What Is the Actual Value Of Money?

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The prices of precious metals have resumed their rise in July as uncertainties surrounding the euro and dollar have intensified. To the bewilderment of many this move in relative terms to almost every fiat currency is irrational. Gold is not money, so they tell us, and should not be acting as if it is an alternative to "real money".

To make this claim sound valid, they challenge those that favor precious metals to demonstrate a currently functioning market where you can exchange unmarked metal for your afternoon beer. If you cannot exchange your metal today for goods and services it must be devoid of innate worth. To put it simply, if you cannot eat gold it has no intrinsic value. The rising gold tide, by implication then, is the fanatical action of the lunatic fringe.

Both of those disparages are factually correct. Taking the latter first, you cannot eat dollar bills and coins either, so it is hard to attach much intellectual weight to the sentiment. But it does get at a much deeper understanding of the question of value. Goods and services have intrinsic value; money and financial assets do not - their "values" are derivative.

The value that we get from goods and services is innately apparent from the simple, most basic acts of living. We need food to survive, so food has value. The value for tradeable goods and services is predicated on utility and relative scarcity.

For financial assets, and money is the world's first financial derivative, there is no direct utility. It does not satisfy any basic demand of survival or continued existence. Therefore, any value attached to financial products does not come from utility. It comes from faith. I discussed this at length here.

When accepting money in the process of any exchange, whether it is during the sale of a tangible asset or in the trade of labor, the acceptance and terms of that exchange are largely dictated by your implicit approval of the medium of money's ability to complete the exchange at some other point in time. Money is the middleman in the barter exchange at the heart of every single economic system. At some point in time the other step must take place, you disgorge that money to acquire something that has utility.

In that interim acceptance stage, before the completion of the far side of the transaction, you have actually acquired liability. You are stuck with money that has no direct utility and can only hope that it will continue to maintain its universal acceptance long enough to complete your own acquisitions. This is called clearing, and it is as close to being a utility as money can get.

Every form of money in existence, to be fairly called money, must be able to function as a clearing agent. Since most people get paid for their labor on a limited number of days, they have desperate need for the ability to clear that pay with their more scattered need to acquire basic utilities at different times. And this gets to the first dismissal of gold as money, in that you cannot walk into a grocery store with gold and walk out with food and drink.

Again, I fully agree that it is a perfectly accurate sentiment. But it is intentionally shortsighted and narrowly defined. If money is to perform its clearing function, it has to be able to earn its derivative value, or faith. You accept money today with the reasonable expectation that you will be able to use it tomorrow or next week or next month to purchase a very similar amount of needs. You accept money because it exhibits a high degree of stability.

The question we have today is not about what gets accepted tomorrow or next month, but on what terms. The question of money today is not about its property as a medium of exchange, it is the ability of money to operate as a clearing agent for the temporal mismatch between its acquisition and disposition. That vital clearing utility interjects another monetary property, the store of value.

If you get paid today and by next week, before your next paycheck, the cost of needs, measured in currency, have gone up significantly then that is as important a property of money as the medium of exchange. Because in that hypothetical situation the medium of exchange is only half complete - clearing is only half finished. This is nothing more than inflation, and the extreme case of this mismatch is called hyperinflation.

In the vagaries of human emotions about money, hyperinflation does not need to exist to force humans to begin evaluating alternate methods. If financial derivatives have "value" based on faith, doubt is an anathema to that equation. Stability is the largest arbiter of any money's perceived value, and any fundamental tinkering around stability creates doubt and sets the preconditions for the extreme path.

In the case of this search for a store of value, what determines the willingness to hold currency is really timescale. Given that accumulated savings exist within the realm of this question of a store of value, there are already derivative solutions to every money problem. We all invest our savings in some other vehicle to garner a "return" that accommodates our idiosyncratic views of risk. But at its core, the investment/speculation process is nothing more than a realization that currency is not a good store of value at a longer timescale.

The governing dynamic of currency timescale is devaluation. I believe that every investor recognizes the folly of holding dollars in currency form (or even deposit account form) over ten years, for example, simply because of the universal erosion of inflationary devaluation. As much as it would be unwise to hold currency over any ten-year period, holding it through the last ten-year period was especially aggrieving.

So what alternative vehicles exist to protect the longer-term clearance utility? Long-term bonds at 4% or 4.5%? Stocks have not exactly performed well over the past 10 years. About the only class that has kept up with financial requirements has been alternate currencies. As much as that should be troubling to the domestic population, you can be sure that this is heavy on the minds of overseas dollar holders.

And therein lies the widening systemic doubt. At some point the population will start to clue themselves in to the drastic, worldwide reset that has been taking place since the tech bubble collapsed. Without any real, revolutionary innovation (Apple's gadgets are nice but can hardly be called revolutionary on the scale of the computer and internet revolutions that spawned entire new industries and productive, wealth-generating activities) the desire to give dollars the benefit of the doubt has noticeably waned. At some point more Americans will start to wonder exactly why our friends in the oil producing countries keep demanding more dollars for the same quantity of oil.

