Open up any economics textbook or website, and you’ll get this “definition” for what money is:

Just to be clear:

• A medium of exchange – so that we don’t have to directly barter eggs for socks, etc.
• A unit of account – so that we can ascribe very specific values to things (eg. the iPhone doesn’t cost “some money” or “about 30 times as much as a toaster” – it costs precisely $649.95, excluding sales tax).
• A store of value – so that if you store it in a mattress, you can still use it to buy stuff at some future point.
• A standard of deferred payment – basically, “an acceptable way to settle one’s debts”.

My two cents (pun intended): I think that part of this is now wrong. Specifically, the “store of value” part. And I think that it’s been wrong since August 1971, when Nixon took the world off the Gold Standard.

Why Did We Leave The Gold Standard Behind?

If you’re looking for the specific historical answer to this question, then check out this post.  But if you’re looking for a more general reason, then I think the answer is: because it became increasingly difficult to have money be both “a medium of exchange” AND “a long-term store of value”.

I realise that I’m about to offend my libertarian friends here, but frankly, the gold standard was probably doomed long before Nixon abandoned it. Over the course of the 20th Century, governments abandoned and re-established and re-abandoned and re-re-established the gold and silver standards (or some variation thereof) over and over again. And as I see it, the obstacle that they kept coming up against was this tension between “medium of exchange” and “store of value”.

In modern-day finance talk, those governments were aiming for their medium of exchange to be an investment as well.

Let me reframe that:

• Today, I take the income that I earn for my work, and I then get to opt in on any investment that I choose (including gold).
• Under the gold standard, I had to opt out of gold before I could opt in to anything else.

So it sounds fine on the surface – income would have arrived with a pre-allocated investment choice, and the wage-earner could either leave it as gold, or exchange it for another investment.

The trouble is: that leaves one with a fixed exchange rate between money and gold. Because in order for one’s money to be “a store of value”, that exchange rate has to be fixed – and against one very particular asset – irrespective of the differing growth rates in the world’s economies in the wake of World War II.

And more importantly: irrespective of the disintegration of the world’s empires into much smaller nation-states, and of the growing swiftness and importance of international trade.

Over the last century, the world has gone from having a few large empires with mostly internal trade, to having dozens of smaller nations with large (and growing) volumes of international trade. And in the face of all this trade and growth and decentralisation, you had an antiquated gold standard. That gold standard meant that the primary function of money – to act as “a medium of exchange” – was continually being strangled by the supply of physical gold, because the increase in the gold supply simply could not keep pace with the rapid rate of global growth.

Completely unsustainable.

The world needed a much more flexible “medium of exchange” than that: the growth constraints created by the gold supply were far too restrictive. And if you take a step back, I think it’s fairly clear that fiat money wasn’t an economic accident – it was almost an economic inevitability.

Sure – perhaps we could have found ways to keep the gold standard by permitting more adjustment to take into account different growth rates, more trade, and a limited supply of gold. We could have had had more regular devaluations or something.

But either way, that’s now history, and the essential outcome is that we effectively wrote “long-term store of value” out of the money definition. That is: “If you want to stay on the gold standard – you can. Just go and buy gold with your earnings. You can also put your money into other things to store its value. But the primary function of money – its ability to act as a medium of exchange – will no longer be hindered by the gold supply.”

Here’s a list of other stores of value (thanks Wikipedia):

That said

Money still acts as a short-term store of value. And it does that pretty well. I mean, what I pay for two litres of milk today will be the same (or close to) what I will pay for two litres of milk next week.

Yes, there may sometimes be small losses of value over the short-term – but those are usually the result of higher input costs or some shortage of supply rather than some shop-owner having a freak-out over the fiatness of it all.

And yes, you do occasionally get hyperinflations. But even countries that had lived for years on the gold standard have undergone hyperinflation – all it took was a government declaring “Hey – let’s abandon the gold standard and have ourselves a money-printing time!” Because, well, anything that’s adopted can be abandoned.

In summary:

• Today, we have a medium of exchange that works really well as a medium of exchange, which is really what money is meant to be.
• If you want to store value, then do it with all the other things that aren’t money.
• And if you want to live on the gold standard, then no one is stopping you. Just buy units in a gold ETF.

Rolling Alpha posts opinions on finance, economics, and the corporate life in general. Follow me on Twitter @RollingAlpha, and on Facebook at www.facebook.com/rollingalpha.