The following is an excerpt from In Gold We Trust? The Future of Money in an Age of Uncertainty (reprinted with permission of The Economist). For more information please visit Amazon.com
Chapter 6: The Golden Question
Money is a matter of faith. Bits of paper and computer bytes change hands billions of times a day as a measure of value because we trust the promise that they represent. In today’s era of fiat money, those promises rest ultimately on a guarantee by governments that they are valuable. That guarantee, as we have seen, is being questioned as the willingness of governments to live up to the promises of fiat currencies is called into question by the deterioration in public finances.
Gold, as an alternative form of money, is based on a different faith – that the intrinsic qualities of this special metal mean that it will hold its value, at least better than fiat money. The clash between the followers of these two economic faiths is, perhaps unsurprisingly, heated and intemperate. For gold bugs, the time has come to end the heresy of fiat money and return to the one true old-time currency. The defenders of fiat money, on the other hand, treat any questioning of the status quo as, at best, kookiness and, at worst, dangerous extremism. Both are wrong.
Photo: The Economist
To treat the debate about the future of money as a battle between economic truths is to misunderstand the nature of money itself. Money is not something absolute. It is a technology that has changed over millennia to meet our evolving need for a unit of account, medium of exchange and store of value. That technology has had to adapt to changes in the real world. The rise of democracy drove the abandonment of the gold standard as a monetary system that, though it protected the value of money, was too rigid for modern welfare states.Just as democracy made the gold standard obsolete, so the world is now going through changes that, in this century, may turn national fiat currencies into a curious anachronism, like the horse drawn carriages that cart tourists through the streets around Manhattan’s Central Park. To understand gold, we need to understand the challenges that our current monetary system faces and what people will want from the technology of money in the future.
The financial woes of many of the governments that issue currencies is the most immediate and obvious problem with the current monetary technology. This is a crisis that exposes the inherent contradictions of money. A return to the gold standard might restore money’s soundness but at an enormous cost in economic growth, wealth and employment. Even getting back to where we were before the crisis, with public-sector borrowing under some control, would take an extraordinary and unprecedented drive by governments, and even that might not be sufficient fully to restore trust in their economic competence.
Even if America’s politicians could set aside the squabbling that has marred the debate about the deficit for too long, it is not even clear that they have much incentive to take the tough decisions. What is in it for political leaders to risk provoking the ire of voters who do not want to hear that the party is over? Likewise, whilst the German public may want sound money, it is not clear that the overall combination of incentives guiding leaders of the Eurozone countries support that outcome.
An alternative strategy, to undermine money’s store of value function through allowing or actively pumping up inflation, is a tempting way for governments to solve the problem of their spiralling indebtedness. This was an option they took once before, in the 1970s, until the public demanded tough policies to control the supply of fiat money. That was then. As governments take risks with the value of money through massive experiments such as quantitative easing, the system of national monetary monopolies of fiat currencies may increasingly be challenged by capital markets that respect no national borders. We now live in a globalised world, where citizens are better able than ever to avoid and protect themselves from such governmental control.
The surge in the price of gold since 2008 is part of that process, as investors like Thomas Kaplan and John Paulson have become the public faces of a broader movement to reduce exposure to the counterparty risk at the heart of fiat money. For them gold is, once again, appealing as an alternative currency and, as a result, they predict, it is once again embarking on a long boom.
This case for gold is, we believe, very different from the one offered by gold fundamentalists. The current resurgence of gold may be understood best not as a return to “true money”, nor, indeed, the beginning of the revival of a barbarous relic, but as part of the latest phase of innovation in the technology of money. It will not be the last.
Money is a technology we often take for granted. Yet it is technology that has huge implications for the efficiency of the economy, and the well-being of society. Getting the technology right is a task we all need to take seriously, certainly far more seriously than mainstream thinkers tend to be when commenting on gold. How quickly new forms of money develop and how widespread they become will depend in part on how good a job governments do in restoring faith in fiat money. It will also depend on the financial innovators and technologists, such as the bitcoiners, who are trying to create the currencies of the future. The challenge posed by the current resurgence of gold is to create new forms of money that outperform today’s fiat currencies and are not merely as good as, but better than, gold.
Check out this neat animated video that The Economist just released on the book:
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