Tonight’s main theme is about gold. As background for this presentation I will provide a brief summary of the conclusions of the first presentation in this “Invisible Hand” series which examined the physical object nature of our money and some of the unfortunate consequences of that nature. I will be concise so if you have already seen one of the earlier presentations don’t worry, this review won’t take long.
All money in history (and pre-history) has been considered to be or to represent physical objects such as a basket of grain, a coin, a cow, or a paper bill. Today most money is in computer accounts and though it zips around the world from account to account at almost the speed of light, it still is treated as if it were a physical object of some sort. Because we treat money as if it were a physical object, anything which is true of physical objects in general will also be true of money. This obvious point is ignored by economists and others who talk and write about money, even though it is the most important truth about money. The importance of the physical object nature of money cannot be overstated. What follows are some consequences of that physical object nature.
First, money is like other physical objects in that it can be taken from its owner against the owner’s will by force, fraud, or stealth and it can be lost or destroyed. This means that you need to suspect almost everyone of trying to get your money by fair means or foul.
Second, money must be amoral because all inanimate physical objects are amoral. Even animals are amoral in that they have neither an ethical sense nor morality, especially when they are used as commodity money. You can use your physical object money for anything, good or bad.
Third, the money supply is independent of the supply of goods and services for sale because the supply of one physical object is independent of the supply of others.
Fourth, money falsely simulates a zero-sum game in monetary transactions because the money gained by one party must be lost by some other party or parties. Money makes us think that other people can gain money at our expense and that we can only gain money at their expense. It makes us treat others as if they were competitors, rivals, opponents, or even enemies.
Fifth, money is almost impossible for a society or nation to control. In every nation that attempts to limit, regulate, or tax trade a black market comes to exist; and organized crime flourishes in all nations.
Sixth, money transactions are two-party interactions. Two-party interaction is inherently unstable because if one party gets an advantage in power such as having more money, the stronger party can use that power to gain still more advantages. This is particularly true of money. The old saying “them as has, gets” is true. Possession of money does make getting more money quite a lot easier. Naturally, the weaker party in such two-party interaction will eventually want to end the interaction. Thus the relationship is unstable.
So keeping that review in mind, let’s consider gold and other metals used in coins.
After the Stone Age came the Iron Age. Iron was a very useful metal: with it, one could make a tool that was much stronger than copper, brass, or bronze. These metals (including tin, of course) made a big difference for those who had the resources (commodity money) to acquire them. There was even a time and place when iron bars were briefly used as a commodity money. But there were problems with iron as a money. For one thing it tends to rust. Rust is not worth much to anyone. For another thing, it’s really hard to make change with iron. It’s so very hard in comparison to the other metals of the day, you really couldn’t “clip” a piece of the iron you were offered for your goat to make change.
It seems that even when one is using metals, there are a number of physical properties which are desirable. Here’s one set of properties provided by an economist over 100 years ago. The 19th century economist was William Jevons and in his time, coins were the most common form of money. Those properties were utility (or value), portability, indestructibility, homogeneity, divisibility, stability of value, and cognizability. Now these properties are physical properties, of course. I do consider these to be properties of some physical object money as compared to and contrasted with functions of money. Functions of money would include providing a medium of exchange, making available a standard unit of account, and providing a store of value. Note the functions tell you what you can accomplish using money. The properties, on the other hand, allow you to describe the money object. Commodity money performs the functions of money. The properties of money give some indication of how well those functions can be performed.
So far as utility is concerned, the various metals in the early days of coins would have included copper, tin, nickel, silver, gold, and iron. These metals were useful for making various tools. Metals are not edible and make very bad clothing. The supply of these metals was not sufficient to use them as building materials for housing, and they did not provide medicinal properties despite the use of copper for supposed healing these days. Therefore it was as capital goods, chiefly tools; that the metals were mainly of use. In small amounts all the metals were portable, but iron and the other metals would corrode with the exception of gold: Gold stayed shiny. Gold alone appeared to be indestructible. For each of the metals any coin would be indistinguishable from any other coin of the same denomination and metal, so they all had that property. Every metal could be made as small as one liked without changing its basic nature. Iron was still iron to the smallest filing. So divisibility was unlimited by the existing technology. Cognizability was not usually very difficult, although mixtures of metals could pose a problem. Lastly, stability of value would depend upon the utility of the metal. That would depend upon the rate of technological change in the culture, as well as the technological level of nearby cultures. So the stability of value was probably rather great since change was very slow for those economies.
