Crypto Gold: The Return of Commodity Money

In this post, we’ll look at how money came to be separated from value, and how and why they’re being tied back together again in ways made possible by new technologies. We’ll see how commodities hold value over time and across borders, and consider how we can combine that stability with the fungibility we demand from a modern, international means of exchange.

Fiat currency is now being pumped into the economy in unprecedented quantities and the result is likely to be a sharp drop in its spending power accompanied by a sharp drop in the real economy occasioned by systemic issues unearthed and exacerbated by the Covid-19 pandemic.

Since it’s now possible to build a self-guaranteeing system, blockchain-based digital asset exchanges, based on the self-guaranteeing value of assets like gold, we can expect to see interest in gold as a commodity and in these currencies rising strongly. All these processes are already observable.

Commodity money, fiat money, and gold

Commodity money and fiat money lie at opposite ends of a spectrum. At one end, commodity money is money as value. The first gold coins were not representative of value; their gold content was their value, and their frankings — markings struck onto the coins by royal mints — were a promise that they were unadulterated and of full weight. (To find an unguaranteed form of commodity money, you’d have to look to devices like hack silver; weighed lumps of precious metals.)

This describes the state of money for most of history. Periodically, the precious metal content of coins fluctuated; adulterating the coinage was a key way for governments to make up for shortfalls in revenue, a practice whose modern equivalent — printing more money — we will turn to presently. When the face value of coins remained the same while their gold and silver content fell, the result was usually a loss of confidence in the coinage.

By the 1700s, a new form of money began to emerge in Europe, spearheaded by the use of promissory notes, or notes of hand, among gentlemen. A gentleman’s note of hand was his promise to pay money, and was as good as money; case law in common law countries supports the notion that a note of hand is money. The issue of paper money began much earlier in China, in the 11th century, and there was also regarded as money itself.

When western governments were stuck for cash money — frequently during wars and most especially the American Civil War — they did something similar, printing paper money consisting of a ‘promise to pay.’ This form is preserved on some nations’ banknotes; in Britain, the bank notes still read, ‘I promise to pay the bearer on demand the sum of five pounds,’ or whatever the value of the note.

On its inception, this promise was meant literally; five pounds of money — gold coinage — could be exchanged for a five-pound note on demand. The requirement to have sufficient gold coinage stored to support demand led to the centralization of the banking system and its integration with state governments and national economies, and their integration into a world financial system based on gold: the gold standard.

After the second world war, this began to break down and was replaced by the Bretton Woods Agreement, which substituted the US dollar for gold worldwide. The world financial system now consisted essentially of promises to pay dollars, while dollars themselves were a fiat currency.

Fiat currencies derive their name from the Latin ‘fiat,’ meaning ‘act’ and more widely ‘make it so,’ or ‘let it be done.’ Thus a fiat currency is currency because the government says so. It represents not a given weight of precious metal but the capacity of the national economy which issues it and ultimately the willingness of citizens to use it: money by fiat, money by consent.

Since the collapse of the Breton Woods system, each national fiat currency stands alone, though in practice the dollar and Euro function as international reserve currencies.

The benefits of fiat and commodity monies, as well as of intermediate forms, can be seen by examining history. Commodity money is inelastic and inflexible. When more money is required, there is none to be had, since the principal benefit of commodity money is its scarcity and stability.

The introduction of fractional reserve banking, in which banks lend out many times their money reserves, reduces both the inconvenience and the stability of commodity money. Combined with fiat money, it tends to create a financial system based largely on mutual confidence and prone to sudden, catastrophic collapses.

In addition, fiat currencies are prone to sudden, radical deprecation in value: hyperinflation. The best-known examples are the wheelbarrows full of worthless Reichsmarks in the Weimar Republic and the infamous hundred trillion Zimbabwean dollar bill, now a collectors’ item worth about five US dollars, but virtually worthless at the time of issue — so much so that Zimbabwe’s currency was replaced by foreign currencies inside the country, a hallmark of state failure.

