This post began in my head, and ended up as a comment war between myself (a naysayer) and one of the main bloggers at mises.co.za (a yaysayer). @CausticPop and I don’t have these arguments very often – but when we do, I’m always sad that most readers don’t get to read them. Because some of the points that come up are awesome.

So I’ve copied and pasted the comments into a post, with Gareth’s permission. Confession: I’ve also exercised blogger privilege by letting myself have the last word.

But regardless, I think Gareth’s points are valid. The key difference comes down to a question of premise. On the one hand, you can argue that a medium of exchange has value in and of itself (its value comes from being the one commodity that can perform that function). On the other, you can argue that the medium of exchange derives its value from being a common item of use. For example, some of the earliest forms of money would be bushels of grain, which everyone would need at some point to make bread.

Some background: my original post on gold can be read here. And the basic summary of my view: gold has very few practical uses (mostly decorative); so I’ve never quite seen why everyone is so attached to it. It’s just metal, after all. And not a particularly useful one at that.

Cue: the argument. And it’s about 2000 words – so don’t start reading this unless you have a few minutes to spare.

Gareth:

Hi Jayson,

Your old gold post is interesting, although it’s notable that you leave out gold’s most prodigious use, which may go some way to explaining why there’s still such demand to hold it after all these thousands of years: as a medium of exchange.

I agree that, in terms of yield, oil is a preferential investment in the present time. Unfortunately the bulk of people on this planet are not commodity traders, do not have access to the means of trading such a commodity on the open market and would find the prospect of owning and storing physical oil rather arduous and risky. The physical characteristics of a commodity can engender certain preferences, after all?

Our noble governments already heavily impede the ability for small-scale investors to diversify out of their paper money, even if you just want to keep another country’s paper! Thankfully, there’re scarce commodities that can facilitate, as you say, a store of value. Given the present time of such low interest rates, concerning future inflationary ramifications of monetary policies and tremendous amounts of interventionism and regime uncertainty, holding such assets should hardly be controversial, no?

Jayson:

If I were to venture a reply, I would quote this part of your response:

“Unfortunately the bulk of people on this planet are not commodity traders, do not have access to the means of trading such a commodity on the open market and would find the prospect of owning and storing physical oil rather arduous and risky.”

And replace “physical oil” with “physical gold”.

At which point, I would go on to agree with the entrepreneurial ability of markets when it comes to finding a medium of exchange when the paper currency fails. And I’d highlight the most recent Zimbabwean example: where no one suddenly started running around with pockets full of gold. When the currency failed, Zimbabweans transacted in fuel coupons. They paid salaries in fuel coupons. There was food purchasing with fuel coupons.

The market found a medium of exchange. And it didn’t just have value: it had value in use.

Gareth:

Provided there was a reliable supply of fuel, that people expected its value to be maintained or rise (for whatever reason) and the issuer of the coupon could be trusted to redeem the coupon, then what we have is a decent a commodity-backed medium of exchange. I heartily support that, and wish such a market process could be left to produce varying competing sources of exchange media, a la Hayekian “denationalization” of money.

However, in the quoted paragraph, I’m not talking in the context of a very esoteric situation, like a post-hyperinflation. People in Zimbabwe adapted that way because they had to, their expectations had to change. The government had destroyed the credibility of its fiat paper, so people changed. But this is happening in slow-motion all over the world. Think of yourself as an individual, to try to preserve the purchasing power you’ve accrued, would you choose to try and stockpile oil, or would you consider other alternatives? That’s my point.

Jayson:

But the point is that the situation is not esoteric. It demonstrates a practical response to currency destruction. In other words, regardless of the commodity-backed medium of exchange created, they didn’t move to gold as that commodity (where they could have – and which is the underlying assumption of using gold as an inflation hedge).

If I wanted to preserve purchasing power, I would look for productive assets. Not a metal arbitrarily selected by history that only has value because we say that it has value. If you’re going to be long-term, then you can ignore short-term fluctuations in stock markets. I would buy food producers and fuel suppliers and/or indices linked to those sectors. Those are alternatives that have value in the “esoteric” scenarios that we’re hedging against. People must eat. Food must get to them. And gold is not in that equation…

I’m really just questioning the logic behind gold. We just take it as logical. But is it really though?

Gareth:

“regardless of the commodity-backed medium of exchange created, they didn’t move to gold as that commodity”

Evidence of absence is absence of evidence! But I digress. You don’t think there’s a teensy bit more to the story as to why that happened? Do you perhaps know what the exchange rate was in fuel coupons relative to an ounce of gold?

“only has value because we say that it has value”

Dunno about you, but I think all value’s subjective so this is a non-issue.

