This is the 4th instalment of a 5-part short educational series. The objective is to impart foundational knowledge of the difference between money and currency. Understanding this will lead to a greater appreciation of gold as an investment.
Inflation is the rise in the prices of goods and services over time. Inflation reduces a currency’s purchasing power. This means you can buy fewer goods and services with the same amount of money. This decline in purchasing power has significant impact on both currency and gold.
Let’s start with money. When there is inflation, the value of a currency falls in relation to other currencies. For example, if the United States experiences high inflation, the value of the US dollar will fall relative to other currencies such as the Euro or the Yen. This means that purchasing the same amount of foreign currency will cost more US dollars. As a result, imports become more expensive, potentially resulting in a trade deficit.
Furthermore, high inflation can cause economic uncertainty. This makes investors lose faith in the currency. If investors believe the value of a currency will continue to fall, they may begin to sell their holdings. This causes the currency’s value to fall even further. This can cause a downward spiral in which the currency loses value at a rapid rate. This results in even more inflation.
Let us now discuss gold. Gold is regarded as a safe haven asset. This means it is frequently purchased by investors during times of economic uncertainty. When there is inflation, the value of paper currency falls. Investors then turn to gold to protect their wealth. This increased demand for gold causes its price to rise, making it more expensive to buy. Also, gold is often used as a hedge against inflation. In contrast to paper currency, which loses value over time due to inflation, gold tends to hold its value. This means that if inflation is high, gold’s value rises. This gives investors a way to protect their purchasing power.