Gold is Not Money

Gold is Not Money

Is gold money?

That’s a good question and one that Rep. Ron Paul asked Fed Chairman Ben Bernanke last week at a hearing on the US economic outlook and monetary policy.

Bernanke’s answer: “No.”

Rep. Paul followed up with another good question. “Why do central banks hold gold?”

Bernanke’s befuddled answer: “It’s tradition.”

You can watch the humorous exchange below:

Why gold is not money…yet

A writer, R.A., in The Economist speaks to this exchange and reminds us that gold isn’t technically money anymore since you can’t take it to the store and use it to buy goods.

The writer goes on to say, “But while gold is not money, it shares a very important characteristic with money: its value (apart from limited industrial uses) is derived from the market's perception that it has value. This is the nugget of truth in Mr [sic] Paul's comments.”

Fiat money works the same way. Dollars have value because people have deemed them to have value. But as the writer in The Economist points out, dollars can be printed easily and at will, devaluing them quickly. Gold on the other hand has an intrinsic scarcity to it.

“But that's precisely the way that fiat money works. People believe the flimsy pieces of paper we call dollar bills are worth some basket of real goods only because everyone else believes the same thing. The crucial difference in the perception of value is that new gold can only be obtained at great difficulty while new bills can be produced by the truckload at virtually no marginal cost.”

Presently, the reason that gold isn’t money in the way most people think of money is because people still think that paper dollars are money.

The writer concludes that dollars will always be money going forward because people have decided to be content with them with money. And regarding gold? The writer says, “What I don't understand is the argument for gold that falls back on the mystical, 6,000-year old Law of Economics that shiny yellow metal is somehow special.”

All currency goes to zero

Though the writer seems to think it’s an impossibility, indulge me for a second. What happens when people no longer want to accept paper dollars as money? What happens if the Fed prints so many dollars, because it’s so simple and an infinite amount can be printed, that no one cares to use them as money any longer? Then what will be money?

Throughout monetary history, all fiat currencies—currencies that are given value solely based on an authority’s claim of value—have fallen to zero. The writer in The Economist conveniently forgets to share this fact.

And throughout history, societies have always resorted back to gold as money. As the writer in The Economist points out, this has gone on for 6,000 years. The writer can call this mystical if desired, but I call it a hell of a track record.

The dollar is toast

As I wrote about last week (“Time Ticks Away”), the US is currently in a battle over the debt ceiling. If the US defaults on its debt, the dollar will be toast, and savers will be losers.

If the US defaults on its debt, many people will wish they’d saved some of the money known as gold. Because just like has happened many times over the last 6,000 years, people will turn to it as the repository of value again.

But perhaps the US will fix its debt problems. If so, then the dollar will live on—for a time. But like all fiat currencies before it, the dollar will eventually fall to zero. No matter what, the dollar is toast. It just could be later rather than sooner.

Real money

At Rich Dad, we say Knowledge is the New Money. This is because wealth is attained by your ability to understand what is happening in the markets and to act accordingly. This means that if the dollar is tanking, you have enough knowledge to invest in things that hedge against the dollar—like gold.

Conversely, if the dollar is skyrocketing, you have enough knowledge to understand that gold will probably go down in value.

At the end of the day, it’s your knowledge—and your ability to apply it—that makes you rich…not dollars and not gold.

Times are certainly uncertain. I encourage you to continue your financial education. Start collecting real money—financial knowledge. Increase your knowledge, and you’ll increase your wealth.

Original publish date: July 19, 2011