Gold is prosperity, but I wonder which basic needs gold can fulfil -

As far as I know, you can't eat or drink it, live in it or use it to move from one place to another.

In essence this means that gold only becomes valuable when you trade it for something you can use. In other words, gold derives its value from other people's willingness to provide their goods and services in exchange for payment in the precious metal.

Gold is consequently not distinctive from paper money or positive bank balances in any way whatsoever. Money, regardless of its form, draws its value from general acceptance. It is nothing more than an agreement.

Not a guarantee of monetary soundness

Gold also does not constitute a guarantee of monetary soundness. The history books are brimming with chronicles of gold coins that through time came to contain less gold and more and more brass.

The most notable exception I am aware of is the Solidus, which was originally cast by the Romans and went on to be used as the most important Byzantine coin for centuries. This coin more or less retained its gold weight through the centuries. Was this due to the magical quality of the gold or to the discipline of the issuing authorities? You guessed it, it was thanks to the latter.

And this completes the parallel with paper money.

The magic of gold

So what lies at the heart of the magic of gold? Many people think it is beautiful and it seems to have a mystical aura. It is also true that it is terribly easy to make paper money.

This obviously makes linking paper money to a non-perishable precious metal that cannot be produced in unlimited quantities very useful. While this linkage can have a disciplinary effect on the creation of money, it also clearly reveals the limitations of the gold system.

If the quantity of money had only been able to fluctuate in tandem with the relatively random supply of gold, there would have never been sufficient monetary expansion to accommodate our growth in prosperity. It would have caused us to wind up in a continuous process of deflation and, as everyone knows, that would have entailed serious problems.

This is why in recent centuries the gold standards have consequently been gold core standards. This enabled them to both sustain the illusion of gold and to organise the required flexibility of the quantity of money.

In order to maintain the discipline of the central banks, it is better for them to be positioned at a distance from the world of politics and to make them responsible for price stability. This system usually works extremely well.

Grand cru red wine

The Gold Standard, which was incidentally based on a surprisingly low quantity of gold and can be described just as effectively as the Sterling Standard, was also not the longest functioning money standard. The shell, wampum and tobacco standards rival for that honour.

The Tobacco Standard functioned more or less satisfactorily for hundreds of years in the British colonies in America. This rich history is chronicled brilliantly in Galbraith's classic masterpiece entitled ‘Money'. If we then still want to go back to a raw material standard, I propose linking the quantity of money to the quantity of Grand Cru red wine.

There is light elasticity in the supply, so it is more predictable than the quantity of gold. And speaking of predictability: You receive a guaranteed 11%-15% with wine.

And, to top it off, it is a 100% liquid investment, so you can always drink it if things take a turn for the worse.

That's a lot better than gazing thirstily at your gold stocks.

Dr. Wim Boonstra, Chief Economist Rabobank Group and has published numerous articles on banking, financial markets, international economics and business cycles. 

www.rabobank.com