Money Basics: gold is not just Gold But it is GOLD

We are a race of Rose Lovers. We give roses when we want to express some positive emotion and this association has made roses valuable. We use grass for feeding our pets which we consider inferiors and so grass is less valuable. But leave us, the humans, and nothing is more valuable than the other. Things are JUST IS….Life is infact isness and we learn the first truth of our life that we make the things valuable as per our associations of those with our life. Individually everything exists on its own. So Roses are Red only for us. Hence this valuation is not linked with the individuality of a thing but to relevancy of that thing to us.

First humans feared fire…it was a sign of destruction for them. But one day they realized that they could cook with it….it could light….and at once Fire was being worshipped…it became valuable for us. We are still confused about the value of God/Religion in our life; whether it is for bringing happiness and worldly comforts or it is about Someone/Something which knows about my origin, my purpose of existence…and our fights over these make the value concept more complex.

But it is not just Religion where value concept is complex. There are many other things which are valuable but we are confused about the nature of valuation. Just like our Gold. We are mad for this and it sits atop among the most valuables of our life. But ask anybody about the reason of its valuation and we will hear nothing concrete. 

It is called the store of wealth….it can store value…so it is an investment vehicle. The purporters of this view take Gold as an investment option where people can park their money and safeguard the same. They don’t see any other significant function of Gold. Here demand for Gold is because of something like Networking effects (I have explained the Networking effects in the post related to ecommerce business valuation, click Here ) where people value Gold highly because it is valued so highly by others. I am after it as whole world is after it. Then there are others who see Gold as worthy of satisfying our needs like luxury, jewelry and industrial. But again why we take Gold as worthy of parking our savings? What is making it so valuable? Networking effects!!

So Gold is faced with two faced anomaly…Whether Gold is an Investment vehicle or whether it behaves like a commodity?? Commodity is something which can satisfy some needs of ours like Clothes, food, fuel etc. Whether Luxury/Jewelry are those needs? But these functions are derived due to associated high value of Gold which makes it desirable. So question about high value of Gold still shines.

Money is a great Commodity created by Humans

To answer this, we need to walk along with first humans…our origin. Humans in those times were just living for foods…so I was just wandering whole day in the thick forests for food…there was nothing else in our life. But one day, I met a person in forest who was peeling a coconut with a stone tool and at once that humble stone became valuable for me. To get the stone, I offered him 10 apples…but he declined my offer. I revised my offer to 10 fish (as fish are much difficult to catch, hence more valuable) and stone was in my hand. So there we were, first trade of human history happened. Humans then realized that they could exchange things among them and live a much richer life. We call this system Barter. It is still present in so many of tribes. 

But as our population and number of products grow…this trade via Barter became increasingly difficult. I am having Eggs which is not required by X who is having shoe. Shoe is required by Y who is having Wheat which is required by me. But unless we three meet at one place, this cross trade will not happen. Also there were times when quantities of exchangeable goods are not comparable like trading a wooden bed for Milk. Like a teacher, for him to get milk he needs to find a milkman who is ready for exchanging milk for some teaching lessons!! Very difficult indeed. 

So humans were looking for some neutral commodity which was required by everybody and could act as a clearing vehicle. So they tried so many things as mean of exchange like Salt, Black pepper, Rice, Sugar, Butter etc. Like Butter, it is demanded by everybody so it is more marketable. So if there is something about which everybody is sure that it will be more readily sold…then there will be greater demand for the same as it can act as medium of exchange. But these things suffered from some limitations which made them to look out for something better…..and then they found GOLD. Gold solved the search for Money. 

Money is the most important invention of the humanity as only due to this that large scale trade was made possible which promoted the production of new things and humanity grew along with. Money was a Commodity the function of which was to facilitate exchange of things. Other commodities could be expressed in terms of money and so could be traded easily. This Money commodity was the creation of Humans unlike other natural commodities which were either a part of earth or derived from other commodities. I think this invention of Money should stand among the most valuable inventions of humanity like Fire, wheel etc. Money was the single most thing which transformed the humanity from barter to easy trade. So money is a commodity which satisfies our needs of facilitation of exchange and trade. It is not a store of wealth but something which can be used for trade of wealth.

