Why did gold win?
Onramp Fundamentals Series – Chapter II
In What is money? we talked about how some monies are commodity monies, like gold or bitcoin; some monies are credit money, like fiat; but all monies are effectively ledgers – a summary of transactions used to keep track of who owns what (1).
But who or what controls the ledger? In the case of commodity money, nature controls the ledger.
A commodity is an asset without an issuer. The supply of a commodity is governed by how much is found naturally in or on the earth, and the rate at which we can extract it.
So long as market participants have relatively equal technological capabilities, nobody can produce more money than anyone else, and everyone must expend the same amount of energy in creating new units of the money (2).
A number of different commodity monies have been used by societies throughout human history, from shells, to beads, to rai stones, to salt, silver, and gold.
But fast forward to today, and only gold, and to a lesser extent silver, are still viewed as monetary assets.
What is special about gold (and silver) that has allowed them to “win” against all the other commodity monies?
The short answer is: they have been best able to maintain their scarcity, specifically, their stock-to-flow ratio, against the rise of human technology.
Stock-to-flow is the ratio of a commodity in circulation to new units produced annually. The inverse of stock-to-flow can be likened to an inflation rate.
Rai stones are large limestones carved into circular discs with a hole in the center, used as money on the Southern Pacific island of Yap for generations (3). The limestone was quarried on nearby islands and brought back to Yap by boat, requiring tremendous amounts of time and energy – proof-of-work, if you will – thus making the rai stones scarce and hard to produce.
Then Europeans arrived with better quarrying technology and bigger boats, and brought many more rai stones to the island. The stock-to-flow ratio of rai stones on the island decreased dramatically as the flow increased. Rai stones were no longer as difficult to produce, nor were they as scarce, and they were soon discontinued as money.
This is an example of a technological advancement obsoleting a previously good money.
Gold, however, has maintained its stock-to-flow ratio for thousands of years at about 67. Said otherwise, the annual increase in the supply of gold has been about 1.5% on average, despite all the innovation in mining technology over the past 2,000 years. Gold has its own natural difficulty adjustment – the more gold you mine, the more difficult it is to mine more gold.
Maintaining its stock-to-flow ratio against the rise of human technology is why gold has won.
Silver has maintained a stock-to-flow of about 22, averaging 4.5% inflation per year.
Why has there historically been a place for silver at all, then, if gold is more scarce?
Because it is more divisible, i.e. it can be divided into less valuable units more suitable for small, everyday purchases.
Over long periods of time, though, gold has held its value much better than silver, as indicated by the long-term chart of the gold/silver ratio, which measures how many ounces of silver are needed to purchase one ounce of gold:
Source: Longtermtrends
Footnote 1: Lyn Alden, Broken Money, 1
Footnote 2: Lyn Alden, Broken Money, 35
Footnote 3: Lyn Alden, Broken Money, 23