With the price of gold recently falling from a high of above $1850 an ounce to just below $1400, many people believe that gold is a bubble that has popped and will unlikely rise again for a very long time. This thinking is wrong and simple common sense will show why.
EconomicsTranslation.com strives to explain things as simply as possible. We do not believe that economics and finance is as difficult as the media, government, and your financial advisor makes it out to be. However if you are not well read on the subject it can often be overwhelming with all the lingo out there trying to explain the volatility across all markets in recent years.
Gold is a good place to start to learn the basic idea of money in economies. Money is a medium of exchange that people use for goods and services. For hundreds of years, gold was chosen by people to be used as money for simple reasons; it could be exchanged easily in bar or coin form, it is easily tested against counterfeit, and most importantly it has intrinsic value. Gold can be used as real things in the form of jewelry because it looks pretty, as well as other real industrial uses.
So we can establish that gold has real value and demand. People claiming a gold bubble will state that the price of gold has increased too much over the last decade to justify the fundamentals. However gold, as a form of money in today’s society, is measured against how much of a specific currency it is worth. Gold has increased from about $350 an ounce in 2003 to its $1400 in June 2013, an 4x increase. During that time the United States money supply, the amount of U.S. dollars in circulation, has increased by more than 5x. Much of this money expansion is the cause of the fed printing money in order to sell bonds so that they can continue to operate despite their annual deficits.
When countries create money out of thin air they create inflation, which devalues the worth of a single unit of currency (1 dollar). In common sense terms this makes sense; if only ten $1 dollar bills existed in the entire world imagine how much would $1 dollar could buy. If you were lucky to have one of these dollar bills you would at the very least be one of the ten richest people in the country. Now if everyone in the country had $1 million dollars, that same dollar bill wouldn’t buy much. These are two extremes, but they show how the value of currency changes based on how much of it there is.
Over the last ten years the supply of U.S dollars has greatly outpaced the supply of gold. This is the reason for the same unit of gold costs four times the amount in 2013 as 2003. The inflation of the U.S. dollar has fundamentally caused the increase in gold prices, not any sort of bubble mania where people are purely buying for the sake of turning around and selling.