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Real Assets - In Depth

A deeper analysis of investment trends and topics across asset classes and global markets.

October 2, 2019

John LaForge, Head of Real Asset Strategy

A History of Money and Gold

Key Insights

“Cause the boy with the cold hard cash is always Mister Right.”
--Madonna, “Material Girl”

  • Today, money is not what it was 500, 50, or even 5 years ago. Did you know that only 11% of U.S. dollars sitting in checking accounts today has been printed?1 Most money today is virtual, not physical.
  • History says that there is nothing wrong with this. Money is constantly changing. Humans have used everything from paper, to gold, to pepper, as money.
  • Few money forms survive time, though. Gold has been a rare exception.
  • Gold, for most of the past 3,500 years, has been revered as money, and a store of value, above everything else.
  • Can today’s virtual money system survive? It might be time to ask gold.

Download the report (PDF)

Did you ever stop and think, “How did we get here?” I’m not talking about life, God, or the big bang theory. I’m talking about money. The ease of it all. An $88 trillion dollar global economy, where no one physically sees much of the money that flows through it. We purchase $25,000 cars by wiring money from our banks to theirs. We buy 9-inch hoagies with 3-inch pieces of plastic. Airlines will serve us a beer—but only if we don’t hand them cash. Huh? Did you know that of the $14.9 trillion sitting in U.S. checking and savings accounts today (blue line, Chart 1), only $1.6 trillion of it has been printed as physical currency (orange line, Chart 1). Most money today is virtual.

Some of you may not think twice about this. My teenage kids certainly don’t. To them, money is mostly gift cards, Dad’s credit card, and Venmo, and they have never known anything different.2 They “trust” that this virtual money system works. Then there are those, like my parents, who aren’t as enamored with it. They will use credit and debit cards, but they still prefer to walk into the bank for “money.” Money to them is something physical—like cash or coins.

History says that neither view is wrong. Money is constantly changing. Humans have used everything from gold and silver to pieces of cotton, spices, cigarettes, and cowrie shells as money. How humans value money, though, has not changed. Money is all about trust. Money, whether bits and bytes in 2019, paper money in 600 A.D., or gold coins in 1600 B.C., must be trusted to work. We need to trust that it has value when we want to exchange it. If history tells us anything, it is that money is only worth what someone else is willing to give you for it. If it can’t be trusted to have value, what was once money can become worthless.

Today, we’d like to shed some light on the history of money—gold, especially—and why investors should care in 2019. Money and investing is not what it was 500, 50, or even 5 years ago. Money is constantly changing. History has one constant, though—gold. It has the richest of histories, trusted by humans above all else for most of the past 3,500 years. Tragically, it seems that recent generations know little about it. Gold was ditched by the West as money 100 years ago, in favor of trusting governments and institutions. This monetary system is working today, and it is trusted. With that said, we say—know your history. Trust can be a fickle thing. Gold has survived time, while little else has. Understanding why may very well “save your bacon” one day.

Chart 1. Money supply versus currencyMoney supply versus currencySources: Bloomberg, Federal Reserve, Wells Fargo Investment Institute. Weekly data: January 11, 1999 – September 9, 2019. M2 money supply consists of M1: (1) currency outside of the U.S. Treasury, Federal Reserve Banks, and the vaults of depository institutions; (2) traveler’s checks of nonbank issuers; (3) demand deposits at commercial banks (excluding those amounts held by depository institutions, the U.S. government, and foreign banks and official institutions) less cash items in the process of collection and Federal Reserve float; and (4) other checkable deposits (OCDs), consisting of negotiable order of withdrawal (NOW) and automatic transfer service (ATS) accounts at depository institutions, credit union share draft accounts, and demand deposits at thrift institutions) plus (1) savings deposits (including money market deposit accounts); (2) small-denomination time deposits (time deposits in amounts of less than $100,000), less individual retirement account (IRA) and Keogh balances at depository institutions; and (3) balances in retail money market mutual funds, less IRA and Keogh balances at money market mutual funds.

