Gold and Supply/Demand Fluctuations

Michael asked me whether it's a good idea to tie our currency to something whose value could fluctuate independently of economic activity. He wondered if a new industrial process might be developed that consumes gold and would cause the gold price to rise rapidly. I think this is highly unlikely for multiple reasons.

First, gold is extremely valuable (it's money). At almost $900/oz as of today, it it too expensive to be used for almost anything. It's hard to come up with a profitable process that would consume gold. The only thing I can even think of that is even close is platinum in catalytic converters and other chemical processes. But the amounts are so tiny and the value of it is so high that market pressure results in the platinum being recycled. Or consider silver which is used in photography. Silver is far more abundant than gold so there's less pressure to avoid consuming it. Still, silver is valuable enough that much of the silver used in the photography process is recycled. And it makes the process expensive which is one of the reason digital photography is far cheaper. The recycling and substitution pressures for gold would be orders of magnitude more powerful. Nobody can afford to consume something that is so valuable at any scale.

History bears this out -- almost all the gold that has ever been mined is still in existence and has an owner. Gold has very little intrinsic value. It isn't needed for any economic process. It's a good conductor of electricity and heat, but so is silver and it's much cheaper. It doesn't pay a dividend. It doesn't go bad. Gold plated plugs and contacts in electronics use so little gold that they are nearly negligible. The value of gold doesn't fluctuate according to economic activity at all. Rather, the price of fiat dollars fluctuate in terms of how much gold they are worth.

The supply side could be more of a problem. What if somebody discovered an enormous amount of gold? Geologists believe most of the gold that exists has already been mined. Gold is becoming harder and harder to find. There aren't very many unexplored parts of the planet at this point. I suppose there could be some in the ocean floor but I am not a geologist. At any rate, what I am pretty sure of is that gold is very expensive to mine. This fundamentally puts a limit on how much can be produced which is a very good thing. It guarantees a very small rate of monetary inflation. On the other hand, with a fiat currency, "printing" it is virtually free because it just is a change of a field in a database at the New York Federal Reserve Bank. Short of somebody achieving low cost alchemy, I think we're pretty safe. On the other hand, if the ice caps melt and we discover that Antarctica is a big block of gold, I agree we would need to find something else to use as money.

Gold makes a lot of sense as money. It's been considered money for most of human history. In many parts of the world such as China, India, and Arab nations, gold is viewed as the ultimate form of savings. It's rarity is nearly guaranteed. On the other hand, since the dollar peg to gold was changed by FDR in the 1930's, the dollar has lost 95% of its purchasing power.