>So what does this process of elemental elimination tell us about what makes a good currency? First off, it doesn't have to have any intrinsic value. A currency only has value because we, as a society, decide that it does. As we've seen, it also needs to be stable, portable and non-toxic. And it needs to be fairly rare - you might be surprised just how little gold there is in the world.
>The demand for gold can vary wildly - and with a fixed supply, that can lead to equally wild swings in its price. Most recently for example, the price has gone from $260 per troy ounce in 2001, to peak at $1,921.15 in September 2011, before falling back to $1,230 currently. That is hardly the behaviour of a stable store of value.
Basically describes what are and are not the problems with Bitcoin.
Purely for the sake of stability, I think it's a lot more useful to look at the classical economic indicators like the Consumer Price Index. Curiously enough, there is no gold found in any of the standard market baskets ... and since we are only looking at stability on a scale of 20-30 years, maybe there are some products that just happen to have a near-constant production effort. Cue the "cheapest possible child labor T-Shirt" global price index with derived currency.
> A currency only has value because we, as a society, decide that it does.
For some reason, many people believe that this is true. I believe that it is not.
Technically, yes, if people all decide the currency has value, then it will have value. But this is a ridiculous argument! How much is this currency supposed to be worth? According to this argument, any number is potentially valid! This means that there is absolutely nothing that should hold the value of the currency fixed, and with a few "no free lunch" arguments (anyone can claim any random thing has value and try to trade with it), we see that things with no intrinsic value should NOT have value.
So why does the US Dollar have value? It's just paper (cotton), right? Not true! If the exchange rate of the dollar decreases, you'll see the Federal Reserve will start trading some of its goodies from Fort Knox (gold, etc.) for US Dollars, in order to maintain the dollar's exchange rate/value.
So in reality, the US Dollar is backed by holdings that have intrinsic value.
EDIT: As pointed out, I should mention that another important backing of the USD is taxation.
Also, what I said about the Federal Reserve isn't technically true. What's important is that they have a mission to moderate the rate of inflation of the USD (i.e., maintain its value), and their asset holdings are critical in allowing them to do this.
I'm confused by the way you say something is "technically" true, then claim you believe it isn not true. Are you really saying that you believe things you know aren't true?
> How much is this currency supposed to be worth?
Whatever we agree it to be worth.
> According to this argument, any number is potentially valid!
Yep. And the value of US dollars, for example, has changed hugely.
> This means that there is absolutely nothing that should hold the value of the currency fixed
Accurate. Note the demise of fixed exchange rate regimes.
> Not true! If the exchange rate of the dollar decreases, you'll see the Federal Reserve will start trading some of its goodies from Fort Knox (gold, etc.) for US Dollars, in order to maintain the dollar's exchange rate/value.
That's not how the Federal Reserve works. Nor exchange rates. Nor US dollars. There's so many errors packed into that sentence, I'm not sure where to begin. There was a time when US dollars were backed by gold, including the gold in Fort Knox; this is no longer the case. And while the Fed does intervene in the markets from time to time, that's not how they do it. Further, the mere fact that interventions are necessary underscores just how arbitrary the valuation is. If, as you argue, USD were backed by gold, the aggregate value of all USD would be US gold reserves; no intervention would be possible, and selling gold reserves would actually lower the value of the dollar. Think about the implications of your argument.
Yes, what I described is not actually how the Federal Reserve works. I was trying to give the essence of what it does in a single sentence.
The USD is not literally backed by gold, but part of the Federal Reserve's mission is to moderate the rate of inflation; that means holding the value of the USD steady. And the way they do it is beyond the scope of this discussion, but it certainly depends on the Federal Reserve trading its holdings on the market (which, as you point out, is mainly debt (in terms of USD), not gold).
You write as if the Federal Reserve is like a benevolent uncle, just doing its best for us, all of us, so we may live long and prosper!
The Federal Reserve is a privately owned entity, it has its stash of gold in New York and the actual government has its smaller stash of gold in Fort Knox.
Let's say that Apple sees the price of its stock drop to something that it thinks is unreasonably low. They may choose to spend some of their cash on hand to buy back some of their stock. This is a wise investment that shareholders would applaud - Apple is getting a good deal.
Same deal with the Federal Reserve. Federal Reserve notes are nominally liabilities for the Fed, and are much like the concept of Apple stock. If the Fed notices the price of the dollar drops, it's in their best interest to trade some of their holdings to buy back some dollars.