Yes, the dollar is currently the world's reserve and it certainly helps to conduct worldwide business, but in the end it is little shelter from the shifting balance of an evolving global system. Other than aging F-16's and structured finance, what does the U.S. offer in return? Our trading partners need little of the latter (though the European Central Bank is availing themselves of it to fix Greece) and will only offer generous terms to a point for the former. The developing world is busy making what the rest of the world needs while developed nations desperately try to live another day off the exchange equation they created when production was one-sided in their favor. The developed world was able to dictate and impose economic terms in the past but it is a mistake to think that dynamic is still in place after successive financial collapses and destabilization.

Instead of acting as an all-encompassing attraction for investment capital from everywhere, the U.S. is falling further into the abyss of a financial regime trading on reputation only. The entire world demands more dollars in return for real goods while the U.S. plays a game of rearranging the financial deckchairs. It's as if the only policy that the "experts" can come up with is confusion and complexity (this is also true of Europe, and we see this play out ever so sadly in the dual sickness of the dollar and euro). In response, the world is turning elsewhere, anywhere, to acquire real, productive wealth.

We have seen the domestic financial economy grow by leaps and bounds, but all that credit innovation has come at the expense of real wealth creation. You can dazzle trading partners with appearances and monetary illusions, but if you don't really have the goods then you don't really have anything to trade.

The monetary timescale compression is taking place, ironically, because of foreign dependence. The U.S. has become so reliant on overseas capital flows because it is a victim of its own financial "success". Americans stopped saving precisely because they were full of the "wealth effect", the appearance of stable, growing net worth. But more than that, the "wealth effect" of this past decade seemed to work only because the growing doubts about the dollar have evolved slowly.

The Great Moderation produced a dramatic shift in the productive nature of the entire economy - it was left to others to create and produce while the domestic economy chased the easy path of paper prosperity. Under the guise of rational expectations, the Fed created nothing more than a path to the dangerous symbiosis of paper-based spending activity coupled to the sticky debt that is not so easily disposed. The term Great Moderation should be changed to the Great Insolvency. We clearly do not have enough productive activity today to pay off all the accumulated debt within and without (though the Fed still searches for the still elusive economic potential that will magically cure all debt ills).

Because so many foreign claims were allowed inside the citadel of the American financial regime, the game has been irreparably altered. The risks to foreign dollar holders are now the risks to the dollar itself. It was once acceptable for foreign trade partners to hold dollars themselves as "reserves". That changed to "high quality" assets, once believed to be government-backed paper (including GSE's). Now, with the federal debt dance drama in full bloom, even that is being rethought and re-evaluated. The clearing function of money is calculating further down to the lowest common denominator - dollar destruction.

What foreign central banks are realizing, and gold detractors fail to account for, is the inevitability of this process. There is small comfort in the mutually assured destruction of the U.S.'s current status as primary buyer of the world's products. As much as China and Japan need the U.S., that does not mean they will sit back and idly absorb the losses still unclaimed for the systemic woes brought about by a long-term commitment to financial engineering and asset price dependency. If the choices are only bad, you can count on even the best of our friends taking care of themselves first. Every single economic crisis ends in self-interested parties acting solely out of self-interest - no one volunteers for financial destruction.

That is where the dollar's loss and the clearing function of money intersect. As foreigners shift reserve "exposures", effectively recognizing the shortened timescale of the cross-border currency clearing function, the burden of economic reorganization will fall on the general domestic population. This burden has already exacted tremendous hardship, and it does not take a lot of imagination to see that there is a breaking point. Protection is opting out of the dollar's harsh realities. Gold is one option.

You cannot buy anything off McDonald's dollar menu with gold coins, but that has never been the exit strategy. A strong dollar is a scarce dollar. The policies of a strong dollar need to be resurrected because "experts" of both political persuasions and dominate economic theories (neo-Keynsians and monetarists) see sunshine and unicorns in dollar devaluation and the imbalance of economic flow that it creates favoring corporate profits. This cannot work, and will never work, without another asset bubble to act as a substitute or filler for wage growth. The answer to every economic downturn or dislocation cannot be the "wealth effect", nothing so ephemeral and abstruse can serve as the foundation for anything so monumental and vital.

If currencies are a reflection of the economic system that they operate within, then the current dollar is an accurate one. A commitment to a strong dollar is also a commitment to market discipline, the economic property that easily dismisses lingering and persistent investor uncertainty. Discipline means assurance that productive wealth generation is never neglected for paper-driven effects and derivations. Hard money is no guarantee that excesses will not build up, but it is far harder to devalue the currency to such a nasty degree when the banking system cannot inflate credit on their own whims and interests.

The road to monetary Perdition was paved with the pledged full faith and credit of a system that abuses that same privilege. To stop the endless, mindless shift of economic burdens onto the vast majority of Americans who have done nothing wrong means to take back control of monetary policy - and effectively wrest control of fiscal policy that continues to abuse its bypass of interest rate discipline. There are different ways of doing this, but every single one involves the shiny metal that nobody can eat. The price of instability grows by the day, and a return to stability is no longer possible on reputation alone. It is absolutely true that you cannot buy a cup of coffee today even with a full ounce of gold, but in the not-too-distant future our country may not be able to import anything we need without it.


Jeffrey Snider is the Chief Investment Strategist of Alhambra Investment Partners, a registered investment advisor. 

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