At various times throughout history money, or currency, has been based on metals, usually silver or gold. This created an objective value to the currency of the period. A dollar, for example, was worth an ounce of gold, or 1/10 of an ounce of gold, or 1/20 of an ounce of gold. Governments and rulers, who always want to spend more money than they take in, either for their own enrichment or in order to bribe voters, usually try to debase their currency. Kings about once a generation used to re-mint their coins (paper currency wasn’t invented yet), using the need to have their own image on the coin as the excuse, and they would dilute the gold content by mixing other metals with the gold, or slightly downsize the coin itself, but calling it by the same name as its predecessor. When governments became well established, they usually did a ‘bait and switch’ routine and substituted printed money for metal coin, and again called it by the same name attached to a unit of its metal predecessor. So a gold dollar was now called a paper dollar, as if their value were the same!
Once governments discovered the delights of the printing press, they would print as much money as they felt they could slip past their gullible and unaware subjects. Acceptance by the herd was essential, and when the debased currency was widely rejected, it was not uncommon for a ruler to create stiff penalties, including the death penalty, for not accepting the paper currency as legal tender. The reason governments prefer to print money is first of all so they are not bound by the usual principles of fiscal discipline (Don’t spend more than you make) but also every time they print money, they are actually lowering the unit value of that currency, reducing its purchasing power. They are actually picking the pockets of their citizens, especially the most conservative ones who save. The money these citizens save will not buy as much when it is finally spent as it would have immediately upon their having received it.
When citizens get nervous about the stability of the banking system, their political system, or their own personal safety, they are inclined to buy gold. Gold does not pay interest, and it is still only worth what a buyer is willing to pay for it, but because there is a fixed quantity of it at any given point in time, its value tends to be very stable. This is why nervous people buy gold as a hedge against inflation. Gold is not without risk, however. At times when the madding crowd is enamored of another of its periodic manias, interest in gold will wane as the herd stampedes in a new direction. When demand falls off, the price of gold drops, like anything else. Even in times of rising price of gold, there is always the possibility of the government confiscating it (that has been done by OUR government, as well as many others.) Ultimately the government has the guns, and whatever we have is pretty much by permission. A democracy, as I have written many times, is no guarantee of anything more than mob rule. All people, in any period of history, need protected most from those they elect over themselves. Inevitably their public servants become their masters. Even here, the freest nation on earth, the Constitution guaranteeing both individual rights and the limitation of government’s powers, has been under steady attack for well over a hundred years by many activists who resent its restrictions. They want to harness the coercive power of government to an endless list of programs to protect us from ourselves, and of course, with them at the levers of distribution and power.
For a short video on how the price of gold is a measure of the mood of the mob, go to http://www.youtube.com/watch?v=yuDZQFPgXCw