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PROPERTIES OF MONEY

These are the properties that money needs to have. They will come handy later in our lesson.

  • It is something that has other, physical uses before it becomes money (it is a commodity) or it is acceptable by the market as money
  • It is widely accepted (it is highly marketable)
  • It is scarce (it maintains its value over time because it is difficult to obtain more or to counterfeited)
  • It is stable (it is not perishable)
  • It is divisible (it can be split in smaller pieces and negotiated with)
  • It is transportable (it can be taken to a market)
  • It has low competition

THE RETURN OF GOLD

This section answers the question: if governments would to collapse tomorrow, would gold return by itself to the market? We can also pose the same question in different terms: if governments would cease blackmailing and threatening us into using their fiat money, would gold return?

If the answer is yes, then it is clear that governments have indeed been maintaining fiat money against our wishes for their own benefit.

The regression theorem

In summary, Ludwig von Mises worked out how commodity-money (e.g. gold) appears in the market. The process is simple. People accepts such money because it has a value that can be spent tomorrow. But the best guarantee people have that they will be able to spend it tomorrow, is because they were able to spend it yesterday. In other words, people expects history to repeat itself. However, yesterday such assurance was based on such money being able to be spent the day before yesterday… and so on. We can use this very same process to go as far back in time as possible. However, at some point in time, we would find that such money was not used as money but as a commodity. It is this property, its value as a commodity that makes would-be commodity-money suitable to become money, because originally it was widely desired for its properties alone (i.e. it had a previous demand).

Note: For a better definition of fiat money, see the lesson Fake Money For A Fake Economy.

Do-it-yourself money

The only difference between government fiat money and DIY paper money you could print in your house is that the government has the brute force to intimidate people to use their paper and you do not.

A valid question is what would happen to government fiat money and your fiat money and commodity money if governments would to disappear tomorrow? For good or for bad, history provided the answer. We have an idea of what would happen based on Somalia’s and Zimbabwe’s recent history.

Note: for a more complete view of what happened in Somalia, please see our lesson Somalia – The Great Austro-Libertarian Failure?.

Everything else being equal

When the Somalian government was deposed, people continued to use the existing fiat money for exchange. Even when other mini-states were created and new money was introduced, people still preferred the old one. They never turned to gold, they preferred fiat money.

So, we know from this history that existing fiat money trumps new fiat money and therefore if governments were to disappear tomorrow, it is likely that people would continue to use whichever currency they were using today.

The regression theorem explains this phenomenon. People prefer to use money they know had value yesterday to money they don’t know if it is going to have value tomorrow. In other words, in a free market new fiat money would simply not be accepted, at least in the beginning.

But what would happen over time? Somalia answers again. If a source of some sort of authority issues new fiat money, it will be accepted over time.

Everything else not being equal

But what happens if prior to the collapse of all governments, they have run a massive hyperinflation? Then people would not trust fiat money because they were not able to trust it yesterday. The regression theorem again. And what would people do in such circumstances? Zimbabwe answers this one: they would revert to something that had other demand and desirability in the past; a commodity. Which one? Gold (and to a lesser degree, Silver).

The return of gold

So, would this mean that in a free market based on existing fiat money would gold never return? Unlikely. Let’s consider some sort of post-government world where all governments have collapsed but people continue to use their respective fiat money. Market operations will not cease. Exchanges will be performed among people with different currencies and exchange values will be established by the market. Rubles for Dollars, Swiss Francs for Bolivars, and so forth. Just like today but without government.

So, why would gold return? This question is equivalent to ask why did gold return in Zimbabwe? Because people did not trust fiat money. And what would make people distrust fiat money in a post-government world? Somalia again provides the answer: counterfeiting. As soon as the government was gone, massive amounts of counterfeit money were printed and placed into circulation. It did not reach the same hyperinflation levels to justify the switch to gold, but it came close.

The answer

We now return to our original question, should governments disappear would people return to gold? The answer is YES. Not immediately, of course, but eventually.

This clearly implies that we have been bullied into using fiat money (i.e. worthless pieces of painted paper), against our wishes. Yes, you can thank your very own government for this too.

FIAT MONEY, CRYPTOCURRENCY AND GOLD

Another valid question to ask is what would happen in a world where governments would suddenly disappear; which of these currencies would win acceptance?

From the example in Somalia we know that fiat money would continue to be used until counterfeited into oblivion. At that point in time, people will switch to a more trustworthy currency. But which one? Cryptocurrency (e.g. Bitcoin) or Gold (and possibly Silver)?

To answer this question, we need to go deeper and look how both respond to the properties of money:

  • Are these currencies either something that had other physical use before they become money (e.g a commodity) or were accepted by the market as money? YES
  • Are they widely accepted (i.e. highly marketable)? YES
  • Are they scarce (they maintain their value over time because they are difficult to obtain or to counterfeit)? YES (cryptocurrencies stabilize at a certain quantity after a time)
  • Are they stable (i.e. not perishable)? YES
  • Are they divisible (i.e. can be split in smaller pieces and negotiated with)? YES
  • Are they transportable (i.e. can be taken to a market)? YES
  • Do both have low competition? MAYBE

It is the last question that may actually help us. We know that Gold only has Silver to compete against, and both metals served quite well together in the past. So there is no problem here. But what about cryptocurrencies? It all depends. To answer that, we need to enter into speculative territory.

So far, there are only two deployed cryptocurrencies: Bitcoin and LiteCoin. For as long as the number of cryptocurrencies remains low, they will have low competition and they could work OK as money. However, what happens if every Joao, Xiu and Ummu decides to create their own cryptocurrency? What happens if the world is swarmed with SmallCoins, BigCoins, ShinnyCoins, SilverCoins, ElegantCoins and a zoo of other e-Coins? Then what?

Then, this case becomes exactly the same as the previous case of DIY money. The market will reject this option and two things may happen. The market may reject all cryptocurrency altogether (unlikely) or only a few will survive (probably the original ones).

At this point we know that Gold (and probably Silver) will be accepted by the market as money. However, we are not sure what will happen with cryptocurrency. It may come a time when both may serve side-by-side. That would not be so farfetched, because the amount of any given cryptyocurrency is fixed after a date and therefore a more-or-less stable exchange ratio with gold could easily be achievable. Furthermore, it is highly probable that Gold warehouse receipts will become electronic. It is conceivable that at that time Gold and cryptocurrencies would merge. And so, Gold (with its sidekick, Silver) has a brilliant future. Cryptocurrencies, we are not sure. In the end it all depends of the wisest of all judges: the free market. We defer to it.

Looking into the future

Right now, cryptocurrency is not counterfeitable by either private or government means. But this could change in the future. In the horizon we have quantum computing. As soon as a viable quantum computer can be built, it can be used to easily break encryption algorithms that are currently unbreakable and form the basis of cryptocurrency. At this point, cryptocurrency becomes counterfeitable, and Gold stands alone. Unless…. a quantum encryption algorithm could be developed (and now we are reaching into science fiction).

Summary

It is clear that in the event of a free market, fiat money will be forgotten over time and Gold & Silver and probably some sort of cryptocurrency will take over. However, as cryptocurrencies will eventually be hackable, we still prefer Gold which is hacker-proof.

Note: please see the Glossary if you are unfamiliar with certain words.

Continue to Gold is a shiny beacon of hope - Part 3

 

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