Gold As A Means Of Exchange

Will Gold ever be a Means of Exchange?  Will Gold be a measure of Value?

WHEN PEOPLE WRITE about gold as money, it means different things to different people: money is what most people see as a means of exchange, something you use to pay for goods and services simply that, writes Julian D.W. Phillips of GoldForecaster.com

However, gold need not be money in the same way at all. Many gold bugs would like to see gold be money in the system, but as gold supplies are so limited, is this realistic? But now that central banks are Buying Gold and some banks are using gold as collateral, gold has returned to a deeply realistic monetary role in the money system. The Bank for International Settlements set of transactions confirmed this emphatically (Read more about the BIS gold swaps here). So what's the difference?

In the early part of last century, the world used the Gold Standard, a system where gold certificates represented an amount of gold. These certificates then transformed into gold-backed currencies and actually were exchangeable into gold. This then halted with the passing of the Gold Standard and in the monetary system, only central banks could exchange gold between each other. The belief and theory behind this was that governments would only issue currency against the gold it held. This was finally halted in 1971 by President Nixon.

When the Gold Standard failed, it was found that the British government had over-issued currencies far ahead of the gold it held. The Gold Standard was deemed a failure. Then governments worldwide dropped the Gold Standard in favour of currencies without any backing whatsoever. That's when gold ceased to be a Means of Exchange. Gold was blamed for the failure instead of the system set up around gold. Had the Pound Sterling been devalued in terms of gold, this problem would have been solved. Let's emphasize that point gold did not fail, it was the relationship paper currencies had against gold that failed!

After the Gold Standard failed gold was relegated to the role of an 'important Reserve Asset' (one of the assets in the portfolio of a nation's reserves alongside foreign currencies). A campaign to discredit and sideline gold in the monetary system was undertaken successfully over the next 30 years up to the end of last century. Now, worldwide, we have a system of national currencies which are simply 'promises to pay' by government.

The reality of life today is that paper currencies have captive users. This allows government to control 'means of exchange' and ensure just what is used. Because of that we face an inescapable fact of life and that is gold cannot be used as a "Means of Exchange" anymore. For it to relate to money supply its price would have to be well into five figures, or more, in all of the world's currencies.

International trade requires the use of foreign currencies which must be exchanged for the currency of the exporter's country. For example, South African gold mines sell their gold for US Dollars, but then have to sell these US Dollars for South African Rands. If the Rand strengthens, the miners see their income drop. If the Rand weakens their incomes rises. Gold would be in insufficient quantities at current prices to be used as an international "Means of Exchange".

In theory a currency's exchange rate is supposed to reflect its Balance of Payments status. That is, money coming in, less money going out, should determine an exchange rate. Capital flows are included in this formula. While the US has had a persistently large Trade deficit for more than one decade, this has been ameliorated by capital inflows. However, if foreign surplus Dollar holders lose confidence in the US Dollar, then they will not invest their Dollars back into the US This could prejudice capital flows into the US Across the Atlantic and after the Greek debacle the debt crisis has continued to worsen. The once so strong Euro has seen confidence plummet significantly. Most Euro investors are worried about its future, leaving the world with no solid reserve currency.

The only way to resolve future currency crises is for governments to be bound irrevocably to an exchange rate that does reflect their financial health or pay the penalty of a falling exchange rate. But that won't happen until the world feels the blows of a major global monetary crisis and foreigners abandon the guilty currency. Only then will a systemic re-structuring be considered. In that case and if we extrapolate what happening out there now, gold will have to display its qualities in that crisis before any role for it could be considered.

Gold can serve a role in such a reformed currency world. Provided it became the relatively exclusive domain of the globe's central banks gold can and does serve as backing to a country's reserves in extreme times. (For individuals, as the US Treasury puts it, gold ownership is a privilege, not a right. This privilege can be withdrawn at any time through confiscation.) In desperate times a nation's gold extends far beyond the gold held in the central bank's vaults. Gold confiscation ensures that.

This would apply in particular to countries where their longer-term future looks bleak and far more support is needed than 3-months worth of international obligation's worth of foreign exchange reserves will be required. There, gold can act as collateral to much larger international support over a longer period. Gold is far more desirable than simply its Dollar value in such situations. It can be stretched and made flexible in so many ways as bankers well know. We are headed for inventive times for gold as it finds its most valuable place in the international monetary scene in the near and far future. As a 'measure of value' gold has returned to the global monetary system.

Last week saw evidence that this is happening already in the BIS 'Gold Swap" revelations.