> How much is this currency supposed to be worth? According to this argument, any number is potentially valid!
Well, I guess the number is whatever supply-and-demand should happen to say that day. Mostly that'll mean asking "how much do people want gold today?" because the supply is relatively inelastic.
That said, fluctuations in the supply of gold and the price of gold would in fact be catastrophic if the price of gold radically changed. See also: the impact of gold rushes on the US economy (tip: it was inflationary). See also: Bimetallism, William Jennings Bryant, "you shall not crucify mankind upon a cross of gold!"
> If the exchange rate of the dollar decreases, you'll see the Federal Reserve will start trading some of its goodies from Fort Knox (gold, etc.) for US Dollars, in order to maintain the dollar's exchange rate/value.
... No? Wrong? Lies? What the Federal Reserve does is buy and sell federal debt, creating and destroying dollars such that the supply of dollars matches the demand for dollars and prices are consistent. You could say the dollar is loosely pegged to the value of the consumer bundle, maybe. (See also: http://bls.gov for CPI information.)
The US is trillions of dollars in debt. The gold holdings in Fort Knox are a few hundred billion at most. You can't prop the dollar up with gold if there's a major economic boo-boo - the value just isn't there to offset such massive deficiencies. When they tried exchanging dollars for gold under the BW system they started to run out of gold.
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If anything's propping up the American Dollar, I suspect a far more likely culprit would be that OPEC primarily uses dollars - creating a demand for dollars in the international exchange markets.
Spot on. Every single month there is a drop in Indian Rupee value when oil importers sell rupees to buy dollars. It's possibly one of the main things that drives rupee value down and dollar value up. We had managed to reach a deal with Iran to buy oil in rupees but it's started happening only recently and in small percentages.
China's Yuan peg is doing more to prop up the dollar's value than anything else. To maintain their low exchange rate which makes their exports relatively cheaper, they have to continually buy dollars with yuan.
The more important backing of the USD is the fact that the US federal and state governments demand that you pay your taxes in USD.
The (exchange) value of anything depends on supply and demand. Demand for USD comes from many places, but most of those are based on circular reasoning: Employees want to be paid in USD because they need USD for their shopping, the shops want to be paid in USD because they need USD to pay their employees.
Taxations is the only entirely non-circular source of demand.
(Bank loans are a secondary somewhat non-circular source of demand for USD, and that explains why bank loans can increase the amount of money in circulation without increasing inflation.)
I pretty much agree - taxation could be the only non-circular source of demand for the USD. But there is also the fact that the Federal Reserve generates demand by offering to buy USDs for other things when the exchange rate of the USD gets low.
If taxation were the only form of backing, things would be a little more strange. The currency could work, but taxes would have to be defined differently. Somewhere in the tax rules, there would have to be some statement that pins the value of the USD.
You only really have that problem when you want to start with a currency out of nothing. In that context, it might be interesting to study Hut Taxes: http://en.wikipedia.org/wiki/Hut_tax
It is a fascinating problem though, because the price level is really just an arbitrary number when you look at it from a global perspective: If all price tags were removed from everything, an alien observer would have no way of telling it.
This makes a lot of people very uncomfortable, and I suspect that is what underlies a lot of the ultimately romantic desire to tie currency to something "real".
Presumably you'd control the value of currency through the same channels as under the existing system: indirectly by influencing interest rates, and instead of doing it by the Fed buying and selling bonds, you'd do it by imposing a new variable tax on leverage created by the banking system. It would be painful to adjust to (the base interest rate would be a direct cost rather than an opportunity cost, making banks' margins thinner) but ultimately work in a similar manner to the existing system.
You have that backwards: creditors can take possession of debtors' property if the debtors fail to repay (in terms of fiat currency). Basically, whatever currency the courts deal in will be the preferred currency of creditors, and by extension of debtors.
No, if I borrow your car (as a loan, with 100% interest) and refuse to pay it back, the court can seize the one car car, or order me to pay restitution in dollars. If I offer the dollars, it can't compel me to produce another car or give you a piece of my house instead.
"If I offer the dollars, it can't compel me to produce another car or give you a piece of my house instead."
Sure, but if you cannot (or simply do not) pay your creditors with dollars, the courts can give them a (figurative) piece of your house/car/computer/etc.:
Yes, figurative. A lien is an attachment, payable in DOLLARS when the encumbered item is sold.
Siezing property happens as a last resort, but doesn't undermine the fact that a debtor can ALWAYS choose to settle a debt in dollars, and can NEVER compel the lender to accept payback in gold or BTC or potatoes.
