In general, things have two different forms of value: intrinsic or extrinsic. Intrinsic value is the value or benefit that something has for its own sake. For instance, food has intrinsic value because it can feed your family. Water has intrinsic value for hydration, for watering plants, and so on.
On the other hand, extrinsic value is any value that’s derived from external sources, like that of an expensive painting. While the paint and canvas itself don’t have much intrinsic value (low practicality because it can’t be used for much), it has significant extrinsic value for its beauty, its history, or the artist’s reputation.
Gold has historically been, and remains, one of the most prized and valuable commodities on the planet. But what makes gold such a sought-after and valuable commodity?
Commerce Before Gold
Although gold has virtually always been a highly-valued precious metal, it wasn’t always used as a means of determining value. Millenia ago, goods and services were traded or bartered between parties. At first, bartering involved the trade of goods directly in exchange for one another: five goats for one cow or a wheel of cheese for a pair of shoes. A good trade represented an exchange of approximately equal intrinsic value.
Over time, civilizations began using certain objects as indicators of value with which trades could be made. These included things like shells, beads, and eventually precious metals like electrum, a naturally occurring alloy. Even the most primitive societies realize it’s far easier to carry a pocket full of beads or coins to market than driving a herd of goats.
Eventually, precious metals like silver were used to create a standardized medium of exchange. With their low melting points, metals like silver and copper could be melted easily from naturally occurring veins and shaped into coins for use in commerce. Even in ancient times, copper and silver coins enjoyed intrinsic value. Copper was useful for making decorations and as the primary ingredient in bronze. Silver’s malleability and rarity made it a choice material for decoration and jewelry.
Gold’s combination of scarcity and accessibility made it another good choice for minting. Like copper and silver, gold has a low melting point and is occasionally found in naturally pure veins near the Earth’s surface. It’s much rarer than copper or silver, though. Like copper, gold has a distinct color that’s easily identified. Like silver, gold was used for decoration and jewelry as well as coinage.
Unlike copper or silver, gold doesn’t tarnish. A gold coin lasts for centuries, long after copper would erode away to a pile of green powder. Silver coins do tarnish, and polishing away the discoloration also removes a small portion of the metal itself.
That’s why gold ultimately became the preferred choice for coinage.
Paper Money and the Gold Standard
What’s even easier to carry to market than a pocketful of coins? A piece of paper.
When local paper currencies were being implemented, they needed backing to ensure that their value was maintained. Trust wasn’t enough. Anyone can write “promise to pay” on a piece of paper. How can a seller ensure there’s anything beyond a promise?
At first, bank drafts filled this void. Dating back to medieval times, a bank draft was a statement that the holder had some amount of physical money on deposit with the issuing institution. The recipient would simply go to the bank and withdraw an equivalent amount of precious metals — or trade the bank draft on to someone else.
The issue of trust still existed. At first, banks kept 100% of their customers’ funds locked away, ready for redemption. However, during the Renaissance, Italian banks invented fractional reserve banking (meaning they didn’t hold 100% of their customers’ funds in the vault, instead investing a portion of the money in the hopes of gains).
Regardless of the issuer, most people continued to prefer payment in precious metals (hence the phrase “hard currency”) over paper promises-to-pay or bank drafts.
Eventually, entire nations got into the banking game by creating national central banks. These institutions were developed to hold some quantity of a nation’s precious metals stocks and make easily-carried, easily-traded paper money. At first, silver was used as the standard commodity with which to back paper currency. However, in 1821, Great Britain switched from a silver standard to using gold as its new monetary standard. It wasn’t for another 50 years that other countries like the U.S., Germany, and France also adopted this same standard. In the U.S., this decision was made easier by the nation’s western expansion and the gold rush, bringing an influx of gold into the country’s economy.
Here’s what some of those pieces of gold-backed paper money looked like in the early 1900s:
At the top, the notes read, “This certifies that there have been deposited in the treasury of THE UNITED STATES OF AMERICA” and continuing at the bottom, “X dollars in gold coin payable to the bearer on demand.” In other words, this slip of paper represents a set amount of dollars worth of gold coins, which anyone holding the paper can get “on-demand.”
This system only works if the nation in question mints gold coins. Back in the 1920s, the bearer of a gold certificate might receive four gold quarter eagles in exchange.
Any country that adopted the gold standard meant that central bank reserves of physical gold backed its local currency. Therefore, the paper currency could be converted into gold at any time. Because most countries around the globe adopted the gold standard, gold became the new global standard on which value was assessed.
This also means that nations weren’t able to inflate their money supply quickly.
Because gold has intrinsic value as an industrial and decorative metal, gold coins enjoyed a certain amount of international acceptance as well. If you spent a gold quarter eagle in England, you might not get your whole $2.50 face value worth of products in exchange– however, if you tried spending American paper money, you’d most likely get nothing.
Post-Gold Standard and a Store of Value Asset
Both the U.K. and the U.S. left the gold standard permanently in the early 1930s, with the rest of the world following suit in later years.
While the gold standard is no longer in effect, gold still retains the same properties that made it valuable during the previous era. Today, gold is viewed as the perfect store of value — something that retains its value over time and does not appreciate. Significantly, central banks worldwide still hold tens of thousands of tons of gold in their reserves (along with paper assets). Why? Because gold remains an internationally accepted store of value due to its intrinsic worth.
The main properties of gold that make it a store of value are:
- Portability – It’s relatively easy to transport if needed
- Resilience – Gold does not deteriorate over time and can be stored indefinitely without changing or losing value
- Divisibility – Gold can be melted down into smaller pieces
- Fungibility – Like paper dollars or barrels of oil, one ounce of gold is the same as every other
- Rarity – It’s a rare commodity that has a finite supply while still not being too rare that it can’t be mined
- Uniqueness – The properties of gold are distinguishable, and it can’t be replicated
- International acceptance – Gold is one asset that’s easily recognized and easily exchanged virtually anywhere in the world
After nations around the globe moved to the new fiat currency standard, inflation immediately became an issue. This is because local governments control fiat currency who can print paper currency whenever they deem necessary. The basic economic principle of supply and demand makes it clear that as the supply of currency increases, its value declines. (It’s as though less and less of the U.S. central bank’s gold stores are available to back the value of each dollar.) Therefore, fiat currencies have steadily lost their value over time. If one were to have held all of their assets in fiat, they would actually be slowly losing purchasing power each day as inflation rises.
As a store of value, gold is now viewed as a great hedge against fiat currency inflation. Gold has shown that no matter the economic or market conditions, its value is retained in the long run, making it a stalworth of investor portfolios for decades. So, even in a world where gold is no longer the backing for paper currency, it still provides an immense value for its holders. Why else would every nation in the world own some?
While gold is most often thought of as a financial commodity, it actually has practical applications as well. Gold as a precious metal is used in a variety of industries, including:
- Dentistry – For use in fillings, crowns, bridges, etc.
- Jewelry – Rings, earrings, bracelets, etc.
- Electronics – Gold is an effective conductor used in building computer circuit boards and other devices
- Aerospace – Used in circuitry and as a lubricant for NASA space vehicles
- Medium of exchange – Melted down into coins and bars, gold is an excellent use for exchanging value
No matter the changing economic, political, and social landscapes in human history, one thing has remained: the value of gold. And for investors, there is no better way to hold gold than within a tax-advantaged retirement account through Birch Gold Group.