The alchemy of money
01 July, 2020
Gold has many powers attributed to it in
terms of its ability to act as money and to offer a real return. We have decided to unpack these topics because
this has become a very contemporary concern. There is a long-held belief that
money was originally commodity based, then it progressed to coinage, and
finally into fiat money. This evolution took a further step with the rise of electronic
money, a step that has been heavily entrenched as a result of the current viral
pandemic. This view of the history of money betrays a key misunderstanding of
its nature which is at its heart entirely abstract.
Coins, being made almost exclusively of
metal, are long lasting, and whilst the language and ideas under-pinning their
use might have disappeared, many ancient coins still exist. What they show us
is the prestige and power required to establish widespread acceptance of a
particular currency. The quality of the metal, often precious for the higher
denominations, and the words and images embossed on the coins give remarkable
clues as to the nature of the projects they represented. It is understandable,
therefore, that a modern mind might be distracted from the fact that money is
not currency, it is a system.
That system is one of agreed credits and debits supported by a method of clearing. Understood in this way, currency is
just a token that helps to record the tally. We can't look back to a
prelapsarian time when money was tangible, real and absolute and this is
because money as an idea has changed very little since its invention. What we
use as a token or representation of it has changed, but this matters less than
most people think.
It is interesting that the history of gold used
as money is full of conflict, with as many violently opposed to its use as
those who would accept nothing but the metal. This opposition of views is more
revealing than most conventional analysis and it appears to arise from the fact
that different parts of society are affected in different ways by the logic of the
economic policy applied at any one time. If gold is at the centre of policy it
will also be at the centre of conflict.
It is easy to imagine a time when relative
stability glossed over any shortcomings that gold might have had as money but as
economic growth began to take off in the 18th Century, problems
arose. This was primarily because the supply of gold has often been limited (or
at best variable) and at times this tended to impose a deflationary pressure on
prices. As we have seen in our own period of austerity, some people gain and
others suffer and this polarisation ultimately becomes highly political. A fall
in prices will favour the creditor over the debtor and if one part of the
population is structurally indebted and the other is composed of a sort of
rentier or creditor class, then the benefits will flow ceaselessly to the
latter and away from the former. The resettlement of this state of affairs by
governments is one of the major reasons why, over time, currencies fall.
This back and forth is best illustrated by
the U.S. presidential election in 1896. The Republican nominee, William
McKinley, narrowed an initially wide manifesto to focus purely on the
superiority of the gold standard whilst his opponent, William Jennings Bryan,
campaigned for bimetallism with a fixed ratio between gold and silver. What
Jennings wanted was looser policy and this was the basis for his famous words, “you
shall not crucify mankind upon a cross of gold”. McKinley won the campaign by a
wide margin because, to quote the economic historian Peter Bernstein about a
similar event “his arguments had the attraction of being cloaked in virtue,
prudence, stability and tradition.” As luck would have it wheat prices rose after the election of 1896, despite
gold, helping the embattled farmers that Bryan was attempting to protect.
Milton Friedman later ascribed this inflation primarily to the
Macarthur-Forrest invention of the cyanide gold-refining process which lead to
a huge increase in gold production, thereby loosening policy.
But this loosening and tightening of policy
as a consequence of variations in the supply of gold continued to bedevil the
gold money system. In his great essay Auri
Sacra Fames John Maynard Keynes talked both about the failure of gold to impose
stability on national currencies (as the Gold Standard) and also its failure to
be stable in terms of purchasing power domestically (as money). Perhaps the British Prime Minister Benjamin Disraeli got closest to the truth in
1895 when he stated that “Our gold standard is not the cause, but the
consequence of our commercial prosperity.” Neither this insight nor Keynes's subsequent attack on the ‹barbarous relic'
stopped the return to gold in the 1920s following its abandonment because of
the outbreak of the First World War in 1914. The subsequent austerity imposed
by the gold standard in the 1930s is thought by many to be one of the key contributors
to the economic problems of the era.
But if gold is not the essence of money is
it perhaps an instrument that allows protection from inflation? We have seen a
return to this discussion as people worry about future price levels as a
consequence of the current substantial economic stimulus. As Keynes noted in
the above-mentioned essay, “gold as a store of value has always had devoted
patrons.” As investors in productive assets, the type where a surplus can be
earned and then ploughed back into a business to drive up its economic value,
we struggle to see how gold can do the same thing, given that it doesn't create
an income stream. What is clear, however, is that money is a work of human imagination
that merely requires a collective belief in its ability to work for it to do so
for a time. If enough people think gold will protect them from inflation then,
assuming supply remains restricted, they will bid up its price and, magically,
it will do pretty much what they have expected of it.
In our view however, equities are much
better at protecting against inflation over any period other than the very
short term. The CFA Financial Market History study from 1900 to 2015 allows us
to test this assumption. This period of time saw deflation, inflation, war,
huge technological change and every type of policy. The mean geometric return
per annum for gold over that period was 0.7% and for U.S. equities it was 6.5%.
US$1,000 invested in gold in 1900 would have been worth US$2,230 by 2015
whereas US$1,000 invested into U.S. equities would have been worth US$1,397,000. Past returns cannot, as they say, be
extrapolated into the future but this seems very clear cut.
The Victorian critic John Ruskin told the
story of a man who boarded a ship with all of his wealth in gold. Some days
later a violent storm led to the order to abandon ship. The man tied his gold
around his waist, jumped overboard, and was lost to the depths. Ruskin asked: “Now,
as he was sinking, had he the gold? Or had the gold him?” Perhaps the true power of gold is how revealing it is of human nature.
Back to articles
 The Power of Gold, Peter Bernstein
 Essays in Persuasion, John Maynard Keynes
 The Power of Gold, Peter Bernstein
 RBC GAM, The CFA Institute Research Foundation, Financial Market History: Reflections on the
Past for Investors Today, David Chambers, Elroy Dimson, 2016
 Unto This Last, John Ruskin