When we compare these metals and their common alloys, we see that quite a few could be used to make coins. The most common difference that was relevant would have been indestructability (resistance to corrosion). In other words, resistance to corrosion would have been one of the most important features of a metal coin. Silver and gold also had the virtues of being shiny and having a low enough melting point to make working them in the mints relatively easy.
There was one way in which gold was substantially different from the other metals: It was soft. Only when alloyed with other metals was it strong. That’s why the image of a rustic biting a coin to test it for gold content exists. So gold had almost no utility in tools. Sure, it did not corrode and it was easy to stamp the image of the ruler on the blank that would become the coin. But you don’t really want a tool that has to be frequently reshaped. A gold plow would be practically useless. Gold knives would need to be frequently sharpened and would not cut a bone. Gold plates would scratch easily and would make hot food cool rapidly. It was not suitable for making armor. In other words, about all it was good for was jewelry. It had almost no utility at all.
Jewelry would not have been for the common folk 2500 years ago. It would have been only for the rich and powerful. But then, 2500 years ago, coins themselves would not have been for the common man either, unless that man lived in a large town or city. Farmers would pay for things with food as commodity money on those few occasions when they needed to acquire something they could not produce on the farm. Also, the supply of gold in those days would not have been sufficient to make gold common coin for ordinary transactions. Gold coins were only for the rich and powerful.
To the rich and powerful, jewelry was important. It demonstrated to everyone that they were important. It guaranteed that others would give way. Therefore, gold had value. If it had value for the rich, it had value for everyone.
So gold was a preferred metal for coins. The problem was in the supply. There was far more silver available than gold. Thus, gold was not used in everyday commerce. It was not the coin of the marketplace. For the poor, base metals like copper or bronze were the typical coins earned and spent. For the talented craftsman, silver coins were significant. The writers from ancient times that we base much of our knowledge of events of those days upon would have been from the lower ranks of the wealthy. For them, gold and silver would have been the common coin. It is their perspective that we probably share.
From 2500 years ago until the last couple hundred years, the predominant money used in civil society, the society of the cities, was the metal coin. In other words, hard money was the only money. There was no paper currency in most nations. China did use paper money for a few hundred years but gave it up. The world’s major nations consistently used a metal money in the form of coins in their economies.
Did this reliance on coins for money prevent inflation or deflation? Did this use of hard money prevent economic problems, business cycles, panics, busts, and economic stagnation? Well, to put it briefly, no. There is no kind of economic problem which we have today that did not exist on many occasions over the last 2000 years. Every form of fraud, theft, government manipulation, scam, monopoly, and bubble have happened again and again over the centuries. You see, coins can be debased by mixing in higher proportions of base metals. Coins can be counterfeited. Coins can be stolen by embezzlers. Government officials can be bribed using coins. It’s the physical object nature of money which makes these things possible, which motivates these behaviors, which provides the means, as well as the attitudes and relationships; and I don’t think anyone would deny that metal coins have a physical object nature.
One of the main reasons given by those who advocate a return to the gold standard is to prevent inflation. One might get the impression that inflation is impossible with gold for money. But we in the U.S. have had inflation while under the gold standard: California in 1849-50 is a stark example. The discovery of gold in California and the mountains near there drove the price of gold down because the supply of gold increased so rapidly. It was eggs, clothes, and tools that were in short supply. People selling those things could get lots of gold in trade for those items.