Gold as money

For most of the past 3,500 years, gold and silver have dominated the money discussion. Other physical things have been used as money at times, too—usually other commodities (spices, cowrie shells, copper coins, etc.), but none have lasted as long as gold and silver. The green line in Chart 2 shows world population, while the blue line highlights the price ratio between gold and silver (since as far back as 1670 B.C.). Yes, gold and silver have that kind of history. The blue line starts getting “squiggly” in the late 1800s, because silver stopped being viewed as official money by governments, and its price was no longer being fixed.

So, what makes gold and silver so special? The answer is that both have literally survived the test of time. Gold, in particular, has been revered above all else.

For one, it is impervious to air and water, and nearly every ounce that has ever been mined still sits above ground today. Even those gold coins, sunk by pirates off the coast of Florida during the 1600s, are still intact—and have the same shine. There is more to it than that, though. Gold is pliable, scarce, and instantly recognizable. Each piece of gold, no matter the size, is valued the same, by its weight and purity. Gold also has the unique distinction of being largely useless for anything practical that needs metal (because of its softness and lack of supply). Ninety-three percent of the gold above ground today is not used, but stored. It sits inside a bank vault, is hung around someone’s neck, or is designed into a work of art. All told, these attributes have combined to make humans trust gold as money, and as a store of wealth, above almost everything else.

Chart 2. Gold/silver ratio versus populationGold/silver ratio versus populationSources: Bloomberg, U.S. Census Bureau, Our World In Data, U.S. Geological Survey, Prices by Warren and Pearson, Kitco, Wells Fargo Investment Institute. Yearly data: 1670 B.C. - 2018. X-axis data points are in increments of 20 years from 1670 B.C. to 1850 (negative years indicate B.C.). Ratio is the price of gold divided by the price of silver.

Paper money—the rise of modern finance

If gold has been trusted above all else, through most of recorded human history, why aren’t we still using it as money in 2019? Well, it turns out that humans have figured out—as civilization has progressed—that gold is a better store of value than it is money. And there is a difference. Stores of value sit. Money moves. Money comes into play when we want to do business. Money must be available (what’s the point in using it, if there isn’t any around), affordable (transacting in airplanes would be cumbersome), durable (ever wash a $20 bill in your jeans?), fungible (widely acceptable), portable (ever try to ship cattle?), and reliable (trust is key). Gold fits most of these traits, but it is not always ideal, especially the affordable part. To help grease the wheels of commerce, humans began designing more flexible types of money, such as paper money.

Paper money evolved in the West in the 1600s, and its impact can still be felt in 2019. Many of the first aspects of our financial economy, as we know it today, became linked at that time. The first known exchange bank (a precursor to the modern central bank), the Amsterdam Exchange Bank, was created in 1609 to help facilitate transactions and loans for the first joint stock company and stock exchange. This may sound financially “wonky,” but it is actually quite simple. That bank was there to grease the wheels and create new credit. Company shareholders wanted to use their stock shares as collateral for loans. This spurred Dutch banks to lend money, so that shares could be bought with credit. Voila! A new modern monetary system was born.

Chart 3 is a snapshot of world population, with markups highlighting some of the more important financial events of the past 7,000 years. As the 1600s bled into the 1700s, 1800s, and early 1900s, the major modern central banks were formed, and with them, more paper money. Gold was never that far behind, though, as trust was in short supply. Most paper money, over those years, was backed by physical silver and gold (of course, there were a few catastrophic exceptions—ahem, 1719 France). You’ll hear this sometimes referred to as the gold standard, or bimetalism. This meant that the bearer of the paper (note) could redeem it for a set ratio of physical gold and silver.

Chart 3. World population and significant financial eventsWorld population and significant financial eventsSources: Bloomberg, U.S. Census Bureau, Our World in Data, Wells Fargo Investment Institute. Yearly data: 5000 B.C. – 2018.

