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Money Makes the World Go Around - Is Gold Money?

May 16, 2012, 5:53 PM

Is gold money?

That’s the question Rep. Ron Paul asked Fed Chairman Ben Bernanke during a congressional hearing in the summer of 2011. Bernanke answered, “no” and went on to say the reason why central banks hold gold is due to “tradition”.

Without a doubt, the value that gold holds is steeped in tradition that goes back thousands of years. But can gold be considered money today?

First, let's have a definition of money, it being a subject that interests almost everyone on the planet. Like Voltaire said: “When it's a question of money everyone is of the same religion.”

Wikipedia defines money as: “Anything that is generally accepted in payment for goods and services and in repayment of debts. The main uses of money are as a medium of exchange, a unit of account, and a store of value.”

Does gold fit this definition?

No other commodity has been as universally valued over time and across as many societies as gold. There is an emotional and cultural attachment to it handed down to us through the generations. It is undoubtedly a store of value, it is a unit of account, but is it used as a medium of exchange?

Not really, other than in Utah which took steps toward making gold legal tender. Other states have proposed similar measures. You can’t pay your restaurant or dentist bill with gold coins. People today are completely unfamiliar with the use of gold as money since everyone uses paper money or bank credit money, such as checks and credit cards.

According to the Austrian economist Carl Menger, its acceptability in trade is the defining property for money and gold does not fit that criteria. According to Menger, while money undoubtedly does serve as a store of value and a unit of account, these properties are derivative, not definitional properties. The reason that a medium of exchange (money) necessarily is also a store of value is the anticipation of its exchange value in the future. The question of whether any particular good is money, can be articulated thus: Is it accepted as the final means of payment for transactions?

At present almost all the nations have their own fiat money or else they belong to a currency union such as the European Union. Some nations use the US dollar. Hardly anywhere do we see gold accepted as a means of payment. So gold must fail the definitional test of being money.

So gold is not really money anymore (not yet?), but keep in mind that it does have most of the desirable properties of money. It is durable, portable and easily divisible into bars and coins that share uniform properties. It is easily recognizable. Gold's value and purchasing power are stable over time, as its supply grows slowly and it cannot be created ad infinitum as fiat paper currency can be.

For nearly three thousand years since the first gold coins were struck in Lydia in 700 BC, Gold's primary use has been recognized as a medium of exchange. The history of gold as money in coin form spans 2630 years, from 700 BC to about 1930 AD. In comparison, the history of paper and base metal and silver coin in circulation spans only about 40 years, from 1930 to 1970. And the history of paper and base metal coin with no connection to Gold or silver, also spans a period now approaching 40 years - from 1970 until today. So it's 2, 630 years of history for gold as money versus about 40 years for fiat currencies not tethered to gold.

Gold coins in the United States were removed from circulation by executive order in 1933. In Europe, the banks' suspension of redeemability in gold coins took place within weeks of the outbreak of World War I in the summer of 1914. England restored redeemability in 1925, but a public run on the Bank of England's gold forced the Bank to suspend payment in 1931.

It was on August 15, 1971 that U.S. President Richard Nixon "closed the gold window" and broke the last official tie between Gold and a circulating currency. This resulted in the financial system of our "modern" era - the "floating currency" system.

After 1971, several central banks sold some of their gold holdings because the only upside to holding gold is the speculative return if the gold price rises or as a store of value against banks' money creation mechanisms - somehow banks never wanted to hedge against the latter... Anyway, gold was no longer money, and holding it earned no interest.

Most economists wrote gold off when the dollar's link to gold was cut. Noble Prize Winning Economist Milton Friedman predicted that the price of gold would collapse since gold derived its value from its relationship with the dollar and without gold backing up the dollar there would be far less demand for gold. The vast supply that had been accumulated over the centuries would overwhelm the market, depressing gold price for the foreseeable future. Sometimes even a noble prize winning economist can be wrong. In fact, it was the dollar that collapsed in the 1970s, while the gold price in dollars began a bull run.

Why is gold a better store of value than most any other option? Politicians and economists assume that it is only political institutions, central banks for example, that have the final say over what is and is not money. But perhaps that is not the case. Maybe it is the market that has the final say.

One could argue that owning the ETF GLD, in a brokerage account fully allocated to GLD, would enable one to write checks on the balance, either using margin or selling down a portion of the position. The ease at which the yellow metal can be held and converted into purchasing power increases its use as a medium of exchange. During the boom stock options were widely used in Silicon Valley as a medium exchange. Homeowners could convert the equity in their house into purchasing power made even the most illiquid of assets, real estate, a form of money during the height of the housing bubble.

The qualities that have made gold and silver legal tender over the centuries are still inherent in the yellow and silver metals. Fiat money has some of these qualities but it fails when it comes to the scarcity test: it is too easy to create more of it, lots more of it.

As more and more people lose faith in fiat money gold functions as an alternative that competes with political money. It remains a store of value because of its potential to become money once again and it is a hedge against the breakdown of the fiat system. When society and the monetary system break down, even if nothing else is accepted as a medium of exchange, gold still will be. The market will only continue to accept fiat money as long as it trundles along. If governments debase their currency beyond a point where it maintains some value over time, people will stop using government currency and switch to something else. Gold?

Thomas Jefferson put it best in 1814 when he wrote: Scenes are now to take place as will open the eyes of credulity and of insanity itself, to the dangers of a paper medium abandoned to the discretion of avarice and of swindlers.

At the very least, if gold is not money, investing in it for the past decade has certainly proven to be a means of getting more money.

Shula Kopf
Sunshine Profits' Contributing Author

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