Must money be backed by gold?

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Revision as of 21:17, 24 November 2011 by Infomaniac (talk | contribs) (→‎See also)

There is a very prominent belief among sound money advocates that we must return to a gold-backed currency and that fiat money is inherently evil. I shall try to dispel these as myths.

First, we acknowledge gold and silver's historical role as sound money. I'm speaking of the coins themselves - the physical commodity. We know that gold has had "intrinsic" value for two main reasons:

The Gulliver Principle

People like gold for some reason, even though it had few uses outside of jewelry. I call it the Gulliver Principle - in Gulliver's Travels he said: "Primitive... People... Like... Shiny... Things." The essential fact is that gold is rare, and because others covet it because it was useful as money, it was universally considered valuable.

Notice the tautology: It is considered valuable because it is considered valuable. It is accepted as money because it is accepted as money. Gold is in essence, valuable by pure consensus.

Gold has few industrial uses or utility value other than its property as an outstanding electrical conductor (carbon nanotubes are far better) and chemical nonreactivity (it resists corrosion) - that makes gold ideal for electronic, dental and surgical applications.

Silver and platinum have more industrial uses, but mainly due to their unique electrochemical properties. Silver is still being wasted as is yet considered not worth the effort of recovering and recycling it from photographic and electronics applications. Its stockpiles are being depleted faster than it is being mined, making it ever more rare.

Anti-counterfeit properties

Gold and silver are (so far) impossible to duplicate. I have read of processes of nuclear transmutation (alchemy) that permit the creation of monoatomic gold out of less valuable materials, but for our purposes, we still consider it impractical or impossible to counterfeit. There is no substitute for mining it out of the ground, at least not at a practical scale. The very cost of effort and energy and time expended to mine gold is part of what makes up its value, or 'true cost' - as opposed to perceived value.

There are other things of value that can be duplicated (cell phones, tomatoes) but they don't serve as money because they are not reliable measures of a share of the economy, that is, units of exchange. Cell phones become obsolete and can break. They are not very portable in quantity, and no one needs more than one, so extra ones tend to be less valuable. Tomatoes are seasonal and perishable. These are not good examples of a stable commodity that can serve as money.

Fiat money and consensus value

Most people understand that fiat money, whatever form it takes, whether paper, plastic, or electronic, serves as nothing more than counting beans - a unit of exchange, just like meters, gallons, or grams. Money is essentially, a common accounting system. That is its essential function.

As long as the measuring and accounting doesn't become fraudulent ("unjust measures" and "cooking the books"), fiat money serves as money just fine. 17th-century England's use of the Talley Stick, and Abraham Lincoln's financing the civil war with fiat Greenbacks, are proof of that.

But as soon as the population take their attention away from this fact, it is possible for unscrupulous politicians or bankers to dilute the measure 'value' by duplicating it out of proportion to the real economy (essentially, the population multiplied by the work it does). This is classical inflation.

But gold's value by consensus is not too different from fiat money's value by decree. The difference is that fiat money is valuable because the king or government says so - but only so long as the consensus agrees. At some level of debauchery, not even the threat of force will make people perceive a worthless currency to be anything other than worthless. In such cases, the people inevitably resort to bartering. Anything of value - gold, or food, serves in a barter economy, but is not nearly as convenient as paper money (or electronic money). If you are a hog farmer, just try bartering hogs to get what you need. Sooner or later, society will need to adopt a trusted, common unit of measure for bartering - money.

But what makes money 'trusted'? - it is not its intrinsic value. For most of the history of the US Dollar, it was universally accepted despite the fact that it was backed by nothing at all (other than military force) - despite insidious inflation and several government defaults. This is because it had a great deal of social-psychological momentum. In people's minds, the USD was very resistant to becoming worthless - again, by consensus.

