Money serves two basic missions, one concerns its function as a medium of exchange, and the second, its ability to store wealth over time. For some individuals, money is cash, as you can easily spend it anywhere. For others, money is gold, as gold never loses value over time.
In 1912, J.P. Morgan stated before the US Congress, “Gold is money. Everything else is credit.”
In this context, we investigate whether different classes of financial assets can be considered money, by emphasizing their ability to preserve value over time.
The Properties of Money
As mentioned at the beginning, money has some basic properties:
- Ability to be accepted in every transaction (medium of exchange)
- Ability to be accepted when repaying loans
- Accounting ability to price goods and services
- Store of value over time
- Ability to be easily stored but also to preserve its purchasing power when it is recovered
Starting by defining a medium of exchange
A medium of exchange is used to facilitate the buying and selling of goods and services in an economy. For a medium of exchange to function, it requires the existence of a wider monetary system that offers a ‘standard’ for pricing goods and services. All parties to a transaction must accept this ‘standard’.
As far as this first property is concerned, that is, functioning as a medium of exchange, cash is the undisputed king. But what about maintaining value over time?
Preserving value over time
The preservation of purchasing power over time is a top issue for every working individual. For an asset to be considered a “store of value” must be able to be stored and retrieved without depreciating its purchase value. In other words, when it is retrieved it should either have the same purchasing power or more.
Comparing the ability of different financial assets to act as money
This is a comparison of several different financial assets in terms of their ability to function as money. It is noted again, that maintaining value over time means protecting the consumer’s purchasing power.
- Average historical inflation: about 3.0% in the EU and 3.3% in the US
- Interest rate (deposits): About 4.5% in the US, lower rates in the EU
- Max Supply: Infinite (+∞)
- Usage as a medium of exchange: Excellent
- Ability to Price Goods/Services: Excellent
- Storage: Very easy
- Recovery: Very easy
Cash refers to the monetary unit issued by a governing authority to price goods and services as well as conduct transactions in the local market. The usage of cash as a medium of exchange is excellent. However, the same is not true regarding its ability to store wealth over time.
What is FIAT money?
FIAT money represents government-issued currencies that are not backed by physical commodities. FIAT money started to predominate in 1971 when Richard Nixon decided to suspend US dollar convertibility to gold.
When holding FIAT money your purchasing power is diminishing over time. The existence of inflation means that the physical money is constantly losing its purchasing value.
On the other hand, if the physical money is deposited in a banking account it can offer an annual interest rate. Therefore, a simplified equation of the ability of the physical money to store value over time could be the following:
■ Future Value = Present Value x (Annual Interest Rate - Annual Inflation)
The annual interest rate can theoretically cover the loss of inflation. But in reality, the annual interest rate offered to depositors is well below inflation, and as a result, physical money's ability to store value over time is very limited.
- Inflation: Same as cash
- Annual Yield: Currently 5.2% in the US, lower in the EU (currently 3.75% in Germany)
- Max Supply: Limited
- Usage as a medium of exchange: None
- Ability to Price Goods/Services: None
- Storage: Very easy
- Recovery: Easy (one month to one year)
What is a T-Bill?
A Treasury bill or else a T-Bill is a debt security issued and backed by the federal government that matures over a short period (one month to one year).
For some investors, treasury bills qualify as money. The reason is that they generate income by offering easy storage and security. Additionally, T-Bills mature quickly and that means the recovery of their purchasing power is very immediate.
Treasury bills are an excellent alternative to bank deposits, especially during times when their yield is much higher than the bank deposit rate. If for some reason (black swan) the T-Bills lose their value in the future, for the same reason, money in the bank will also lose its value.
