Is Gold Money?

What is money?

Cowry shells

Money can be any token of value that helps facilitate trade. It could be an IOU (just a promise to pay someone in exchange for something). It could be a piece of paper in the form of a US $20 bill (legal tender). It could be cowry shells (a form of money once commonly used across Europe and Asia). It could be large stone wheels (once actually used on the Pacific island of Yap), or it could even be gold.

Whatever the form of money may be, it use is always based on trust.

The stone money of Yap

It seems that whenever someone makes the observation that the US dollar may be losing its value people suggest there may be a need to return to a "sound" monetary system, perhaps like one adopted after the end of World War II called the Bretton Woods agreement.

Bretton Woods became operational in 1945. It obligated each member country to adopt a monetary policy that maintained the exchange rate by tying its currency to the U.S. dollar at a fixed agreed-upon rate.  Bretton Woods made the US dollar the global reserve currency. And it was backed by the full faith and credit of the United States government along with a promise to exchange, on demand, US dollars for gold at a fixed rate. It was through this mechanism that trade imbalances were corrected by gold reserve exchanges or by loans from the International Monetary Fund.

And it seemed to work well up until president Richard Nixon closed "the gold window" in 1971, officially taking the US off the so-called gold standard.

Gold vending machine

This refusal to honor the long-standing agreement was considered a form of default that broke the trust the international banking community had in the US dollar, even though the dollar continued to enjoy its privileged status. The closing of the gold window has subsequently became known as the Nixon Shock. It hardly seems coincidental that the US dollar has consistently lost its value in terms of real purchasing power since the Nixon shock.

The growth of US deficit spending along with the expansion of the money supply has begun to further erode confidence in the US political system and the US dollar. China, a big holder of US debt, has begun reducing its US treasury reserves. China has also suggested that an aggregate of currencies replaced the US dollar as the global reserve currency.

Some have now called the United States the new Italy because of its absurd monetary policy. The US, however, is not compelled to act in a responsible way because of its privileged status as the controller of the global reserve currency. Hence its installation of a helicopter dropper as Fed chairman who plays a lead role in bombarding the world economy with dollar emissions in what has come to be known as the "international currency war."

But the US is now being downgraded and alternatives are emerging. The dollar certainly is suspect as a store of value, "strong dollar" policy pronouncement evoke sneering hilarity. A particularly interesting new development now lies in the realm of futures trading.

It turns out that the largest US futures exchanges are now allowing the use of RMB for margin. As you know, the Chinese have been experimenting with internationalizing the use of its currency for currency exchange, trade settlement and other purposes in financial centres such as Hong Kong and Singapore. Not one to be left behind, London is lobbying PRC authorities to some extent for similar privileges as the PRC experiments with making its monies more readily available.

Gold has not been in common circulation since about 1933-34 when Congress and President Roosevelt implemented a series of Acts and Executive Orders which suspended the common circulation of gold except for foreign exchange, thus, revoking gold as universal legal tender for debts, and banned private ownership of significant amounts of gold coin. People were required to redeem their gold coins for silver backed legal tender at $20.67 per ounce.  Then under the Gold Reserve Act of 1934 the value of the dollar was fixed at $35 per ounce. the gold was store in Fort Knox, Kentucky.  The possession of gold except as jewelry and collections of rare coins was outlawed.  And it wasn't until 1975 that Americans could again freely own and trade physical gold.

Many economists have pointed out that gold isn't viable alternative to a fiat currency that can expand and contract according to the demand of markets.  Although it is true that the amount of available gold cannot be expanded to match market demand for all forms of money, gold was never used in the manner that this observation suggests. Gold has never been the sole token of exchange in any economic system.

Although no one I know is suggesting that gold could ever be the sole token of exchange,  some people have suggested that gold, as a commodity, could never be viable alternative to a fiat currency because its price fluctuates too much.  This kind of statement demonstrates a clear lack of understanding of how money markets function.  Anyone can open an account with one of the 200 or so companies that provide a means to trade in the various global currencies on the FOREX.  The price of money, as a commodity, also fluctuates.  Money is just another commodity it seems.

In these turbulent financial times, for individual investors, holding a commodity such as gold is very reasonable way of hedging against currency fluctuations, or worse the threat of another banking collapse or a bank holiday.

Who is holding gold reserves as a form of a monetary asset?

The US government holds the world's largest amount: some 8,133.5 tons of gold. see - Gold Reserves

Should the US return to its so-called "gold standard?"

This is the wrong question. The right question is how can the United States restore the trust it once held in the eyes of the international financial community.  This is not just a question of monetary policy. The US is in need of some fundamental political changes before any meaningful discussion of its monetary policy is even possible.