Gold Certificates and Silver Notes

Sound money advocates insist that the only way forward is to go back - to gold-backed paper. But isn't this how paper money started out to begin with? As soon as the ancient moneychangers realized that paper demands against deposits of gold never exceeded ten percent, they started resorting to fraud, issuing paper loans for more gold than they actually had. This is fractional reserve lending. Note that if depositories had no legal power to lend paper currency and charge interest, there would be no incentive to practice fractional banking at all.

The practice of inflation is not too different than fractional reserve banking. In this case, it is the government that is committing the fraud. What they are doing is spending tomorrow's money today - issuing money they do not have by printing fraudulent, worthless paper. Sooner or later, it snowballs, as the volume of currency falls out of proportion to the real economy.

Notice that the two practices are the same in that they multiply currency out of proportion with real assets - by substituting 'sound money' with paper receipts for non-existent assets.

Therefore, the problem with certificates that represent real assets is simply the trustworthiness of the issuer. Certificates like silver certificates became worthless by decree as soon as the government reneged on its obligation to redeem them for physical silver.

Ultimately, banks, moneychangers, and governments can't be trusted to keep their contractual obligations. That is just the first problem with gold-backed currency. The power to create money must be taken away from governments and bankers. When this power is reserved by the people, it is once again consensus that gives 'value' to whatever society chooses to use as currency for trade. It is all about mutual trust.

Another obvious problem with gold-backed currency that is, for some reason, irrationally overlooked: there is simply not enough gold in the world for it to serve as money for billions of people.

The reason people used asset-backed paper instead of the physical asset itself is for practicality. Coins are impractical because they are not fungible enough for small purchases. The coins would have to be minuscule grains, or tiny clips of silver or gold wire would have to be used. Large transfers require physically moving impractically heavy amounts over impractical distances, consuming impractical amounts of time and energy.

As the population and economy grows out of proportion to physically-available gold, its proportionate value changes. Growing population against increasing relative scarcity of gold will make infinitesimal amounts of gold increase in value to the point where we will be counting paper bills that represent minuscule grains that do not have stable value, thus can't serve as a unit of measure for a global economy. Imagine using stretchy measuring tapes to buy lumber!

The third problem with gold-backed currency is: who has all the gold? The law of the jungle says that he who has the gold, makes the rules. The government does not have enough gold to finance its deficit spending, and if it has not already hawked the gold in Ft. Knox, it will soon. My research tells me that the last of the gold at Ft. Knox was sold off (to the Federal Reserve) in 1972 when the gold standard was finally abandoned. This does not necessarily mean it has been physically moved, just that the title of ownership has changed. That explains why the government has to borrow from the Federal Reserve to finance its operations.

This begs the question: who has all the gold now? The privately-owned central banks. Can they be trusted to issue sound money certificates? We already know the answer to that. Will the gold they cheated out of the public trust be fairly apportioned among the people to serve as currency? No, of course not - at least without a bloody revolution. In the end, getting the gold means war.

In summary, what is sound money? That's like asking what is a sound unit of weight or length or time. It has to be standard, stable, and not subject to the whims of bankers and governments. They cannot be trusted to manage it. The people have to take responsibility for it just as they have universally agreed to use 24 hours to mark the length of the day. We don't need anything more than consensus for that to happen.

We don't need the currency to be backed by physical gold - it's an oxymoron - a paper certificate that represents physical gold is just a paper certificate. What it should represent is trust - an honorable utterance.

We need to have a standard unit of exchange that is not monopolized. The only way to do that is to have NO CENTRAL ISSUING AUTHORITY. If it is ever delegated to anyone - investment firms, governments, accountancies - NONE of them must be permitted to loan out money they have been entrusted to count or invest. Likewise, fractional reserve banking must be outlawed because it is fraudlent accounting - which in every other sector, is already illegal.

The best idea for money is this:

  • It must simply be an accounting system that allows the trading of any valuable asset, good, or service.
  • It must be open and auditable.
  • It must be technically and physically resistent to fraud of any kind.

