In this post, we’ll look at how money came to be separated from value, and how and why they’re being tied back together again in ways made possible by new technologies. We’ll see how commodities hold value over time and across borders, and consider how we can combine that stability with the fungibility we demand from a modern, international means of exchange.
Fiat currency is now being pumped into the economy in unprecedented quantities and the result is likely to be a sharp drop in its spending power accompanied by a sharp drop in the real economy occasioned by systemic issues unearthed and exacerbated by the Covid-19 pandemic.
Since it’s now possible to build a self-guaranteeing system, blockchain-based digital asset exchanges, based on the self-guaranteeing value of assets like gold, we can expect to see interest in gold as a commodity and in these currencies rising strongly. All these processes are already observable.
Commodity money and fiat money lie at opposite ends of a spectrum. At one end, commodity money is money as value. The first gold coins were not representative of value; their gold content was their value, and their frankings — markings struck onto the coins by royal mints — were a promise that they were unadulterated and of full weight. (To find an unguaranteed form of commodity money, you’d have to look to devices like hack silver; weighed lumps of precious metals.)
This describes the state of money for most of history. Periodically, the precious metal content of coins fluctuated; adulterating the coinage was a key way for governments to make up for shortfalls in revenue, a practice whose modern equivalent — printing more money — we will turn to presently. When the face value of coins remained the same while their gold and silver content fell, the result was usually a loss of confidence in the coinage.
By the 1700s, a new form of money began to emerge in Europe, spearheaded by the use of promissory notes, or notes of hand, among gentlemen. A gentleman’s note of hand was his promise to pay money, and was as good as money; case law in common law countries supports the notion that a note of hand is money. The issue of paper money began much earlier in China, in the 11th century, and there was also regarded as money itself.
When western governments were stuck for cash money — frequently during wars and most especially the American Civil War — they did something similar, printing paper money consisting of a ‘promise to pay.’ This form is preserved on some nations’ banknotes; in Britain, the bank notes still read, ‘I promise to pay the bearer on demand the sum of five pounds,’ or whatever the value of the note.
On its inception, this promise was meant literally; five pounds of money — gold coinage — could be exchanged for a five-pound note on demand. The requirement to have sufficient gold coinage stored to support demand led to the centralization of the banking system and its integration with state governments and national economies, and their integration into a world financial system based on gold: the gold standard.
After the second world war, this began to break down and was replaced by the Bretton Woods Agreement, which substituted the US dollar for gold worldwide. The world financial system now consisted essentially of promises to pay dollars, while dollars themselves were a fiat currency.
Fiat currencies derive their name from the Latin ‘fiat,’ meaning ‘act’ and more widely ‘make it so,’ or ‘let it be done.’ Thus a fiat currency is currency because the government says so. It represents not a given weight of precious metal but the capacity of the national economy which issues it and ultimately the willingness of citizens to use it: money by fiat, money by consent.
Since the collapse of the Breton Woods system, each national fiat currency stands alone, though in practice the dollar and Euro function as international reserve currencies.
The benefits of fiat and commodity monies, as well as of intermediate forms, can be seen by examining history. Commodity money is inelastic and inflexible. When more money is required, there is none to be had, since the principal benefit of commodity money is its scarcity and stability.
The introduction of fractional reserve banking, in which banks lend out many times their money reserves, reduces both the inconvenience and the stability of commodity money. Combined with fiat money, it tends to create a financial system based largely on mutual confidence and prone to sudden, catastrophic collapses.
In addition, fiat currencies are prone to sudden, radical deprecation in value: hyperinflation. The best-known examples are the wheelbarrows full of worthless Reichsmarks in the Weimar Republic and the infamous hundred trillion Zimbabwean dollar bill, now a collectors’ item worth about five US dollars, but virtually worthless at the time of issue — so much so that Zimbabwe’s currency was replaced by foreign currencies inside the country, a hallmark of state failure.
This tendency has haunted fiat currency since its inception. When the typically forward-thinking Bank of Stockholm issued paper money backed by government decree, in 1661, the enterprise had first to be taken from royal charter into the care of parliament and then replaced by the silver standard before money became entirely worthless.
The contrast in stability of price also indicates something intrinsic to commodity money: independence of political control. Fiat money deprecates all the time, whether as cataract or drip. A dollar in 1970 had the same purchasing power as $6.65 today; a 1900 dollar was equivalent to more than $30 today, according to calculations from the consumer price index.
