Wednesday, April 9, 2008

Why is gold valued?

With all the talk about recession, depression and doom, gold seems to be again in the mind of many people, and its price climbed significantly (with large fluctuations). So why would people rush to gold?

We live in a world of fiat currency, and if people stop trusting in the currency, they abandon it and by experience something else it used as money, typically another currency. This phenomenon of dollarization is based on the fact that people still trust the replacement currency, ofter the US dollar. But what if people do not trust that either, as some imply is likely?

Thus people fall back on gold. But gold is not a good currency for everyday transactions, as it is not possible to have small change in gold. This used to be a problem before fiat money, as discussed by Thomas Sargent and François Verde.

But whether gold is the optimal currency is not the question here, it is why people value it at all. It is rare, it is shiny, people like to look at it (although this may just be because it is highly valued). But it is not particularly useful. If you think about it, if society or the market collapses, there is not much you can do with a gold bar apart from hitting people with it or using it as a doorstop. Ammunition, tools, clothing, food are much more valued in such circumstances.

Is the value of gold just an illusion, as much as the value of fiat money? Why would people trust gold more than money? In fact, Dubey, Geneakoplos and Shubik argue that given that gold has no consumption value, it should not be valued. Cigarettes, however, are valued, and their value disappears once consumed.


Independent Accountant said...

They're all idiots. That gold has few alternative uses is exactly why it is MONEY! It has the highest "stock/flow" ratio of any substance and little consumption demand. We don't worry about a freeze destroying this year's "gold crop" unlike oranges. Why is paper money? Why should something that can be printed for say 3 cents, a paper dollar, be worth a dollar? Why do we now see the alchemists of 700 years ago as fools but do not see all the paper money pushers as modern day alchemists? Why is counterfeiting illegal except when Helicopter Ben does it? Gold production regulates itself, unlike dollar production which is determined by fiat. Gold is the economists enemy. Why? With gold we don't need them. When gold hit $875 in 1980, did Uncle Sam sell? No. Why not? Because it was worth more than $875 then and Uncle Sam knew it.
The real mystery: why do people treat paper dollars as if they are wealth? If Helicoper Ben suddenly ten tupled the Fed's balance sheet would we all be ten times richer? What nonsense to believe creating dollars creates wealth. In a regime of totally fixed money stock prices would continually fall. So? The falling prices are in effect "interest" as expressed in other goods. Interest for what you ask? Holding gold, by which you "lend" value to the rest of society.

Economic Logician said...

independent accountant: in terms of regulation, gold is a really poor object. As the gold standard showed, prices are highly dependent on gold production and in particular gold discovery. Why should the price of milk depend on what is discovered in South Africa?

Also, I think everybody agrees money is neutral, at least in the long run. If M0 is multiplied by ten, I bet all prices get multiplied by ten as well. Printing money does not create wealth.

Anonymous said...

independent accountant: The post is mentioning that people value gold for no obvious reason. You appear to value gold above all. Care to explain why? Your rambling about dollars does not explain why you value gold over, say, cigarettes.

Unknown said...

Can I have all of your valueless paper dollars, then?

Also, can I have your laptop. If societies collapse, I doubt we'll generate the power required to run or repair them.

Finally, gold has many scientific uses and applications which are unique to gold, the least of which is its high conductance.

Anonymous said...

I agree, gold is vastly overvalued compared to its underlying value. It is thus not much less a fiat currency than US dollars.

Anonymous said...

people value gold because of it's rarity, it's permanence, it's difficulty to counterfeit. its been used as currency for over 6000 years because of these properties by different cultures, many of whom were isolated from the rest of humanity.

There's many good reason's why gold is valued other wise it just plain wouldn't have been almost universally across the world. people can suffer mass delusion's but for them to be identical whilst unconnected? Please...

Kansan said...

I just came across this article, where the second item indicates why humans seem to like shiny things like gold and diamonds that have no intrinsic value. We evolves in this way to instinctively recognize clean water from dirty one.

YankeeRadio (22) said...

Gold, cash, silver, what have you, has value in modern civilization. When shit hits the fan survivor groups will be interested in trade, much like the American Indian, whom deemed gold bad luck to touch. Until larger groups are reformed and become governments or an empire, then it will be desired again. The question of why?, that takes you back to the beginning and how it looked, how easy it was to work with, and the fact that is was hard to find, all played a role in why. Let me ask this. If the remains from a distant exploded star, found its way, in a fire hail storm, to the earth, leaving a new deposit of pure gold, larger then the last, would gold be so valuable?

