How Gold Lost Its Inflation Luster

Gold is lots of things to lots of people. To some, it’s the ultimate store of value and a source of financial freedom. To others, it’s just a shiny rock with an inflated, emotionally-driven price. Gold’s most popularly used to hedge inflation risk; to preserve purchasing power from thieving bureaucrats and central bankers seeking to fund government expenditures via currency debasement. However, gold is not as effective as many think in this regard. Oddly enough, the change in monetary regime lessened gold’s ability to hedge inflation.

To be sure, I’m sympathetic to the bull case for gold. I own some in my own portfolio as of this writing. However, the data don’t support its efficacity as an inflation hedge as I believed. Gold doesn’t appear to protect against rising consumer prices. Rather, it seems to have other value drivers. This is no surprise, really. Gold’s relationship to money changed. Hence its relationship to inflation changed too.

Gold’s historical protection

There are countless accounts of monetary debasements throughout history. Kings, emperors, and governments of all stripes routinely looked to their currencies as means to fund their expenditures. Rather than raise taxes, sell assets, or plunder foreign lands, governments simply debased their currencies. They stole their desired wealth for wars, palaces, pensions, and bribes from citizens and creditors via inflation.

For example, the Roman denarius—the empire’s standard silver coin for nearly 500 years—was continuously debased by emperors. A nearly pure silver coin under Nero in 64 AD contained just 5% by the year 300. More recently, the U.S. inflated the dollar under the gold standard. The Gold Reserve Act of 1934 authorized the near 40% reduction in its value from $20.67 per troy ounce to $35. There are many other examples of governments filling their coffers via inflation too.

“Starting with Nero in AD 64, the Romans continuously debased their silver coins until, by the end of the 3rd century AD, hardly any silver was left.” By Nicolas Perrault III – Own work, CC0, Source: Wikipedia