People say that gold is rare this is why it makes good money. To make an
analogy to the porridge in Goldilocks, the temperature could not be too cold
or too hot. If gold were too common, or too rare, it would not work as money.
Think of sand, which is too common, or blue diamonds which are too rare (and diamonds
would not work as money anyway.
Rather than focusing on its rarity, let’s look at extracting it. It has
generally held true that the cost to mine an ounce of gold was around one
ounce of gold. When the cost falls below the value of an ounce, the miners go
to work; when the cost rises above, they shut down.
The end result is that people have been accumulating gold for a long time.
How long? As far as we can tell, gold has been hoarded for thousands of
years. Think about this; it is amazing. In any other commodity, if there is a
small surplus it is a “glut” and the price falls until the glut is worked
off. In gold, there is no such thing as a glut. People are willing to
accumulate whatever gold the miners produce, without any particular limit.
By this measure—accumulated inventories divided by annual production—gold
is actually the most abundant commodity. Not including water and air, gold stocks
as a ratio to flows is officially estimated at 80 years. We believe
the actual number is much higher, perhaps multiples higher. People have been
hiding gold from their governments for thousands of years, and it is
impossible to accurately inventory.
Economists use a term: marginal utility. This concept refers to the
fact that one values the next unit of any good less than one values the
previous unit of that same good. Think of walking through a desert, thirsting
to death, and finding a vendor of water. What would the first gallon be worth
to you? How about the second? The third? At some point, the water has zero
value.
The marginal utility of every good falls. But the rate of decline is
faster for some and slower for others. Gold is the good with the
slowest-declining marginal utility. The proof of this claim that gold is the
good with the highest inventories. People are still willing to accumulate it
thousands of years after they first began accumulating it. Gold is not really
consumed (though it is recycled from bullion form to jewelry and objet d’art
and back). Virtually all of the gold ever mined is still in human hands
today.
In every market for goods, there is a bid and an ask. The
spread between them represent the loss to get into and out of that commodity.
The wider this spread, the more “friction” to trade using the good. The
narrower it is, the more liquid the commodity. Gold has the narrowest bid-ask
spread. It is around 20 cents an ounce during normal market hours. A narrow
spread is critical to the concept of money or currency. Artwork from old
masters may hold its value, but it could never circulate as money due to the
bid-ask spread.
Silver has one advantage over gold. This is for small values. If a worker
saves 10% of his weekly wage, or a retiree sells a small amount to buy
groceries, gold is impractical. This is because in such small quantities, its
bid-ask spread becomes much wider. There are high costs to produce a 1/10 or
1/50 ounce gold coin. Silver does not suffer from this problem.