Thursday, March 05, 2009

What's currency got to do with the price of gold?

There are still some loons out there who preach a return to the gold standard. Yes, loons: crazy and/or simple-minded individuals. Here's why the epithet is appropriate.

The argument for the gold standard is essentially this: currency should be backed by something with intrinsic value; gold has intrinsic value; therefore currency should be backed by gold. Let's take the second premise first.

Gold has no intrinsic value. A hunk of gold in your basement cannot feed, clothe or house you. It is only beneficiated (given value) by the uses to which it is put. Those uses include electronics, but primarily gold serves a decorative function, as in jewelery, souvenirs and ornamentation. Artifacts of fashion, in fact. Enduring fashion, to be sure, but whimsical nonetheless.

Now for the first premise: is a floating currency not already backed by something of intrinsic value? Of course it is. The intrinsic value here is the ability to purchase the goods and produce of the economies that make use of the currency. Backing the dollar is the American economy. Would you trade that for the gold in Fort Knox?

(On a side note, I believe this is one of the rare instances where Ayn Rand didn't carry her philosophy through to its logical conclusion. In arguing for the gold standard, she implies that gold has productive power, much as Marx argues that factories do. Wrong, as she herself pointed out - it's the productive powers of the individuals that count, not the materials they use.)

But wait, there's more. Coupling a currency to the value of gold is inherently dangerous, not just because that value is subject to the vagaries of fashion, but precisely because the irrational belief persists that gold has intrinsic value. What happens to the price of gold when the stock market crashes? It tends to go up. Investors buy into gold (and gold producers) just as the demand for consumption of (as opposed to investment demand for) gold goes down. Safe haven or mirage in the desert? What happens when the economy recovers, and forward contracts are fixed at economically unsustainable prices? You have a huge investment surplus undermining an overpriced supply-chain. Something's gotta give.


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