When discussing currency and money, we didn’t treat gold and bitcoin as either. Some people believe gold and bitcoin are money. We do not.
Government Treatment of Gold and Bitcoin
The United State government treats gold as investment property or collectibles depending on how it is held. It considers Bitcoin as investment property. The United Kingdom, European Union, Japan, Canada, and Australia treat them similarly.
India and China immensely value gold as jewelry and are the largest consumers of gold globally. Both nations also value gold as an investment property. Despite large ownership of gold by individuals and governments, they do not recognize gold as legal tender. They treat and tax transactions as a consumable or an investment depending on the buying and selling method.
Most governments do not treat gold and Bitcoin as currency or money.
Historic use of Gold as Currency
Remember the properties of a currency: medium of exchange, unit of account, portable, durable, and fungible (interchangeable). Gold was used as currency in the past across several civilizations dating back thousands of years. Gold coins were minted and were used as a medium of exchange.
Theoretically, gold is divisible, but this is not practical. Imagine having to break out the right quantity of gold from a coin to pay for a small purchase. Similarly, while theoretically fungible (interchangeable), in practice it isn’t easy to precisely assess the purity of gold without specialized tools and techniques. It was even harder in the past when people only had access to imprecise methods.
Gold Replaced by Paper Currency
Yet, our ancestors managed to get by. Where they used gold, it was perhaps a better choice than bartering. It’s all relative! Over time, ruling authorities introduced paper currencies to overcome these limitations.
As societies transitioned from gold to paper currencies, it was logical to think of paper currencies as a form of payment instead of using gold. Initially governments explicitly linked paper currencies to gold held by them. They held gold in vaults and issued a corresponding amount of paper currency for circulation. People exchanged paper instead of gold, with the understanding that one could always exchange their paper for gold.
Gold Isn’t Currency. Is it Money?
Our ancestors lived with many inconveniences that we no longer suffer today. Why use gold as currency when we have much better alternatives?
Money shares all the properties of a currency. Additionally, it is also a store of value. This characteristic sets it apart from a currency. This means it can retain its worth over time, allowing individuals to save and retrieve value in the future. Some believe that gold can hold its value against inflation, so they treat it as money.
Yes, historically gold has tended to hold its value if you held it long enough. But so did many other classes of investments such as land (real estate), art, antiques, other precious metals, diamonds and other precious stones, etc.
Gold isn’t good at being a currency. It was a good store of value in the past. Whether it is a great store of value in the future is anybody’s guess. It derived its “intrinsic value” from its historic role as a currency and near-universal acceptance around the globe. But it no longer plays that role. Those who buy gold do it for a variety of reasons, just as they buy other commodities and collectibles. Its price is subject to the laws of supply and demand.
Should You Own Gold?
You can use gold as jewelry. You can speculate in gold by investing in it. You can either hold it in a physical form, such as a gold biscuit, or as a piece of paper.
Whether you possess gold as a consumable (jewelry) or invest in it, you should be very clear why you are buying and holding it. Don’t confuse your jewelry for an investment. And don’t confuse your investment for a sure thing. Investment advice is beyond the scope of this article. We just want you to be very clear in your mind about gold.
What About Bitcoin?
Bitcoin, being a digital currency, addresses gold’s limitations as a currency. Bitcoin was also designed to mimic two other important properties of gold.
First, gold is limited in availability. Gold, as is the case with other heavy elements such as silver, resulted from cosmic activity and found their way onto earth. No new gold is being created on earth. We are simply mining and processing what’s already here. Bitcoin was carefully designed to also be limited in quantity.
Second, no government authority can create new gold out of thin air the way they create fiat currency. Knowing that no fiat currency in history has survived forever, some don’t want to trust their savings and wealth to fiat currencies. Bitcoin was also carefully designed to not be created by a centralized authority.
Therefore, by design, Bitcoin was to be a better currency than gold. In most places, a fiat currency is a legal tender within its jurisdiction. You can use it to buy and sell goods and services. But you can’t say the same about Bitcoin or any other form of currency because they are not legal tender in most places. You are limited to using your non-fiat currency of choice only with those who accept it. It could be Bitcoin or gold or seashells. If someone is willing to accept them as currency, it’s an agreement between those two parties.
