Why the gold standard could make a comeback

Money is essential to mankind. But the financial system people built on paper money seems to be collapsing. So could we see a return to the gold standard, where currencies are backed by physical gold?

Over the last few weeks, three people have told me they refuse to buy gold.

My dad told me gold is only worth what someone else is willing to pay for it. That it only has theoretical value. That he'd much rather own something useful, like copper.

Then the Thai politician I met in Bangkok told us he couldn't own gold because he didn't understand it or know how to value it.

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Then one of my friends in England told me gold is a fraud and if it ever lost its appeal as jewellery, its price would plummet.

I've heard all these arguments many times. They almost always come from people who've worked in the financial industry. The truth is, gold is an incredibly useful commodity. Like any other commodity, supply and demand determine its price.

First off, gold has applications in technology and communication. Gold is the most malleable and ductile material known to man. Second, gold is eye-catching. Humans use gold for jewellery. That's never going to change.

But the third reason is by far the most important. This reason is the one that's going to send gold prices to the moon.

Money is essential to humans. We need it to trade. The material you make money out of must be portable, divisible, homogeneous, durable, and valuable. Without each of these five qualities, it's useless.

Gold and paper are the only two basic materials on Earth that can serve as money. (Silver and platinum might be good complements to a gold system.)

Right now, we're using a paper-money system. So gold isn't really important to anyone (except a few fringe investors on the Internet). It's why so many people don't understand gold, especially those who work in finance.

The flaw with paper money is, it's portable, durable, homogeneous, and divisible... but it's not valuable. It's only paper. So there's always a temptation to print money out of thin air. And that's what always happens. Paper-money systems always end up collapsing.

That's what's happening now. We're coming to the end of the largest paper-money experiment the world has ever seen. It may take a few years, but when it ends, whoever is in charge will implement a gold standard. Gold is the perfect foundation of a currency system. It's the only material we have that meets all five essential characteristics of money. It's the only available alternative.

But how high would you have to price gold to use it as a foundation of the world's monetary system? The money supplies of Japan, China, the United States, and Europe add up to around $50 trillion. There are 5 billion above-ground ounces of gold. You'd need to value each ounce of gold at $10,000 to back these four currencies in gold.

According to consulting firm McKinsey, the value of all the world's financial assets stocks, bonds, and bank accounts is $167 trillion. These assets are also denominated in paper currency. To back them with gold as well, gold would have to rise over $40,000 an ounce.

I'm not suggesting gold will ever trade at $40,000 an ounce. But it shows you how, unlike paper money, gold is a useful commodity and has intrinsic value. I do think gold is easily worth over $2,113 per ounce. That's the level gold set in January 1980 $850 per ounce stated in today's money.

To invest in gold, I recommend you buy physical gold and keep it hidden on your property. Pick up the yellow pages and look for gold brokers or coin dealers. Ask them what price they charge on gold bullion coins. Buy from the broker with the lowest price and the longest history of doing business in your town.

One more thing, don't buy it right now. Physical gold is in short supply and prices are at rip-off levels. I called two dealers yesterday and both said they were out of stock. They told me they could get gold bullion for me, but I'd have to pay a large premium over the gold price to buy it... as much as 13%.

I recommend you wait for the panic to die down in the market and start accumulating gold when there's more gold bullion in the market.

This article was written by Tom Dyson, co-editor of free daily investment letter DailyWealth