Written by Jordan Eliseo, Chief Economist, ABC Bullion and Project Subcommittee Member, Gold Industry Group

Why is money like oxygen? There is a lot of it around, and we use it all the time. Like oxygen, not surprisingly, we end up taking it for granted. 

Just like most people don’t worry too much about where their next breath is coming from, most of us don’t reflect much on the importance of money itself to the way our society functions.

We can’t survive without oxygen, and society as we know it can’t function without money. Alongside language and private property rights, a stable and trusted monetary system itself is one of the primary mechanisms required for a market-based society to operate efficiently. 
Money itself has ‘no use’, yet a market-based society simply can’t exist without money for the very simple reason that money represents 50% of every transaction each and every one of us undertakes on a daily basis.

If you want to buy a coffee or settle a bill, you’ll need money. Your employer; they’ll pay you for your labor in money.

Money is the glue, which holds markets together, measuring value, facilitating transactions and allowing each one of us to specialise in our chosen fields, a process that adds incalculably to our overall prosperity.

Without money, we would have no easy way to measure the worth of our individual output, nor would we be able to trade efficiently for the goods and services we lack the skill to produce for ourselves, but which we can easily acquire in a market based society with an honest and functioning monetary system.

In short, money really does make the world go round, and one can make a credible case that money really is the most important thing, although not in the manner that Gordon Gekko implied with his famous line; “Greed is Good”.

Types of money

Over the course of history, there have essentially been two types of money. There have been gold and silver, limited in supply and chosen freely by the people (the market). There has also been fiat money, issued by the state, and assigned value by legislative decree.

Whilst there are some in the precious metal camp who claim that fiat is not “real” money, people are paid in fiat money, can use FIAT money to pay taxes, and they can purchase goods and services in fiat money too. 

Gold and silver, whilst they can’t typically be used in day-to-day commercial transactions directly, are also still accepted worldwide in that one can easily convert an ounce of gold or silver into the local currency in any nation on the planet, and then consume goods and services in that nation.

For example for an Australian tourist, precious metals are no different to the Australian dollar when one is on holiday in France, Japan or the United States. In those nations, the AUD can’t be used directly to purchase goods and services, but must instead first be converted into Euros, Yen or US Dollars. It is the same for gold and silver.

So, in appreciating that money is essential to the functioning of society, and there are two types of money; what are the characteristics money must display, in order for it to perform its essential function, facilitating commerce in our society?

Characteristics of money

There are several characteristics money must possess, including the fact it must be;

  • Durable: It can’t ruin easily
  • Divisable: Must be easy to change denominations
  • Portable: Must be easy to move around
  • Homogenous: Each unit should be the same as all others
  • Acceptability: People need to recognize it for daily usage
  • Limited and Stable Supply: This is a precondition of it maintaining value as if supply can be increased at whim it will lose value

Only if money meets these characteristics will it able to serve its functions, primarily as a unit of account (to measure value), a medium of exchange (to facilitate transactions) and as a store of value. 

The last function is arguably its most important. Money is essentially deferred consumption. If I choose to save $100 rather than spend it today, I’m consciously deferring consumption in the here and now in order to consume (or invest) later on. 

For money to be the medium in which society saves, society must be able to trust that the money itself preserves value. 

The failing of fiat!

This is of course the great problem with money. Being unlimited in supply, and controlled purely at the whim of central banks and politicians, it is inevitably debased and loses value over time. In extreme cases, too much debasement leads to a point where the money is no longer accepted as a medium of exchange or unit of account.

This has happened many times throughout history, where fiat money has been steadily debased, and it is happening again today, with US Dollars, Swiss Francs, Euro’s, British Pound, Japanese Yen all having their value inflated away, bit by bit, day by day.

Why gold and silver?

Gold, and silver, on the other hand, being limited in supply (and also having an enormous stock of existing supply vs. annual production), have always maintained their purchasing power. 

For this very reason they have been histories superior form of money, and the natural choice of people interacting in the free market.

This is important for investors to acknowledge, as apart from the critique about its lack of yield, the second most commonly heard objection to investing in gold, or valuing gold at all, is that it has ‘no use’.

But what does this criticism really mean? Certainly it is accurate that gold has no (or at least minimal) industrial use. But it is an incomplete observation, for whilst gold ‘lacks use’ from the standpoint of a traditional commodity, this ‘drawback’ is of course precisely gold’s virtue and why it’s so perfectly suited as a monetary asset.

The role of gold

The role of gold as a monetary asset has been well understood across the centuries, with my favourite quote regarding the importance of gold included below:

“Nations, differing in language, religion, habits and on almost every other subject susceptible of doubt, have, during a period of near four thousand years, agreed in one respect: that gold and silver have, uninterruptedly to this day, continued to be the universal currency of the commercial and civilized world.” – Albert Gallatin

Gallatin knew his history well, for there is evidence that, across all the continents, market based societies developed around physical gold and/or silver standards. 

This process occurred hundreds, if not thousands of years before these peoples were even aware other continents existed, or societies on those other continents had to organise themselves around a gold and/or silver monetary standards.

One wonders what the odds on that happening by chance would be, if it were not for the very simple fact that gold and silver have always been, and will always be the best monetary standard, or the ‘numeraire par excellence’ as one time French President De Gaulle might have put it.

In summary, fiat money systems such as the one we operate under today are practically pre-conditioned to inflation as soon as they are created.

Gold and silver on the other hand have never failed as monetary standards, and will always be accepted as money in one form or another. Over the long run they will always have value and will protect purchasing power, making them a far superior savings asset, especially in today’s world of low interest rates and money printing. 

For two of the best reads into gold’s superiority as a monetary asset, and therefore it’s essential role in our society, we suggest both Alan Greenspan’s “Gold and Economic Freedom” from 1966, or Howard Buffett’s (the father of Warren), “Human Freedom Rests on Gold Redeemable Money”.

READ OUR SERIES OF GOLD INVESTOR ARTICLES.

References
http://constitution.org/mon/greenspan_gold.htm
http://www.fame.org/pdf/buffet3.pdf
Disclaimer
This publication is for education purposes only and should not be considered either general of personal advice. It does not consider any particular person’s investment objectives, financial situation or needs. Accordingly, no recommendation (expressed or implied) or other information contained in this report should be acted upon without the appropriateness of that information having regard to those factors. You should assess whether or not the information contained herein is appropriate to your individual financial circumstances and goals before making an investment decision, or seek the help the of a licensed financial adviser. Performance is historical, performance may vary, past performance is not necessarily indicative of future performance. This article was written in conjunction with ABC Bullion NSW Pty Ltd