Will Gold replace Currency & God?

February 10, 2009

Commodity Online
NEW DELHI: When you lose faith in everything, including financial institutions and even governments and gods, what you will do?

If traditional wisdom is any indication, at such a situation people tend to go for gold. And that is what is happening across the globe now.

During such a period the most valued asset is the one which is incorruptible, and because the scarcity of gold is almost uniquely beyond the power of men to change it is gold which re-appears as the agent of wealth storage and transfer at the junctions between the much longer episodes of representative money.

So, will gold emerge as the medium of wealth storage across the globe? At these relatively rare junction points, as the wheel of optimal monetary solutions turns through its phases, ownership of gold is what empowers a bold and contrarian few to take control of large amounts of capital.

When the economic conditions are right for productive work and useful business development gold is an inferior form of money. Given two neighbouring currency systems, one gold based and one fiat, and with a decent variety of opportunities with underlying demand, the fiat system will comfortably outperform the gold system. Braver businessmen will back 2, 3 or 4 ventures at once, rather than the single project which gold allows, and they will usually win the race to the top of the economic pile.

So at least half the art is to appreciate that there is no permanent answer, and that ultimate success depends on being flexible enough to profit from a return to a token based monetary system.

In complete contrast gold also operates as money under the completely opposite circumstances, when all is well; so well that there is indeed enough to go round.

Where gold is the unit of money in use by the rich, there is no obvious reason why a central bank should not take to issuing gold coinage or gold backed notes itself. And that is precisely what has frequently happened.

But it is never a phenomenon which is available everywhere at once, only, in fact, to one or two strong trading countries in the world at any given time, and then temporarily.

The accumulated wealth undermines the productive energies of its creators. Their domestic producers start to concentrate on supplying things which poorer countries neither want nor can afford, and the bullion inflow stalls.

Gold based money - even for economic superpowers - is temporary. It disappears from circulation and seeks out the next great producers — to whom it will generally gravitate in settlement of new international trading debts.

Curiously the strongest industrial exporting nations of the last 50 years (notably Japan and Germany) have chosen to accumulate US dollars rather than gold, and now, instead of possessing bullion within their own borders these great exporters now own substantial slices — apparently some 40% — of the capital stock of foreign countries (particularly the United States) which buy their exports.

This is a break with ordinary patterns of international trade. It indicates that Germany and Japan are trusting the people of the USA to defend foreigners’ property rights over American self-interest.

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