The other comment is not quite right. Suppose I break your iPad without permission. This creates a debt for the cost of replacing it and the incidental losses arising from its absence. If I offer the appropriate number of dollars in repayment, the debt is cancelled, even if the payment is refused.
Our currency has not been pinned to gold for 40 years (when the Bretton Woods system collapse), but the Federal Reserve still maintains the holdings.
Before the Bretton Woods system collapsed, the US government was required to allow large entities to exchange their USDs for gold. Now, it isn't required to. But the fact that the Federal Reserve holds the gold, and that it is well known that they would use it to support the value of the USD, helps maintain the value of the USD.
Money is money because people believe it is money.
Right now, you can turn in a $20 for food and booze and whatever. I'll believe that's money. And if people don't have a reason to stop believing, it'll continue to be money.
The whole "money has value because people believe in it" thing isn't exactly correct. Money has value because somewhere along the line, someone accepted US dollars for something valueable to them. If you're hungry, you value food. When you produce food and allow someone to pay you in US dollars, you've injected value in to the US dollar. The dollars you hold are an abstract representation of the value you provided that you can then exchange for something else of value in the future. The US dollar is a means of accounting.
The term "has value" is used loosely when it comes to currency. It's true that the currency itself is valueless outside the context of trade, but most modern economic theory is predicated on the axiom that this is OK.
Think of it in math terms. Arabic numerals are a means of specifying quantity.
* * * * *
How many asterisks are there? There are 5. The numeral 5 describes the quantity. The number 5 is not literally five asterisks. It only describes the quantity. The same is true of modern currency. $3.50 is not literally a gallon of milk, it merely represents the economic quantity of milk. If I agree to sell you milk for dollars, I'm adding value to the dollar.
When viewed in this way, something else becomes clear. One of the basic values of currency is trust, not "intrinsic value" (which is a euphemism for intrinsic utility). When I add value to the dollar by exchaning valuable goods or services for dollars, I trust that everyone will play by the rules. Specifically, I'm trusting that the value of my trade will be preserved over the term that I hold the dollars.
That's actually backwards. Money has value because somewhere DOWN THE LINE someone anticipates turning those dollars into something valuable to them. As such they accept it in the stead of that valuable thing.
Actually, that pricing behavior sounds a lot like bitcoin. The evidence is adding up that deflationary crypto-currency can behave a lot like bullion currency, and perhaps help us usher in a new sort of Bretton-Woods system to finally get the financial sector back under control.
Mostly the consistent long-term rise in value punctuated by periodic panics that send prices crashing. As I understand, it was characteristic of bullion economies to behave that way.
> Most recently for example, the price has gone from $260 per troy ounce in 2001, to peak at $1,921.15 in September 2011, before falling back to $1,230 currently. That is hardly the behaviour of a stable store of value.
Is it gold, or the dollar that's exhibiting that behavior?
Gold. The dollar's been mostly at 1-2% inflation through that time period, reaching a high of 5-6% (I think? from memory here) for a year or two during the peak of the housing bubble.
Gold had a huge ramp-up in value after the housing bubble burst, due to people panicking that the dollar would lose value. There were a lot of people with a vested interest in hyping the idea to sell gold, as well.
The dollar's been very stable compared to other currencies or compared to baskets of dollar-denominated goods other than gold.
"Chemically, it is uninteresting - it barely reacts with any other element."
What a bad start, this is chemically very interesting... :)
The whole article comes across this way to me, it starts from a bad hypothesis and then continues to make baseless assumptions until it reaches its desired conclusion. :/
It explains a load of reasons exactly why gold has value, then claims that this is not intrinsic?
Interesting read though... I do enjoy that we have abandoned gold and silver standards, although knowing this does make me wonder why our leaders are so terrible at managing the economy. We made it easy for ourselves, and now we have politicians selling us the idea that its complicated to fix...
Gold's market price is completely disconnected from its simple "intrinsic" value. How much gold would you buy if you were never allowed to sell or trade it? Maybe a pair of earrings? If you own more gold then the amount you answered, you effectively believe that gold is worth more then its "intrinsic" value (for example, you could believe it has value as a medium of exchange or a store of value).
maybe i just don't know what i'm talking about, but i feel there is a disconnect, but its not clean - its because of the intrinsic value that it is such a 'tradeable' thing.
the prices of many things are driven by supply and demand, and i'm not going to disagree with that, but the article gives far too much weight to that side of it imo and poisons me against it with sloppy wording.
without the intrinsic value there would be no demand...
its not like, e.g. bank notes, EPNS or copper coins, whose value is almost entirely due to trading and very nearly completely disconnected from their intrinsic value. even then they inherit some of their value from their durability and utility in that arena...
tbh, i've only ever bought gold for cosmetic reasons... i know very well that gold contacts and radiators are generally a sales gimmick rather than beneficial.
