Gold: Common Law Money

How Gold Bullion became money by choice, not by government rule...

PEOPLE ASK ALL the time what inherent quality gold has that makes it a superior medium of exchange to salt, pepper, oxen, or bubble gum, writes Dan Denning for the Daily Reckoning Australia.

But the fact is, Gold Bullion is the common law version of money.

Gold has at least four physical qualities which make it suitable as money. It's durable, it's divisible, it's convenient, and it's consistent, not to mention hard to counterfeit. Gold Bars, Bullion, Gold Coins, even goldsmiths notes...throughout history you could be pretty sure people were going to accept a quantity of gold in exchange for some good or service.

And that's really the best reason to explain gold's historic popularity as a medium of exchange. People have accepted it as such.

That makes gold, in our view, a kind of common law money. Because if people traditionally view gold as money, there's something to it – a de facto use that doesn't require official rules to make it happen.

So maybe this whole fractional reserve paper money experiment is an historical aberration in the history of money. And for the record, yes; there are certain physical properties of gold that make it especially useful as money. And it's worth nothing people have used it as such for thousands of years. It's not that there's any higher mystical principle behind the yellow metal as a medium of exchange. It's just that gold's what people have accepted as money for a long time. This acceptance is noteworthy if you're somewhat philosophical. It's a voluntary exchange without coercion. In a perfect world, that's the way you draw it up.

But as we've said before, money is not wealth. Neither is Gold. You have to trade it for something useful. And it's better if you receive it for what you produce and then invest in it capital goods, rather than hoard it or worse, squander it. Just ask the Spanish and the Portuguese.

"The mines of Brazil were the ruin of Portugal, as the mines of Mexico and Peru had been the ruin of Spain," writes Henri Martin in his History of France to 1789. Martin shows that although Spain and Portugal brought home untold amounts of precious metals from the New World (a polite way of saying they raped, robbed, and pillaged the indigenous people in South America), they merely consumed the money rather turning it into real, lasting, productive wealth.

In Portugal, "all manufactures fell into insane contempt; ere long the English supplied the Portuguese not only with clothes, but with all merchandise, all commodities, to salt, fish, and grain. After their gold, the degenerate sons of the Albuquerques and Gamas abandoned even their soil: they very vineyards of Oporto were finally bought by the English with Brazilian gold, which had only passed through Portugal to be dissipated in England."

It is very easy for the people of a nation to mistake money for wealth, or even commodities for wealth. But any useful theory of wealth would probably focus, at least in the material world, on the production of capital goods, and not, say, the consumption of consumer goods. There is no inherent value in anything. It's what you produce and how useful others find and what they're willing to exchange for it that determines value.

The Spanish had tons of gold, but they imported salt and fish and textiles from England. In fact, the huge increase in precious metals flowing to Europe sparked a great inflation in British land prices. This inflation, coupled with a quirk in how land was leased in the country-side, allowed nearly all the gains from rising land values to go to the new British merchant class, rather than the crown, the clergy, or the gentry.

What's more, gold and silver metal migrated to British and Dutch merchants as these two countries manufactured and traded with the bullion rich Portuguese and French. It was one of the first Money Migrations, a giant wealth transfer from bullion-rich consumers to producers of real goods. It's no coincidence that shortly thereafter, the Dutch first and then later the British developed more sophisticated capital markets with which they allocated accumulated savings into risk-taking capital investments.

Still, at least the Portuguese and Spaniards had real money on their hands...unlike today's officially mandated "fiat" paper and photons, imposed by rules rather than developing spontaneously and becoming money by common usage – and thus by common law. Yet they merely consumed it, exchanging it for manufactured French, British, and Dutch goods, and not building any capital assets of their own (or in the Spanish case, building a naval war machine that would run into trouble of the British coast in 1588).

The moral of today's story? Woe to the modern economy that treats paper as wealth and fails to save or invest. We may think we have money on our hands. But paper is not metal and credit is not a substitute for saving. If things keep going the way they're going, you may have to trade a lot of paper to get anything of substance.