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Rediscovering Money

|Includes: CEF, Sprott Physical Gold Trust (PHYS), PSLV
What is money? If you go out and ask most people that question, you’ll find that you get some puzzled looks and few coherent answers. Try it! If nothing else it’s a great ice-breaker while you’re chatting with the barista at your local coffee shop. Come on, we all know what money is – right? I challenge you to find one person in ten who can provide a reasonably accurate definition of money. I would suggest that this ignorance concerning the nature of money says less about the intelligence of our society in general – and a great deal more about those who control the life-blood of our global economy.
“Give me control of a nation’s money supply, and I care not who makes its laws.”
~Mayer Amschel Rothschild
It occurred to me recently that I am the product of the first generation of Americans to live under a wholly fiat-based system of currency. (The term fiat is derived from the Latin phrase “Let it be done.”) Money, in its current form, is a creation of the state, with no underlying intrinsic value or quality other than its status as legal tender; that is to say, we are required to accept it as payment “for all debts, public and private.” My generation is the first to have never used “sound money.” Before we delve into a definition of sound money, a little background is in order.
Historically, paper money had some relationship to an underlying asset, typically gold and/or silver. The paper represented a claim on that underlying asset. This relationship also limited – if not prevented – the ability of the issuer of the paper money from creating too much of it. Some of the earliest paper money was issued by goldsmiths (who also provided safe storage for individuals’ gold) as a certificate of ownership for the gold deposited in their vaults. These pieces of paper eventually began to be traded as payment for goods and services, always redeemable for the real thing. The paper was merely a more convenient way to pay for things.
When governments got into the business of issuing money, they too backed the paper with precious metals, allowing the holder of the paper to redeem it for the metal. But, governments make promises, some of which they cannot afford. If they were able to pay for these promises with paper money created out of thin air, they could avoid the politically unpopular option of increasing taxes.
Without going into a very long history of fiat money, suffice it to say that the modern welfare state has promised more than it can ever hope to pay for without taxing itself into oblivion. Cradle-to-grave care by the state comes at the expense of the currency. In 1971, the US ended its ties to a gold standard (convertibility of dollars to gold at a fixed rate of exchange) in order to pay for The Great Society, the Viet Nam War, and numerous other big ticket items. Instead, we merely printed and borrowed what we needed and the dollar began its final, terminal decline.
“It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.”
~Henry Ford

In the 4th century B.C., Aristotle gave us one of the earliest definitions of the qualities of good money:
  • It should be durable (which is why, say, wheat isn’t a good money – it rots).
  • It should be divisible (which is why artwork isn’t a good money – you can’t cut up the Mona Lisa for change).
  • It should be convenient (which is why lead isn’t a good money – it just takes too much to be of value).
  • It should be consistent (which is one reason why land can’t be money – each piece is different).  
  • And it should have value in itself (which is why paper money leads to trouble).
(Credit: Doug Casey)

This brings us to the function of money in an economy. By most definitions, it serves as a:
·         unit of account;
·         a medium of exchange; and
·         a store of value.
Any money can adequately serve the first two functions above. In the past, tobacco, seashells, and any number of other items have been used as money. It is the third function that we have almost entirely lost – in less than one generation. As a store of value, one would expect that, over a given period of time, a unit of currency would maintain its purchasing power. That is to say, a dollar that would purchase one widget today ought to be able to purchase that same widget ten years from now. Why then do we consistently find that it requires more dollars in the future to by the same things we buy today? Assuming the widget has no improvements or new qualities to make it more valuable – why does it cost more in the future?

(Credit: James Turk and Gold Money )
The chart above illustrates the loss of purchasing power of fiat currencies over time.  The cost of crude oil in US Dollars or British Pounds has risen over time. Priced in gold (the red line on the bottom of the chart), a barrel of oil costs about the same today as it did in 1945. Gold did not go up in value, nor did oil. Instead, the value of the currencies in which we buy the oil, simply lost value over time.
Is Gold Money?
In an interesting recent exchange between Rep. Ron Paul of Texas and Fed Chairman Ben Bernanke, the two discussed the nature of money and gold.
RP: Do you think gold is money?
BB: No. It’s a precious metal…an asset.
RP: Why do central banks hold it?
BB: Well, it’s a form of reserves.
RP: Why don’t they hold diamonds?
BB: Well…it’s tradition, a long-term tradition….
Mr. Bernanke knows full well the historical role of gold as money. The slight-of-hand that has been played on the public and investors for years is that the paper money we use is now “real money” – and that shiny, barbarous relic is not. In the wake of the 2008 financial crisis, and the two concurrent sovereign debt crises on either side of the Atlantic, it may be that we are now in the process of “rediscovering” what money has been all along.

Disclosure: I am long PHYS, CEF, PSLV.

Additional disclosure: This commentary should not be construed as investment advice. Author's Investment Advisory firm, AFCG, LLC currently invests in and recommends to clients investments in precious metals as part of a prudent overall investment strategy.