By contrast, how has gold fared?
Gold is measured in Troy ounces, so an ounce of gold weighs 31.10g. That ounce of gold is currently worth $1,700, up from $1,400 in December of last year. Does this mean the value of gold is less stable than that of fiat currencies like the dollar?
In 1929, gold was worth $20.36 a Troy ounce; in 2019, ninety years later, it was worth $1,400. The purchasing power of that ounce of gold has risen rather than fallen, as the economy has become more productive. In 1922, a men’s readymade wool suit from a catalog was $25 — 125% of an ounce of gold, or $1,750 relative to 2019 gold prices in dollars. In 2019, a Brooks Brothers Milano fit suit was $998, equal to 71% of an ounce of gold. But what about a catalog suit? Sears will sell you an all-wool men’s readymade suit for $117.29. That’s 8.3% of an ounce of gold.
Partly this is because the economy is vastly more productive than it was in 1922. But partly it’s because the dollar has lost value, while gold paradoxically becomes more valuable in a richer world.
Result? The dollar is worth a fifteenth of its 1922 value. Gold is worth nearly sixteen times more. And compared to other products whose value is determined by scarcity, such as gasoline, the price of gold has also risen. Gasoline was 25¢ a gallon in the US in 1922, or 1.2% of an ounce of gold at contemporary prices; in 2019 it was $2.50, or 0.17% the price of an ounce of gold.
Economic slumps and financial collapses don’t occur because of overnight causes, but they do occur overnight. Society skirts multiple cliff edges until one fatal tumble. To see this in action, sadly, it’s only necessary to look at the news. The Covid-19 pandemic has thrown millions of people out of work and blown holes in projected GDP across the developed and developing world. Service-dominated economies can’t stay home.
Beneath and behind the virus’ effects lie structural issues, entwining economic stagnation and geopolitics in a way reminiscent of the crash in industrial economies in the 1930s. Societies with polities based on sovereign debt are unable to control it; cuts in spending drive debt up faster. Meanwhile household debt spirals even in successful economies. Fractures in international structures such as the European Union make it impossible to ignore the fragility of the international financial system. However, the virus has brought to the surface these deeper issues and will remain a source of economic anxiety in its own right until decisive medical measures are available. Thus, it likely heralds a long-term economic downturn.
Organizations can only do what they are designed and equipped to do. Armies fight; health services heal. Central banks print money and lower interest rates. Currently, the world’s central banks are at the point where they are considering negative interest; for those recently familiar with the concept of negative pricing in the oil industry, this is the same phenomenon applied to the money supply. Banks are ready to pay people to take money away.
As central banks attempt quantitive easing — an oddly descriptive euphemism for printing money — this will be exacerbated, particularly because easing is typically applied to ‘the economy,’ ie, to businesses which do not stand in urgent material need of money and the goods it can buy. Citizens who must pay rent and bills will be forced to go deeper into personal debt again, where they can. In a society where the worth of money is crumbling and everyone carries unserviceable debt, the edge is already near.
One sign that we have stumbled a step closer to it will be sharp declines in the value of money, especially in previously highly-reliable currencies such as the Euro and dollar. We can expect to see this partly as confidence in these currencies falls in the wake of stimulus packages designed to pump money into the economy.
As this happens, investors will seek safe-haven investments as an alternative to stocks and bonds in fragile businesses and to unreliable and rapidly-deprecating cash.
However, we can also expect a resurgence of interest in commodity money: money whose value is intrinsic and cannot be altered from above or outside. The requirement for money will be as great as ever — exchange must continue. And where investors are interested in money for its value-storing function, the majority of people are more concerned with exchange; with getting paid and paying. Hyperinflation becomes truly damaging when it happens so fast that your paycheck loses value on the way to the store.
Signs of a surge in the relative value of gold are already detectable, as the dollar’s value falls and gold rises.
As much business now takes place online, and much more requires higher fungibility than can be supplied in franked precious metals, we can expect to see much of this renewed interest in precious-metal commodity money taking the form of uptake of stablecoins.
Isn’t tokenizing commodity money the same thing as issuing paper money backed by gold or silver?
Paper money’s relationship with its gold backing is guaranteed by the government, not by something intrinsic about the paper. This was true throughout the history of gold money too; successive emperors adulterated the Roman coinage, creating a disconnect between gold and face value and leading to periods of economic instability. It’s this capacity of value guarantors — whether franking on a gold coin or writing on paper money — to be manipulated to the detriment of currency value that makes fiat and representative currencies unstable.
