Dear Thoughtful Investor,

a series of letters on real estate, finance, and economics

#10 The Alchemists (part 1)

Dear Thoughtful Investor,

You likely recall the classical tenants of money: 1) store of value, 2) unit of account 3) medium of exchange. Over the millennia, many ‘things’ have met this criteria from wampum, to stones, to metals, to digitized electrons arranged on a computer chip. One stands out as the enduring and ancient standard for money: gold. But why? Gold has no *intrinsic* value in the sense that as itself it does not fulfill any of the criteria for human survival (air, water, food, shelter, sleep). You can’t eat gold, you can’t burn it to stay warm, its only industrial use is as a good conductor of electricity. It only has value because of the human social contract that it has it value - and yet from eons past gold has been the most universal form of money. Again, but why?

A chemist and University College London professor, Andrea Sella, takes an approach that only a chemist would. In a BBC interview with Justin Rowlatt ( Sella starts with a periodic table of 118 elements and through the process of elimination answers the question: why is gold perfectly suited to be money in the physical world?

The noble gasses and the halogens are easy to dismiss, its impractical to carry around a phial of gas - plus they’re colorless so it would be easy to lie - subtract the 5 gases. The two liquids, mercury and bromine, are also impractical because they’d still require a container - plus they’re poisonous. We’re at 111 potential elements for money. The alkaline and earth metals are too reactive (potassium, sodium, etc); they react with water and then ‘disappear’ which means they’re a poor store of value. Cross off all the radioactive elements like uranium and plutonium, because again, they’re poisonous. The rare earth metals look very similar to one another so it would be hard to know what you really had (who’s going to say, “wait you gave me me a dysprosium coin, not a ytterbium coin!”?). We have 49 ‘transition’ metals left like iron, aluminum, copper, lead - each has drawbacks. They either rust, corrode, are too flimsy to make into units of account like coins (aluminum), or are too hard to distinguish their purity, too hard to smelt (zirconium, titanium). We are now down to eight elements that could be used for money. The noble metals that do not react and are relatively rare. Six of these are extremely rare - too rare to be money - and many are very hard to extract (platinum melts over 3200 degrees). We’re left with two familiar elements: silver and gold. Both rare, but not impossibly rare, with low melting points so they are easy to turn into coins/jewelry or larger/smaller units. Of these two elements, silver tarnishes, reacting with minute sulphur in the air. And we’re left with gold. A uniquely colored, inert, easy-to-smelt, rare-but-not-too-rare, non-toxic, solid-at-room-temperature, metal that is perfect to be used to store value and exchange as money. That is the reason why gold.

Gold is “perfectly scarce”. The long-term growth rate of gold is 1.6% per year, the long-term global rate of population growth is 1.2% per year. Every year more gold is mined out of the ground. It gets harder to find because all the ‘easy’ gold has already been found and dug out. More sophisticated and expensive technology, equipment and techniques are used to find the next vein of gold. As these methods are effective at finding the next bit of gold, each year slightly more gold is pulled out of the ground than last year, enough to maintain that 1.6% long-term growth rate. If the market price of gold goes down for a few years, than it doesn’t make financial sense for miners to go to the expense of finding more, they suspend mining or go out of business. After a few years gold has become more scarce because population has increased, gold prices go up incentivizing miners because it is now economically rewarding to go find more gold.

Gold is perfectly balanced - both in chemical properties and scarcity to BE money.

(To be continued…)


A Thoughtful Investor

#11 The Alchemists (part 2)

#9 Monopoly, Game Theory, and why we're all going to be using Bitcoin