Gold's value versus money supply

Historically, increases in the supply of fiat currency through increased money supply have caused the demand for gold to increase. There was a time when gold was money and vice versa. If citizens felt that there may be insufficient gold to cover the paper money in circulation, they would queue up at the bank to change their paper currency back into gold.

However, since the gold standard was ended on August 15, 1971, governments have been free to print as much money as they choose, without fear that their populations will come knocking on the central bank's door demanding to change their paper money back into gold.

In January 1959 US M3 money supply was $288.8 billion , and the official gold reserves of the United States was then 17,335.1 tonnes, or 557,336,000 ounces (there are 32,150.7 troy ounces in a tonne). That means that in 1959, there were $518 in circulation for every ounce of gold reserves held by the USA. Although the actual ratio of dollars to gold was $518 per ounce, the actual price, as fixed under the gold standard, was only $35 an ounce.

By August 2005, the US M3 money supply had risen to $9,873.9 billion, whilst at the same time the Official Gold Holdings of the United States had fallen to just 8,133.5 tonnes, or 261.50 million Troy Ounces. This means that today, in 2005, there are $37,831 in circulation for every troy ounce of gold held by the United States.

However, this increase of 75 times in the ratio of central bank gold holdings to debt does not allow for the fact that the gold standard was abandoned in 1971 and gold holdings have been deliberately and considerably reduced. Another far less dramatic way of looking at the same figures is this: In 1959 US government debt valued in gold was 8 billion Troy ounces, in 2005 US government debt was 20 billion ounces gold - an increase of only 2.5 times.

The US Federal Reserve ceased publishing M3 data on 23 March 2006, with the last published data indicating a year-on-year growth rate of 8.23%. Central banks may see this as a reason to limit further increases in their reserves of dollars, and thus alternatives such as gold or the euro might be considered.[citation needed] Jon Nadler, an analyst at Kitco Bullion Dealers, said gold was still benefiting from August 30, 2006 release of the minutes to the last rate-setting meeting of the US Federal Reserve. The minutes to the August 8, 2006 meeting, at which the Federal Open Market Committee kept short-term interest rates unchanged for the first time since 2004, supported the view that US borrowing costs have peaked.

For many years, the dollar was pegged to the gold standard.