Why Gold Continues to Endure

All of this raises a key question, though: Why did gold gain its safe-haven status, one that is only growing in the modern global economy?

Gold is seen as performing well during times of crisis, underscoring its value as a “last resort” asset.

In practice, gold has long been valuable, used throughout history in the form of coins as a means of exchange, a store of value and a unit of account—all the classic features of money. This is why when governments began issuing fiat currencies, they placed them on gold standards, whereby they would commit to limiting the amount of currency notes they issued to the public to a predetermined multiple of their stocks of gold, while guaranteeing convertibility at a fixed rate. The idea was that this would constrain the printing of money by central banks, while also ensuring they had enough gold on hand to “defend” their currencies against any runs by depositors. However, governments often cheated on that commitment, devaluing their currencies by printing more of it than they could defend or changing the rate of convertibility—and sometimes paying the cost when depositors sought to convert their notes to gold due to the resulting inflation.

Despite these practical uses, however, gold has no inherent value. In 1776, Adam Smith wrote in his classic economics treatise, “The Wealth of Nations,” that the “principle merit” of both gold and silver arose “from their beauty, which renders them peculiarly fit for the ornaments of dress and furniture.” Almost 150 years later, in 1924, John Maynard Keynes wrote that the gold standard was “a barbarous relic” of the era that led to—and, he hoped, ended with—World War I.

But that didn’t prevent governments from returning to gold standards in the late 1920s and again following World War II, through the indirect gold standard established by the Bretton Woods system. This was slightly different than the classic gold standard, in that only the U.S. dollar was convertible to gold at a specified price, though only internationally in government-to-government transactions, with other currencies then pegged to the dollar in a flexible but narrow range of exchange. That system ended in 1971 when Nixon closed the “gold window,” temporarily pausing and subsequently ending convertibility of the dollar at a fixed price.

But even though gold is no longer used to officially back currencies, central banks, as mentioned above, continue to possess large holdings of it. This raises another fundamental question: Why, in a world of electronic banking, where transactions, settlements and deposits can be easily carried out and tracked digitally, do central banks continue to keep large stockpiles of gold?

For some central banks, such as the Bank of England, the reason is to ensure that it can support local gold exchanges. More generally, surveys of central bankers around the world have found that they see gold as a useful asset to hedge against inflation and diversify their holdings. It is also seen as performing well during times of crisis, underscoring its value as a “last resort” asset. If the global economy were to collapse or the electrical grid were to completely shut down, central banks could still operate with gold.

As a measure of gold’s continued importance, consider which of the world’s governments have the largest stockpiles. The United States comes in first, with over 8,000 tons of gold, far ahead of the individual holdings of three eurozone countries, Germany, France and Italy, though their combined total gold reserves actually exceed those of the United States. Next come Russia and China, each with over 2,000 tons. Stated differently, the issuers of the two most widely held currencies in the world also retain the largest gold holdings, and the two countries most keen to break away from the dollar-dominated global system also have substantial stocks of it.

This reflects the fact that gold also remains a potent symbol of prestige and a source of stability in troubled times. Even if the days of currencies being pegged to gold are far behind us—much to the chagrin of the “gold bugs” who assert that the world economy would be better off on the gold standard—the metal still plays a central role as a store of value during times of uncertainty, and as a way to secure the global economy in the case of unforeseen disaster.

Paul Poast is an associate professor in the Department of Political Science at the University of Chicago and a nonresident fellow at the Chicago Council on Global Affairs.

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