In comments to the gold standard blog post from this morning, a lot of people asked a question that I have asked from time to time in my life: why gold? You can’t eat it. You can’t wear it. Who cares if you have a little yellow metal or not? Who cares if the country does? If banks do? Etc.
It’s a natural reaction, but I think I have learned the basic answer in beginning to study Austrian economics. Beware: I am not an economist. Beware: I have read very little. Beware: A little knowledge is a dangerous thing. And so on and so forth. As always, I am throwing out these ideas to be discussed; this is not my area of expertise and I am happy to be corrected or to have my arguments improved upon. That said, I think I understand enough to contribute some insight into this question.
Before we get there, let’s take a step back and talk about the division of labor. (We’ll get to gold, but this is necessary background.)
As I have remarked before, the division of labor is the reason that we have a standard of living that would have been the envy of kings centuries ago. But it’s as simple as this: people specialize in those areas that they do best.
In providing examples of a very simple economy, economists love to cite Robinson Crusoe and Friday on a desert island, and who I am to try to improve on that? So: imagine a desert island where Crusoe and Friday each need 10 bananas and 10 coconuts per day to live. Crusoe can gather 10 bananas an hour, but only 4 coconuts per hour. Friday can gather 10 coconuts per hour, but only 4 bananas per hour.
If each is left to his own devices, he will work 3 1/2 hours per day: one hour gathering that which he is best at, and 2 1/2 hours gathering that which is he least efficient at gathering.
But if each spends two hours gathering what they are best at, Crusoe can get 20 bananas in two hours, and Friday can get 20 coconuts. Each trades half his supply for half of the other’s, and each has his 10 coconuts and 10 bananas, and each has cut his labor time from 3 1/2 hours to 2 hours.
It is this concept that allows you to live in a comfortable house you could never construct, drive a car that you could never build, and turn on the air conditioning even if you don’t have the slightest clue how it works.
So far so good. But in a more complex economy, it is difficult to barter your own commodities in kind, because the person from whom you need goods or services doesn’t always want what you have. So you want to try to trade your goods or services for something that more people will accept. That’s a “medium of exchange”: a commodity that everyone in the society (or nearly everyone) wants. People will accept that commodity in exchange for providing you with what you want — because they know they can turn around and provide it to someone else for what they want.
Different commodities have functioned as media of exchange in different societies. Some have used cigarettes. Some have used cocoa beans.
The more universally desired the commodity, the more valuable it is as a medium of exchange. Initially, there is competition among various commodities. But over time, people start to notice which are the more universally accepted commodities, and those commodities crowd out other commodities. Think about it. If two people want my services, and one is offering me cigarettes, and the other is offering me gold, I will provide my services to the person who can give me the medium of exchange that most other people will accept when I try to buy something.
With me so far? Good. Here’s the important part. A good medium of exchange should have several characteristics. (I’m not taking these from a textbook, but am rather going from memory, so cut me some slack if I miss some.)
It should be unchanging. Thanks for the fruit, but in two weeks it will be spoiled. Gold is inert — one of the “noble metals” that resists corrosion or oxidation.
It should be transportable. There are fascinating stories of cultures that use giant unmovable boulders as currency. Everyone knows that is Og’s boulder over there, even if Og can’t drag it to his cave. These cultures have been known to employ giant ships to move boulders from neighboring islands — and if the ship capsizes and the boulder sinks to the ocean floor, they don’t even sweat it . . . because, well, Dag’s boulder is the one at the bottom of the sea! That’s nice and all, but most societies tend to think that a medium of exchange should be transportable. A related factor is that it should be divisible, such that different amounts (weights) can be used to represent different values.
It should be rare, in the sense that, while you don’t always want a fixed amount, you don’t want to have a situation where one can easily double the supply. After all, when you increase the supply of a commodity, you decrease the demand and therefore the price. A medium of exchange that is rare, and cannot have its amount increased by multiples overnight, is one that preserves value (purchasing power) for all who hold the commodity.
There are other desirable characteristics that a successful medium of exchange should have. It should be recognizable, hard to counterfeit, easy to store, and have some intrinsic value. And so on.
Well, it turns out that, over time, humans have always gravitated towards gold and silver as containing the best mix of characteristics to serve as a medium of exchange. Silver has typically been employed for smaller transactions, and gold for transactions involving higher values (because gold better provides the mix of characteristics needed for a medium of exchange).
But the most important fact here is this:
GOLD IS A COMMODITY. It is a thing. It is tangible. It is a commodity used as a medium of exchange, but it is nevertheless a commodity. It has some intrinsic value in its beauty and use for ornamentation. But it is a thing, which just happens to be the best thing to use as a medium of exchange.
That answers the question. You can stop reading now if you want. But I have to keep writing.
CIRCLING BACK TO CURRENCY AND THE GOLD STANDARD: I now have to circle back around to paper (currency), because I know that people will object that in a modern economy, you simply can’t have rapid financial transactions occurring with people handing pieces of gold back and forth. That’s why you have to have pieces of paper or the equivalent (nowadays, it could even be computer code) — something that cannot be easily counterfeited, that represents your right to exchange it for gold if you so choose. Call it currency, call it a bank note, call it what you like.
The genius of Murray Rothbard is to compare these currencies to a warehouse receipt. Here’s the idea: again, GOLD IS A COMMODITY. So, you can’t always carry around your commodity. Business will arise that will warehouse your commodity for you, and give you a slip of paper (call it a bank note) which you can use to redeem for gold any time you like.
When these warehouses, which we call banks, begin to engage in “fractional reserve banking” — lending out more gold than they have — they are giving multiple people warehouse receipts to the same commodity. This is fraud. Let me repeat: THIS IS FRAUD. Giving multiple people warehouse receipts to the same commodity is fraud, because the receipt should entitle the holder to repossess his property whenever he so chooses (although this can of course be limited by a contract with the bank).
Although it’s fraud, it works great — unless and until people get suspicious that they can’t get their commodity back . . . and then you have a “bank run.” People line up to get their gold, because they are afraid they can’t get their gold back. And, if their bank is a fractional reserve bank, as all banks are these days, they are right. They can’t get their gold back, because the bank committed fraud the minute it promised the same gold to multiple people.
If society treated fractional reserve banking as the fraud that it actually is, and kept us on a strict gold standard, then maybe — just maybe — governments would not have the ability to borrow endlessly; to mask their debts and lessen their pain by causing runaway inflation; and to generally deprive people of the value of their savings.
I could go on and on, but hopefully this gives readers a better idea of why humans might value gold, why fractional reserve banking is dangerous; and why going off the gold standard unmoors us from any fiscal discipline.
Don’t say any of this too loud, though. People will think you’re crazy.
Ah, but the system of fiat money we have nowadays? The one that is about to drive us into the depression to end all depressions? That system? Yeah, that system is totally awesome. And stuff.
It’s the gold standard that’s crazy, we’re told. What we’re doing right now? Perfection.