Gold vs. “real money”

Gold Mine
image credit: Kake Pugh via flickr (cc)

The basic function of money is as a medium of exchange.  Inevitably, a secondary function arises as a measure of value. Money can be paper, precious metals, shells, whatever people in a particular time and place use as a medium of exchange.  There’s no reason that it would need to have “intrinsic” value. If  people use U S currency to buy and sell, then it is “real money.”

So is gold “real money?” I don’t think so. Just about nobody uses it as a medium of exchange. Historically, gold coins have sometimes been used but for ordinary people silver, copper, or base metal fiat-type money would be much more common.

Certainly fiat money can depreciate, usually does, and for us in the U S that has been and will almost certainly continue to be the trend.  And gold might be a good investment, in the sense that it will be exhangeable in the future for more real wealth than it is now, or at least more in comparison to other kinds of investments available to ordinary people. Of course, gold can depreciate too, if large new deposits are discovered or folks decide they really don’t want gold after all.  Which isn’t to say that either of these things will happen any time soon.

Anyone who wishes to resurrect the “gold standard” might want to read the late Peter Bernstein’s “Power of Gold,” or some other history books. Somehow we end up electing people who don’t put a high priority on keeping the dollar strong (or at least, not too much weaker).  If that’s a problem, then maybe we should be electing other people, or finding ways to reduce the power of those who purchase elections. Making the U S dollar convertible into a fixed amount of gold is not going to bring prosperity, or even prevent further disruption. There are plenty of examples of economic collapse under a gold standard.

It might, however, benefit those who own gold, or gold mining stocks.

Somebody please disagree with me, or I will assume all of the above to be true.

What bitcoin illustrates about fiat money

The value of bitcoin seems to have surged to over $7, from less than one dollar a couple of months ago.  This is a far faster increase than the price of gold, or silver, or other “hard” assets.

Bitcoin was invented by Satoshi Nakamoto, who must be a skilled and innovative programmer.  Anyone can generate bitcoins by setting their computer to solve specific mathematical problems.  As more bitcoins are generated, the difficulty of the problems increases.  Relatively few vendors currently accept bitcoins, but several dealers are willing to trade dollars for them.  And the reason their value has increased must be that people are willing to pay more dollars than previously.

Why pay more dollars?  One reason is that the total number of bitcoins is limited, so presumably they cannot suffer the kind of inflation that often occurs with paper currency. (Could that rule change? Yes, just as some new major deposit of gold or silver might be discovered.)  Another reason, of course, could be that people are just learning about bitcoins, and seeing the trend, expect it to continue.  Also, bitcoins give some indication of being truly anonymous, secure money.

Now, if I was a skilled programmer, I could invent my own bitcoin-ish system, and generate my own coins.  But unless someone is willing to accept my coins in exchange for something people want, they’ll have no value.  Perhaps Satoshi Nakamoto is not only skilled, but also charismatic.

Bitcoins have intrinsic value in the sense that it takes a lot of work (done by the computer) in order to generate one, much as it takes a lot of work to discover, mine and refine precious metals. But, whereas I could use precious metals to make jewelry or tableware, I can’t think of anything that anyone could do with a bitcoin, other than spend it or save it.

So it seems to me that bitcoin shows that fiat money could work quite well, provided that the proper amount of it is issued.  If bitcoin’s deflationary trend continues, it might be a good investment but would lose usefulness as actual currency.  I think the most likely outcome will be, either, a decision to produce more bitcoins (however that might be made), or the creation of other alternative currencies operating in parallel.

Interesting times.