Anonymous said...

I believe I found the answer to this question. Gold was valued in all prior history because of indwelt superstions and beliefs in it having magical powers. In today's world we know such powers do not exist, yet many mostly women still value it only for their empty superstitions relating to it combined with their lustful vanity for it, which holds no intrinsic value to mankind's sustainability.

What is true value is HUMAN SKILLS AND INGENUITY that he keeps in his mind even if all "legal tender" is stolen from him. Because when this happens he creates from what is in his mind, without charge.

Combine man's skills and ingenuity placed in him by God from creation with the natural resources of the earth such as soil for growing crops and stones and metals for building materials and one finds the true "legal tender" that people should invest in which will never run out or be printed from nothing, since it takes the sweat of man's face and his mental abilities to extract and subdue these things.

If you want to invest your money in something, put it into educating yourself in self sustainable skills in various fields, then add buying farmland in politically more stable countries in tropical locations.

Forget gold, even if you could sell it to some vain women in Asia, after a collapse how would you travel all the way there, and what would you exchange it for to begin with while you are over there?

Lastly everyone is forgetting the threat of nanotechnology which certainly will be able to almost perfectly replicate it very soon without being able to be deciphered between it and the real stuff with all the techniques known to gold dealers.

Adrian Waters said...

Gold never deteriorates unlike many other assets. Consequently, one can store it, confident that it will have a reasonable value when required.

Anonymous said...

All money should first be considered as a representation of wealth, not wealth itself. Paper dollars and gold are only 'valuable' because they represent wealth. And they only represent wealth because the government says so.

The reason government can say money represents wealth is because it is acceptable to be used for taxes. Gold has fulfilled this role for thousands of years, therefore it has significant historical value as money.

However, recently (in the last 150 years) gold has lost its position as a representation of wealth to paper money. This is for a number of reasons, not least of which include a massive increase in productivity and population

Here are some things to compare the time between when paper was still paper and gold was money:
In 1800, the average GDP in the entire world was 250$ a year. The population was between .9-1.0 billion people.
In 1900, the average GDP worldwide was 850$, almost 3.5 times as much as 1800, and the population nearly doubled to about 1.7 billion people. If the same amount of gold in 1800 also existed in 1900, this means that the value of gold in 1900 would be about 6x as valuable than in 1800.
So now productivity and population are increasing at unprecidented rates. Coins would have to have increasingly less gold in them to meet that demand. And now that gold is worth more than $1000 an ounce, gold can't even be used to purchase everyday goods. Gold's rarity didn't increase, its demand increased. This is why paper has largely replaced gold and why gold is much more valuable.

Gold's properties are indeed interesting, and gold has certainly worked well as money for thousands of years. But that is only because productivity and population had stayed low.

Now, the population is 7 billion, and average GDP is more than 8000$ a year, which would make any non-consumable good in 1900 40x as valuable today.

Economic Logician said...

Regarding this last comment: this would imply that gold would have had an amazing return on investment. It does not, see my other post on this.

BrianS said...

If you begin to argue that gold has been nearly universally recognized as valuable by all cultures and, therefore, is valuable, that is equivalent to arguing there is a some type of god because nearly every culture has, at some point, univdrsally accepted there is some type of god.

And I believe that leads to the original question: "Why do we value something with little to no intrinsic value?" This is where sociology and econimics start to weave a web of utter chaos.

bongstara420 said...

It is super valuable in objective terms, but not based on the current markets actual supply/demand logistics (it is currently worth less than the cost of extraction due to huge amounts being tied up in jewelery and storage). Gold is currently valued in symbolic terms. That price is hollow. The real value in the price originates from technology and to its greatest extent, high end technology. Look at the industrial use of Gold vs Jewelery/Financial. When Gold's spread sheet looks like Silver, I will then believe in its Value and Price as an investment. Now, price is entirely dependent on dumb asses looking for status symbols or assholes looking to create false scarcity.

I do not believe in high Gold prices over long terms of time. We have one more price spike in our future that is intrinsically related to living standards, the size of the population, and our status as not fully transitioned to space faring status. This will occur in approximately 20 years. It will be short lived as the first commercial scale asteroid harvest will bring prices down for the rest of colonization. There may be price fluctuations on the order of months to years if wars happen in space or something like unforeseen xray solar flares disrupts supply. The space industry seems to be developing in a way that will generate a great deal of independent supply chains from nation states and private enterprises.

Anonymous said...

Gold is valued just because gold is yellow as the hair of blonde white people.