By contrast, tokenization might involve representation — a digital pattern represents a quantity of gold — but the representation is inherent to the digital pattern. It can’t be changed by a central authority. Like gold, it is its own guarantor.
Here’s how they’re usually set up.
Typically, a token backed by a commodity, referred to as a stablecoin, will be set up with a traditional custody and trust structure managing the underlying assets. Trustees are regulated financial professionals who manage assets, while custodians arrange for secure holding, whether themselves or through third parties. Trusts are audited by third parties, and in an additional layer of protection, tokens are issued on a public blockchain that’s transparent, unhackable and automatically preserves immutable audit trails. The tokens issued represent a legal claim on the trust’s contents — ownership in a certain sum of gold. Tokens are proof of ownership, not a promise to pay.
This might be best explained by Jim Manning:
The token and the particular amount of gold it represents are one and the same. So while it’s not entirely incorrect to think about the token as a unit of value that derives its worth from the price of gold, it’s even more specific, as the token represents a particular piece of gold you own. The token acts like your record of ownership of an asset, effectively becoming the digital shadow that a real piece of gold casts into the virtual world.
Multiple commodities could and do back digital assets. But among the most common is gold.
Gold-backed digital assets are both more secure and more fungible than gold itself. After all, if gold is more stable, its very lack of extrinsic value guarantors means it’s a much better target for theft. Cash a stolen check and the system will catch up with you; hack a bank account or rob a bank and note numbers and digital forensics give law enforcement a chance. Stolen gold can in theory be rendered untraceable.
Additionally, transacting in gold comes with logistical problems. In today’s prices, $55,000 is about a kilogram of gold bullion. That’s light enough to be a target for theft, heavy enough to make transporting it securely from, say, the United States to Hong Kong a serious inconvenience.
By contrast, digital assets backed by gold can be transported effortlessly and instantly, across borders, without reference to currency or customs regulations (except in countries where digital assets are highly-regulated or illegal). They offer users the opportunity to combine the benefits of tokenization with those of commodity money; fractional ownership, instant transactions and global liquidity are all possible with tokenization, as is a positive yield from digital asset lending, as opposed to the standard negative yield for safe storage of bullion.
There’s an older solution to this problem, the ETF. But ETFs don’t deliver all that a gold-backed digital asset does. ETFs don’t provide users with a spendable token. Gold-backed digital assets can be spent like money. (In many ways, they’re closer to being money than fiat currencies, remember.) They’re inaccessible and trapped behind national borders. If your $55,000-worth kilo of gold is in an ETF, you have to redeem it against its (fiat) cash value, then spend the cash — accumulating service, conversion and other fees en route. If it’s in a gold-backed digital asset, you just spend the token.
The recent leap in the perceived value of gold has been accompanied by an increased uptake of gold-backed digital assets, suggesting that users are interested in a more reliable and stable currency, not just in a safe-haven investment. It’s also possible that for some purchasers, gold-backed digital assets benefit from a dual halo effect: the stability of gold and the potential of cryptocurrencies, still the best-performing asset class in the world.
So does all this mean that commodity-backed digital money — stablecoins backed by gold — will replace fiat currencies across the world? Not this year, not next year, and probably not ever. Instead, what’s more likely to happen is that the mainstream economy will find space for both to co-exist. The easy spendability of cash and the extent financial system for processing payments in fiat currency will militate for its retention; so will the conservatism of some institutions and payees.
At the same time, cross-border transactions and stability will make gold-backed stablecoins an irresistible proposition for many and an intriguing opportunity for many more. Therefore we can expect to see the two banking systems initially existing side-by-side, before increasingly becoming integrated into a global system characterized by professional role separation and standards and interlocking, compatible regulations, as well as by currency agnosticism.
With these likely outcomes in mind Stably is currently working with large commodity companies and regulated trustees, including Legacy Trust Company in Hong Kong, to tokenize a wide range of assets including precious metals, oil and rare earth minerals — some of the most vital commodities for creating modern electronics — under FinCEN’s Convertible Virtual Currency (CVC) framework. To find out more, visit: www.stably.io/stablyenterprise.
Stably Enterprise: Looking to Tokenize Your Assets Legally? Seeking Blockchain Technology, Institutional & Exchange Support for Your Project? Need to Launch Quickly & Cost-Efficiently? Visit www.stably.io/stablyenterprise
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