How to leverage gold as a loan?
Imagine my good friend, Mr. Jack, who was very kind and lent me SGD 2000 in 2010 (about 11 years ago). If I chose to return the money today, the amount would still be SGD 2000. However, the purchasing power of the same amount of money has dropped over the ten years. The number remains the same (no doubt about that!), but the actual value has fallen. In gold denomination, the exact SGD 2000 was equivalent to 60 grams of gold back then, while today, it is worth only 23 grams. Do you see how the value of money has dropped over the years?
Loaning paper money creates a loss
Based on the example stated above, we can see clearly that using paper money to loan someone will create a loss, especially in the purchasing power. Mr. Jack intended to help his poor friend (me, in this case!), but doing so has put him in a position to lose money. That’s not fair.
When we think about it, things would be different if the loan was made in the denomination of gold (approximately 60 grams of gold based on SGD 34 per gram in 2010). If I were to return the loan, I should return 60 grams of gold based on the current price. Since gold retains the purchasing power, Mr. Jack would not be losing his money while trying to help me. This is way better, don’t you think so?
A recap on gold as store of value
Previously, we have seen how Prophet Muhammad (PBUH) could buy a goat with one gold dinar about 1400 years ago. Even today, we can buy a goat for the value of 1 gold dinar. This was unlike the cash, as observed in the situation above. To give another scenario, let us look at the price of Old Chang Kee curry puff (a Singaporean food retail chain best known for its Hainanese-style curry puffs). In 1981, one piece of curry puff was worth SGD 0.35, while today, it is sold for approximately SGD 1.60. The purchasing power of SGD 1.60 today is essentially similar to 35 cents back in the 1980s. We needed more money to buy the same item due to inflation.
Therefore it makes sense for Mr. Jack to loan me in gold and expect me to return in the same form. The purchasing power remains the same even after so many years. It’s a win-win situation when the arrangement is made this way. When Mr. Jack hands over the gold bar, I can choose to sell or pawn the gold. Either way, I have no choice but to return the loan in the same form. Mr. Jack’s only concern is whether the gold is of the same weight and purity. This would make me hurry up in returning the money because the gold price appreciates in the long run. If I feel like postponing the payment, I am losing because I do not want to overpay for the loan I made.
Debt creates friction in the relationship
We have seen theoretically that borrowing in the form of gold makes more sense for both parties. But we must also beware that no matter how strong my friendship with Mr. Jack is, things could be tricky when money is involved.
So, when we are placed in such a tricky situation, we can consider handing the amount of money that we are comfortable with if the money never gets returned. The additional fund (required by the other party) can be sourced elsewhere, not creating friction in the relationship.
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Your buddy on gold investing,
Naresh G