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Gold as Fiat Currency

2011-09-02 19:07:12.78227+00 by ebradway 19 comments

Another aspect of the debate last night centered on the good ol' Gold Standard. My friend has been reading various books stating that taking the dollar off the Gold Standard was a bad idea. He also mentioned that various countries, China, Russia and France, have voiced strong opinions about the US economic policy. I simply stated "Since when did China and Russia become experts in capitalism? And France? Criticizing our economic policy?" But that wasn't the best part of the discussion...

My friend kept saying how much value the dollar has lost. But I kept calling "bullshit". I mean, a pint of beer costs pretty much the same now as it did 10- 20 years ago. In terms of the stuff I actually buy, some things have gone up a little (like bread and gas) and some things have gone down a lot (like computers and airfare). Overall, the dollar seems fairly steady.

If you look at the price of gold, you see some wild fluctuations. Recently, the price of gold has just gone crazy. It's been threatening to break $2000/oz!
But I kept asking my friend "what good is gold?" According to WikiPedia, 50% of the demand for gold is for jewelry, 40% for 'investment' and just 10% for industrial purposes. That made me think "If the world economy really goes belly up, how many people are going to continue buying jewelry?" That means real demand would drop to 10%. You would have an enormous supply relative to demand and you know what that should do to price! Even as it is, there is only a 60% real demand placed on the supply. If supply is outstripping demand, why is the price going up?

Gold is a fiat currency. It's price is derived from its perceived, not intrinsic value.

On an aside, I was surprised to find nothing in the WikiPedia gold article that discussed the 1981 peak in gold prices. There's a description of the recent run up in prices but it's like the people editing the article want us all to forget Silver Thursday.

[ related topics: Photography Beer Currency Economics ]

comments in ascending chronological order (reverse):

#Comment Re: made: 2011-09-02 19:28:50.147921+00 by: ebradway [edit history]

For future reference:

I didn't directly link to the last site because it has the bad habit of omitting 1981 from its charts. All of the horrible downward curves don't look nearly as scary when you include 1981.

#Comment Re: made: 2011-09-02 19:36:42.549619+00 by: Dan Lyke

Planet Money had a couple of interesting episodes on gold a few months back. If I remember right, they came to a similar conclusion as you do: Gold doesn't have as much of an intrinsic value as we normally think, so it's really just another shared value currency.

It's also important to remember that one of the reasons for a fiat currency is to remove deflation, so, yes, there is going to be continual inflation on the dollar. We see that. But in deflationary circumstances people hold on to goods (because they're worth less, so why sell it?), they hold on to money (because it's becoming worth more). This is what stagnates an economy, and this is the reason to have a central control on money.

So, yeah, a buck is worth about half of what it was when I was in high school (and it's kinda weird, when I think about the things I remember the cost of in high school, it seems like it's really worth about a quarter, but energy and food haven't scaled with the rest of the CPI), and that's by design. If you want to make an argument for doing away with that control, you'll have to make an argument that it'll make my life better to have the recessions be deeper. I tried to make that argument when I was in my 20s and generally had to fall back on principle. I'm more pragmatic now.

#Comment Re: made: 2011-09-02 19:41:36.799608+00 by: Dan Lyke

On the memories of prices: I seem to remember gasoline being about $.90 in 1986 in Fairfield County, Connecticut, it's about $3.60 now (yeah, it's hovering around $4, but I suspect that's summer seasonal). And I remember that a large soft-serve ice cream was $.75, here in Petaluma it's about $3.

#Comment Re: made: 2011-09-02 21:08:15.193032+00 by: ebradway

My memory of prices:

In 1986, my mother bought me an IBM-PC clone with 256KB RAM, a 4.77Mhz 8088, dual 360K floppies, a Hercules compatible mono video card that could emulate CGA and a 13" monochrome monitor. The price $999.

In 2011, I just bought a new workstation with 16GB RAM, a quad-core 3.3Ghz i5 (turbo boost overclocked to 4.2Ghz, liquid cooled), a 60GB SSD + dual 1.5TB hard drives, a 420GPU video card with 1GB of GDDR5 RAM and a 22" LCD screen. The price: $950.

#Comment Re: made: 2011-09-02 21:17:31.534743+00 by: Dan Lyke

I'll bet your new one has about the same latency in keystroke processing when you're writing papers as the old one did...

#Comment Re: made: 2011-09-02 21:40:16.232117+00 by: ebradway

Yeah. But it goes from a cold start to opening web pages to full shutdown in less than 60 seconds. It can also run ArcGIS on Windows XP in a VirtualBox faster than my laptop runs ArcGIS in the native OS. Chrome and Tweetdeck no longer seem like resource hogs!

#Comment Re: made: 2011-09-02 22:16:27.939291+00 by: TheSHAD0W

Gold is not a fiat currency, in that the money is based on a limited commodity, rather than currency whose production may or may not be limited. It's possible to base a money on a commodity different from gold, and some commodities may work better. Gold is a good monetary base if you want to carry the actual commodity with you, for several reasons, including its rarity and durability.

The price of gold is fluctuating badly now because its desirability as an investment is greater than its use as a commodity, and as a result it is being traded more for betting than for use. Were gold to become a money again, its use as money would count as commodity use, and its value compared to other monies wouldn't fluctuate as badly.

