Gold: Reality vs. Liquidity

Deep thoughts from a long-time thinker on gold...

AS SOMEONE WHO'S BEEN interested in gold for the last forty years, writes William Rees-Mogg for The Daily Reckoning Australia, I have always been interested in the definitions which can be applied to gold.

Is gold money? It often has been, but it is not at present. I suspect it may become money again, but is gold also a commodity? I think the answer to that question is "Yes". Gold used in chemical reactions, or in jewelry, is plainly a commodity which can sometimes be replaced by another commodity.

However, the question I find most interesting is whether gold is a real asset.

One of the problems of investment is that there are two variables, reality and liquidity. Land or property are relatively illiquid, but are also real, in that they have a use which does not depend on their value in exchange. Gold is highly liquid, indeed it is more liquid than paper money. In extreme circumstances, paper money can lose all its value, but gold is still acceptable as payment.

In 1940, for instance, when the French Army was defeated, many French people took to their automobiles to escape the advancing Germans. They found that petrol stations would not accept paper francs, but would sell their petrol in exchange for Gold Coins.

Gold Bullion also remains an acceptable currency in periods of high inflation, when paper money can lose all its value. But what does "reality" mean, when applied to an investment?

Obviously we talk about "real estate" to describe the legal possession of property. I think that means property with a permanent character and at least a potential use. In the same way, the traditional theorists of the Gold Standard would say that gold was a real currency, because it has permanence and a potential non-monetary use.

I accept that reality in an asset is a relative factor. In an ideal world, we would all like to hold our financial needs in a currency with a high degree of permanence, strong alternative uses and high liquidity. We have to make do with currencies which fall short of perfect "reality", and fall short of perfect liquidity as well. We make do with imperfect currencies because we have no choice.

Gold Investment makes one think about these issues, but it makes one even more uneasy about electronic money. In book publishing, I am well aware of the library demand for archival books which can reasonably be expected to last for centuries, like the printed works of earlier centuries. We need also to have permanent money, which can be relied upon to survive, even it its value may decline over time. The historic value of gold has been astonishingly stable over centuries.

In an extreme example, one could be worried about the issue of money and about its preservation. Mr. Madoff has shown that fraud can reach the unbelievable level of $50 billion. Might there not be still larger frauds, so large as to achieve what the Nazi war machine attempted – the complete take-over of a targeted currency?

Suppose that Al Qaeda, instead of attacking the twin towers, had attacked the electronic systems which record all the monetary holdings of New York. No lives might have been lost, but an electronic pulse might have erased one of the central counting houses of world finance. And is there not already some element of this cyber-catastrophe in the present world crisis?

Reality may be a variable concept, with nothing 100% real and hardly anything zero per cent real. When I was born, in 1928, gold was money, and gold was over 90% real – the rest existing as paper certificates and bank-notes issued in excess of the full bullion backing. By 1970, when I was in my forties, money was paper, and even the convertibility into gold of the Bretton Woods Agreement was breaking up. Now money is a largely unidentifiable electronic pulse, itself vulnerable to attack by electronic means. Virtual money has very low reality, much lower even than paper.

Surely this is a system which could be blown away because there is nothing in it to gain confidence. Even a return to paper money would raise the level of reality attached to world currencies. There is a problem of raising the reality level of all currencies – a problem which nineteenth century economists solved by convertibility to gold.