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Minyan Mailbag: Why Should Gold be Valued as a Currency?

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Just like paper currency, faith must exist that it is so.

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Prof. Succo,

Can you give a good reason why Gold should be considered of any value as a currency? Why not any other metal or compound? What if the market suddenly gets flooded with gold? Are you suggesting there is a finite supply?

I obviously don't "get it" and I've never heard a good answer to this question either.

Respectfully...

Minyan Scott

MS,

There is no good answer, at least not a mechanical one.

Any and all currencies have value for only one reason: society has faith that any and all individuals of that society will accept that currency in exchange for goods or services. Problems with a paper currency only occur when a government is given, and uses, the ability to create as much of that currency as they want. When this happens, the society may go along for a while and accept that decline in value, but at some point the "faith" that the next individual will accept the paper as a unit of exchange begins to wane and then collapses.

Gold throughout history has been considered a currency. Modern economics has officially severed the mechanism by which that occurs, but there still is left the "reputation" of it. Just like paper currency, faith must exist that it is so.

The difference is that gold does have a finite supply, at least in the short run. When a central bank begins to devalue their paper currency; the "reputation" for gold as a currency increases among that society. When the world was on a gold standard, paper currencies could not be printed willy nilly: governments had to have a certain amount of gold backing the money stock. This prevented exactly what has now occurred: the ability of governments to create huge amounts of credit.

Now it seems all major economies are attempting to devalue their currencies to fight deflation, that is, to fight a reversal of too much credit that has been created. The solution is the problem: to fight off too much credit, they try to create more. This has caused imbalances in the extreme between lending countries (who borrow from their own populace to lend externally) and borrowing countries (that borrow externally to buy goods from lending countries). The fact is everyone is borrowing: they are able to do this because they are just borrowing more currency which is worth less and less.

And so the price of gold rises in response to the fact that it is the only "currency" that cannot be infinitely manufactured. It is all psychological, even gold bugs must admit.

But then what isn't?

-Succo
No positions in stocks mentioned.

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