You may remember hearing about the large amounts of gold and silver the Spanish shipped back to Spain from the Americas during the last half of the 16th century. These treasure ships brought great inflation to Europe because the Spanish Crown spent money on war like a drunken sailor. Spanish citizens moved away from the coast to escape raids by pirates of various nationalities who were after the Spanish wealth. The economy of Spain was almost destroyed, and production sagged. Spain never recovered its position as one of the leading nations in Europe. The influx of gold and silver actually weakened Spain.
Going even further back, Alexander the Great captured huge amounts of gold and silver from the Persians (and others). When these riches were shipped back to Greece the expected happened: Inflation damaged the economy.
These cases are famous, and you were probably already familiar with them. But there were many other cases of inflation occurring less spectacularly on a more localized basis in all the nations of the world. There’s no escaping the fact that the supply of physical object money is independent of the supply of goods and services for sale. There’s no way of getting around the fact that sharp fluctuations in money supply, whether up or down, harm the economy and reduce production. Shifting from one metal to another or from one commodity to another does not eliminate these problems.
Still another problem with metal coins as money comes from what is popularly known as “Gresham’s Law.” Now Gresham was not the first to notice the principle but he happened to mention it to the Queen (that’s Queen Elizabeth the First back in the 1500s) and became famous for it. Gresham’s Law is commonly stated as “bad money drives out good.” With coins there is usually a face value stamped on the coin itself. There is also the value of the weight of metal in the coin. If there are coins of two types of the same denomination or governmentally assigned value whose metallic content is not the same then the coin with the lesser value will be used to buy things and the coin with the greater value of metal will be hoarded or, in extreme cases, even melted down to be sold as bullion. But bad money as coins can also come about due to what is called “clipping.” One would clip off some of the edges of the coin or scrape off some of the metal to keep and spend what was left. After a few people did this, the smaller coin would be spent as “bad money.” There were also bad money coins in the form of counterfeit coins. Those would also be spent before good money.
Of course Gresham’s Law assumes that the bad money is worth something rather than being viewed as worthless; because if it’s considered to have no value, the bad money disappears since no one will accept it at all. So when there are various monies, the relationships among them are not necessarily simple.
You can see that paper currency is not necessary for there to be inflation or deflation. Those unhappy features of physical object money can exist just as easily with gold currency.
Since people tend to ignore history, let us consider what would happen if the modern world went back to the gold standard. That is, what if the supply of currency were limited to the supply of gold in our economy?
The first thing we’d need to do would be to convert some of those tons of gold in Ft. Knox into coins. We could then distribute those coins in exchange for currency. So how much money would a gold coin represent? If I can trust the internet (fat chance!) Ft. Knox has 4578 metric tons of 368,000 standard, 400 ounce troy gold bars. At $1276 per ounce that’s roughly $180 billion worth of gold. (That price per ounce was as of February 2011 so it may be different now. There’s still more gold in the Federal Reserve Bank in New York (about 7000 metric tons) but a lot of that gold is owned by other nations. To keep the math simple we’ll just assume that there’s another $180 billion worth of gold there for a total of $360 billion in gold altogether.
The exact numbers aren’t important, we need only ballpark figures for my points.
The money supply in the U.S. that most closely approximates the total amount of currency (or its equivalent) is called “M1.” In April of 2014 the value for M1 in the U.S. was over 2500 billion. If we refer to M2 which includes all of M1 and savings deposits and other time deposits the amount is about 12,000 billion. Money in the U.S. is over twelve trillion. When we compare the current money supply with the value of the gold supply we see that the value of gold would have to increase by thirty three times. So an ounce of gold would have to be worth about $42,000.
Now picture how many things you could buy with one coin made of gold at $42,000 an ounce. How many things that you buy cost $42,000 each? Obviously, we will also need some other form of money, perhaps silver coins, to avoid that nasty paper stuff which can be printed off in unlimited amounts. But we run into the same old problem with Gresham’s Law again. The face value of the coin will not necessarily match the value of the metal in the coin. Regardless of whether the value is more or less – it’s bad for the money.
