This blog post is going to cover the similarities between Gold and Bitcoin as a store of value and how thinking about Bitcoin as digital gold is, in my opinion, a solid way to think about Bitcoin.
History of Gold as a measure of wealth.
Gold was first used as currency back in 643 BC in what is now Turkey. At this point in history, the value of the gold coins was equivalent to the metal it contained. The principle was that the more gold a country-owned, the richer it was. This led to explorers being dispatched to the New World by European powerhouse nations like Spain and Portugal in search of the precious metal.
Fast forward a few hundred years and, as nations looked to grow and develop their financial systems, they needed a form of exchange that could scale, so printing coins and banknotes became the vogue. But this question remained: “How do these paper notes and coins actually have any worth?” One way to answer this fundamental question was to back these newly minted notes and coins with a physical asset of value; nothing fits this requirement better than gold. When the US established the dollar, the Gold Standard Act was used to establish gold as the only metal for redeeming the paper currency. The initial value was set at $20.67 per ounce. Basically, you could redeem your notes or coins for gold at a set rate. Which made it a lot easier to conduct transactions rather than using gold bullion and having to check the authenticity of the metal.
Sounds like a straightforward system. However, challenges existed. Gold is not a finite metal. If you find new deposits then gold prices will fluctuate, and this would impact the fiat currency tied to its value. So, in 1913 Congress created the Federal Reserve with the aim to stabilize gold and currency values. Soon after, WWI started, and European countries broke from the linkage between gold and their currencies and started printing money. This ultimately led to hyperinflation. After the war, almost every country returned to the linkage between gold and their currency. For a great write up on the timeline of the Gold Standard, this post by the Balance is highly recommended.
A key date in the history of the Gold Standard is the 15th August 1971. This is when President Nixon formally allowed the Federal Reserve to no longer have an obligation to redeem dollars with gold. He also moved the dollar/gold relationship to $38 per ounce, almost doubling the rate overnight. Gold and the dollar are now not linked in any way and gold has floated in price with record highs of $1,895 per ounce being recorded in 2011.
Monetary Policy and Why You Should Care
I am certainly no macro-economic expert, so I am not going to claim expert knowledge in the next few paragraphs. What I will cover is why you should care about what your politicians and their appointed officials are doing with the Dollar, Pound and Euro in your pockets. We take the money in our pocket for granted, we use it every day, but the majority of the population doesn’t understand how its true value is determined and actively managed by our elected officials.
As I have gone down the rabbit hole of Bitcoin and deepened my understanding, one thing that has leapt out is how the money supply of fiat currencies is manipulated by governments. I always knew governments printed money in varying degrees based on macro-economic factors. What I had failed to fully grasp is the profound impact this has on the general population, who largely either doesn’t care or isn’t educated on the implications or worse, both.
The sheer scale of how much our currency has devalued over time is scary when you dig into the details. If you take 1919 as the base year and 2019 as the current year and base on $100 according to www.measuringworth.com the purchasing power based on the Consumer Price Index is $1,450 for 2019. If we look at it through another lens, the household purchasing power of that $100 in 1919 is equivalent to $3,330 in 2019. Let those numbers sink in for a moment. Now, lots of factors play a role in these disparities but imagine you put your $1000 dollars under your bed in 1919 and then your grandkids found that $1000 this year. You would have thought in 1919 you were leaving them a considerable amount. Imagine their relative satisfaction on finding that $1000 today.
Money supply is a key element in this equation. According to this chart from The Balance, the M2 supply of money in the US has gone from $3.2 trillion in 1990 to $14.5 trillion in 2018. M2 is currency in circulation, plus savings accounts, money market accounts, money market funds, but doesn’t include IRA or Keogh retirement accounts. Put another way, since 2007 the US Federal Reserve has doubled the money supply, largely in response to the 2008 Financial Crisis.
Why is this an issue? Well, put simply, your dollars are worth what the US government and its representatives at the Federal Reserve want them to be worth. On a whim, the government can change your wealth to drive whatever agenda it has at the time. Now, this has always been the case, but with the abandonment of the Gold Standard and the massive printing of money since 2007, the pace of change is increasing.
You either are concerned by this reality or you are not. The Crypto world is typically more worried. Bitcoin will only ever be limited to 21 million bitcoins as the maximum amount in circulation. No single party, government or corporation can change that fact. Nobody can ‘print’ more than 21 million Bitcoins. This fixed, and known supply of bitcoins appeals to those who are concerned by the macroeconomic climate and the controllers of fiat currencies around the world. For the most detailed understanding of how Bitcoin supply impacts the relative price of Bitcoin, check out this blog post by Plan B. The post is tough going, so be warned, but it has been widely circulated and has gotten traction in the Crypto Twitter community for good reason.
I plan to come back for a more in-depth dive into the money supply and Quantitative Easing in future blogs as it’s a very interesting topic when you start to dig in… But let’s get back to Gold and Bitcoin. The attraction of Gold as a store of wealth or a way to ‘back’ a currency is largely based on its scarcity and universal acceptance. Because the Gold Standard has long since evaporated and the price of gold has been allowed to float, then its position as related to currency has weakened. Although in times of crisis in the markets, gold is seen as a safe haven for investors and the price of an ounce will typically track to the inverse of the stock market.