“If you’re going to be long-term”

And then you talk about stocks. Which have plenty of risks, including the kinds not usually pondered by investors such as whether or not there’ll even be an economy around in the future, whether you’ll be able to liquidate when you like, the presence of a non-insane government etc. There’s also the small matter of your “ownership” of them, or rather how that’s reliant on multiple factors remaining constant too (my family,vacating Zimbabwe, lost all the equity they owned. Great nominal gains in a hyperinflation, but not so great when the time comes to “cash out”).

Also, didn’t you recently do a post about how the average stock is held for like 9 months now? Surely not a broad endorsement of going ultra-long stocks then?

“If I wanted to preserve purchasing power, I would look for productive assets”

Sure. I know that’s Warren Buffet’s line, but again there are all sorts of risks and constraints on owning such assets that are typically out the reach of ordinary people (and I’ll concede government intervention has a lot to do with this, so your paradigm is not entirely at fault).

However, Is it really ideal for each individual to have to roll the dice in the stock market just to maintain purchasing power? I know it’s perfectly possible, but is it ideal when there’re alternatives that work idly?

“People must eat. Food must get to them. And gold is not in that equation…”

And is money in that equation? Is exchange? Is trade? C’mon Jayson, don’t be obtuse for the sake of it.

“I’m really just questioning the logic behind gold. We just take it as logical. But is it really though?”

I’ll hark back to “value is subjective”. I also think there’re plenty of qualities and characteristics about gold that make it an ideal medium of exchange and, thus, a good means of preserving purchasing power. Plenty of other people do too. So long as that’s the case, it will hold its “value”. As is the case with everything.

Jayson:

You don’t think there’s a teensy bit more to the story as to why that happened?

Absolutely: the story is that gold was impractical, as well as the fact that we are now multiple generations away from a time when there was a gold standard. The concept is foreign. And this is part of my point: that without the historical association of gold with value, there is no natural logical leap to its use as a medium of exchange. And even if you could argue that there is a logical leap – there is no practical leap.

And then you talk about stocks. Which have plenty of risks, including the kinds not usually pondered by investors

Sure, there are risks. As there are risks with gold. The stock alternative doesn’t have to be perfect – it just has to be better than the gold alternative. There is as much an ownership issue with gold as there is with equity. Gold also requires an economy in order to have value (if we’re looking to transact for basic food supplies without an economy – your metal is not going to preserve its value, I would say). Gold is not so simple to liquidate or transport in today’s world. And gold would also give nominal gains during a hyperinflation that would disappear when the currency eventually dies. Those risks are universal.

And I would again come back to the question: if gold is such an obvious choice – why didn’t your family leave Zimbabwe with a pile of gold loaded in the back of their twin cab?

Also, didn’t you recently do a post about how the average stock is held for like 9 months now? Surely not a broad endorsement of going ultra-long stocks then?

That argument revolved around the impact of shareholder-value maximisation. That doesn’t make equity a bad or unproductive investment – it’s just interesting from a managerial incentive perspective. There was nothing in that post to endorse equity investments one way or the other.

Is it really ideal for each individual to have to roll the dice in the stock market just to maintain purchasing power? I know it’s perfectly possible, but is it ideal when there’re alternatives that work idly?

Dicing on the stock market is dicing on perception. Which, by your “value is subjective” argument, is exactly what everyone is doing with gold, right? There is no risk-free asset. And I would be especially concerned when gold has more risk than the market gives it credit for: as has been a historical market shortcoming. The market sentiment was that subprime mortgages were a great investment, and that sovereign bonds were riskless. Perception is a flaky thing. And I still haven’t come across an argument that places gold in a value position that is anything other than “historical perception”.

And is money in that equation? Is exchange? Is trade?

It doesn’t have to be in the equation! The transaction is an underlying need for food and an underlying need to transport that food to where it is needed. The medium of that exchange is, by no means, guaranteed to be gold. In fact – it’s not guaranteed to be anything. We could just go back to bartering, as people did in the “esoteric” scenario where this theory was tested. How is that an obtuse point?

I also think there’re plenty of qualities and characteristics about gold that make it an ideal medium of exchange and, thus, a good means of preserving purchasing power. Plenty of other people do too. So long as that’s the case, it will hold its “value”. As is the case with everything.

I’m not disagreeing that gold has qualities that make it a good medium of exchange. But I am saying that, today, gold is only a good theoretical medium of exchange. And that is concerning – because people invest in gold as though it is a realistic alternative. Just as people invested in subprime mortgage assets that were backed by land and housing (“as safe as houses”), and invested in sovereign debt (as though first world governments never default). Value may be subjective – but some values are more subjective than others.