Gold is the best medium of Exchange: The Money

 The things humans tried before Gold as mean of exchange or Money had some great limitations like they were perishable. Over time Rice, sugar, Butter etc. would degrade and loose most of their identity and value and so ceased to be a commodity. There were also problems of easy availability and easy supply which can be increased at ease any time. These were not portable either like for buying something in big quantity or valuable we needed to carry a big quantity of these might be in thousands of KG’s. So we were in search for something which is best suited for use as money. How can a carpenter exchange a big bed made by him for meeting his requirements of Food, cloth and Milk? As he is having one large item to trade with a number of persons all having different items of his need. Gold was having all the necessary qualities.

1)      Not easily available: It is not easy to produce Gold and this is the quality which makes Gold as best suited for money. Money should not be easy to produce. Like one can increase the supply of Rice very easily which can raise the inflation and relative prices will vary frequently. But it is very difficult to produce Gold…requires a lot of effort and investments…even then the chances of getting the Gold are not guaranteed. The quantity of money should not be increased at will. In fact most of the easily mineable sources of Gold is already exhausted and it is getting increasingly difficult to mine more Gold every year.

2)      Durable: Almost 99% of Gold which is ever mined (around 180000 Metric tons) by Humanity is still lying above earth because Gold is one of the most durable elements which can withstand the vagaries of environment and time very well. Gold is the most non-reactive of all metals and it never reacts with oxygen which makes it corrosion free.

3)      Portable: Gold can be reduced to small sizes even up to micron levels. It makes it possible to trade it for small value items to most valuable of items. It is very easy to carry Gold for trade. It does not require any special storage. However silver was mainly used for small value exchanges and gold for much expensive trades.

4)      Some other reasons like production of Gold is not dependent upon the variables like rain, drought in case of Sugar etc. Gold is not required for human consumption so there is no dilemma whether to keep it for money or used for human consumption like sugar, butter. Also producers of Gold will not run for overproduction as more production than required will decrease the value of Gold and its exchange value.

So as we can see Gold derives its value for its being best suited as Money. As it is fulfilling its function as money so it is desired as money to use it for trade and commerce; the building blocks of our society and growth. Gold is valuable and unique because of its being capable of performing the role of money. So we know now that Gold is demanded and behaves as a commodity.

So Gold was our not first but best money. But this invention was not a sudden decision but a slow gradual process wherein humans understood the working of a market place, the difficulties faced by them in clearing of trades due to not so good Moneys. These difficulties made them aware about looking for things which could eliminate the limitations of other Moneys….and in their quest they finally found the Gold.

Gold Standard

Slowly Gold was replaced by Government backed Currency notes. These currency notes were nothing but a depositary certificate of Gold. Every note could be redeemed for a promised fixed amount of Gold. So still Gold was the real currency or money of the world (I will explain this shift from Gold to currency note in another post, I am leaving it here due to length of this post). The first truly global reserve currency was the British pound sterling. The world’s great trading nations settled their trade in gold, but they might accept pounds rather than gold, with the confidence that the Bank of England would hand over the gold at a fixed exchange rate upon presentment. But by the end of World War II, the US dollar was given this status by treaty following the Bretton Woods Agreement. As per this, 35 US dollar could be exchanged for an ounce of gold.

But later on during the Vietnam War era, USA did not honor their commitments for maintaining a fixed dollar gold ratio. USA printed big quantity of dollars to finance its wars and over consumption. USA increased the supply of Dollars much more than the increase in the production of goods and services, and along with, it consumed much more than its needs. So USA consumed too much, local and foreign goods which severely impacted its balance of trade with other countries. Actually these things are still happening as Governments all over the world have wrong economic notion regarding stimulating the economy by deficit spending and easy credit. These measures just drag the future consumption into present and severely hamper the savings in the economy which are the main building block of future growth.  

