Gold, Common Stocks and the Dollar

A very insightful quote from a recent Barron’s letter to the editor observed that the dollar is useful to facilitate transactions on a worldwide basis, but terrible as a store of value. I decided to verify this by doing some research and found that it was absolutely accurate. The dollar is indeed used transactionally more than any other currency, including the Euro and Chinese Yuan. The fact that most oil trading is conducted in dollars is a big contributor to this phenomenon and is a reason people in foreign countries are happy to accept your dollars for a meal, a nice glass of wine, or entry into the Louvre.

You would think that because it is accepted worldwide, it would also be a great store of value. You would be wrong on that point. The dollar is a terrible store of value, having lost 88% of its purchasing power since 1970. In other words, a dollar today will only buy 12% of what it could buy in 1970. Why? Because the cost of living as measured by the consumer price index is up 777% during the same time period.

Since 1971, when President Nixon took the dollar off the gold standard (meaning the dollar could be converted into gold at Ft Knox), the purchasing power of the dollar has declined every year that inflation has increased. Today, if dollars were still exchangeable into gold at Fort Knox, you would receive 1/10,000th of an ounce of gold!

The lesson…fiat paper currencies not backed by gold are very poor inflation hedges and not too useful for savings accounts either. Well, what are some legitimate stores of value? A quick answer… gold, which is up 1,653% in dollar terms since 1970 (based on compounded annual rates of return), and common stocks as measured by the S&P 500, which is up 39,180% (using the same methodology as above) since 1970. My advice to young investors is to divide your assets into gold and quality common stocks. Use dollars to meet your monthly expenses, but not as a hedge against the relentless rise in the cost of living.

Mike Meehan, CFA, MBA