In view of the instability that the metal gold faced in the first decade of the 21st century, many are of the opinion that a gold standard should be in place once again. In the earlier times, when gold was a standard, people failed to realize that gold was indeed a currency. Many a time gold has been linked to the USD because its price is usually rated in terms of dollars. Many do not realize that gold and the USD are inversely related. It is important to realize that gold price is merely an exchange rate. Just as one can exchange one currency for the other, in a similar manner, paper currency can also be exchanged in lieu of gold.

Is Gold a Currency ?

Typically, in a free market system, individuals have the power to make their own economic decisions. With such a system that is prevalent today, it can be said that gold is indeed a currency, though not obvious to people. The price of gold fluctuates in relation to the fluctuation of other currencies such as yen or the USD. Gold can be stored and is not used as a direct method of payment for goods and services. However, it is a very liquid form that can be converted to cash very easily.

Gold possesses most characteristics that the other currencies have. Whereas its value may trend upward during some times, at other times its value falls compared to other asset classes and currencies. It usually increases in value when currency values fall down and vice versa. It also increases in value in the face of a war and when stock market options and instruments are not doing well.

There are many ways of trading gold: it can be purchased physically, CFDs can be purchased without physically owning the gold, futures contracts, etc.

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Relationship between USD and Gold

The relationship between gold and the USD is very interesting because when the value of USD falls, the price of gold rises. This is true over the longer term. However, during shorter terms, this relationship need not always be true. This relationship is a direct effect of the Bretton Woods System when US made international payments in dollars and dollars were redeemed at a fixed rate. However, the Bretton Woods System no longer exists and was done away with in 1971. In the light of the fact that the US remains a global economic power, no talk of gold is complete without the USD.

Gold Chart Dec 5, 2016

In this context it is also vital to understand that the price of gold is affected by many factors and not just one. The price of gold is dynamic and is impacted as a result of many factors other than just inflation. It is a commodity like many others in the market and its price varies as a result of change in global sentiment. The variations in price of gold are not the result in the change of sentiment of just one set of people.

The Older Gold Standards

Gold standards were in place from a very long time ago. However, those that were implemented between 1800 and the middle of the 20th century (1970 to be precise), faced a lot of problems. The system was not followed completely with relation to gold standards. The systems were reliant on central banks that were expected to follow all rules. Central banks were expected to adjust discount rates for control over exchange rates among trading and member partners and to control the inflow and outflow of the metal. However, countries such as France and Belgium did not stick to the rules and this caused a problem against the smooth functioning of the gold standard. In the free market system these days, countries are not penalized for not sticking to the required protocols.

Another problem was that while the gold standard was able to maintain long-term average price stability, sudden price shocks did show up. An example was the finding of gold during the California gold rush in the mid-1800s. Inflation was the result and all expenditure and prices rose. However, there was a short span of instability in spite of having a gold standard in place.

However, in the period after the gold standard was removed and a free-market system came into existence, gold acts like a currency for all practical purposes. Gold allows all those who trade in the metal to hold it as an investment that will guard them from any economic disruptions that may be caused. It is also wise to know that whereas during sometimes gold can be favored as an investment while other times it may not have the same sentiment. In spite of the absence of gold standards, the price of the yellow metal is still impacted by global sentiment and other factors. Therefore, gold deserves to be treated just like other currencies.

Whatever be the system that is currently in use, people believe that gold will serve them in good stead in times of difficulties. Gold helps to provide a good backup for paper money. Paper currencies will be used, as they are today, for the purchases of goods and services. Gold is not likely to be used for that purpose. Free markets, however, allow gold to be used as a currency for those who wish to do so. The popular idea and public belief is that paper money can be used to buy goods and services and gold cannot be used to build a house. Gold is currently thought of as a commodity that people can invest in when it is advantageous to do so.

Gold can be thought of as a means to hedge any economic insecurity and to counter potential threats to the existing paper currencies. If the threat has already appeared, gold loses the advantage that it may have offered. Keeping this in mind, it can be said that both gold is a forward-looking metal and it serves people who invest in this precious metal in times of economic crises. However, they should be forward-looking and make the investment well in advance.