Worse, you will notice that the old coins that you have are showing signs of wear. That will be true even faster with gold coins in your pocket. Unless you want the value of your money to wear away, you probably shouldn’t carry that gold around in your pocket… you should probably leave it in the bank. So now you have silver in your pocket. The price of silver will also have to be greatly increased to provide all that money in between what a gold coin is worth in face value (which is $42,000) and the costs of ordinary things people buy. Silver will also be in short supply. We’ll have to bring in other metals for the less valuable coins. By the time we get down to $5 and $20 dollar coins, we have coins that have metal worth far less than the face value of the coin: Here we go again!
With all the gold still in banks, how do we know how much gold there actually is in the banks? What prevents the government or the banks from saying they have plenty of gold to match what everybody has deposited when they really have far less gold? We can’t use the gold in the marketplace, because it’s far too valuable. We can’t use metal coins for all the ordinary transactions because of supply problems and Gresham’s Law type problems. You see… we’ve been through all this before in history.
But isn’t the use of metal money largely to prevent inflation by the government? If that’s the case, why didn’t all metal money economies in the past escape inflation? Ah, I see, they had inflation because the amount of the metal increased in that nation, or decreased with deflation. But money flows in huge amounts from nation to nation these days. Since our balance of trade with many other nations has us buying more from them than they buy from us, wouldn’t that take the money out of our economy? Wouldn’t that result in severe deflation with everyone sharing a much smaller amount of money? Wouldn’t that cause prices to crash, incomes to plummet, and the economy to grind to a halt?
Or would the banks hold our gold… and provide paper money worth one forty two thousandth of an ounce of gold per dollar? And when you took your paper gold-backed currency to the bank could you really withdraw some tiny fraction of an ounce of gold? I don’t think so. How would you measure it? How would you keep from losing such a tiny gold thing? How could you spend it? Would your grocery store be able to accept such a tiny amount of gold, all accurately weighed and measured? And how could you distinguish actual gold from debased coins? Do you have the equipment to weigh and measure the coins or fractions of a coin?
The idea of preventing inflation by tying money to metal has some other problems as well. Let’s say that, by some magic, we find some way to keep the total amount of gold in our borders fixed at some amount – and that we prevent mining or other sources of additional gold. If production increases and the money supply remains the same, then either prices go down or the velocity of money goes up. The velocity of money is a measure of how long money stays in the hands of its owner. If you get $1000 per month and spend it over the course of the month, that will support one level of consumption. But if you spend that $1000 over the course of a week and do that every week, the same amount of money will support four times as much production. As you can see, it might be difficult to arrange that. The pay to employees would have to be staggered, as with the staggering of quitting time to avoid traffic jams. The coordination required would be huge.
If production increases in our fixed-money-supply fantasy world, prices would have to fall. But if prices fall, that takes away the incentive to produce more… because more work does not produce more money income. Over history, people have generally been happier with some inflation than with any amount of deflation. But there’s worse to come: Let’s say that there is a fixed amount of gold to be used. If there are loans with interest, then somebody who’s wealthy can put their money in the bank and live on the interest. If the interest is far greater than that person’s living expenses; the person can gain, without effort, a larger and larger share of the total supply of gold. Any interest rate will, over time, result in a collapse… with there being too little money remaining in the hands of ordinary people to keep the economy going.
We have seen this occur many times throughout history, even with changes in the money supply. Wealth becomes concentrated in the hands of the few until the point of economic collapse.
Let’s leave the world of fantasy and rejoin the actual world we live in. Let’s address a question which has bedeviled numerous economists and political thinkers since money was first produced in the form of paper currency. With paper money, thinking people ask: “What backs up that currency?” At one time in the U.S., we used paper bills which were silver certificates. One could present those certificates at the bank and have them redeemed in silver coins. They represented actual silver. These silver certificates were backed by silver. Paper currency has also been backed by gold. Going back to a gold standard has often been suggested as a solution to our inflationary problems. After all, if the bill is “as good as gold” who would not accept it in trade? That’s money sound as a dollar, you might say.
