Gold As A Currency

by | Oct 15, 2018

“Do you think gold is money?” he asked.

Ron Paul, then a Texas congressman, posed the question to Federal Reserve Chairman Ben Bernanke in this entertaining exchange before the US House Financial Services Committee. The hearing was held during the summer of 2011, when concerns over inflationary consequences of the Federal Reserve’s monetary policy were driving gold to record high prices. Ron Paul led a somewhat quixotic quest against the Federal Reserve during his Congressional career and relished the opportunity to confront Chairman Bernanke.

A long pause followed Paul’s question as Chairman Bernanke gave it some thought. It probably wasn’t a question he was asked very often.

“No, it’s a precious metal,” Bernanke concluded.

“It’s not money? Even though it was money for 6,000 years, somebody reversed that and eliminated that economic law?” countered Paul, unable to hold back an incredulous smile.

“Well, it’s, you know… it’s an asset,” conceded Bernanke. “Would you say Treasury bills are money? I don’t think they’re money, either, but they’re a financial asset.”

“But then why do central banks hold [gold], if it’s not money?”

“Well, it’s a form of reserves.”

“Why don’t they hold diamonds?”

Another pause. Another question Bernanke probably didn’t often contemplate.

“Well, it’s tradition,” he offered, nodding a bit as if to convince himself, too. “Long-term tradition.”

“Some people still think it’s money,” scoffed Congressman Paul, ending the discussion.

Historical Adoption of Gold as Money

Most people in mainstream finance (including Ben Bernanke) have indeed lumped gold in with other “financial assets.” But this characterization doesn’t do justice to the central role gold has played in economic development for thousands of years, and Bernanke’s reasoning for gold’s continued prominence as “long-term tradition” is laughable.

Many different materials were used by early societies as a store of value – cowrie shells, salt, barley, and so on. These early forms of commodity money each had advantages and disadvantages. Over time, gold emerged organically as the most highly-prized form of money in virtually every society. The natural properties of gold best satisfied the requirements of money. Gold is a softer metal, easily worked with by ancient craftsmen, and can be divided into infinitesimally small quantities. For merchants, gold was easily weighed and divided. It was also durable so that it maintained its value over time. While easier to work with than other metals, is not easily destroyed or dissolved, and doesn’t react with many things. It is also difficult to create more gold, which must be done through mining and refining; it is an element and can’t be grown or created. No other material possessed all of these qualities. Silver came close, but is about fifteen times as common in nature and tarnishes more easily; it was consequently used in trade but has always been less prestigious. Gold’s early association with royalty and high status translated readily to its use as money and the establishment of government-issued coinage in the first millennium BC.

For thousands of years – until the 20th century, for the most part – there was virtually no distinction between gold and money, because gold simply was money.

Money Vs. Currency

The difference between money and currency is subtle, and many definitions of the two terms overlap. Generally speaking, currency has a connotation of everyday use, whereas money applies more when we talk about long-term stores of value; similar to how we distinguish short-run versus long-run in modern microeconomics. In former times, a trove of heavy gold bars would be considered a store of wealth, and someone who owned them would certainly “have money,” but smaller, circulating gold coins would be considered “currency.”

The use of gold as circulating currency persisted into the early 20th century. Paper notes were certainly more popular by then, but in most western countries they could be exchanged for gold coin. The distinction between holding wealth in US dollars or British pounds was less relevant since one could be exchanged for the other (or for gold) at a stable and clearly defined rate. After gold was abandoned as a monetary standard during the Great Depression, exchange rates became much more important. Most circulating currencies began to depreciate in buying power (relative to gold, for example, this implies a large price increase), and a few were so badly mismanaged that hyperinflation destroyed them. Infamous hyperinflations in Germany, Hungary, China, and elsewhere resulted in the destruction of many people’s life savings and contributed to geopolitical changes (often adverse ones).

Fiat currencies that lost their value may have been used as legal tender until the bitter end, as seen in old photos of people trying to pay for everyday items with wheelbarrows full of paper currency that had lost value. But when currencies no longer hold value from one day to the next, they lose an essential function of money. All of the world’s major currencies have lost significant purchasing power since going off the gold standard. Their losses may be less dramatic than in Zimbabwe or the Weimar Republic, but it is still detrimental to their status as money. In every case, gold has retained its value under every adverse circumstance. While it may not be legal tender in most jurisdictions, gold is certainly still a form of money.

Gold as a Currency in Modern Times

Until the 1970s, central banks could still exchange US dollars for gold, and Switzerland did not remove its last gold reserve requirements until the 1990s, so gold was still integrally tied to the currency system until very recently. Gold also retains many characteristics of currency to the present day. For example, it has its own code under ISO 4217, an international system of currency codes. US Dollars are “USD”; Chinese yuan are “CNY”; and gold is “XAU” (Au being the chemical symbol for gold, and X being a prefix for supranational currencies). XAU is defined as 1 troy ounce of gold, so the currency pair “XAU/USD” refers to the price of 1 troy ounce of gold in US dollars (just as “USD/EUR” refers to the price of US dollars in Euros). And whereas a trove of gold bars in ancient times was more distant from circulating currency, large gold bars today are actually the most easily tradeable form of gold. Gold bars defined as “good delivery” bars (>99.5% purity, approx. 400 troy oz in weight, and appropriately marked) by the London Bullion Market Association (LBMA) are readily accepted in the world’s major commodities exchanges.

Gold also responds to market movements like a currency, acting as a flight-to-safety during times of geopolitical instability. And as Ron Paul pointed out, gold is still held in great quantity by central banks around the world. Some central banks have recently taken deliberate steps to hold more gold (and fewer Treasury bills) as a means of strengthening their balance sheets, thus demonstrating its continued significance for the currency market.

Under Basel III, the most recent set of banking standards from the Bank for International Settlements (BIS), gold is considered a risk-free asset (just as good as cash) for purposes of determining a bank’s capital requirements:

“A 0% risk weight will apply to (i) cash owned and held at the bank or in transit; and (ii) gold bullion held at the bank or held in another bank on an allocated basis, to the extent the gold bullion assets are backed by gold bullion liabilities.”

You might not carry gold in your pocket anymore, but it’s fair to say that gold is indeed still a currency under specific circumstances. It’s certainly more of a currency than Treasury bills or diamonds!

Use of Gold in the Cryptocurrency Market

Gold is also preferred by many investors as a means of achieving separation from risks inherent in the banking system. That same desire among investors was a major factor in the rise of cryptocurrencies since the Global Financial Crisis a decade ago. Considering its history as money, gold is a natural match for cryptocurrency investors looking for the next advancement in the history of money. Many innovations in the cryptocurrency space attempt to redefine currencies away from those currently issued by a handful of national governments and some innovations have renewed the use of gold as currency.

In the world of cryptocurrencies, stablecoins are a class of tokens that attempt to keep their value stable (as the name implies) to give traders a convenient unit of account and stable store of value in volatile markets – often serving as a flight to safety in turbulent times. Given these similar use cases, it is logical that cryptocurrency enthusiasts have long sought to bridge the gap between cryptocurrency technology and precious metals, and a number of tokens pegged to the price of gold have appeared. In this landscape, however, USDVault stands alone with a unique value proposition. By creating a token that is backed by and fully redeemable for gold bullion or fiat currency, and being pegged 1:1 to the US dollar, Vault has created an offering that serves a valuable function for multi-asset class investors. It provides the security of stability to a meaningful unit of account vis-a-vis the US dollar, while ensuring auditable backing in form of the world’s most reliable form of money, gold bullion.