A lot of commentators on my "Why Gold Is Not Currency" article stated that gold was an inflation-proof store of value and therefore a superior currency. This may be true over time, but it's not true from year to year or even day to day. As people buy food and shelter for immediate consumption, a currency has to be predictable so households can plan a budget.
Gold fails the stability test as both a currency and a buy and hold commodity. Anyone who believes otherwise must be able to handle a lot more changes in portfolio value than I can -- or really likes fairy tales.
I've done a chart that shows this using year-to-year data from 1972, when the dollar went off the gold standard. We will do our own fairy tale to make it interesting and hopefully more understandable.
Zimbabwe Reserve Bank Governor Gideon Gono realized that his plan to put Zimbabwe currency on the gold standard was 40 years too late, so he went to the local witch doctor and asked, "Can you send me back in time to 1972 so I can put our currency on the gold standard?" The witch doctor said, "Sure, and with my magic I'll make Zimbabwe exist in 1972."
So Gono goes back to 1972 and finds his job exists in the magically-created Zimbabwe. Rather than making the mistake of debasing the currency and generating hyperinflation, he says, "I will have no inflation by putting us on the gold standard."
The first year is great. Gold appreciates 36% in 1973 and everybody take out US dollar-denominated loans to buy fancy cars and big houses. Then 1974 is great as gold appreciates another 32%. Everybody takes out even bigger US dollar loans they can pay back in ever-appreciating gold. Gono is made a national hero.
In 1975 there's a bump in the road as gold depreciates 8%. Everyone tightens their belts and makes do. Disaster strikes the next year as gold plunges 37%. Nobody is able to pay their US dollar-denominated loans, so everyone loses their houses. Food prices skyrocket and citizens riot. Gono is lynched.
Those were the actual price variations year to year in gold from 1972 to 1975. The chart below shows the year to year changes in value for the US dollar compared to currency pegged to gold. Below the green line, currencies lose purchasing power; above it, they increase in purchasing power. The issue for currency is not whether it holds its value over time, but whether its purchasing power is predictable tomorrow. Gold's only consistency has been in having prices swing of 10% to 20% or more.
[Click to enlarge]
Click to enlarge
The dollar may go down continually over time, but it's predictable. The normal downward price swings for gold currency will result in monetary contraction recessions.
The fact that gold has not had a down year since 2001 should be a warning that a significant drop in price could occur any time. The drop in usage outside of the Asian markets and the increase in hoarding (purchase for investment) are strong indicators that gold is in a bubble. The currency fairy tale is not going to rescue gold.
Disclosure: I have no positions in any stocks mentioned, but may initiate a short position in GLD over the next 72 hours.