måndag, november 17, 2008


Negative return

Today I would like to draw the attention of my readers to the fact that physical gold, be it coin or bullion, stored in hypothetical money warehouses yields a negative return. What does that mean?

Suppose that there were institutions issuing substitutes for gold coins and that those money substitutes were fully backed by vaulted gold. One ounce of gold either in the form of token coins or notes would simply correspond to one ounce in the vaults of the issuing institution.

Most obviously such an enterprise would be unprofitable unless it would charge its customers some kind of fee. To store gold is associated with costs. The vaults must be built and maintained and the issuing company must also employ armed security guards to protect the vaults from theft. Furthermore the enterprise must print notes and have precise book-keeping to make sure that the issuance of notes is not in excess of the gold actually vaulted.

One benefit of such an institution would be that the gold stored would not circulate in the form of coins. Gold coins get worn down in circulation and therefore it is more economical to circulate paper tickets or token coins made of non-precious metals. However, the same advantage could be attained if the gold coins were covered with a thin film of transparent plastic.

Another benefit would be that it would be possible to issue token coins of small denominations. A gold coin with a weight of, let's say, a few grains would already have such a huge purchasing power that it would be inconvenient for many every day transactions and in spite of its huge purchasing power you would need a magnifying glass and tweezers to handle it.

One very big problem, not to be overlooked, associated with the issuance of such money certificates would be how the issuer could charge its customers fees to pay the expenses of the enterprise . Would, for example, a gold mining company transferring gold bullion to such an institution get a smaller sum in the form of token coins and notes in return than it had transferred? I think that the only realistic opportunity to charge fees would be for the issuer to give those who would entrust the enterprise gold fewer money substitutes in return than the amount of gold bullion they had actually transferred and to make the money substitutes subject to prescription.

If, for example, the issuing company would calculate that the cost of storing one hundred ounces of gold for ten years would be nine ounces of gold and it would consider one ounce a reasonable profit, the issuing company could charge those who would transfer gold a 10% fee and make the notes subject to prescription a ten-year period after their issuance. On top of that the issuing institution could earn some extra revenue if, which seems likely, some of the notes were not presented before their prescription.

However, the whole idea of an institution issuing such money certificates is obviously unrealistic. The only ways it would benefit its customers would be that the coins would not get worn down and that the customers would get smaller and more convenient denominations than they could if they would rely exclusively on gold coins.

Would those small benefits really outweigh the costs associated with the storage of gold and the issuance of money certificates? I do not think so and for this reason I seriously doubt that there ever were any such money warehouses. They did exist in the imaginary world of some theoretical economists, but I do not think that they ever existed in the real world.

The essence of this discussion is is that a money warehouse so to say would yield a negative nominal rate of interest. We can therefore conclude that already a bank offering 0% interest on gold coins could attract customers in a free market. 0% interest is after all a far better deal than a customer's fee.

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