Tuesday, December 29, 2009

Gold and Economic Freedom

A friend recently remarked to me,

I am also not convinced that if there is a total meltdown like these guys predict that precious metals are going to be all that precious anymore. They become themselves a fiat currency, since gold is useless. It's merely a social convention that it's valued (along with being fungible and limited), and that can break down pretty easily. It's easier to believe people will be forced to barter in immediate necessities (e.g. food/water/guns/ammo).

I had to respond to the suggestion that precious metals might not be precious, even in some horrendous economic conditions. I agree, in a way it's a curious thing that people value gold and silver as much as they do, but it's also remarkable that they have valued them so much for so many thousands of years, in economies (Incas, for instance) that were so immeasurably worse than ours. Why this is so is interesting in itself. Some of it was discussed in Greenspan's essay "Gold and Economic Freedom" in "Capitalism, the Unknown Ideal". (I hate referring to Greenspan, but the points in the article are still valid, even if he betrayed his own ideals and everyone else much later.) So I answered:

Gold is far from useless -- many properties of gold make it valuable, even in a primitive society, but even more so in an advanced one:

  • malleability and ductility (it's easy to form into complex shapes, and easy to subdivide into very small quantities),
  • non-reactive, non-corrosive, and low immiscibility (if that's the right word) with many other elements, so it stays pure,
  • non-toxic (safe to handle),
  • doesn't oxidize easily (it won't corrode like iron or even silver does, so it retains its form in jewelry, coins and bullion over long periods of time),
  • very high density (it has one of the highest atomic numbers to occur naturally and very small quantities can represent large stores of value in other things),
  • high electrical conductivity (useful for engineering, but also for verifying the purity of gold),
  • easily electroplated (it can be deposited in atomically thin layers), not to mention
  • a highly desirable appearance that is created and maintained because of these properties.

Then throw in the historical and mythological value of gold to people -- it occurs throughout history. Subjective, perhaps, but not to be dismissed.

Then consider that someone can't just make gold in their basement -- alchemysts notwithstanding. (Only 161,000 tonnes of gold have been mined in human history -- a cube 67 feet on a side; compare that to all the iron ever produced!)

And last, all these properties make it extremely easy for someone to objectively determine if they are receiving pure gold and not some fake dubloons. It's impossible to devalue gold with fakes, and this offers tremendous protection against being defrauded. Putting aside reports of gold depositories storing fake bullion that no one can get access to to verify, it's extremely hard to make undetectable "slugs" or bullion filled with some heavier metal filling (a combination of two isotopes of tungsten have damn near the density of gold). Combined with a heavy gold plating, it might have a net density and exterior appearance of gold, but you can detect the fake. I looked into it at length a few months ago, not cause I wanted to go into that line of work, but to prove it couldn't be done. I found several completely reliable means of detecting pure gold. For one, electrical conductivity. There's simply no way to fake it, and the equipment to do so can be made in your garage. Magnetic properties exist, also.

Applications today abound in engineering (gold has long been used in many high-performance microchips), dentistry, etc., but even today most gold usage is in jewelry. I did some research awhile ago into gold pricing to figure out why the price wasn't moving very much and found that almost 60% of gold consumption was jewelry (see http://www.research.gold.org/supply_demand/ for instance), and most of the remainder was electronics and bullion, with relatively little into coins. That's one reason the high demand for coins today hasn't driven up the price of gold more than it has.

Back to the main point. As Greenspan discussed (and remember, Ayn Rand edited all those essays -- nothing got written without her agreement with the content), gold is invaluable even in a pre-industrial society as a form of money because it simply is incredibly difficult to conduct transactions on a barter basis alone.

Take an industrial example of barter, though. Imagine you're a big farmer with a lot of wheat and what you need desperately is gasoline to power your tractors, but the guy selling the gasoline has plenty of wheat already, and he doesn't want to expend the effort to find buyers of wheat, nor build facilities to store your wheat, nor bear the risk of having the wheat go moldy on him till he finds a buyer. (Maybe it's right after the wheat harvest and everyone and their cousin is selling wheat, but fall rains are a possibility.) But suppose you have some hard money -- great: for the guy selling gasoline, that's fungible and it saves him a lot of work and eliminates the risk of your transaction. But suppose the government is promoting paper currency while running xerox machines night and day. That paper may be rapidly diminishing in value (as today). The guy selling the gas has to make an estimate of the rate of decline in value of the paper money, including a generous margin of error in his own estimate. He ups the price of his gas to include the extra risk and the time value of money, till he can spend it himself.

But suppose you, the seller of wheat come to this guy with hard gold -- a form of currency that the government *can't* dilute and devalue. Your stature goes up with the gasoline seller, immensely. (Assuming he won't get thrown into prison because the government has made possesion of gold a capital offense.) You've suddenly eliminated the risk and time factors from his transactions. You get a big discount on your gasoline. Likewise, when you want to sell your wheat to the local grainery, how do you view the transaction if the grainery pays you in gold or in government fiat? I bet you offer a much better price for gold, especially if the economy sucks.

But what if the grainery offered you copper instead (maybe they're getting paid in copper wire stolen from the power lines around the country)? Copper is running around $3/lb today (http://www.metalprices.com/FreeSite/metals/cu/cu.asp). Gold, in contrast, is about $1100/troy ounce (14.6 troy ounce/lb), or $16,000 per pound. On top of that, gold is over twice as dense as copper (19.3g/cc vs 8.92 g/cc), so you can carry home almost twice the value of gold from your harvest ($35k/lb). Or twice the value back into town to pay for other farm supplies (like gasoline).

When you consider all these factors, it's just very, very unlikely (I would say impossible, barring the wiping out of 99.99% of the human race to scattered tribes of 20 people or less per tribe) for gold to lose its value, and for humans to rise to any higher level, they will need an objective form of currency which gold provides better than any other substance.

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