This went on into the late 1920s, when gold started becoming a hindrance to the ambitions of Western economies. Gold had a knack for that, especially around wars and economic recessions. Parts of Europe desperately needed money to rebuild and pay debts after World War I. Printing money, however, was tethered to how much gold each country owned, and much of it was sitting outside of Europe. Countries with gold could (theoretically) expand credit, and stimulate their economies, while those without it could not. Without sufficient gold stores, many countries were forced to abandon the gold standard. The U.S. went as far as confiscating all gold in 1934, to force Americans to put their trust not in gold—but in the U.S. government, U.S. dollars, and the American way. Intriguingly, America, at the time, had the most gold in the world.

The gold line in Chart 4 highlights the impact on gold prices—once the West ditched the gold standard. For centuries, gold prices were fixed at a certain level, for money needed to be dependable. As gold was no longer being used as money, gold prices eventually were allowed to float freely as the 20th century rolled on. The U.S. started the process of removing itself from the gold standard in 1934, but “officially,” the U.S. severed itself from the gold standard in August 1971.

The red line in Chart 4 emphasizes another interesting tidbit that connects gold with the rise of central banks and paper money. The red line represents annual world gold production. Notice how it spikes higher starting in the early 1800s. The timing of the jump was no coincidence. The need for money was growing, the modern financial system of credit was expanding, and new central banks were being formed. This led to a search for more gold, and the West found it. Mother lodes were found in the U.S. (California, in 1848), Australia (Victoria and New South Wales, in 1851), South Africa (in 1886), and Canada (the Yukon, in 1896). In the end, gold mines still could not keep up. The demand for money by the masses was too great in the 20th century, and gold lost its identity as money.

Chart 4. Gold production versus priceGold production versus priceSources: Bloomberg, Prices by Warren and Pearson, Kitco, U.S. Geological Survey, Wells Fargo Investment Institute. Yearly data: 1496 – 2018. Data shown in log scale.

All that virtual money

We talked about the rise in virtual money on page 2, and it has its roots in Amsterdam (in 1609). The first stock market spurred a need for credit, which led to the first exchange bank. As this new interconnected world of borrowers and lenders grew, the need for money did too. It sprouted modern central banks, and new financial innovations, such as fractional reserve banking (deposit $1, and a bank lends $10), along with cashless transactions. The expansion of credit is how the virtual money system of today came about. Credit is the answer to the question, “how did we get here?” Sorry Dad—the answer isn’t spaceships.

Can gold make a comeback as money?

Credit is also the answer to how gold met its demise as money. Gold had people’s trust, but it couldn’t keep up with the West’s economic ambitions. We do sometimes get asked if gold can make a comeback as money. In fact, 2019 has been a popular year for this question. President Trump recently nominated Judy Shelton to the Federal Reserve Board, and Ms. Shelton is one of the rare economists of our time that has argued that a return to the gold standard may be needed.

Our answer is “yes” to the gold standard question—it is possible that gold could return to a role of “backing” paper money. But it isn’t likely. Gold still has its supply shortcomings, and the earth does not yield its gold easily. Plus, the sheer volume of paper money in existence today, versus 1933, is problematic. To back this money with gold likely would push the price of gold to an absurdly high level (orange line, Chart 5).

Chart 5 shows one potential gold price outcome today, based on the gold standard, as it was structured in the U.S. in 1933. In 1933, each $100 Federal Reserve note was backed with $40 worth of gold. The 40% level was used to contain inflation—keeping the government from printing too much money. If the U.S. government today backed the $14.9 trillion in money supply shown on page 2 with 40% gold, it would need roughly 120,000 tonnes of gold at today’s $1,520/ounce price. This is 112,000 more tonnes of gold than the U.S. currently holds. It is also two-thirds the total amount of gold ever unearthed by mankind during its existence (Chart 6, bottom panel).

Chart 5. Gold price needed for a return to the gold standardGold price needed for a return to the gold standardSources: Bloomberg, Federal Reserve, International Monetary Fund, Wells Fargo Investment Institute. Monthly data: January 31, 1959 - August 31, 2019. Gold price necessary calculated by: (40% * U.S. M2 money supply ) / (official U.S. gold reserves in ounces).
Chart 6. Gold above ground versus global populationGold above ground versus global populationSources: Bloomberg, Our World in Data, U.S. Census Bureau, Prices by Warren and Pearson, U.S. Geological Survey, Wells Fargo Investment Institute. Yearly data: 1901 - 2018.