This tendency has haunted fiat currency since its inception. When the typically forward-thinking Bank of Stockholm issued paper money backed by government decree, in 1661, the enterprise had first to be taken from royal charter into the care of parliament and then replaced by the silver standard before money became entirely worthless.

The contrast in stability of price also indicates something intrinsic to commodity money: independence of political control. Fiat money deprecates all the time, whether as cataract or drip. A dollar in 1970 had the same purchasing power as $6.65 today; a 1900 dollar was equivalent to more than $30 today, according to calculations from the consumer price index.

By contrast, how has gold fared?

Gold is measured in Troy ounces, so an ounce of gold weighs 31.10g. That ounce of gold is currently worth $1,700, up from $1,400 in December of last year. Does this mean the value of gold is less stable than that of fiat currencies like the dollar?

No.

In 1929, gold was worth $20.36 a Troy ounce; in 2019, ninety years later, it was worth $1,400. The purchasing power of that ounce of gold has risen rather than fallen, as the economy has become more productive. In 1922, a men’s readymade wool suit from a catalog was $25 — 125% of an ounce of gold, or $1,750 relative to 2019 gold prices in dollars. In 2019, a Brooks Brothers Milano fit suit was $998, equal to 71% of an ounce of gold. But what about a catalog suit? Sears will sell you an all-wool men’s readymade suit for $117.29. That’s 8.3% of an ounce of gold.

Partly this is because the economy is vastly more productive than it was in 1922. But partly it’s because the dollar has lost value, while gold paradoxically becomes more valuable in a richer world.

Result? The dollar is worth a fifteenth of its 1922 value. Gold is worth nearly sixteen times more. And compared to other products whose value is determined by scarcity, such as gasoline, the price of gold has also risen. Gasoline was 25¢ a gallon in the US in 1922, or 1.2% of an ounce of gold at contemporary prices; in 2019 it was $2.50, or 0.17% the price of an ounce of gold.

The Covid-19 crisis, global recession, and the future of commodity money

Economic slumps and financial collapses don’t occur because of overnight causes, but they do occur overnight. Society skirts multiple cliff edges until one fatal tumble. To see this in action, sadly, it’s only necessary to look at the news. The Covid-19 pandemic has thrown millions of people out of work and blown holes in projected GDP across the developed and developing world. Service-dominated economies can’t stay home.

Beneath and behind the virus’ effects lie structural issues, entwining economic stagnation and geopolitics in a way reminiscent of the crash in industrial economies in the 1930s. Societies with polities based on sovereign debt are unable to control it; cuts in spending drive debt up faster. Meanwhile household debt spirals even in successful economies. Fractures in international structures such as the European Union make it impossible to ignore the fragility of the international financial system. However, the virus has brought to the surface these deeper issues and will remain a source of economic anxiety in its own right until decisive medical measures are available. Thus, it likely heralds a long-term economic downturn.

Organizations can only do what they are designed and equipped to do. Armies fight; health services heal. Central banks print money and lower interest rates. Currently, the world’s central banks are at the point where they are considering negative interest; for those recently familiar with the concept of negative pricing in the oil industry, this is the same phenomenon applied to the money supply. Banks are ready to pay people to take money away.

As central banks attempt quantitive easing — an oddly descriptive euphemism for printing money — this will be exacerbated, particularly because easing is typically applied to ‘the economy,’ ie, to businesses which do not stand in urgent material need of money and the goods it can buy. Citizens who must pay rent and bills will be forced to go deeper into personal debt again, where they can. In a society where the worth of money is crumbling and everyone carries unserviceable debt, the edge is already near.

 

The token and the particular amount of gold it represents are one and the same. So while it’s not entirely incorrect to think about the token as a unit of value that derives its worth from the price of gold, it’s even more specific, as the token represents a particular piece of gold you own. The token acts like your record of ownership of an asset, effectively becoming the digital shadow that a real piece of gold casts into the virtual world.