If gold was money, how would foreign investment work?

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Clayton replied on Fri, Oct 19 2012 2:32 AM

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Gold is still used as money in very large transactions. Understanding how it is used in the modern world is instructive to understanding why the objections raised by people like Warren Buffett, Ben Bernanke and your friend are nonsense. Look at the New York Federal Reserve gold vault:

The first thing you'll notice is that there's a lot of gold there. Turns out business in gold is still brisk all these years since the 1933 FDR heist.

The next thing you'll notice is that these are large bars. A "good delivery" bar is 400 ounces and worth around $700K each at today's prices. You can pack a tremendous amount of net worth into a very small volume.

The third thing you'll notice is that the bars are stack on separate pallets. This is called "allocated gold" and means that an account holder actually owns the specific bars on a specific shelf, kind of like the way you own the items you store in a storage unit or a bank safe-deposit box.

Where things get interesting is when you transfer gold. Let's say Prince Rashid wants to transfer 3 gold bars to Mr. von Eckhart, both of whom have an account at the same Swiss gold bank. In this case, the Prince calls up the bank and instructs them to move 3 of his gold bars from his shelf to Mr. von Eckhart's shelf. Once the bars have been moved, the transaction is completed.

But let's say the Prince and Mr. von Eckhart are clients of different banks, let's say Aureus Bank AG and Lux Aeterna Bank AG (fictional). No problem here, either - it turns out that gold banks regularly do business with each other. In this case, Aureus Bank calls up Lux Aeterna Bank and tells them that they will be shipping 3 gold bars to them by armored truck before close-of-business, to be deposited in Mr. von Eckhart's account with them.

Now, this might seem like it would get very costly but it turns out that there are these things called "clearing houses" that help banks settle their payments and reduce unnecessary use of armored transport. For example, if it so happens that one of Lux Aeterna's clients is also transferring 3 gold bars to one of Aureus's clients, then no armored truck needs to be ordered at all. The banks simply agree that the balance-of-payments between them is now 0. 

Banks that do business with each other very frequently might even open accounts with each other for the express purpose of avoiding constant use of armored transports. In this way, balance-of-payments can be settled less frequently as short-term transfers are settled immediately by transferring gold bars from the cross-accounts to the clients' accounts.

But not all gold accounts are allocated. You can also have unallocated gold accounts which simply means that the same physical gold bar might be owned by multiple people. The key is that the gold bank is merely required to have on hand as much gold as it has outstanding gold deposits. Who happens to hold the deposits at any given time is immaterial. This allows further cost reductions as smaller, irregular amounts (non-bar-sized) can be transferred.

So, you have to ask yourself, why are there still gold banks? Why does anyone in their right mind engage in this behavior if what Warren Buffett says of gold is true: "“[Gold] gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head." But it's really not so complicated. The reason for using gold is to secure the transaction. When Aureus calls up Lux Aeterna and says it's ordering the armored truck, it has to actually have on hand the gold bars to be shipped. It can't pretend to have them. It can't ship an IOU instead of the gold bars. It can't even ship a bunch of paper dollars of equivalent value. It has to ship what was contracted to be shipped: gold bars. This physical constraint keeps every party to the transaction honest. And that's its purpose: secure honesty.

And as for the wonders of paper money and digital ledgers... well, the very same technologies that have reduced the costs of doing business in all other industries have likewise reduced the costs of gold banking. Computers allow instantaneous transfer of ledger data between banks, as well as powerful encryption for use in verification and transferring confidential data.

Before the war on gold began in earnest in the 20th century, the common person used silver coins or paper banknotes (which were often backed by silver or gold). Large transactions were conducted with gold, though rarely with physical gold since it was usually a matter of writing a bank draught (check). Debit/credit cards or any other ledger system will never really be faster than direct cash payment. Time must be expended to secure most transactions either through some kind of identification code or signature or whatever. The only inconvenience of cash & coin is that you have to select the right size bill. Horrors.

Weight is not an issue unless you're going to be keeping enough cash on your person to buy a Rolls Royce at all times, for some reason. A few slips of paper in your wallet and/or a couple small silver coins are no weightier than those stacks of plastic cards crammed into your wallet. In fact, there's no reason that digital smartcards could not be used to exchange gold or silver in unallocated accounts. There is no conceivable difference in terms of actual convenience to the consumer - the only real difference between the current system and an unhampered market in money production is that, in the latter, the consumer would be king and money producers and banks would cater to the demands of consumers, not the politicians.

Clayton -