Gold as Money: Exchange & Value

Whether Gold or not, money's role as a medium of exchange relies on its longer-term value...

SUBJECTIVE decisions about how useful different goods are – made by each and every individual – determine the value of those items, writes Toby Baxendale, founder and chairman of the Cobden Centre.

The utility of money is determined by its prospective use as a medium of exchange. This is interesting as the subjective utility is determined by its objective exchange value – the only product whose price is determined in such a way.

If a good such as tea did not have an objective exchange value, it would have no price and would thus be free. Money without an objective price would be worthless as no one could use it for exchange. If it cannot command any purchasing power over others goods and services, there is no point to it.

Increases in the supply of goods and services are generally seen as social progress, as people have more of the things they value. Production and consumption happen and more satisfaction for more people happens in this capitalistic process. Increases in money however, whose only purpose is to exchange for more things, does not bring about more production or more consumption, as it is solely used for the purposes of exchange.

This would imply that there is always an optimal amount of money to perform the function of exchange in an economy. Adding more of it does not confer an increase in social benefit, unlike more goods and services.

When a government prints money and places it in the economy, it weakens the ability of the purchasing power of money to command what it previously did in terms of goods and services. It does not in itself produce more goods and services.

So if money were rooted in Gold – as it historically was – this would imply that an increase in gold supply would be of no benefit to society whatsoever. However, we should be aware that gold has other use values, in industry and in jewelry. So social benefit is gained by Gold Mining.

A gold miner may produce his product and sell it to industry, jewelry shops or central banks. The first two have use value. The latter has exchange value only. However if there is more demand to facilitate greater exchange, people will willingly swap real goods and services to buy more of the commodity of money to facilitate more exchange. Something that the person or institution values less is exchanged for gold, which the gold miner values less than that which is exchanged. An exchange of something for something happens.

Therefore we can conclude that with the supply of gold, we only see a gold mine providing a very useful set of services to facilitate peaceful indirect exchange between consenting adults, metal for industry and metal for jewelry.

Contrast this with a fiat currency, and you have money produced at a whim.

In a simple economy, with two people bartering their goods and services, no money is needed. When the economy is more complex and there are three people, they cannot facilitate barter. So they invent money and happily exchange gold lumps with each other. Enter the bandit into the economy, whom I am going to call "Gordon Brown", who says to the three people:

"From hence forth, you will accept, by pain of imprisonment, my new money paper notes."

With this new money, he offers me paper in exchange for my saved goods and services. He has achieved an exchange whereby he gets my real goods and services and I get his bits of paper. There has been a one-off wealth transfer from me to him.

Granted, I now have this new purchasing power and can spend on other things. But Gordon has got goods, for which he had done no prior production. This banditry is called "monetising" the debt and is the way we (or rather our governments) do things in most of the world. Contrast this with Gold Mining, when something is produced and exchanged for something else produced. One is honest and one is dishonest.

Besides being a medium of exchange, money is also used as a unit of account. Gold can be kept in bullion and paper claims to it can be granted for ease of use. It can be melted and made into many smaller units, for ease of use. As a store of value, gold cannot be rapidly printed like fiat paper money, and it has a cost to dig out of the ground. So the supply cannot be increased on a whim, and thus it is a good store of value.

I strongly suspect that if the free market were allowed to choose its own commodity to facilitate exchange, it would choose gold.

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