Gold - What is it Really Worth?

Gold – the allure of it still binds us, as it did our ancestors thousands of years ago. Why do we care about it? Why is it worth anything? Until the invention of modern electronics 40 years ago, you couldn’t make anything useful with it. For the vast majority of mankind’s history, gold has just been a shiny metal you pull out of the ground. Why is it so valuable?

Gold gained its value in ancient times because it was the perfect solution to the money problem. Before gold, the ancient economies were mostly barter economies. The problem with a barter economy is that if two people want to trade, but don’t have the goods that the other wants, they can’t barter. Further, bartering is inconvenient. Imagine trying to haul 50 bushels of potatoes to Wal-mart to buy a new lawnmower! Gold solved the barter problem.

Gold was a great choice for money in antiquity because it is rare, durable, divisible, fungible, and easy to identify. Gold’s rarity prevented inflation. Its durability allowed coins to be struck once and circulate for years. Its divisibility and fungibility made it easy to pay in increments. All gold is the same, so if you want to pay half a gold piece, you cut your gold piece in half, and it doesn’t matter which half you use. Also, the fact that gold is easy to identify helped prevent counterfeiting.

Paper money, in contrast, is a poor choice. It’s easy to counterfeit, especially in older times. It’s not durable, wearing out in a matter of months. It’s also not divisible. If you have a dollar, and something costs 50 cents, you can’t cut your dollar in half like you could your gold piece. Further, paper money has a literacy problem. Very few people in antiquity knew how to read. This made it nearly impossible for a common person to correctly identify paper money from paper that wasn’t money.

This doesn’t mean gold was the perfect money, however. Gold did have, and still has, its own problems. Chief among them is its rarity. Gold is exceptionally rare – perhaps too rare. The problem with basing any significant economy’s money on gold is that there is not enough gold. To illustrate the point, since the beginning of recorded history, the total amount of gold ever mined stands at about 142,000 metric tons. At $1,000 per ounce, there is roughly $4.5 trillion worth of gold in the entire world. There is, however, about $8.5 trillion in currency circulating in the United States alone. There simply isn’t enough gold to use as money. That’s why ancient economies also used silver coinage. Silver was more common than gold, but still had gold’s advantages. Using both gold and silver coinage greatly increased the money supply, and thus economic activity.

Gold’s rarity, however, also presented another, surprise problem – inflation. I know what you’re thinking, I just said gold’s rarity prevented inflation. Generally, it did. Because gold is so rare, the money supply was predictable, stable, and grew slowly. Inflation generally wasn’t an issue – until a new gold mine opened. The best illustration of the point is the discovery of the New World by the Spanish. In addition to subjugating native peoples and claiming new lands in the name of the Spanish crown, the Conquistadors also discovered untold riches in the form of gold, silver, and spices. Spanish treasure fleets brought back hundreds of tons of newly mined gold annually. The increase in the amount of gold in circulation had a predictable effect – rampant inflation.

Currently, we don’t use gold as currency anymore. The main reason is precisely because of its rarity. There simply isn’t enough gold in the earth to fund the global economy. This is a new development in human history, however. The world, including the US, was on the gold standard until almost 40 years ago when the Bretton Woods agreement collapsed. For 5,000 years before that, gold had been the foundation of the world economy. The value of gold in our mind still resonates with us because of that history.

That, in sum, is why we still perceive gold to be as valuable as it is.