Even if we could make the math work, a return to the gold standard could be a hard economic road to travel. President Roosevelt nixed the gold standard in 1933, because it was making the Great Depression worse. The gold standard did help to contain inflation, but it had the unfortunate side effect of making the “tough times tougher” by fueling deflation. Country leaders without gold, looking to put their people back to work, couldn’t. No gold = no currency creation = no economic growth. The blue line in Chart 7 represents commodity prices from 1800 to today. The shaded areas represent periods of commodity price deflation. Notice that commodity price deflation went deeper, and lasted longer, while the U.S. was on the gold standard (prior to 1933).

Chart 7. Commodity bear market super-cyclesCommodity bear market super-cyclesSources: Bloomberg, Prices by G.F. Warren and F.A. Pearson, Bureau of Labor Statistics (BLS), Bureau of Economic Research (NBER), Wells Fargo Investment Institute. Monthly data: January 31, 1800 - August 30, 2019. Fed = Federal Reserve. Commodity prices tend to move in overall bull and bear cycles, some lasting decades. These are super-cycles.

What could trigger a return to the gold standard?

Credit, again, is the likely answer. Too much of it, and trust could be broken. Remember, money is all about trust. If it can’t be trusted to have value, what was once money can become worthless. History is littered with the corpses of paper money not backed by gold. President Roosevelt knew this when he took the U.S. off the gold standard in 1933. His advisors routinely classified the move as crazy, as many felt that “trust” in money was more important than stimulating economic growth. So far, so good for President Roosevelt, though, as of September 2019. But how much money, virtual or paper, is too much before trust is broken? No one knows for sure, but should that time come, gold is history’s trusted choice.

We’ll leave you with two money and gold charts to chew on. Chart 8 shows global money supply growth, broken out by major country, since 1987. As noted, no one knows for sure how much money is too much, but the acceleration in money supply, since 2001, has some investors concerned.

Chart 9 shows us how the price of gold has been reacting to the growth in global money supply. The gold line shows the price of gold. The blue line tracks the growth in global money supply, divided by growth in the supply of gold. The blue line will rise if money is being created at a faster rate than the supply of gold. Notice how the two lines track one another. The fact that the two lines have been rising together in recent years tells us that some investors are buying gold as a hedge against too much money creation. Today’s report is a brief look back at the history of gold and money, and how they may interact in the future. It is not meant to capture all the dynamics impacting gold in 2019. We do recommend holding gold as part of a well-diversified portfolio. At today’s price of approximately $1,520, we believe that gold is a tad expensive. In our view, a better entry point for new gold buyers would be in the low-to-mid $1,400s.

Chart 8. Global money supplyGlobal money supplySources: World Bank, Federal Reserve Economic Data (FRED), Bloomberg, Wells Fargo Investment Institute. Monthly data: January 31, 1987 - August 31, 2019. See M2 definition on page 2.
Chart 9. Global money supply versus the global gold supplyGlobal money supply versus the global gold supplySources: Bloomberg, U.S. Geological Survey (USGS), World Bank, Federal Reserve Economic Data (FRED), Wells Fargo Investment Institute. *Global Money Supply estimated by combining M2 measures for the U.S., U.K., China, Japan, Canada, and the eurozone. Ratio is the global money supply divided by the global gold supply. Monthly data: January 31, 1987 - August 31, 2019.

1 Data from the Federal Reserve. Calculated by dividing the $1.6 trillion currency in circulation by the $14.9 trillion M2 money supply.

2 Venmo is a mobile payment service through which U.S. accountholders can transfer funds to others via a mobile phone app.

Risk Considerations

Investments in gold and gold-related investments tend to be more volatile than investments in traditional equity or debt securities. Such investments increase their vulnerability to international economic, monetary and political developments.

Global Investment Strategy (GIS) is a division of Wells Fargo Investment Institute, Inc. (WFII). WFII is a registered investment adviser and wholly owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company.

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