Thousands of years ago, gold became money. Why did this occur? After all, why should any substance have value? Gold is merely a metal which just sits there and does nothing. Yes, it can be fashioned into jewelry for women and men to wear and, yes, gold is beautiful. Why did it become money? Even today, why is gold a form of money which competes with the fiat currencies which governments issue in infinite quantities? The answer is very simple. Gold became money because the free market selected it as money. The free market consists of millions of individuals who act in what they perceive to be their own best interests. The market chose gold as the result of economic decisions made by millions and millions of individuals over the course of thousands of years.
When one thinks about it, there is no reason why many different substances cannot perform a monetary function. Early humans used barter in order to obtain goods and services. In that context, corn, wheat, firewood, meat, livestock, and land can all serve as means by which people can exchange goods and services. After World War II, even chocolate bars and nylon stockings had their monetary uses in war-torn Europe. However, none of these things have ever been chosen by free markets to serve as money over the long-term. Why not? To understand this, we need to understand why we want and need money at all.
Some of the greatest minds have contemplated the reasons why we need to have money as a medium of exchange. In the 4th century B.C., Aristotle enumerated the characteristics required of money: durability, divisibility, convenience, consistency, and intrinsic value. What do these things mean? The best form of money will be something which, unlike wheat or corn, does not decay. It must not rust like iron. Money must also be divisible into uniform smaller units. One cannot do this with a rare painting or a diamond. Money must be consistent and uniform. Wheat, real estate, diamonds, and rare art are not uniform. Indeed, they can vary quite significantly in quality. Finally, money must have intrinsic value and uses.
When one considers all of the characteristics needed in money, it becomes clear that only something like a metal can fulfill ALL of the functions needed. Metals are divisible, consistent, and most have some intrinsic value. However, not all metals will suffice. Lead is too heavy, so it is not convenient. Iron rusts, so its durability is in question. After centuries of trial and error, human beings selected gold and, to a lesser extent, silver as the primary forms of money. No government ever had to pass a law mandating that gold or silver be used as legal tender. Gold and silver were selected because they fulfilled ALL of the requirements of money.
Ironically, in 1966, Alan Greenspan wrote what this writer believes is the best essay ever written on the subject of gold's function as both money and as a guarantor of individual freedom. The irony lies in the fact that Mr. Greenspan later became the biggest purveyor of paper money the world has ever known. However, at least back in 1966, he understood why gold was, is, and always will be, money.
The main functions of money are: 1) to serve as a standard unit of exchange and 2) to serve as a means by which to store or preserve wealth. Greenspan recognized this and pointed out that without a means of storing value, people would have no way of saving and no way of making long-range plans. We might as well go back to being hunter-gathers, living from day to day, hoping that we will kill enough animals and pick enough berries to live another day. Of all the substances which humans have tried as media of exchange, precious metals have worked the best, and gold the best of all.
Gold has served as money throughout most of recorded history. Gold and silver are the only forms of money referred to in the Bible. However, beginning with the ancient Chinese, and in Europe in the 17th century, there have been many experiments with other types of currency. All have ended badly. As Voltaire (1694-1778) once observed, " Paper money eventually returns to its intrinsic value...Zero!"
In the late 1600s, the advent of paper money in England caused a monetary crisis. In his capacity as Master of the Mint, Sir Isaac Newton was instrumental in formulating what would later be called the gold standard, a system of backing the nation's currency with gold, thus preserving and stabilizing its value. This system worked well for about two hundred years. Nonetheless, governments continually tried to avoid the restraints imposed by the gold standard, always with similar results.
During the American Revolution, the Continental Congress attempted to pay for the war by printing paper money, the so-called Continental Dollar. As in other similar situations, the Congress printed up so much paper money that it caused a hyperinflationary nightmare. For generations, the phrase "Not worth a Continental" was a familiar one in American life. It was primarily because of this experience that our founding fathers intended that only gold and silver be used as legal tender in the United States. This has obviously been subverted by subsequent politicians and by banking interests. It is not a coincidence that, in our current era of limitless, unbacked, paper fiat currency, the phrase "Not worth a Continental" is no longer known by most Americans!
In the aftermath of the French Revolution, the government tried the Assignat currency system, another inflationary paper money scheme. It ended in disaster. During the American Civil War, the Union government printed huge quantities of "Greenback" dollars in order to "pay" for the war. Once again, this triggered hyperinflation, and Greenbacks ultimately lost their value. The same thing happened in Germany in the early 1920s. The Weimar Republic attempted to "inflate its way out" of having to pay the war reparations imposed upon it by the victors of World War I. The end result was hyperinflation. People used paper money as fuel to heat their homes. The "money" was worth more as fuel than as money. The whole system collapsed. There is a plausible argument that Hitler's rise would not have been possible without the occurrence of the Weimar hyperinflationary nightmare. Don't say that "it can't happen here" or that "it will never happen again." These kinds of things can and will happen any time and anywhere governments abandon gold and use unbacked, inflationary monetary schemes.