Dan, IMO your view of deflation is a bit off. During a deflation the value of money increases compared to other fixed goods, but during an inflation the value of other commodities increases compared to money, and both will tend to pull investment out of the economy. The original mission of the Fed was to keep the effective value of money constant, neither inflating nor deflating, expanding the money supply as the economy expanded. Using monetary policy to try and force the economy into an expansion by issuing more currency is only destined to backfire.

#Comment Re: made: 2011-09-02 22:59:17.75914+00 by: Dan Lyke

Shadow, but during inflation there's no reason to hold money out of the economy. Spend it or invest it, because if you just hold on to it it'll become worthless.

I'm not sure that I agree with the standard economic thinking, but I believe that what I described above is the standard economic thinking. In practice I think that people take their money out of the inflating economy, if they can, so long-term anything but basic inflation (0-3%/year) is detrimental to the economy.

#Comment Re: made: 2011-09-02 23:21:29.654439+00 by: meuon [edit history]

The " intrinsic value " concept reads true to me in many ways. Gold has some, must most of it (and diamonds and.. ) only hold their values because enough of society agrees on their value. Then we get into different scenerios for what has &ampampquotintrinsic value" for short and long term investments.

Somewhere between mild recession recession and zombie apocalypse (great name for a band) different things hold value and intrinic long term (not consumable) value.

In the middle might be some not quite long term things like: Fertile naturally breeding livestock and seeds..

At the bottom comes: Medical Items (drugs/antibiotics, etc..) Sharp edged manual tools/knives. A good water filtration system.

Which reminds me: I should invest in a good crossbow. Bullets are reasonably expensive and hard to make in comparison. BioDiesel vehicles and the ability to make biodiesel or some other fuel might be good also.

[Stepping off the paranoid soapbox now]

#Comment Re: made: 2011-09-03 13:45:54.154427+00 by: meuon


His term is: Extrinsic Value

#Comment Re: Gold standard made: 2011-09-05 03:41:59.00627+00 by: Don Davis

there's a core problem with the gold standard: there's just not enough gold to represent all of the economic value that money has to represent. specifically, 5.3 billion troy oz have been mined in human history, according to wikipedia; even if we assume a gold price of $2000/oz, these 5 billion oz represent only $10 trillion dollars. the world's GDP in 2010 was $62 trillion, and the US's GDP that year was $14 trillion. so even if the US owned all of the gold ever mined, we wouldn't have enough gold to represent one year of american GDP, never mind the value of land, buildings, corporations, etc. further, the US's gold reserves are worth only $500 billion. so, there's no way to make a gold standard work in the modern economy.

#Comment Re: made: 2011-09-05 12:24:36.595024+00 by: meuon

"there's no way to make a gold standard work in the modern economy." - Sure there is, you just adjust the value of everything (and/or gold) to match. Your new car might cost $500.00 and you make $1000 a year. A penny is a significant amount of money. The US Mint starts minting fractional cents: AGAIN. It's all a game of setting values to things, and they are all variables.

#Comment Re: made: 2011-09-05 13:40:32.295636+00 by: Don Davis [edit history]

a single year of US gold production is $13 billion, 1000x less than US GDP. so, revaluing everything to match a gold-backed coinage would effectively raise the price of gold by a factor of 1000, to $1.8 million per oz. why would anyone accept the proposition that a one-gram gold coin could buy a luxury car? people just don't value gold that much.

#Comment Re: made: 2011-09-06 02:48:18.839735+00 by: TheSHAD0W

Gold doesn't have to match the value of the economy, just the amount needed to circulate. Currently there is only about a trillion dollars in circulation, according to the US Treasury (http://www.fms.treas.gov/bulletin/index.html). Since the 5.3 billion oz number reflects worldwide holding, $2000/oz is about the correct order of magnitude.

#Comment Re: made: 2011-09-06 23:23:58.058684+00 by: Don Davis [edit history]

The US gold reserve is only 8100 metric tons, or half a trillion dollars. It's not enough. Further, to found even just the circulating dollars on gold, we'd have to devalue the dollar by half? Good luck with that...

#Comment Re: made: 2011-09-07 02:20:44.637181+00 by: meuon

Only half? No problem. Don, I am in the Dominican Republic now, the local currency is about 35:1, I deal with over 20 countries currency right now, most of the would shrug at the idea of a 50% devaluation, they are used to seeing a few zeros at a whack, every few years. I bought dinner in Guyana a while ago for about $10,000 GYD, and it was not even a nice dinner.

But the real point is: The value of gold is a figment of your imagination, and because enough other people imagine the same thing, it works. The dollar is worth what our perceived value of a dollar is. Nothing more, nothing less.

In many places outside the USA, the US Dollar is the preferred currency. Even for the government that prints other money. When THAT changes (and the Chinese are trying hard) we will have issues.

#Comment Re: made: 2011-09-07 03:02:13.744526+00 by: Don Davis

The claimed goal of restoring the gold standard is to improve the strength of the dollar, but the outcome at best would be to cut it in half at a stroke.

#Comment Re: made: 2011-09-07 21:29:30.938655+00 by: Jack1

Sure seems like its about to peak, and may be on its way down as we speak! (seeing how it dropped $60 today)

#Comment Re: made: 2011-09-08 14:27:32.207529+00 by: TheSHAD0W

It's been bouncing for a while, and has bounced back up this morning.

IMO the dollar is due to inflate by at least 100% anyway, so switching to gold wouldn't hurt any more than what's coming. It'll never happen though, not with both our major political parties happy suckling on the taxpayer's teats.