Did our economy run smoothly when we used gold certificates as money? Were there no economic hard times? Was employment high? Sadly, no. Just like today, there were economic booms and busts as well as times of high unemployment. William Jennings Bryan made a famous speech about the “cross of gold” on which the average worker was being crucified. This speech was motivated by the financial panic of 1893. You can look it up. That was just one of the economic disasters we had with the gold standard in place.
Let’s explore this idea of using gold to back up a paper currency. I suggest that it brings up a much more meaningful question. If we used actual gold as our currency, what would back up the gold? Since gold has almost no intrinsic worth and very low utility, why would people accept gold in payment of debts? If you are hungry you can’t eat gold. If you are thirsty you can’t drink gold. Gold clothing will not keep you warm. Gold will not help you to float. Gold will not cure what ails you. Even gold teeth must be alloys or they are too soft to be useful. All you get with gold is glitter and all that glitters is not gold. I have glasses whose frames are made of titanium. These frames don’t corrode despite being in contact with my skin. They are very light and strong and can be twisted like a pretzel without breaking. They have much more utility than gold frames. And titanium is a very common element in the earth’s crust.
So why do we value gold? What’s the big deal with gold? When inflation threatens, why do people buy gold and expect it to retain its value when the economy tanks? The answer may surprise you. Gold coins are not valuable because of the value of gold, gold has value because it has been the best of the money metals. It is because gold is useful as money that gold has value. If gold had never been used as money it would have far less relative value than the other metals. When the Spanish came to the new world seeking gold, they did not seek gold for the tools it could make, they sought it for the coins it could make. They did not seek gold because it made fine plates and cups but because it made fine coins. The only good use they had for gold was for pretty things to look at and for coins. Since gold could be used to make coins, using it for some other purpose as in to decorate one’s armor, would show that one was rich.
I ask again. What backs up gold? What commodity is of value in our economy such that it could support the value of some kind of money? I suggest that there is none. It isn’t commodities that make an economy prosperous. One can have a huge amount of money, piles and piles of it in the form of paper or gold, but one can still be living uncomfortably, malnourished, sick, outcast, unloved and miserable. Piles of money don’t make people happy. Just ask those lottery winners: According to their reports, most of them were happier before they won. Piles of money are not adequate compensation if they are physical objects. I suggest that feeling appreciated and loved makes us feel good. That would be something that would really be significant to back up money. I suggest that being proud of oneself is worth more than money. I further suggest that being attractive to the opposite sex is quite valuable. I also suggest that ensuring the people you love are safe and taken care of is worth far more than money.
Does physical object money provide any of these rewards to back it up? Does owning money make you feel appreciated or loved? Does having money make you proud of yourself? Or was it what you accomplished that gave you the pride? Does having money make you attractive to the opposite sex – or is it your money they are attracted to? Does the fact that you have money make your loved ones safe and well taken care of? Only if that money is not taken from you and them against your will. I suggest that money does none of these things for you. I suggest that physical object money, like gold, makes you worry, leads you to commit immoral actions, makes you suspect your family, and makes you fear other people. I suggest that love of money is a root of evil.
So what backs up gold? It certainly needs something to back it up because on its own it’s almost worthless unless you have a thing for trinkets. Gold is a fraud in that it is thought of as money. Gold lies to us with its glitter and glamor. Gold suckers us in: It’s fool’s gold.
Remember all those consequences of money being a physical object? They apply to gold just like they apply to any other physical object. Gold can be taken from you against your will. Gold is amoral. The supply of gold is independent of the supply of goods and services for sale. Trade in gold falsely simulates a zero-sum game. The use of gold is almost impossible to control. Gold transactions are two-party transactions and are thus unstable interaction. Gold can even be counterfeited by being debased with other metals.
Gold will not save you or the economy, nor will it make us better people. Gold will not make the government moral, defend the nation, eliminate poverty, or prevent war. Gold will not eradicate the drug problem or reduce violence. Gold does have its uses and can be very useful for some functions. But gold as money solves no problems at all. It never has and there is every good reason to believe it never will.