Gold prices indicate economic instability

The price of gold is something that is highly debated by economists from varying schools of thought. The Austrian school of thought says that the value of gold is inherent and never changes, but that the value of fiat currency changes, and thus the price of gold. Other schools of economic thought argue that gold prices can go through boom bust periods, just like any other commodities. In history, the Austrian school of economics seems to win out.

The price of gold has been going up rapidly. Just a few years ago in 2003, the value of an ounce of gold was right around $270 per ounce. Fast forward to 2008 and the price of gold has quickly risen to $1000 per ounce, now down to the low $900s. This flee from fiat currency to gold has some investors worried that the world’s markets are about to enter a meltdown.

In the history of fiat currency, not a single one has lasted the test of time. Romans introduced the fiat currency, but after a series of wars and other large expenses, a loss of appetite for a fiat currency eventually fell to inflation. The problem with a fiat currency, Austrian economists argue, is that currency can be rapidly devalued due to inflation. The Romans did that, over history they clipped coins and printed currency that was not backed by anything of value. Because of this, historians warn, the world’s great empire faltered.

Now that gold prices are reaching their peaks there comes a new worry that inflation is rapidly devaluing the worlds currencies. The dollar has been devalued by over 97% in spending power since 1913, the year the Federal Reserve was created. Due to a larger money supply the market corrects itself with higher prices for goods.

The US Dollar has gone through some very important moments in history. In 1944 as WWII came to an end, the US Dollar was said to be as good as gold, thus the world placed their reserves in dollars rather than metals. By 1971, Nixon knew that the amount of gold would never cover the amount of dollars in circulation, thus the US went full-fledged fiat currency, no longer backed by any amount of gold.

The value of gold seems to be in a boom period for just the last 5 years after more than tripling in value. The expansion of credit during the 1990s and 2000s with the real estate boom boosted money supply and drove down the value of the dollar. Now that the dollar is no longer pegged to a specific value of metals, the price of gold floats with the amount of money in circulation.

Just in the last 6 months, the value of gold has risen from $600 per ounce to $1000. This gives us early warning signs that the amount of credit in the system is far too high and people are afraid to hold onto dollars. The money supply grew similarly today to how it did during the last Great Depression by doubling from 1920-1929 then dropping greatly from 1929-1933. Could it happen again? Austrian economists say yes.