 Hence the volume of outstanding dollars exceeded the US’s store of gold at $35 per ounce. Countries around the world who were happily holding dollars in place of gold became concerned about the Fed’s ability to redeem their Dollar Gold exchange commitment. So they started redeeming their dollar reserves with Gold from USA and USA found that Gold reserves had shrunk to 8000 MT in 1970 from 20000 MT in 1958. USA did devaluation of dollar twice in that period and then finally USA scrapped the Gold standard in 1971 and Dollar was no longer backed by any sort of Gold. However Dollar is still global reserve currency and it is still preferred by global nations to settle their international trade.

Price of Gold

So Gold is no longer the global currency but it’s characteristic of best suited money still contribute most to its current price. Scrapping of Gold standard by every nation resulted in huge supply of currency money created often by governments to fund their wasteful expeditions of wars or political milestones through subsidies. One can imagine the real price of gold if we divide the total gold by all printed money…it can be 20 times of the current although I haven’t made any analysis of this.

But Gold is still hold by Governments across the world as they know that it is the real money which is acceptable to all. Actually so much money has been printed and created that everybody is running on the edge of sword which can cut with a small misbalancing force. If something like that will happen than Gold will still remain the last trusted commodity to carry out the exchange function.

But Gold or money is not an investment vehicle or store of value as widely believed. People use their money or savings to buy gold as it is much more widely accepted and marketable than anything else in the world. So this store of value function is an outcome of one great function; the medium of exchange. If we limit ourselves to present times and to Gold then Gold should be accumulated only because it is the safest money not for returns. Price of Gold doesn’t increase due to improved performance like in the case of stocks where demand rises due to better show in the economic results or real estate where prices rise due to better economic growth and demand for real estate. 

So price of Gold rises because of natural demand supply function. In fact all prices are a function of demand supply equation. Price of something is a constant flow which is forced by the forces of demand and supply. Same thing is true for Gold also….its price rises when widespread fears about global economy force people to park their money in Gold. Its price falls when people are optimistic and looking for better investing avenues like stocks and so they take out the money from Gold and price falls due to low demand. 

But it should not be the case with Gold. Value of something is relative to our association and satisfaction of needs but price is not related to Value at all…it is just an outcome of Demand-Supply equation. Just like water which is valuable but priced low due to perceived demand supply interplay. But if you are trapped in a hot humid desert, you can give anything for a bottle of water….but make no mistake here again the price is related to demand supply not to inherent value. 

So Gold is just like water; very valuable as a commodity but priced very less due to demand supply forces which are taking it just as an investment vehicle. However Gold is like an insurance policy. It saves and preserves the value of our money (paper money). 

Like during great depression of 1930, People lost their life savings as the value of money plummeted due to excessive printing of paper currency by governments. The situation was such that it was easy to burn dollars for heat than buying a log of wood. Many retired persons lost their savings of life. Hyperinflation wiped out most people's savings, turning wealthy citizens into poor ones literally overnight, those who had gold experienced no loss in purchasing power. In Germany, In January 1919, one ounce of gold traded for 170 marks; by November 1923, that same ounce was worth 87 trillion marks!!!

In those times, Inflation, due to excessive printing of money and loss of faith by people in the paper currency, began to grow rapidly, and quickly became a monster. What's important to us as investors is that the price of gold grew faster than the rate of monetary inflation. The data reveal that over this five-year period, the gold price increased 1.8 times more than the inflation rate.

So I am always a believer of Gold. 

I have promised readers of this blog to post a study about currency wars. So I have written this post as a first step in that direction as the knowledge about money is the first enlightenment that will make us understand the complexities of currency wars.

This MONEY has brought great revolution in our life…we took a quantum jump towards growth and prosperity. The situation here is such that the food i am eating, the clothes I am wearing…these were not even available to Lord Krishna. My life is full of comforts. But for Lord Growth is when you don’t FEAR, when you yearn for your true self, when BRAVERY outshines the Gold, when you have tears for others. And these are the things which can never be EXCHANGED or TRADED.