Monday, January 31, 2011

Gold is not Money

This is not money either

Not even at $1,335.65/oz. It never was. Silver is not money either. Neither is the paper in your wallet.

The “mercantilist” governments of the eighteenth century thought otherwise about gold. Yellow metal in the coffers, they thought, let them project military power, expand their dominion, and increase their wealth. “Bounties” encouraged exports and tariffs discouraged imports. Gold exporters paid heavy duties*. This was thought the surest way to national wealth and regional dominance. Mercantilism was a zero-sum game: gain wealth by impoverishing your neighbors.

Colonial trade was restricted to the mother country. North America was deliberately kept agrarian by the British to prevent competition and maintain a captive market for British manufactures. All colonial shipping had to pass through British ports where merchants charged their commission and the Crown its duties. It seemed a lucrative monopoly—certainly if you were a London merchant or the tax authority—and a prime reason the British were not particularly anxious to cut their colonies loose.

Mercantilism was first surpassed by the theories of the French “physiocrats” (later “économistes”), who Franklin met during his first visit to Paris in 1767. “Opinions which had hitherto moved separately through [Franklin’s] mind were precipitated in to order,” wrote Van Doren, and “he came to be dramatically aware of the differences between Britain and America.” (BF.372)

Physiocrats held the wealth of a nation was measured by work, especially agricultural work; artisans, merchants, bankers, and others being mere accessories to real production, that being farming: the only activity in which “something is made from nothing.”

So the arguments went, but both the mercantilists and physiocrats had it wrong.

The year 1776 produced more than one revolution in thought. Adam Smith published the “Wealth of Nations” (HC10.009) where among other things he eviscerated the ideas that gold and arable land were the measures—and limits—of national wealth. His book is Harvard Classics volume number ten and the subject of the next few posts.

But what then is gold? Simply a commodity. Gold has no more nor less inherent value than wheat grain or pork bellies, which is to say that the owner of 23** pork futures contracts “can put into motion a greater quantity of industry, and give revenue, maintenance, and employment, to a greater number of people” than the owner of a 20 kilos (46 pounds) of gold (HC10.380).

Rushing to gold in times of crisis is not much better, and may be worse, than buying wheat. The price of wheat depends on the weather, but that of gold depends on human fickleness—and you can’t eat gold. Of course neither can you trade a bucket of lard for a new suit if the tailor is not especially hungry. Gold is more portable, more durable, and is easily exchanged (as it has been for millennia) which leads to its confusion with money. But neither gold nor bacon is money.

I'd gladly pay you Tuesday
for 42,444.31 pounds of bacon in February
So what is money? Money is, literally, the ultimate confidence game. The value of a “Benjamin” (pictured at top) is agreed upon by society at large. Like gold, the bill is easily portable, a universal reference, exchangeable at equal value with intimate friends or perfect strangers, but is not money—like gold (and pigs), it only represents money. Each note is “…legal tender for all debts, public and private” whether a kid’s allowance or a kidnapper’s ransom. Money is a convention, abstract yet precise to the penny, by which we convert what we have individually produced to what we individually desire—the desired thing being the production of another.

The wealth of a nation is a measure of its collective production. “Money” is the measuring-stick. In other words one hundred dollars is what we collectively decide it to be, and nothing more.

Money is a state of mind.

* The real price of exported gold was increased by either the government levy (50% in the case of Spain in Smith's time), or the risk premium charged by smugglers.
** Prices as of 31 January 2011. Gold = spot; Pork Bellies = Feb 11 delivery.

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