Gains in Gold – Fractional Banking and Other Insanity

Many investors have taken advantage of the inflation fighting benefits of gold investing. To be sure, gold has offered decent returns and should have a place in a normal investment portfolio. I personally keep a small percentage of gold in my investment portfolio as a matter of principle.

On the other hand, many investors have a difficult, if not impossible, relationship with their beloved metal. During times of financial stress “gold bugs” emerge from hibernation and inundate the public, and anyone else who will listen, with wild predictions of unheard of gold prices. Of course, to make these sort of claims, one must ignore the usual tenants of supply and demand. But gold has always had a hypnotic and irrational allure for some investors, and no claim (no matter how preposterous) seems too audacious.

It should be noted that gold has made some very nice gains at certain times, so ignoring gold as an asset class would be a grave mistake. Unfortunately, gold bugs trumpet the idea of loading up on only gold in hopes of the long awaited and meteoric rise many have long waited for in messianic anticipation. To date, gold has performed much like any other asset class such as stocks, bonds or mutual funds; it has had some good years and some bad years.

potential gains in gold

The question is, though, why this euphoria over the potential gains in gold?

The answer is not an easy one to answer in a short essay. In the early 1970s, Pres. Richard Nixon demonetized gold, which essentially removed the United States from what could be loosely called the “gold standard.” Instead of our currency being backed by hard currency such as gold, our currency was backed with the full faith and credit of the United States of America. Ever since that decision, the howls and caterwauling have persisted by a small group of investors and economists who felt this move was a grievous mistake. I am not qualified to judge whether or not we should have stayed on the gold standard, but there were many developing problems associated with adherence to the gold standard and the time had come to move on to what is called fractional banking. To be sure, fractional banking is the “de facto” standard in current world banking. It’s detractors call it “fiat” banking and claim the currency issued by the government is merely paper and of marginal value, since it is not backed by hard currency. A casual perusal of the chat boards on this topic regularly feature raging arguments as to the pros and cons of fractional banking versus gold standard banking.

We have reached the crux of the gold valuation issue here, since many feel fractional banking and fiat currency is worthless, they steadfastly maintain that gold will rise as the only true money. This argument gains marginal credibility when one considers the effects of inflation on the dollar. As inflation increases, the buying power of the dollar decreases. Our country has have been experiencing this phenomena for decades, hence the increase in prices, wages, and overall living costs in the United States.

Of course, there ought to be a happy medium between these two conflicting points of view on the gold standard and fractional banking, but adherents to both systems seem to find little common ground and the argument rages on. To my way of thinking, having a portion of your investment portfolio in gold is a good idea but abandoning the fractional banking system we currently employ is not an option that is currently available to our burgeoning economic system. But the gold bugs continue their dogged defense of the gold standard, and the adherents to centralized banking give no ground. Hence, the loud cry for an eventual massive gains in gold value.

Personally, I see gold as subject to the same supply and demand constraints all commodities are faced with and believe it will periodically rise in price and periodically fall in price. I can foresee no circumstance where a gold will rise to unheard of values nor can I envision gold declining precipitously in value. Quite simply, gold is subject to the same supply and demand constraints shared by other commodities.