Gold is Money

I would like to evaluate whether or not Gold functions better than paper as a currency. This subject comes up, because of an engaging argument that I had last night about the U.S. Constitution and it’s purview of the monetary policy of the U.S. government. In particular, though the Constitution does not define what Money is when it allows the Federal Government the power to “coin money” [Article 1, Section 8], it also expressly denies the States from “mak[ing] any Thing but gold and silver Coin a Tender in Payment of Debts”[Article 1, Section 10]. Why the explicit mention of precious metals? Wouldn’t a paper currency (such as any of those used throughout U.S. history) be just as good, maybe better?

Even though Gold and Silver have a long history of being used for currency, I’ve thought often that the exercise of digging gold out of the ground, purifying it, stamping it with an insignia, and then locking it away in a vault as you trade a representational paper certificate instead, was a rather silly thing to do. (Only about 40% is actually used this way. 50% goes to jewerly and 10% to industry [wikipedia]) Why should we use this stuff as money? Can’t you dispense with the gold, and just use the paper instead?

That great historical thinker Aristotle identifies the utilities essential to a currency:

  • Durable: Money must stand the test of time and the elements. It must not fade, corrode, or change through time;
  • Portable: Good money needs to hold a high amount of ‘worth’ relative to its weight and size;
  • Divisible: Money should be relatively easy to separate and re-combine without affecting its fundamental characteristics. An extension of this idea is that the item should be “fungible”, defined as “being freely exchangeable or replaceable, in whole or in part, for another of like nature or kind.”
  • Intrinsically Valuable: This value of money should be independent of any other object and contained in the money itself, starting with rarity.

Clearly, gold by its very nature is durable, portable (though not so much as paper), and divisible. But some contend the last part: it doesn’t have a clear intrinsic value other than rarity.

But platinum (and many other metals) are more rare than gold, why not use one of them? Still other metals are more difficult to recover from raw earth, making them more valuable as measured by the economic cost of obtaining them, why not use one of them?

Both of these objections can be dismissed on the basis of recognizablility: Other metals are all silvery in color, while gold stands apart for its yellowish color. This property makes it alone easily distinguishable from a counterfeit. So the ‘intrinsic value’ of gold is actually derived from three aspects: rarity, difficulty to produce, and recognizablility. These aspects plus the other utilities make gold the best suited natural material for money. We should therefore add to the ‘intrinsic value’ a fourth aspect: natural suitability as money.

But a printer can produce paper currency with fancy designs, for recognizability, and in limited quantities, for artificial rarity. Thus simulating those aspects which make gold so suitable as a currency. Also, in practice, people do not usually cut the coins in half to make change for a transaction because it trespasses upon the ‘borrowed trust’ of the mint, defacing the stamped insignia and destroying future transaction value. So, divisibility isn’t nearly as strong as the other utilities. Paper currency can be made better than gold in rarity and portablity so it should function better as currency.

Yes, except for that rarity and recognizability do not automatically satisfy intrinsic value. Gold is also difficult to produce. And no matter how complex the anti-counterfeit designs raise the cost of printing, a real government would never try to make the cost of printing a bill equal to the cost of extracting the equivalent amount of gold, because paper lacks durability. Paper bills must be replaced as they wear out.

So, knowing this, how can a government give a paper currency an intrinsic value that the populace will respect? Declare the paper currency good for the payment of taxes. Now, some initially worthless paper, printed in limited amounts and stamped with recognizable designs becomes useful for maintaining ones lifestyle outside of a jail cell. Now people desire having at least some amount of the paper, and are therefore willing to trade to get it. So, by Gresham’s Law paper rapidly becomes the only currency in circulation.

Further, the government now has more control over the currency supply, and has the power to practice monetary policies which can stabilize prices. It is easier for the government to print money as the economy expands than it is to extract more gold. But, it should be noted, that governments historically have not exercised this beneficial aspect of control. Rather, they routinely opt for inflationary measures which destabilize prices. Given that I harbor a strong distrust of government, I actually see this power as a drawback rather than a benefit. You see because gold is a limited chemical element, it can’t be replicated at will: So the use of gold as money prevents government from counterfeiting! Gold is more durable than any government and its printing press.

There is one standing objection I have not yet addressed: shouldn’t the money supply expand with the economy? Adopting a rare and finite substance such as gold prevents that flexibility.

I was not able to verify this on my own (even looking in google scholar), but I’ve heard Doug Casey say that the price of a tunic, sandals, and belt in ancient Rome could be purchased for about 1 troy oz gold; roughly equivalent to a fine suit, shoes, and belt today (at $2,000/oz gold). Though it wouldn’t have been possible to obtain such high quality fabrics then, the price for items functionally equivalent has remained comparable across 2,000 years of economic growth.

Furthermore, it should be noted that as the economy expands, so too does the technology for extracting minerals. Thus we can add to the gold/money supply as the economy grows (though maybe not at exactly the same pace). And, since the economy is now so vast and most of the gold has already been recovered we should not experience any large swings in the money supply (such as Spain experienced during the plunder of South America). Even if gold is a deflationary currency (because only a finite amount exists and extraction is asymptotically approaching zero while economic growth remains exponential) the very predictability of its supply is useful as a stable bedrock for pricing, and the inability of government to counterfeit gold prevents undue market interference for political purposes.

Because paper must make up for intrinsic drawbacks via government coercion, I conclude that Gold is natural Money.