How Gold Affects Currencies?

Gold is one of the most valued commodities in the world. Since the beginning of its existence around 12,000 years ago, gold is considered a status of wealth. People who had stacks of gold were considered rich and powerful. In fact, the dominance of a king in ancient days used to depend on the amount of gold lying in his vault. Gold was used to buy and sell commodities before the fiat currency and other forms of money came in. In countries like India, gold also has a religious and cultural connotation as people purchase gold jewellery and objects during festivals and marriages. But did you know that gold has a direct impact on the currencies around the world?

Gold and currencies are co-related. The value of a country’s currency has a strong connection with the gold reserves of that country. The gold rate today in a country affects the strength of that’s nation’s currency. However, this concept is not recent. Gold has been largely impacting the currencies of the world for decades.

Back in Old Days

In the 20th century, gold was used to support fiat currencies or legal tender of a country. It was used as a world reserve currency through most of this time. Countries had to back their printed fiat currencies with an equal amount of gold in their reserves. They weren’t allowed to print the currencies if they did not have gold up to the same value. Thus, it limited the printing of fiat currencies. In fact, the United States of America used gold standard up till 1971 after which it was discontinued. To help you understand how the gold rate today affects currencies, let’s first understand what gold standard is.

What is Gold Standard?

The gold standard is a method of determining the value of a country’s currency with the help of gold. Under the gold standard, the value of a country’s currency is deciphered by setting a fixed rate for buying and selling gold. For example, if India starts using gold standards and fixes the gold rate today at Rs 25000 per gram, the value of Indian rupee will be 1/25000th of one gram of gold.

The gold standard was beneficial in the following ways –

  • Offers reliability in stabilizing gold prices
  • Prevents inflation and deflation
  • Helps to stabilize the country’s economy
  • No need to conduct transactions via gold coins or bullion
  • Helps to establish trust for successful global trade

The gold standard is not being used today. In its absence, let us now find out how gold affects currencies across the world today.

Gold Imports can Weaken Currency Value

The import and export of a country impact the value of its currency. If the value of a country’s export is more than its import, it will strengthen its currency. On the contrary, if a country import way more than what it is exporting then the value of its currency will fall. Similarly, a country that exports gold will witness an increase in the value of its currency with the rise in the gold rate today as it will increase the value of the country’s exports. In other words, countries that export gold will witness a trade surplus when the gold prices rise, resulting in the strengthening the value of its currency and vice versa. For instance, the value of Indian rupee will fall if there is an increase in the gold rate today as India is one of the top importers of gold in the world.

Gold can Lead to Inflation

As established earlier, the gold import is adversely proportional to the value of fiat currencies. But importing gold can also lead to inflation in the country. If the central bank of a country imports gold, it influences the demand and supply of fiat currency in the country. This is because central banks print additional fiat currency to purchase gold from other countries. This would lead to a surplus supply of currency, causing inflation in the country. For example, if the Reserve Bank of India imports gold, then it will result in inflation in India.

Gold Hedges Inflation

While gold imports by a country’s central bank can cause inflation, purchase of gold by investors is a solution to hedge inflation. Investors prefer to buy gold at the time of inflation. This is because gold is considered more stable and retains value much better than fiat currencies. Since gold cannot be diluted, there is an increase in its demand during inflation even though the supply remains limited. Thus, people with more gold have a better chance of dealing with inflation and feeble fiat currency. As a result, greater demand for the yellow metal and an unbelievable increase in the gold rate today can suggest a feeble fiat currency on the world market and uncertainty of the future economic stability.

Gold Helps to Measure Fiat Currency’s Value

Gold does not always adversely impacts the value of a fiat currency. Every time there is an increase in gold prices does not mean that the value of a country’s currency is declining. An industry that uses gold for production can create an increase in its demand leading to a rise in the gold rate today. However, this has no correlation with the value of a country’s currency and can happen even when the fiat currency’s value is at a high.

For instance, if there is an increase in the demand for gold by the jewellery manufacturing industry in southern India, it does not mean a lower value of Indian rupee even though it resulted in the rise of gold rate in Kerala. It can happen even when the Indian rupee is at a higher value. Thus, all aspects relating to gold rate today needs to be analyzed before establishing a direct or inverse relationship with the country’s currency.

How Gold Impacts US Dollar?

The relationship between gold and the US Dollar is very old. However, the gold rate today is inversely proportional to the value of the US Dollar. An increase in the value of the US Dollar will lead to a decline in the prices of gold. Similarly, if there is an increase in the gold rate today, it will suggest a fall in the value of the US Dollar. The appreciation and depreciation in the value of US dollar help ascertain the value of the currency of other countries.

How Does the US Dollar Determine the Value of Indian Rupee?

The value of Indian rupee is determined in accordance with the demand and supply of the US Dollar. If there is an increase in the demand for the US dollar in the forex market, the value of the dollar against Indian rupee will appreciate. This happens when India imports more items from the US than the number of items exported from India. The importers exchange Indian rupees for the US dollar, increasing the demand for the US dollar. Thus, the value of the US dollar appreciates against the Indian rupee. Similarly, if the US dollars are exchanged for Indian rupees to buy products from Indian exporters, the value of Indian rupee will appreciate and the dollar will depreciate.

The Last Words

Gold has a substantial impact on the value of a country’s currency even though the practice of gold standards is long gone. The imports and exports of gold along with inflation heavily affect the value of a nation’s currency. The gold rate today determines the value of the US dollar, which helps to establish the value of other nations’ currency, including India. No wonder gold is considered a precious commodity as well as an investment.