By Dominic Frisby Jun 19, 2012

I know I’m supposed to be taking the summer off, but comments on Twitter from Alan Beattie, international economy editor of the Financial Times, raised hackles and lured me from my bunker.

Beattie declares that there is “no fundamental valuation model” for gold; that “it pays no interest” and that therefore it’s “intrinsically speculative”. Really?

These are common arguments we hear from the gold-has-no-use brigade. I want to address them.

First, gold pays no interest. True. But then, nor does cash – unless you lend it to people. The world needs to realise that by putting cash in the bank you are lending it. Gold can pay interest – if you lend it out. And lots of people do (though for what purpose I cannot say).

But in this environment of negative real rates (when the central bank rate of interest is below the rate of inflation), who gives a hoot about interest anyway? 1 or 2% interest. Whoopee-do.

Next, there’s this idea that “gold has no use”. Really?

Gold has very little industrial application, yes. It’s too expensive. But no use?

Gold, unlike bubbles and government bonds, lasts forever. This makes it a highly effective form of money, as I’m about to explain.

But how can gold be money, runs the next argument, when you can’t go into a shop and buy stuff with it?  Absolutely. You can’t.

Err … actually, you can. The gold sovereign is still legal tender. But it only has a face value of one pound, when it’s worth over £250. You’d be a plum if demanded that some poor shopkeeper accept it as payment. (And he’d be a plum if he refused it). But I’m splitting hairs.

As a day-to-day medium of exchange, gold has never found much use. A piece of gold the size of a penny (about £125 or $200 in today’s money) contains too much value for anything other than expensive transactions. Copper, nickel, silver, paper and now digital money have all found far more prolific use.

But to assert that you can’t buy stuff with it therefore it isn’t money, is a facile and ignorant argument. Money is more than just a medium of exchange. Indeed, this is just one of the three essential functions of money: it also has to act as a store of wealth and as a unit of account.

It is gold’s very inert, intrinsic, eternal uselessness – and we have Mother Nature to thank for that – that makes it such an effective form of money. It has no other function other than to be a store of wealth. Even its use in jewellery is an extension of that function – to store (and display) wealth.

Governments can’t print gold, they can’t ‘quantitatively ease’ it, they can’t loan it into existence. They can’t debase it the way they do their own currencies. It just stays there, unconsumed, forever. Which all means that gold is constant – and therefore an excellent unit of account, far better than government money.

Demand for a store of wealth tends to fall during times of economic expansion – such as in the 80s and 90s – and so the gold price falls. People are looking for opportunities to grow their wealth, not simply hang on to it.

On the other hand, demand for gold increases during periods of economic contraction and monetary stress – such as we have experienced, on and off, since the turn of the century. These are times when people are more concerned – as the oft-quoted saying goes – about the return of their capital, rather than the return on their capital.

Gold’s fundamental use is to be money.

via Gold pays no interest, has no use and no fundamental value – really? – MoneyWeek.

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