"Most recently for example, the price has gone from $260 per troy ounce in 2001, to peak at $1,921.15 in September 2011, before falling back to $1,230 currently. That is hardly the behaviour of a stable store of value."
There are many who believe gold is somewhat of a proxy to the probability that at some point there will be complete lack of faith in fiat currencies (combined with the belief that it will be an acceptable substitute in such an eventuality). If that is the case, the price volatility of gold has in fact a lot to say about the viability of fiat currencies as a stable store of value.
Yeah, that statement suffers from an unquestioned assumption that dollars are the definitive, correct measure of value. It takes two to make a currency pair and if you were to look through the lens the other way it would seem like the dollar that is wildly swinging about in value, not gold.
I like the word 'value' as a signifier of what a person or people desire and ascribe worth to; both gold and fiat currencies attempt to measure this, and neither is perfect. I wish people would be more dilligent at keeping these concepts seperate, but y'know, rhetoric.
(See also the idea that GDP - which of course exists completely in fiat currency terms as a gross numerical figure - has its flaws as a measure of what humans actually value: http://www.globalexchange.org/resources/econ101/gdp )
In evolutionary biology and anthropology "Everything is the way it is because it got that way".)
Gold was cross-culturally "evolved" (due to ancient trade and customs) to be recognized as a precious metal suitable for garments, wealth storage and, consequently, payments for no other reasons but being good enough.
Currently I'm studying accountancy, so the concept of monetary value has suddenly become important to me. I had pondered it in the past, but not to a great extent.
A currency only has value because we, as a society, decide that it does. As we've seen, it also needs to be stable, portable and non-toxic. The second sentence contradicts the first. Portability is very important to the effectiveness of a currency, especially in times past when our modern communication methods did not exist. Currency represents an agreement as well as a quantitative value. The ten pound note currently in my wallet is a liability that the Bank of England owes to me when demanded. This is far more convenient than having to call up the Bank of England and demand a portion of their liability every time I go and buy a pack of ciggies (another viable currency, if you are presently incarcerated).
A similar argument applies to another whole class of elements, the radioactive ones: you don't want your cash to give you cancer. Regarding Uranium 238, this has a very long half life (roughly the same as the age of the Earth) and it is an alpha-emitter. Radioactive effects of alpha-emitters are usually only toxic if ingested or inhaled, whereas a strong beta-emitter can burn your skin in sufficient amounts. The chemical toxicity of Uranium is a far more serious issue. If the potential radio-currency is highly radioactive, it would lose its value very quickly. Of the four main decay series, three result in lead.
I'm reading that very same ten pound note. On the side which bears the image of Queen Elizabeth II, it says:
Bank of England
I promise to pay the bearer on demand the sum of TEN Pounds
Regarding what is returned...
Whatever I buy with the ten pounds is what I get in return from the seller. When I pass the ten pound note over, the Bank of England now has liability towards the seller, not myself.
Sure, because people don't buy and sell things with gold, they buy and sell things with modern currencies. They do so because well-established legal frameworks ensure future demand for the currency to pay taxes and meet debt obligations, and also keep the supply in line with demand.
Sure, Bitcoins are similar to gold in being relatively, rare, but so are tulip bulbs. What matters isn't the restriction in the supply, but the sustainability of the demand.
Gold sustained its demand over millenia not just because it was rare, but because people needed gold to meet future tax and debt-repayment obligations, or to purchase things from foreign lands. The number of people needing to receive BTC-denominated income in future, on the other hand, is negligible; virtually anyone [considering] providing real goods or services in BTC can cease to transact in BTC at any point they have doubts about its future value or liquidity.
> Nixon made his decision for the simple reason that the US was running out of the necessary gold to back all the dollars it had printed.
That's the whole problem right there. The ~~counterfeiting~~ quantitive easing is simply too attractive to the congresscritters to allow a little honesty to get in the way.
Economics is not a morality play, and connecting money to gold has nothing whatsoever to do with honesty.
