I recently published an article examining the long term outlook of gold as an investment.
My conclusion is that gold is best used as a tool for short term speculation and has limited value for long term investors. As expected, this view was met with hysterical backlash some of which was legitimate.
We all agree that gold is a store of value, but on top of this there is a fundamental question of whether or not gold is money. I will follow up on my last article by provide an objective analysis of the potential of gold as money as well as exploring the possibilities and risks of gold being used as currency in the future.
Money vs. Currency:
So far I have used the words currency and money interchangeably, but what is the difference between the two? The gold bug's position is that currency is a medium of exchange with no intrinsic value, it can be created and destroyed. Money on the other hand is gold. Unlike currency gold has intrinsic value because it exists in limited supply and cannot be created. Both money and currency can be used to represent and exchange wealth but currency is intrinsically worthless.
I think this is a reasonable view to have, but In my opinion there is no fundamental difference between money and currency. Anything can be subjectively used to represent wealth; from cowrie shells to salt. It is not reasonable to arbitrarily define one form of money as the only true from when none of them actually have intrinsic value.
The true value of gold is its cost of extraction. This is because the cost of extracting gold represents actual economic activity that was sacrificed to produce it. In this view any price of gold above its cost of production represents a premium and a price below this sum represents a discount.
But Gold Actually Is Different:
So while gold is not the only form of money, it has undeniably had the best track record in this role. Gold is relatively scarce, its it fungible and malleable and retains its chemical composition forever. No other medium of exchange compares to the track record of gold.
However, in modern times gold has run into one key problem. Its lack of transferability. With an ever increasing amount of economic activity being transacted and recorded digitally this weakness of gold has become more crippling. But there are several ways to overcome gold's limitations as a medium of exchange, I will explore these possibilities: Physical gold coinage, gold backed currency and BitCoin.
Physical Gold Coinage.
Historically gold has been used as literal money. Coins were created from solid gold and were equal in value to the market price of gold. The most famous of these coins was the Spanish Escudo. This beautiful currency was introduced in 1535/1537 and was worth 16 Reals (a Spanish silver coin from the same period.)
These large weighty blocks of metal certainly look like a store of value. They are beautiful, substantial and have a denominated exchange rate. However, physical gold as currency will simply not work in modern times and solid gold coins like the Escudo had some serious flaws.
While a gold coin is issued at a set value, it is not immune to debasement:
Debasement was simply the ancient version of inflation. During times of war, debt or economic crisis ancient governments decided to create more money. Does this sound familiar?
Debasing a metal currency was done through a variety of methods. Often times gold coins were mixed with a cheaper metal and distributed as real gold. In other cases multiple coins were placed in a container and shaken to wear off metal dust which was then collected and melted down to create new coins.
But the most common and egregious form of currency debasement (performed by governments and citizens alike) was clipping. In almost every civilization that used precious metal as money we see that tiny bits of the coins have be clipped off to be collected and melted down for profit while selling the clipped coins at face value. Here are examples of Roman coins which have been blatantly debased:
The Anglo Saxons debased their gold currency by mixing it with silver:
This should be a wake-up call to those who think gold is special. No currency is immune to debasement and inflation. Every government will spend beyond its means when pressed and it doesn't matter if its currency is made from paper or metal. Human history shows us that there will be corruption in every civilization and there is no way around this fact. While paper money is not perfect, metal money is no better.
Gold Backed Currency:
Many of the problems we see in physical gold currency can be remedied by using gold as a backing for printed currencies instead of using the actual physical gold to exchange goods and services. The reasons why this is a bad idea are simple and obvious.
First, gold backing makes it even easier for a government to debase its currency. The ratio of gold backing to the physical metal can be constantly adjusted downward creating essentially the same effect as regular money printing. Secondly, gold backed currency would lead to mass panic during times of uncertainty. Wealth gaps would accelerate and economic stagnation would set in. This is the primary reason why gold backing was lifted from so many currencies in the early part of the 20th century and will never return.
The problem is that gold backed currencies, especially those that are redeemable with physical metal, encourage hording and the sequestration of money from the economy. This reduces the funds available for investment and growth. As we learned in economics 101 an economy depends on the flow of wealth from savers to investors then from consumers and eventually back to savers. When cash is placed in a bank, that bank can then lend it to an investor who will use it go grow the economy. But when money is hoarded the wealth is essentially removed from the economy. If the gold standard were to return the world would slide into an economic depression which would never end.
BitGold is a product created by GoldMoney that allows investors to purchase physical gold online at within 1% of the current bullion price. It is then stored for free and is fully redeemable.
BitGold overcomes the limitations of gold as currency by issuing a gold backed debit card that can be used to make international purchases based on the value of the physical gold stored in the customer's account. They are not the only company to offer this service, but are the only one widely available to Americans. BitGold is an example of a promising proof for the concept that gold can still be used as a viable currency (among others) in modern times. I would certainly recommend this product for those who are bullish on gold. I think it is an infinitely superior alternative to BitCoin.
But in the grand scheme of things, while products like BitGold are great they just another scheme to make money off the hysteria and misinformation that is common in the gold bug community. You best believe that when the CEO of GoldMoney is getting his paychecks they are denominated in dollars not gold.
Gold is one of the best stores of value in human history but it is certainly not money. Gold is a form of currency like any other and as a currency it shares the same risks of inflation, debasement and other government shenanigans that mainstream currencies like the dollar suffer from. For those who are still keen on the idea of using alternative currencies to buy stuff, services like BitGold offer a convenient and secure alternative to sketchy products like BitCoin.
Thank you for taking the time to read. Make sure to follow me for more unbiased and through articles about precious metals and other investments. I look forward to your feedback.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.