In a recent article Mike Shedlock (Mish) weighs in on the question of whether or not gold is money. Near the end of the article he concludes: “The only possible debate about whether or not gold is money pertains to the phrase “demanded mainly as a medium of exchange”.” That’s totally correct, which is why it is not correct to say that gold is money. However, earlier in the same article Mish seems to argue that gold has again become money thanks to the advent of BitGold. As discussed below, this makes no sense.

There are two major problems with the argument that the advent of BitGold means that gold is now (once again) money. The first and more important is that the BitGold system comprises only a miniscule fraction of the total gold supply, so in no way does it result in gold being “demanded mainly as a medium of exchange”.

The second problem is that the BitGold debit card does not involve using gold as money. When someone uses such a card to buy something, the merchant doesn’t receive gold in exchange for goods/services. What happens is that some of the gold in the cardholder’s account is sold to obtain “money”, which is then transferred to the merchant. In this respect, paying for something using a BitGold debit card is similar to paying for something by writing a cheque on a Money-Market Fund (MMF). When you pay using a MMF cheque (check, if you are American), the receiver of the cheque doesn’t end up with MMF units. What happens is that the MMF sells some of its assets to obtain the “money” needed to complete the transaction. That’s why MMFs should not be counted in the money supply. They are investments in securities, not money.

Moving on, it’s important to understand that money isn’t just ‘a’ medium of exchange. At any given time in any economy, many things will be occasionally used as media of exchange, that is, as currencies. Take Frequent Flyer Miles as an example. Frequent Flyer Miles are sometimes used as a medium of exchange. In fact, in most developed economies they are used more commonly than gold as a medium of exchange. However, nobody is seriously claiming that Frequent Flyer Miles are money. Cigarettes are another example. Cigarettes are used as mediums of exchange in some prisons, but cigarettes obviously aren’t economy-wide “money” and nobody (as far as we know) is seriously claiming otherwise. Clearly, then, sometimes being used as ‘a’ medium of exchange is not the same as being money.

Money is not simply A medium of exchange (a currency), it is THE medium of exchange used in the vast majority of economic transactions (a very commonly-used currency throughout the economy).

The final word goes to Ludwig von Mises, the greatest economist of the 20th Century. It was Mises who, from beyond the grave via his writings, convinced me many years ago that gold is no longer money*. Here is Mises from his book “The Theory of Money and Credit“:

“The balancing of production and consumption takes place in the market, where the different producers meet to exchange goods and services by bargaining together. The function of money is to facilitate the business of the market by acting as a common medium of exchange.”

And for those people who harp on about “store of value” as if it were the dominant characteristic of money:

“The simple statement, that money is a commodity whose economic function is to facilitate the interchange of goods and services, does not satisfy those writers who are interested rather in the accumulation of material than in the increase of knowledge. Many investigators imagine that insufficient attention is devoted to the remarkable part played by money in economic life if it is merely credited with the function of being a medium of exchange; they do not think that due regard has been paid to the significance of money until they have enumerated half a dozen further ‘functions’ — as if, in an economic order founded on the exchange of goods, there could be a more important function than that of the common medium of exchange.”

And here is Mises from his book “Human Action“:

“The theory of money was and is always the theory of indirect exchange and of the medium of exchange.”

 

[*Like many of the people who responded negatively to my “Gold Is Not Money” articles, once upon a time I also laboured under the misconception that gold was money.]

A recent Bloomberg article notes that household leverage in Australia is now almost twice the developed-market average. Specifically, the article states that Australia’s household debt as a proportion of gross domestic product has risen to a record 134 percent, the highest among 36 developed- and emerging-market nations analysed by Barclays. This compares to a developed-market average of about 74 percent.

The article contains the following chart, which suggests that the easy-money policy of the country’s central bank is driving the housing-finance binge.

This is not going to end well.

As we enter ‘Fed day’ (the day on which the US monetary politburo is scheduled to provide a new set of clues on how it intends to manipulate the price of credit in the future), the gold-mining sector is poised for a breakout. Unfortunately, the HUI chart (see below) doesn’t clearly indicate the most likely direction of the breakout. This is normal. It’s always the case that price charts say a lot more about the past than the future.

Sentiment indicators and the HUI’s price chart suggest two different near-term outcomes. The first is that the HUI made a short-term top (a top that holds for at least a couple of months) 10 trading days ago and will confirm this top by breaking downward from its 2-week range in the aftermath of the Fed news. The second is that there will be an upside breakout in reaction to the Fed news followed by a quick move to a short-term top over the ensuing several days.

I think the second outcome is the more likely, but I’m not buying in anticipation. Instead, I will continue to do what I’ve been doing over the past 2.5 weeks, which is look for opportunities to raise cash.

In my two “Gold Is Not Money” posts (HERE  and HERE) I explained why it is not correct to think of gold as money these days, and in a subsequent post I explained why it was not correct to view gold as an economic constant (there is no such thing as an “economic constant”). It is clearly also not correct to think of gold as “just a commodity”, because if it were just a commodity then its price would have collapsed relative to the prices of other commodities due to the massive size of its aboveground supply relative to its annual usage in commercial/industrial applications. Instead, the price of gold is near an all-time high relative to the CRB Index. So, if gold isn’t money and it isn’t an economic constant and it isn’t just a commodity, then what is it?

Is gold a speculation? That’s a matter of opinion. Some of the commentators who claim that gold is money tell us that gold is not a speculation, but they are only expressing a personal view. For example, if I buy gold with the aim of selling it in a few months at a higher price, then gold is a speculation to me.

Is gold insurance? It can be, but many of the people who own gold do not hold it for insurance purposes. Gold is certainly not inherently a form of financial/monetary insurance, but it can be held for such a purpose. Furthermore, of the people who believe that gold can be used as financial/monetary insurance, one group thinks that it should be used for this purpose all the time while another group thinks that it should only be used for this purpose when the risk of monetary collapse is high. For example, I own gold and recognise its ability to be a form of insurance against financial catastrophe, but none of my gold is currently held for insurance purposes. In my opinion there isn’t a good reason to hold gold for insurance purposes right now, because there will always be warning signs well in advance of a monetary collapse and those signs are currently not present (at least with regard to the US$). That’s my opinion. Other people think differently.

Is gold a good store of purchasing power? It depends on the starting point and the time frame. Gold has lost a lot of purchasing power (PP) since its September-2011 peak and lost more than 90% of its PP from its January-1980 peak to its April-2001 trough. Furthermore, despite the huge gold rally of 2001-2011, someone who bought gold at its January-1980 peak (almost 36 years ago) and held to the present day is still down by more than 50% in PP terms. However, someone who accumulated a long-term gold position during 1998-2002 and held to the present day would still have a substantial gain in PP terms, despite the large decline of the past four years. In this respect gold is similar to investments in companies or real estate. Regardless of the quality of an investment, if the purchase price is high enough it will probably generate a large PP loss.

As an aside, the importance of timing will be obscured by extremely long-term studies. Of particular relevance, studies that assess gold’s performance over centuries will suggest PP stability and will mask the fact that if you bought near one of the speculative peaks you would have sustained a permanent loss.

Is gold a financial asset? The answer is yes. Moreover, it is considered to be one of the world’s most liquid financial assets, which is why some of the world’s most important clearing houses accept gold — along with other liquid financial assets such as T-Bills — as collateral. However, physical gold is not someone’s liability, which means that gold can’t suddenly become worthless as the result of a default. In this respect gold is a safer financial asset than a T-Bill or any other security.

In summary, gold is primarily a liquid financial asset that can be held for speculative, insurance, store-of-purchasing-power or collateral purposes.