Look, the most important point of money is to facilitate economic exchange. Yes, rentiers want to store their savings somehow, but there's a reason that the word rentier has negative connotations.
Facilitating economic exchange requires that the amount of money correlates with the size of the economy. Fiat currency can do that (thanks to bank loans, which can shrink and expand based on endogenous demand from the economy), and gold-based currency cannot do that. It's really as simple as that.
Being a rentier means having income without working. Traditionally, this was because you inherited wealth, e.g. in the form of land.
Most people's sense of distributive justice has some aspects of desert theory, i.e. people tend to believe the economic distribution should align with what people deserve, where the latter is typically defined via what their contribution to the economy is.
From that perspective, rentiers have undeserved income, hence the negative connotations.
An interesting, mildly related tidbit is that certain types of seashells were used as currency in large parts of the world until about 150 years ago. [0] Probably occupying a similar sweet-spot: rare but not too rare and robust. An additional feature (or bug) would have been the inherent quantization.
The argument for why a medium of exchange (a currency) needs to be transportable and relatively nondestructible goes all the way back to Aristotle, in the West. (Similar arguments about silver surely must have appeared in Chinese culture, long ago.) I'm sorry not to follow my usual practice of providing references here, but I guess I think it is drop-dead obvious that not all features that give something value necessarily make that thing a convenient medium of exchange for trade.
The particular argument in the article kindly submitted here (well worth a read, even if you have read all the comments here) takes a good look at the properties of gold as contrasted with other chemical elements, and points out what features gold (and silver) have that most other elements do not share.
Interesting article. The article claims that gold has no intrinsic value. I may be wrong, but I can't think of any entity that has intrinsic value, or, "value in and of itself." On the other hand, I can think of countless things that have value in relation to other things, such as, a loaf of bread and a hungry man.
Could it be that gold makes a good currency, and a good currency makes trading easier, and people value the ability to trade with one another, and therefore, gold has value?
How so ? Gold isn't just a currency/exchange medium, it's a valuable material on its own in many ways. Neither bitcoins nor dollars are, they're not commodities turned currencies, they were always meant to be currencies and nothing else.
Let's say you want to go buy a loaf of bread. How do you pay for it with knowledge of energy sources? I'm quite sure the cashier would be quite tired after performing the 300th viva of the day.
Some people do trade knowledge of energy sources for stuff, using money as an intermediate store of value, but most people cannot, and it wouldn't be desirable either otherwise we wouldn't have a varied and healthy economy.
By own material value do you mean for electronics, and thus for us now ? But what about centuries ago ?
Someone suggested me that gold doesn't rust and that stability was interesting as a long time token. But I don't find any usage beside the social status gem.
It works particularly well as a social status gem, because it's at the same time malleable (ie. easy to work with), shiny-looking, and not easily corroded. It's relatively easy to authenticate (compared to a bitcoin for example), and seriously hard to fake (unlike, say, a dollar).
Anyway the point wasn't the merits of gold over currencies, just pointing out the fact that it has a real status as a useful commodity, in a way that purpose-built currency doesn't. That means, among other things, that demand for jwelery in India for example, or changes in electronics manufacturing processes are bound to affect its price.
That makes it quite different from other currencies.
I bet a significant number of comments here are by people who do not especially value gold. I personally don't care for jewelry and don't have the giant piles of money needed to make gold a useful hedge, so I basically own whatever gold is in my electronics and such.
Nearly 20,000 years ago a man said said, "we have to stop trading seashells, they are to plentiful, people just go get more of them, and they break"
"Fine what do you propose we use?"
"Have you seen this shiny yellow stuff? You can form it with heat and it stays shiny forever."
"That Gold stuff? yeah It is pretty. I like Pretty things. But there isn't that much of it, and it is hard to find."
"Yes, that way we can control how much of it there is, so it will have value. No one will be able to just wander down to the ocean and pick up more. And we'll make different sizes of it so that we know how much each is worth"
This is why we use Gold. Because it was the first metal we could work with, it is scarce enough, and requires enough skill that only certain people (usually a government) can issue coins of it. You can still trade the raw stuff, but to fewer people and with out the trust of the minter you get a lower price for it.
>The demand for gold can vary wildly - and with a fixed supply, that can lead to equally wild swings in its price. Most recently for example, the price has gone from $260 per troy ounce in 2001, to peak at $1,921.15 in September 2011, before falling back to $1,230 currently. That is hardly the behaviour of a stable store of value.
Basically describes what are and are not the problems with Bitcoin.