In gold we trust

In Gold We Trust by Matthew Bishop and Michael Green

IF YOU are part of the world of investment and as worried about a return on your assets as you are about getting your assets returned, you should be reading this book.

This e-book was written by the Economist's New York bureau chief and author of the publication's official guide to economics, Matthew Bishop, and economist and writer Michael Green.

It reads like an Economist article (only very much longer) - thought-provoking, well researched, summarising divergent views and coming to reasonable and sound conclusions.

Humanity has long regarded gold as special; the Biblical Ark of the Covenant was made of pure gold and it was one of the three gifts brought by the wise men to Jesus.

There is the myth of King Midas who wished that all he touched would turn to gold until he touched his daughter, who turned into the metal – a cautionary tale of loving the stuff too much.

To put gold into physical perspective, the total amount of gold in existence above the ground would only fill three-and-a-half Olympic-size swimming pools. Getting at more gold is becoming ever more difficult.

The problem the book addresses is one we all struggle with – what will our money be worth in the future? Underlying this question are two others: what exactly is money, and can we rely on our governments to keep it sound?

Money is nothing more than a technology, a means of doing something that needs to be done. It started as a way of solving the problem of exchanging your goat for the bowl of apples you want.

The solution was to find some other accessible store of value that could also act as a unit of account, which would facilitate the exchange goods of different values.

Using small, portable quantities of silver as such a medium was an innovation no less creative than an iPad, and significantly more useful to more people.

When the problem of fraud and deceit emerged, it became necessary to standardise the quantities in little round bits – coins, and then to control the size and value.

With time the control of standards moved to the authority of the local rulers, another less common metal - gold - was added, and the problem was solved for a very long time.

To overcome the difficulty of transporting large quantities of silver and gold, trusted people and institutions were issued with notes attesting to individuals' right to a stash of the metals that they held.

And with these pieces of paper as good as gold, a further innovation in the technology of money entered commerce.

Imagine you are a head of state and your country is at war. You have to pay your soldiers to fight and protect your territory and citizens, but you are running out of precious metals.

Do you surrender or do you bet on all the soldiers not turning up immediately to cash in their notes for the equivalent of gold all on the same day? If so, you can hand out a lot more notes than you have gold. Not a hard choice.

With time the value of your bank notes separated from its relationship to an object of value, gold, and a new technology of exchange and preservation was created – "fiat money".

The Latin word "fiat" means "let it be done" and fiat money is money because a government says "Let it be money!"

Its value does not depend on your right to exchange it for a fixed amount of gold, but on (ready for this?) the determination of the government to honour its promise hat it will be worth what it is supposed to be worth.

The US dollar carries the words "In God We Trust", but it should, for accuracy, carry the words "In Government We Trust".

The question for investors and savers is which currency should you trust - which is little more than asking which government you should you trust.

For decades the world has trusted the American dollar, but when its connection to the US government is made stark, the question is no longer academic.

Standard & Poor's downgraded America's government debt because it saw the country's dysfunctional government in action. Can we trust the euro when the question actually means, can you trust the various European governments?

The book also considers alternative currency technologies, such as private "currencies". Your airline loyalty points that can be traded for flights, accommodation, car hire or gifts are an example.

There are local area currencies that have some success, as well as IT type currencies that are little more than a sophisticated algorithm. 

So the investment question returns to gold. Is gold a better store of value than a currency? Gold, as the book explains, is a currency technology that comes with its own problems and limitations. As Warren Buffett once quipped, "All you can do with gold is fondle it".

Gold has done well recently, rising to a peak of over $1 900 an ounce in September 2011 and sliding back to about $1 650 at the time of writing this article.
 Even if gold returned to its long run average since the early 19th century, it would still fall to a range of $475 to $650 an ounce in today's dollars.
 
So what is the answer? There isn't a silver or gold bullet that will defend your assets against the decisions of bad government or economic or social catastrophe.

What the book does achieve is a description of a portfolio of possibilities.
 
Forewarned is forearmed, and this is a thought-provoking forewarning. 

Readability: Light ---+- Serious
Insights:    High -+--- Low
Practical:   High ---+- Low

 - Fin24

* Ian Mann of Gateways consults internationally on leadership and strategy.