by Matt Scott on April 7, 2019
Is Gold Money?
Yes! Now, right off the bat you might well be thinking, “Gold is money? Really? Surely it’s a commodity rather than money?” Yes, gold is money and has been used as money for thousands of years.
But how can we actually define what is money and what makes gold an ideal form of money? Well, money is primarily defined as fulfilling three fundamental functions: it is a medium of exchange, a store of wealth and a unit of account. Gold functions in all three ways, and although it is no longer used to back the currencies of today, gold is still hugely important in the global economy.
The earliest usage of gold as money is known to have occurred in Lydia (modern day Turkey) where Lydian merchants used stamped pieces of mixed gold and silver as a means of exchange. This practice became widespread and ever more sophisticated down through the centuries as the Greeks, Romans and the kings of medieval Europe and elsewhere developed gold coinage. To this day, we still think of money as having the physical form of a coin or a banknote – the paper ‘bill’ was originally developed to solve the problem of carrying around heavy bags of gold, whilst in more modern times, coins were increasingly minted from alloys such as copper. These paper bills and alloy coins were tokens or substitutes for the real gold held in secure locations (banks).
The Gold Standard
It was not until the end of the Gold Standard under President Nixon that gold was unpegged from currency. Because the US dollar was the world’s reserve currency, the end of the gold-standard in the United States caused a global chain reaction that resulted in abandoning of gold backing for the vast majority of the world’s currencies. Today the dollar is a ‘fiat’ currency, like almost 200 other currencies worldwide which are backed by the governments who issued the currency, rather than by gold. Many of us have never known anything but fiat currency whether it be the dollar, the euro or the pound, and so gold as a monetary asset seems like a rather strange or outdated concept.
Even in the eyes of many of today’s economists, gold is of no more value to the monetary system other than as a traditional store of value. Investors too, view gold as just another commodity to be bought and sold on the commodities market rather than seeing the truth – that gold has all the essential functions of money.
Is Gold a Good Investment?
Okay, so not everyone will see the truth that gold is money. But is gold a good investment? Well, not according to one of the world’s most successful investors, Warren Buffett. His disdain for gold as an investment is based on his observation that, relative to other investments such as stocks or real estate, gold offers no attractive return; it produces no dividends and it cannot produce any substantial extra value.
Warren Buffett is right, of course! Investment in gold is not likely to yield any dramatic returns. An ounce of gold will always be an ounce of gold.
But in the world of investing, gold acts more like an insurance or a hedge against political or market crises such as deflation, inflation and currency devaluation. Gold, therefore, is a wealth preserver, not a wealth creator. Gold glitters in times of trouble and this is the fact that should be weighed up by would-be investors.
Gold a Store of Wealth
Today, gold being used as a store of wealth is evidenced all over the world. Central banks and governments store gold. Originally, they did this to support the ‘gold standard’ currencies, but today’s banks hold gold as a safe haven asset to be used in a time of crisis. This is because of gold’s incredible and almost unique ability to store wealth. Another advantage of storing gold is its liquidity: in other words, the ease with which it can be bought and sold on a regulated market while retaining its value. Again, this makes gold an insurance against the economic doomsday scenario. In the darkest economic crisis, gold gleams brighter and is more liquid than any other asset.
What does this all mean to us? Should we be looking to gold as a store of wealth, or even as a safe haven asset? Most investors rarely give gold much thought, but those who do recommend little more than 2-3% of personal wealth to be held in gold. ‘Gold bugs’ go further and recommend a minimum of 10% of a portfolio or personal wealth to be held in gold to provide some insurance against political or economic turmoil. With increasing tensions between the world’s economic superpowers, trade wars breaking out and a global recession an ever-growing possibility, maybe gold is something we all need to be taking a little more notice of.