An understanding of the relationship between between the gold price and inflation requires historical observation and factual understanding. Below are three specific statements that are rooted in historical fact…

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1)  Gold Is Real Money

Lots of things have been used as money during five thousand years of recorded history.  Only gold has stood the test of time. It has earned its role as real money because it is the only thing which meets the three specific criteria for money: a measure of value, a medium of exchange, and a store of value.

Gold is and has been easily incorporated into recognizable forms and amounts for use within various standards of weight and measure. Also, gold is scarce, malleable, indestructible and beautiful.

2) Paper Currencies Are Substitutes For Real Money

Gold is also original money. It is the original measure of value for everything else.

A medium of exchange needs to be portable, which gold certainly is. Gold is and has been easily incorporated into recognizable forms and amounts for use within various standards of weight and measure.

Gold was stored in warehouses and the owners were issued receipts which reflected ownership and title to the gold on deposit. The receipts were bearer instruments that were negotiable for trade and exchange. Some consider these negotiable receipts to be a precursor to our modern checking system.

3) Inflation Is Caused By Government

One thing that should be clear from history is that governments destroy money. Inflation is the debasement of money by government. It is practiced intentionally by governments and central banks.

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The effects of inflation are volatile and unpredictable. The Federal Reserve Bank of The United States has managed to destroy the purchasing power of the U.S. dollar little by little over the past century. The result is a dollar that is worth ninety-nine percent less than in 1913.

More Always Equals Less

When the Fed began its grand experiment, the price of gold was fixed and convertible at the rate of $20.67 per ounce. This fixed rate of exchange was supposed to act as a restraint on government to keep them from creating excess dollars to meet their spending needs.

Here is a historical example of how inflation was practiced with gold before the invention of the printing press and the advent of paper currencies…

“Early ruling monarchs would ‘clip’ small pieces of the coins they accumulated through taxes and other levies against their subjects.

The clipped pieces were melted down and fabricated into new coins. All of the coins were then returned to circulation. And all were assumed to be equal in value. As the process evolved, and more and more clipped coins showed up in circulation, people became more outwardly suspicious and concerned. Thus, the ruling powers began altering/reducing the precious metal content of the coins. This lowered the cost to fabricate and issue new coins. No need to clip the coins anymore.” (see Inflation – What It Is, What It Isn’t, And Who’s Responsible For It)

From the above example it is not hard to see how anything used as money could be altered in some way to satisfy the spending habits of government. But a process such as this was cumbersome and inconvenient.

Enter: Paper Money

With the advent of the printing press and continued improvements to the mechanics of replicating words and numbers in easily recognizable fashion, paper money became the “next big thing.”

At first, people viewed the new ‘money’ with skepticism. Coins with precious  metal content continued to circulate alongside the new paper money. Hence, it was necessary, at least initially, for government to maintain a link of some kind between money of known value vs. money of no value in order to encourage its use.

Eventually, that link was severed; partially at first, then completely. And it was done by fiat (a decree or order of government).

Not only does our money today have no intrinsic value, it is inflated and debased continually through subtle and more sophisticated ways such as fractional-reserve banking and credit expansion.

Government causes inflation by expanding the supply of money and credit.  And that expansion of the money supply cheapens the value of all the money.  Which is exactly why the US dollar continues to lose purchasing power.

Effects Of Inflation

The ongoing expansion of the supply of money and credit by governments and central banks is inflation. 

This intentional debasement of money leads to a gradual loss in purchasing power of the US dollar.

The loss in purchasing power results in higher prices over time for most goods and services.(see “A Loaf Of Bread, A Gallon Of Gas, An Ounce Of Gold” Revisited)

The loss in purchasing power and subsequent higher prices are the effects of inflation.

Gold And The US Dollar

A declining U.S. dollar means a higher gold price. A stable or strengthening U.S. dollar results in a stable or lower gold price (UUP, GLD).

In other words, over time, a higher gold price is correlated inversely to the US dollar’s loss in purchasing power. 

When the gold price peaked last August at $2060 oz., it was one hundred times higher than its original fixed US dollar price of $20.67 oz. a century ago.  That indicates almost exactly the ninety-nine percent decline in US dollar purchasing power mentioned earlier and is indicative that gold is a store of value.

If you think the current effects of inflation are understated, that would mean the potential for a higher gold price is implied. Except…

The effects of inflation are unpredictable. And a higher gold price is predicated on seeing the actual price increases first.

The gold price doesn’t go up because people expect inflation to get worse. It only goes up to reflect the loss in US dollar purchasing power that has already occurred.

Furthermore, it can take years for the gold price to reflect any subsequent  loss in purchasing power (1980-2011; 2011-2021).