None of these disasters occurs when free markets choose gold as the primary form of money and when governments do not interfere with gold's role as money. This is the eternal battle. Governments hate gold because a gold standard imposes restraints upon the ability of any government to create unlimited amounts of money out of thin air. Huge social programs cannot be imposed upon society and destructive wars cannot be waged on an open-ended basis where there is a gold standard. Where there is a gold standard, the money supply remains relatively constant, so inflation is nonexistent. Prices remain stable. If you do not believe that this is possible, just take a look at the monetary history of the United States. The value of the U.S. Dollar remained much the same during most of the 19th century (with the exception of the Civil War and other brief inflationary episodes). Business cycles were less severe than they are now. In fact, prices even declined over time. The United States had the highest growth rate in the world at that time, and it was the 19th century which made us the world's manufacturing giant. All of this is gone now.
Beginning in 1913 with the creation of the Federal Reserve Bank, the United States gradually departed from a gold-backed, stable currency system. In 1933, FDR isued an Executive Order making it illegal for individual citizens to own gold except as jewelry, for dentistry, or in the form of rare coins. (Note: It was illegal for U.S. citizens to own gold bullion until 1975). However, the U.S. Dollar was still backed by gold vis a vis other governments. Foreign governments could bring dollars to the U.S. "gold window" and exchange them for gold. Under such a system, when a government spends too much, its gold tends to leave the country as foreigners trade their paper dollars for gold. During the 1960s and 1970s, Presidents Johnson and Nixon embarked on irresponsible deficit spending sprees in order to "pay" for the Great Society social programs and for the Vietnam War. This meant printing lots of paper money. Gold began to leave the U.S. In particular, French President Charles DeGaulle insisted on trading paper U.S. dollars for gold held by the U.S. Facing the potential depletion of the United States' gold reserves, in August, 1971, President Nixon unilaterally took the U.S. off the gold standard. In essence, the United States defaulted on its promise to back its currency with something of stable value, gold. At about that time, Nixon famously declared that "We [politicians] are all Keynesians now!" In other words, he indicated quite clearly that the U.S. was embarking on an economic policy based upon debt and fiat currency, rather than one based upon savings and honest money.
Since 1971, the U.S. money supply has expanded at an insane pace. One dollar today buys only what $0.20 bought in 1971, and that estimate is based upon the bogus statistics published by the U.S. government. The reality is even worse than that. By abandoning gold as a standard with which to back our money, our leaders also abandoned all restraint in monetary policy. When government has the ability to conjure up unlimited quantities of "money" out of thin air, it is possible to buy votes by creating more and more social programs and entitlements. It is also possible to engage in foreign wars on an open-ended basis.
Whenever a government abandons gold as the anchor for its monetary system, inflation is always the result. The classical definition of inflation is: a rapid increase in the amount of currency relative to the amount of available good and services, thus resulting in an increase in prices. Inflation operates as a hidden tax on a country's population, and it serves to lower living standards. And this is why gold is so important. Gold prevents governments from stealing from and impoverishing their citizens. It restrains governments from engaging in reckless spending policies. It protects the individual's efforts to preserve his wealth, buying power, and standard of living.
Let us examine the words of the apostate himself, Alan Greenspan. The late Kennedy Gammage, a champion of honest monetary policy, once observed that it seemed to him as if Greenspan had sold his soul to the devil. Beginning in 1987 when he became Chairman of the FED, Greenspan became the biggest money printer in world history. In 1966, Greenspan still "got it" where gold was concerned.
"In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. If there were, the government would have to make its holding illegal, as was done in the case of gold.....The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves.
This is the shabby secret of the welfare statists' tirades against gold. Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists' antagonism toward the gold standard."
Alan Greenspan, "Gold and Economic Freedom" (1966).
In conclusion, it must be said that despite the best efforts of governments to "demonitize" gold, gold remains money. Trying to "demonitize" gold is similar to trying to hold a balloon under water. Sooner or later, one becomes tired or loses one's grip. The balloon will rocket out of the water at great speed. Ever since 2000, gold has been gradually reasserting its monetary role. At first, it did so against the U.S. dollar, but more recently it has done so against ALL major currencies. This is not surprising because all nations are now using unbacked fiat currencies. Some countries, like Russia, are expanding their monetary supply at an ever faster pace than the United States. On the other hand, there has never been a government which could print up unlimited quantities of gold. Gold is very rare, and it takes a lot of time and effort to mine it. No wonder that gold has gone from about $250 per ounce in 2000 to over $900 in 2008! Our government has passed laws making pieces of paper with ink on them required as "legal tender." However, gold still functions as a currency which competes with all of the fiat, unbacked currencies of the world. You can sell it immediately at any coin or bullion dealer's shop. It is incredibly "liquid." Where would you have best been able to protect your wealth from 2000 to 2008? In a U.S. bond paying 4% interest or by owning gold? The answer is easy!
Gold is money! That's it!