Note that when we say Bitcoin, we mean Bitcoin. We haven’t discussed other cryptocurrencies. Not all of them are limited in quantity the way Bitcoin is. To the extent some treat cryptocurrencies as a currency or money, they are no different than Bitcoin or gold or seashells.
Should you use Bitcoin as currency? It’s your choice if you prefer it over fiat currency. Remember that Bitcoin doesn’t hold the same privileges held by a fiat currency in its jurisdiction. Should you invest in Bitcoin? As with gold and other forms of speculation and investment, it’s your choice. If you decide to, do it with a good understanding of what you are dealing with.
Gold, Intrinsic Value, and Confidence
We clearly don’t hold gold and Bitcoin in the same regard as some others do. Nevertheless, it helps to understand why some hold them in high regard. Even better if we can explain why we don’t agree with them. That should help you form your own considered opinion.
A fiat currency has no intrinsic value. Some claim that gold, on the contrary, has intrinsic value. The concept of intrinsic value is intriguing. You can read this long article for a deep philosophical treatment of intrinsic value. We adopt the view that intrinsic value is the value that an object or entity has in itself, not because of its utility to achieve something else, but because of its inherent properties. When considering gold, if we say it has intrinsic value, we are suggesting that there is something about gold itself – its rarity, its aesthetic appeal, its physical properties – that makes it valuable, irrespective of any other uses it may have.
Contrast that with extrinsic value, which is the value that something has not in itself but because of its ability to help achieve or obtain something else of value. In the context of gold used as jewelry, its value can be seen as extrinsic. People may value gold jewelry not solely because of the gold itself, but because wearing it brings joy, enhances social status, or is perceived as a symbol of wealth. Here, the value of gold is instrumental – it is valued for the joy, status, or wealth it helps to achieve or represent.
Do you value gold for its intrinsic value or for its extrinsic value? We argue that gold as money, or a store of value, is pursued for its extrinsic value. Just as we do with a certificate of deposit or a government bond or other such forms of money. The difference is that the extrinsic value of gold is derived from what others are willing to pay for it at any given time. Whereas something like a government bond or a rental property has a defined return protected by a contract. Given a contract with a defined rate of return, you know its value at the end of the term. There are no such guarantees with something like gold because it doesn’t have an assured rate of return.
A contract is a formal and legally binding agreement enforceable by law. Who enforces the law? In most modern societies it’s the government. So, if you made a loan and the borrower doesn’t want to honor the terms of the loan, the legal system steps in to enforce those terms. How confident are you that the legal system will step in and effectively deal with the situation? In most developed and developing economies, these contracts hold up well. That creates trust in the financial system, which helps in the smooth functioning of the financial system.
A fiat currency is essentially backed by a legal contract enforced by the issuing authority. However, for any number of reasons, some do not trust the legal system with their savings and wealth. That’s another reason why gold is in favor with some investors. This non-reliance on a central authority is also an important aspect of Bitcoin.
This desire to be free of a central authority may be a motivation for you to hold some of your savings in gold. Let’s unpack what that really means. If you do not trust the power of the law to enforce contracts, you should be physically holding your gold. If, instead of owning physical gold, you own a security such as GLD that represents gold, you are owning a contract. This contract guarantees that you indeed have a claim on that gold, and it is enforced by the legal authority. The same one that has issued the fiat currency. If, instead of hoarding physical gold in your own safe, you lock it up in a bank locker, you are owning a contract. This contract gives you the right to operate the contents of the locker. Who enforces this right in case of a dispute with the bank about your ownership?
Unless someone hoards their gold in a fully controlled secure location, they rely on a contract. That contract is backed by the same authority behind a fiat currency. So, if you distrust government authority with fiat currency, why trust it with other contracts? In that case, you must physically secure your gold without others’ help.
Be an Informed Investor
We shed some light on gold and Bitcoin’s appeal. If you buy farmland or a rental property, you can assess their capacity to generate income. Farms yield crops. Rental properties yield rent. That gives a basis for valuation. You lack such metrics for gold and Bitcoin because they yield nothing. So, buying gold or Bitcoin means speculating that someone will pay a higher price when you sell. You can speculate but do so with a clear understanding of the motivations of buyers and sellers.
We hope we have provided a framework for thinking about gold and Bitcoin as a store of value.
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Thank you for yet another well written article!