar to gold, effectively establishing a “floating” exchange rate for the U.S. Dollar. Over the years, other nations have followed suit and adopted identical or similar systems for controlling the value of their respective currencies.
The Mechanisms of Exchange Rate Fluctuation
To say that the value of a currency is “floating” means that it is not fixed to some standard. At that time, supply and demand alone influences its value. Affecting the demand for global currencies is the demand for a nation's products. Because the purchase of a good is generally made with the currency used in product's country, this currency must first be acquired by the purchaser. This need then increases demand for the currency in question. Assuming a fixed supply of this currency, one could expect its “value” or exchange rate to increase.
Affecting the supply of a currency however, is the actions of a nation's central bank. One of the main objectives of most central banks is to affect the money supply by performing open market operations – that is, the purchase and sale of government bonds. If a central bank desires to increase the supply of its currency, it needs to purchase government bonds. New money is printed to pay for these bonds, and the money supply has increased. The opposite is also possible. If a central bank decides to contract the money supply, it can sell the government bonds in its possession and take out of circulation the money it receives in this process.
The Desirability of Precious Metals
Because of the reasons stated above, the value of currency can be volatile. While it is unlikely that a central bank would aim to purposely sabotage its own currency by increasing its supply over and above a reasonable amount, it is not so difficult to imagine a scenario wherein the demand for this currency could decline dramatically. In this case, the exchange rate in question would plummet, devaluing the portfolio of any investor holding cash.
In the face of economic crisis, such as the one our country now faces, this is not such an outlandish scenario. In fact, as suggested before, the move of worldwide investors from securities denominated in say, the U.S. Dollar to those perceived as less volatile (the Euro for example) would engender a decline in demand for the U.S. Dollar. The expected end result would be a decline in the value of any Dollar-denominated asset, including cash itself.
What stands comparatively immune to the whims of global investors, however, is the value of precious metals.
Historically speaking, these stores of wealth have not experienced the kind of boom and bust cycles present in other forms of investment. This observed stability exists for several reasons. First, precious metals like bullion have intrinsic value. The fact that precious metals consist of something that actually has value makes them more stable than fiat currency which is made of near-worthless paper. In addition, these metals in many cases have practical applications. Modern industrial processes make use of metals such as gold and platinum for their unparalleled conductivity and use in manufacturing electronics.
Moreover, in the case of economic turbulence, when investors do seek investments other than those vulnerable to market fluctuations, they wisely turn to the stability of precious metals. This increased demand has the effect of increasing their values, making them an even better investment. Finally, when precious metals are minted as collectable coins such as the popular Gold Eagle or Gold Buffalo, they are sought after not only for their intrinsic value, but for their rarity as a collectable item. Again, because there is a fixed supply of any one coin, increased demand for such an asset increases its value.
The use of precious metals as a store of wealth or investment is more stable than investing in any currency-denominated asset. The ability of precious metals to exist unaffected by the capital flight generally observed during times of economic crisis speaks to their desirability.
This information is provided for general reference purposes and does not constitute professional advice. For detailed coin collecting or investing information, please consult with a professional expert.