In the last entry of The Future of Money, we discussed the nature of intrinsic value and how it’s largely subjective. This led me to question the difference between a fiat currency backed by government creed versus one that is backed by gold. If intrinsic value is subjective, aren’t they essentially the same thing?
The answer lies in the fundamental difference between currency and money.1 Most use these words synonymously, when in fact, they have unique etymological roots.
The term money comes from the Old French word, monoie, which was used interchangeably with “coinage, coin, and metal currency.” Currency, on the other hand, literally means “condition of flowing” (which I find amusing—a perfect metaphor for what our currency does when it “flows” from the printing press).
Today, people sometimes distinguish between money and currency, although they do it by referring to gold as “hard money” or “good money,” and fiat as “soft money” or “bad money.”
In order for something to be considered money, it must possess these seven traits:
- Fungible: One unit is interchangeable with another. I can exchange my $1.00 for your $1.00 because they are the same.
- Portable: Money must be able to be easily moved from one place to another.
- Durable: Money must be able to be resist wear or decay.
- Acceptable: Money must be able to be generally distributed and widely accepted.
- Uniform: All versions of the same denomination must have the same purchasing power.
- Divisible: One unit can be broken down into smaller units to pay for a wide range of goods and services.
- Store of Value: The limited supply of the money in circulation ensures its value is preserved over time.
So, why is one money “good” and the other “bad”?
It’s simple. Good money (gold) is a store of value, whereas bad money (fiat currency) is not. In other words, since fiat currency is designed to lose value over time due to inflation, it does not qualify as money.
I feel it’s important we begin to make the conscious distinction between money and currency, as the language we use is extremely powerful in shaping our beliefs. In neurolinguistic programming (NLP), for example, the careful and deliberate use of certain words is used to “program” the way one thinks about the world.
Each time we refer to currency as money or use these words interchangeably, we subconsciously reinforce the idea that they are the same thing, when they are profoundly different.
The reason money is superior to currency is due to its historic success rate.
While gold and silver have retained their purchasing power over time, fiat has not.2
As Voltaire said, “Paper money eventually returns to its intrinsic value: zero.”
A hundred-trillion-dollar bank note. Zimbabwe, 2009.
Throughout history, there have been thousands of fiat currencies, and every single one has eventually failed. Those that have yet to fail have an abysmal track record of maintaining value, which is why they cannot be considered money.
Take the British pound sterling for example, the oldest, most “successful” fiat currency in existence.
When it was adopted as Royal Chartered Bank of England’s currency in 1694, the British pound was defined as 12 ounces of silver, whereas today one pound is equivalent to 0.08 ounces. This means it’s worth 1/150 (or 0.67%) its original value. In other words, the most longstanding fiat currency in existence has lost more than 99% of its value (or purchasing power) over the past 327 years.
Key Takeaway: In order for something to qualify as money, it must be a store of value. Fiat currencies are not money because they all either fail (go to zero) or lose value large amounts of purchasing power over time.
Scarcity Gives Money Its Value
If intrinsic value is largely arbitrary, why has gold maintained its value over time, while fiat currency has not?
The answer: scarcity. In economics, supply and demand have an inverse relationship, meaning as the supply of something increases, its price decreases, and vice versa.
In order for something to be a long-term store of wealth, the supply must be scarce.
Many things have been used as money in the past (shells, tobacco, salt, barley), yet they all were all selected by society and collectively recognized as money because their supply could not be easily manipulated. It required physical labor to produce tobacco. Shells were hard to come by. Gold is difficult to extract from the ground.
Other things which aren’t considered money are valued based on their rarity.
From real estate and collectible cars to fine wine and art, humans appreciate things with a limited supply. Scarcity explains why an original painting is worth more than a copy—both have the same intrinsic value (the beauty they provide to the beholder), yet only the original is truly unique.
Key Takeaway: Humans place value upon things that are scarce.
Question to Ponder: Given what we learned about the subjective nature of intrinsic value and its fundamental relationship to scarcity, if an object even more scarce than gold were discovered, would humans place value upon it?
Why Gold and Silver Were Chosen by Society as Money
If many things in the world are scarce, some with arguably more intrinsic value to humans than gold and silver (such as cattle), then why were the aforementioned items chosen as money by society?
Some believe it’s because gold has the most inelastic supply.
For example, because it’s more difficult to mine an ounce of gold than it is to produce a crop, humans place more value on gold. Using this logic, one could conclude that gold is the world’s scarcest resource and was chosen as money because it most successfully preserved value.
That’s not the case.
Iridium, osmium, palladium, platinum and rhodium are all rarer than both gold and silver, yet only the latter two ever became money. Known as “noble metals,” all of the above are fair candidates to be used as money because they all have a limited supply. So why’d we end up with gold and silver?
Recall that there are seven characteristics of money, and being a store of value is merely one of them. In order for money to be widely used, it must adequately satisfy all of its traits.
Looking at the periodic table, every element besides gold and silver has its respective drawbacks. For example, platinum is too hard to extract—its melting point is 1,768 Celsius. Other metals such as lead, iron, copper, and aluminum are prone to corrosion over time, thereby making them unusable as a store of value.
More broadly, nonmetals are inferior to metals because they are far less practical. Cut a live goat into five pieces and it loses quite a bit of value—and a dead goat doesn’t store its value for very long.
The reason coins are preferred to cattle is simply because they better satisfy the “portable” and “divisible” characteristic of money. We can reasonably conclude that gold and silver became money not exclusively due to their rarity, but also as a result of their efficiency in meeting the properties of money.3
The way we’ve transacted has continued to evolve and become more and more efficient over the years, giving credence to the theory that the most efficient form of money eventually wins. Today, we use credit cards and ApplyPay over writing checks and paying in cash because they’re faster, easier, and require fewer moving parts.
Key Takeaway: Society chose gold and silver because they were the most efficient form of money.
Question to Ponder: Is it possible that a more efficient money could exist than the one we currently have? What would that look like?
In the next edition of The Future of Money, we’ll take a look at the drivers behind why people adopt a certain form of money, utilizing insights from my poker career and knowledge of game theory, as well as how this discovery could lead to what the future of money could hold.
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