Memo to PC: Gold is useful because it is useless

Gold bashing seems to have become the favourite pastime of Finance Minister P Chidambaram these days. He has repeatedly warned Indians to get over their fascination for gold. But maybe Chidambaram does not know his history well enough. If he did he wouldn’t be saying the things he has been.

Gold over the centuries became universal money and there were several reasons for the same. It is not fragile and is durable. It does not rot. It is chemically inert unlike copper, silver and iron, which means its radiance is timeless.

Given its chemically inert nature, most of the gold mined since eternity is still around. Estimates suggest that the world has 1,65,000 tonnes of gold. The supply of gold rarely goes up suddenly.

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A report released by Standard Chartered in 2011 expected the supply of gold to go up at the rate of 3.6 percent per year between 2011 and 2015, suggesting stable supply of the yellow metal. In a bear case scenario, the report said the supply would grow at an even slower rate of 1.2 percent per year. The price of gold has rallied over the last two decades, but even so there has hardly been any significant growth in the supply of gold, with production going up at the rate of minuscule 0.7 percent per year. During 1900 to 1990, the production of gold grew at the rate of 1.9 percent per year.

This has historically held good as well. Since 1492, the supply of gold has never gone up by more than 5 percent in any given year. In fact, during the normal course of things gold supplies have grown between 1-2 percent every year. The exception to this is when new gold discoveries happen and lead to a gold rush. These are the only occasions, as was the case with California and Australia in the 1850s or South Africa in the 1890s, when gold supplies went up faster than 4 percent a year.

[caption id=“attachment_583836” align=“alignleft” width=“380”]  With the supply of gold being limited, what it means is that it has held its value better than other forms of saving, and especially paper money. AFP[/caption]

With the supply of gold being limited, what it means is that it has held its value better than other forms of saving, and especially paper money.

Gold is 20 times as dense as water and twice as dense as lead, which means a lot of it can be packed into a very small size. One cubic metre of gold would weigh around 19.3 metric tonnes (i.e. 19,300 kg). What this means is that a very high value of money can be easily moved around if it’s in the form of gold.

When it came to rarity, something like a diamond or a ruby was a better bet. But figuring out the quality of a diamond and other stones was difficult. Experts could easily haggle on it, with different experts having a different opinion. When it came to gold such problems did not exist.

As Aristotle, the Greek philosopher and teacher of Alexander the Great put it: “It became necessary to think of certain commodities, easily manageable, safely transportable, and of which the uses are so general and so numerous, that they insured the certainty of always obtaining for them the articles wanted in exchange.” Gold had all these qualities.

And that’s how over the centuries gold emerged as money that everyone preferred to use. What also helped was the “uselessness” of gold.

Despite the fact that it is highly malleable (can be beaten into sheets easily) and ductile (can be easily drawn into wires) and the best conductor of electricity, gold does not have many industrial uses that other metals like silver have. This is primarily because there is very little of it going around.

Also when commodities are used as money they are taken away from their primary use. So if rice or wheat is used as money for daily transactions and to preserve wealth, it means a lesser amount of rice and wheat comes to the market. This in turn would mean higher prices of grains which are a staple food in large parts of the world. Golddoesn’thave many practical uses. So if people hoard gold, itdoesn’thurt anyone.

As the blogger FOFOAput it, “Gold’s utility is that for thousands of years it has held its value relatively well. And because it is not used for many things other than mere hoarding, the act of hoarding gold is not an infringement on the natural rights of others to enjoy the utility value of “real world” things like BMWs and oil and wheat… If one were to corner, say, the copper market or the chocolate market, there would likely be repercussions as those industries fought back through the power of the collective that likes to consume chocolate and copper. But with gold there is no such worry.”

Gold started giving away to simple paper money at the start of the First World War in 1914. While it did make a few comebacks as money over the years, the world moved onto a complete paper money system in the early 1970s.

What this did was that it allowed governments around the world to print as much money as they wanted to. And this has led to paper money rapidly losing its purchasing power over the years. Things have become particularly worse since the start of the financial crisis in September 2008. The governments of Western nations have been printing more and more paper money and pumping it into their financial systems. This was been done in the hope that their citizens will spend that money, which will help revive their economies.

Given that the global money supply has increased dramatically over the last few years, there is a grave danger that paper money will lose value rapidly in the years to come. And this has led to people buying gold all over the world which is seen as the ultimate store of value.

People in India have bought gold because of this reason as well. The other reason has been our high rate of inflation which has led to the purchasing power of the rupee going down dramatically, motivating people to buy gold which is seen as a commodity which holds its value relatively well.

And the good part is that people in India have been ‘hoarding’ gold to ensure that the value of their accumulated wealth does not fall.

Imagine if they had tried to hold wealth in the form of rice or wheat. In a world where nearly 79 million people are being added to the dinner table every year (and a lot of them in India), hoarding rice and wheat could have caused food riots. Imagine if all the Indians would have actively speculated on metals used across industries. Their prices would have gone through the roof. (In fact with huge demand for industrial metals from China, these metals had been rallying for the last few years. Imagine what would have happened to the price if Indians had started actively speculating in them?)

So its good that people are buying gold to hoard their wealth and not something which is actually useful. As FOFOA puts it, “Thankfully we have a commodity that is mostly used for hoarding, and little else. Like Warren Buffet said, we dig it up and then bury it again in a vault. And all it does is one little thing: it maintains its value over thousands of years. That’s gold’s utility.”

And Mr Chidambaram should thank his stars for that.

References:

Chen,Y and others. 2011._In Gold We Trust._Standard Chartered

Bernstein, P. 2000._The Power of Gold - The History of an Obsession._John Wiley and Sons.

FOFOA. 2010._The Value of Gold._Available atwww.fofoa.blogspot.com

Skousen, M. 2010.Economics of a Pure Gold Standard. Foundation for Economic Education

Vivek Kaul is a writer. He can be reached at vivek.kaul@gmail.com