Gold

I occasionally run across someone who thinks that gold is the only real form of money. These people call dollars “fiat money” (or “fiat currency”), and argue that real money is based on gold.

In fact, this makes no sense. All money is a social convention: money is something which people will normally accept in exchange for goods. That is just as true for gold as it is for dollars. The difference between gold and dollars is that dollars are just paper, which is essentially worthless in and of itself, while gold has some inherent value (it has industrial uses, and artistic uses). In fact, though, there are many things which have inherent value, and any of them could in principle be used for money (e.g., oil, corn, etc.).

The advantage of using gold for money–the reason that it has historically been used as money–is that it is solid and durable, while still being easy to manipulate. That is, it does not rust or otherwise degrade. It can be separated into pieces when convenient, and you can use fire to combine pieces of gold. These are all desirable properties in money. All the precious metals (gold, silver, platinum, etc.) have these properties.

Paper dollars, by comparison, do degrade. Using dollars as money requires a bank which can hold values denominated in dollars and can exchange new dollars for old ones. Fortunately, we have such banks.

Of course, in principle, the government might collapse, and banks might disappear. In that case, would it be better to have gold? At one time, it would have been, but today it would be useless. Nobody would know how much value to attach to the gold. A new form of money would be developed over time. It might be based on gold, but it might not. Barring a complete collapse of civilization, it would be more likely that some new form of paper money would be developed, since that is now familiar to everybody.

An interesting aspect to using gold as money was that you could literally dig money out of the ground. Of course today you can almost do that by drilling for oil, but you can’t actually buy things directly with oil. The ability to dig money out of the ground means that the size of the money supply can change if somebody happens to find a new mine. When William Jennings Bryan famously said, in 1896, that farmers were being crucified on a cross of gold, he was arguing for a shift to the silver standard (i.e., to use silver as money) because the more plentiful supply of silver would mean an increased money supply and hence lower interest rates and easier credit terms.

These days most people would consider letting the money supply vary unpredictably would be a disaster for the economy. Currently the size of the money supply is more or less controlled by the central banks in each country, by setting key interest rates, by requiring banks to keep a fraction of their deposits available for withdrawal, and by selling and buying government bonds. The process is rather complicated and indirect, but in principle controlling the money supply permits the central bank to chart a course between serious inflation and serious recessions.

Gold was a good form of money in the much simpler economies of the past. Today, gold, while still valuable, is not and can not be money.