This is easily achieved with computer technology that is not under the monopolistic control of anyone.

When we go to the farmer's market, we have two ways to barter: Say that I have watermelons and you have hogs. We can physcally bring them if we want, but it's a pain in the ass and completely unncecessary because we are both honorable men of our word. We simply leave the merchandise at home and say, 'save me two big melons' and 'I can't use any hogs this month, but next month I'll bring you more melons and I'll take some bacon.' This can all be done without any gold or silver or even paper. It is done by mutual agreement.

Essentially, sound money is an agreement that will be fulfilled by honorable people who either trust each other implicitly at an individual level, or honored by the society as a whole. All that is needed is the ability to swap obligations (like the gold in Ft. Knox that never moved). An accounting system that acts as a direct exchange for goods and services without even the need for an intermediary commodity (silver or gold) is not only possible, but is the only way forward for society.

You can take your gold and silver with you, but at the end of the day, you can't eat it. It has only become necessary as a store of value because public trust in the government (and mutual trust in society) has been lost.

The problem with Gold

1) gold-backed paper is not gold

2) the quantity of available gold itself

If we assume that there are 10 billion ounces of available gold to use as money, we arrive at two facts:

A) There is approximately 1.7 ounces of gold per person in the world. period. And this ratio is falling as population increases. This fits in a cube about the size of your living room

B) an economy that relies on physical gold as money has to move most of those 10 billion ounces around every day. It's a huge waste of effort and would immediately be vaulted and exchanged by accounting, which is what you call 'virtual' currency.

So there is simultaneously both not enough and too much gold to use as money.

Bitcoin is an accounting system

Bitcoins are like intellectual property that cannot be stolen or plagiarized. Actually the 'coins' don't move anywhere - the change of ownership is simply publicly recorded in a way that can't be altered -- better than any accountant, bank, notary public or county clerk could ever do. Bitcoin is a publicly-auditable accounting system; nothing more. To say that Bitcoin is worthless because it is not 'made' of some substance of 'intrinsic value' is like saying accounting and mathematics is worthless because it isn't made of anything but ideas.

Michael Suede, in "The Economics Of Bitcoin – Doug Casey Gets It Wrong" explains it like this:

"To claim Bitcoins are nothing is like claiming your operating system is nothing, therefore it is worth nothing. Clearly an inordinate amount of time and resources went into the development of your computer’s operating system. The time and resources that went into the development of the software constitutes “something”, which is obviously more than nothing. Software can have inherent properties that give it value in and of itself. In the case of Bitcoins, they are imbued with value by the free market because of the properties they have that allow them to act as a store of wealth and as a trade facilitator. Those properties which allow Bitcoins to act in this specific capacity are exactly the same properties that gold has which allow gold to act as a store of wealth and as a trade facilitator. Again, even if gold had absolutely no other uses besides sitting in bank vaults as ingots, gold would still be a money."

Transition from Monitarism to Resource-based Economy

I understand that from an individualist, survivalist, point of view that expects civilization to descend into chaos, gold is much preferable to virtual money. But it is only a survival mechanism, not a 'Thrival' mechanism.

I don't deny that we may very well enter into an emergency scenario as a result of the current collapse of monetarism. We need to transition to a resource-based economy that apportions natural resources fairly to everyone. There is a better transitional mechanism than falling back to metals as a medium of exchange: the gift economy.

My perspective is not to focus on merely a few people surviving a "Mad Max" scenario, but to create a society that is not based on primitive values.

One primitive value of a patriarchal civilization is that human beings are inherently evil and cannot be trusted, therefore gold is necessary to bridge the gap.

Another is a mentality based on scarcity rather than abundance. This leads to a "dog-eat-dog, every-man-for-himself" world, instead of a world where first priority is ending human suffering and where everyone's basic needs are met.

When all people have basic needs like love, shelter, food, and education, a golden age can arise where people collaborate instead of compete. In such a world money as we know it is not needed.

See also

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