Thursday, April 19, 2012

It Is What It Is

One common issue with money is what it is "backed" by. I guess this way of looking at it stems from paper money's origin as a receipt for tangible gold at the local goldsmith's. This grew into convertibility of national currencies: you could convert a dollar into a prescribed amount of gold on demand. Once upon a time if you took a dollar to the bank you could actually walk out with gold in your pocket. The dollar was backed by gold.

But what is gold backed by? I'm starting to hear this question more and more - maybe that in itself is a sign of a growing awareness of fiat money and precious metals. Time-travelling back a few hundred years, I think this question would have been laughed at. Because gold is hard to find and dig up it has scarcity value. Its other properties make it the best money we have on earth, and most cultures over time have accepted gold as a store of value. Many countries still do, India being the prime example. For most of history and even now in many places, you would have no trouble exchanging gold for whatever you want.

On the other hand, people in the western world have lost that connection to gold and don't really know what it's worth. We in the advanced economy no longer "get" gold - we don't understand its value. If it's not backed by something else that has value we can understand then what good is it? Warren Buffett gets his hate on for gold as an inert metal:
Today the world's gold stock is about 170,000 metric tons. If all of this gold were melded together, it would form a cube of about 68 feet per side. Picture it fitting comfortably within a baseball infield. A century from now the 170,000 tons of gold will be unchanged in size and still incapable of producing anything. You can fondle the cube, but it will not respond.
True enough - gold doesn't produce. It's not a power plant, it's a battery that stores the power.

I believe one of the reasons gold is a near-perfect money is that it isn't productive, meaning it doesn't do anything or have any other uses besides being gold. Gold is what it is, nothing more or less. Even precious metals like platinum and silver have considerable industrial use, which makes it difficult to value it purely on scarcity. Also, as industry actually uses these other metals, they get used up, so the quantity is variable.

Maybe the right question isn't what is backed by what else, but how confident are you that your money will be worth the same when you spend it as when you earned it? How good a store of value is it? Gold generally holds its value over the long term compared to things like wheat, real estate or even oil. Unlike fiat currencies, bitcoins or seashells, you can't just create more. There is a finite endowment of gold in the ground, which can only be mined at an increasingly slower pace. Which means you have a good idea what it will be worth tomorrow (the volatility in the "price" of gold is actually the dollar). Currently you might have to temporarily turn it into dollars before exchanging gold for some other commodity or service. But somebody will always be happy to take your gold anywhere you go and give you something equally valuable in return.

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