Ray Dalio on Gold, the Safe Medium of Exchange and Store of Value

Posted on February 17, 2022

By Paul Vanguard, for BullionMax.com

I’ve been reading Ray Dalio’s book, the newer one called Principles for Dealing with the Changing World Order. Generally it’s a fantastic book, incredibly researched, thorough, and highly recommended. 

The key concept, which he repeats frequently, is that studying history’s most turbulent economic and political periods reveal why the times ahead will likely be radically different from those we’ve experienced in our lifetimes — but similar to those that have happened many times before.

Today we’ll zero in on some of the specific sections where Dalio discusses economic cycles. He has a LinkedIn post summarizing some of the relevant portions of his book.

Here’s our summary… 

Games central bankers play

History has shown that we shouldn’t rely on governments to protect us financially. On the contrary, we should expect most governments to abuse their privileged positions as the creators and users of money and credit for the same reasons that you might commit those abuses if you were in their shoes.”

Here, Dalio is talking about central bankers facing tough decisions (like our own Federal Reserve Chair Jerome Powell is today). Given the choice between raising interest rates to fight inflation, or printing money to stimulate the economy, which is easier?

It’s always easier for central banks to make more money. Here’s why:

Raising interest rates makes borrowing more expensive. That forces indebted businesses and families to make tough choices. Higher interest rates make new homes more expensive. Businesses grow more slowly. 

Keeping interest rates low (and printing more money) is always easier. Businesses borrow and expand, creating new jobs. Families buy bigger houses, new cars, all financed by cheap debt. 

So, given the choice between doing something hard and something easy, central bankers (just like me and you) nearly always choose the easier path. 

The consequences of this easier path are higher prices on everything (inflation) and speculative bubbles across markets, from stocks to homes to cryptocurrencies. 

Now, you’d think people would notice this and get upset! But as Dalio points out:

Most people worry about whether their assets are going up or down; they rarely pay much attention to the value of their currency.

In the last few weeks, we’ve seen two pieces of relevant news:

  • American wages are up 4.4% year over year
  • U.S. prices are up 7.5% during the same period

The average person looks at the number on their paycheck. That’s what makes them feel good! When they see that number going up, well, they feel wealthier. 

They tend to pay less attention to their grocery bill, which in this case rose 66% more than their pay. 

There’s some cognitive dissonance involved, see? How can I feel less rich if I have more money?

The number of zeros on your paycheck doesn’t matter if the purchasing power of that money declines. 

Dalio again:

…when the central bank faces the choice between allowing real interest rates (i.e., the rate of interest minus the rate of inflation) to rise to the detriment of the economy (and the anger of most of the public) or preventing real interest rates from rising by printing money and buying those cash and debt assets, they will choose the second path. 

It’s like deciding to start an exercise routine, which is so hard for most people. Short-term pain, discomfort and inconvenience? No thank you! But you’ll live longer, feel better and probably be healthier, too… Not interested!

Given the choice of making investors and families unhappy now but better off in the future, or happy now but worse off in the future, it’s an easy choice. Heck, by the time that future rolls around, you might not even be in office anymore! Then nobody can blame you for the bad stuff that happened, right?

Here’s what happens next

The problem is that money-printing lowers the purchasing power of all dollars, everywhere. It usually takes a while for people to catch on, though. That’s because we’re accustomed to thinking of cash as a safe store of value. 

Eventually, we move into the next part of the cycle. Dalio says:

When the creation of money sufficiently hurts the actual and prospective returns of cash and debt assets, it drives flows out of those assets and into inflation-hedge assets like gold, commodities, inflation-indexed bonds, and other currencies (including digital). This leads to a self-reinforcing decline in the value of money.

That “self-reinforcing decline in the value of money” means people are less willing to be paid in dollars, generally less willing to hold assets denominated in dollars. That’s why commodities are prized – their value is intrinsic. In other words, their value doesn’t change except in relation to supply and demand.

Along the same lines, world central banks are dumping dollars. Currently they’re holding the fewest dollars in 26 years. Might be that central banks are catching on faster than the man on the street?

It probably isn’t a coincidence that world central banks are replacing those dollars with gold, 36,000 tons of gold bars last year, a 31-year high.

It might surprise you to consider, when you look at the price of gold, that demand from central banks around the world is affecting that price.

Why emphasize gold, when any commodity serves as a store of value? 

Here’s what Dalio has to say on that:

There is an old saying that “gold is the only financial asset that isn’t someone else’s liability.” When you receive gold coins from a buyer, you can melt them down and exchange the metal and still receive almost the same value as if you had spent them, unlike a debt asset like paper money, which is a promise to deliver value (which isn’t much of a promise, given how easy it is to print). When countries are at war and there is no trust in their intentions or abilities to pay, they can still pay in gold.>So gold (and, to a lesser extent,silver) can be used as both a safe medium of exchange and a safe storehold of wealth.

Why is silver “to a lesser extent”? Simple: at today’s prices, it takes 80 oz of silver to equal the value of a single 1 oz gold bar. Gold is just easier to store, especially in the kind of volume central banks buy. (Last year, 36,000 tons of gold went to central banks – imagine how much bigger their vaults would need to be if they’d purchased three million tons of silver instead!)

So, yes, any commodity can help preserve purchasing power against inflation. Precious metals are better for everyday folks because they’re easier to store than, say, a “diversified portfolio” of equal parts cotton, copper, natural gas and corn. The same is true for central banks. However, most of us are unlikely to need a safe haven for hundreds of millions of dollars, for better or for worse. That makes silver a viable choice for most Americans.

“All currencies are devalued or die”

Maybe this whole scenario sounds farfetched to you? Maybe you can’t imagine a dollar not being worth, well, a dollar?

I understand! That’s one of the reasons Dalio tries so hard to put his overall argument into a firm, historical context. Remember this part from the beginning:

…the times ahead will likely be radically different from those we’ve experienced in our lifetimes — but similar to those that have happened many times before.

If you have a long-term view, you can see the eternal patterns that affect humanity. Empires rise and fall. Great nations fall into decadence and then irrelevance. Visigoths camping in the ruins of the Coliseum in Rome are filled with awe, wondering whether giants built this massive structure.

Back to the dollar. Dalio tells us:

Of the roughly 750 currencies that have existed since 1700, only about 20 percent remain, and all of them have been devalued.

Know what? Gold and silver are the only things we know of that were considered mediums of exchange, in other words money, in 1700 and today. 

Honestly, it’s frightening to soberly consider the thought that the U.S. dollar might be hyperinflated into extinction. It’s simply awful to watch the Federal Reserve twiddle their thumbs while inflation makes just getting by harder and harder for everyday Americans. Consider: at the end of 2021, 61% of the U.S. population was living paycheck to paycheck.

Even folks earning six figures are struggling! 42% of them reported they were in the same situation, a single paycheck away from financial catastrophe.

On the other hand, as Jan Nieuwenhuijs reminds us:

Because gold is the only international currency that isn’t issued by a central bank and thus can’t be printed, there is no limit to its price denominated in fiat currencies, which can and are printed.

Dalio says that, according to history, things will get worse (possibly much worse) before they get better. If he’s right, and if history is a reliable guide to the future, we should all probably start setting aside some of our income to buy gold bullion. The only financial asset that isn’t someone else’s liability has a whole lot more upside when we consider that printing an infinite number of dollars could result in a $∞ (that's "infinity dollars") price per ounce of gold.


Paul Vanguard is a lifelong precious metals enthusiast and a proud member of the BullionMax team.