- Inflation (gold): Estimation about 1.2% (2,500-3,000 metric tons of gold mined annually)
- Annual Yield: 0%
- Max Supply: A total of 244,000 metric tons of gold (187,000 tons are already mined, with another 57,000 tons estimated to be in the ground)
- Usage as a medium of exchange: Very limited (in a few cases, gold pounds can be used for purchasing valuable assets)
- Ability to Price Goods/Services: None
- Storage: Very difficult
- Recovery: Difficult (high fees)
Unlike cash, gold and other precious metals have proven their ability to store value over time, so let's see why:
□ They suffer from low inflation while their new supply (mining) is limited
□ A part of the new supply is consumed by various industries (jewelry, industrial applications, etc.)
□ The lifetime of precious metals is essentially forever
□ Historically, they have been recorded in the memory of mankind as a reliable tool for storing wealth
Even though precious metals do not offer any interest rate, they can be considered a reliable investment, especially in times of high inflation and monetary uncertainty (like today). Their problem is mainly their storage, but also in many countries, the recovery of their purchasing power (if the exchange costs are high). Perhaps, placing 10% of your portfolio's value in physical gold is a smart thing to do.
New Digital Money (mainly Bitcoin)
- Inflation: 1.74% (decreasing every 4 years)
- Annual Yield: 0% (However, depositing BTC on DeFi protocols can offer yields)
- Max Supply: 21 million Bitcoins (max supply)
- Usage as a medium of exchange: Limited today, but growing
- Ability to Price Goods/Services: Very limited today
- Storage: Complex today (hardware wallet)
- Recovery: Easy
Bitcoin (BTC) is a decentralized payment system that focuses on eliminating intermediaries and storing wealth over time. But since it only came out in 2010, it needs a lot more time to be considered a reliable tool for preserving wealth. The great advantage of holding BTC is the limited max supply (21 million units) and the low inflation (going lower over time). The great disadvantage of holding BTC is the difficult storage and the extreme price volatility against FIAT money. After the introduction of Bitcoin ETFs, the problem of storage will be solved to an extent. While over time, its price volatility against the US dollar is expected to decrease. But the question is whether Bitcoin will still be attractive to investors after its volatility is reduced, given that today is mainly used for speculation. Perhaps, what will determine the future of Bitcoin is its ability to establish itself as an alternative global medium of exchange. If it succeeds in this global mission, its future is certainly promising.
Ethereum Blockchain
There is also another digital currency worth mentioning, and that is Ethereum. Ethereum is the main Layer-1 platform for hosting NFTs, DeFi, and other decentralized applications. The native currency of the platform is called Ether or ETH. Ethereum dominates the DeFi market, with a market share of well over 50%. Additionally, in 2021, the implementation of the EIP-1559 introduced fee burning, which has the effect of reducing Ethereum's inflation rate over time. Today, the annual inflation of Ether is estimated to be below 0.45%.
General Conclusions
- Cash is the undisputed king of everyday transactions, but it is too unreliable as a store of value.
- Maintaining as much cash as you will need for a calendar year is maybe the smartest thing to do
- Treasury bills are better as a store of value than cash, as they offer better returns with basically the same risk
- Physical gold has historically proven its power as a store of value. Gold advantages include low supply and particularly low inflation. On the other hand, it is difficult to store and retrieve gold, while it does not offer any annual return
- Placing 5-10% of your portfolio's value in physical gold is probably the most sensible strategy
- Bitcoin is a new asset (it came out in 2010) and it will need time to mature. BTC's advantages include low supply, particularly low inflation, and an easy recovery. At the same time, through various protocols (DeFi) Bitcoin can also offer an annual return, but this practice entails a counterparty risk. It also has difficult storage and high volatility risk (market risk)
- To the question of owning Bitcoin, or not, the answer could be to maintain 1-2% of your portfolio's value in BTC
Large-cap stocks
As far as portfolio management is concerned, some high-cap stocks could be added. The focus should always be on highly liquid stocks offering good prospects and greater dividend yields than T-Bills.
Final Thoughts
There is no direct answer to the question of what is the best form of money. Maybe it doesn't matter, given that money can be easily distributed across different asset classes.
In today’s rapidly changing financial environment, the smartest strategy is to spread your money widely across different types of investments. If this distribution is the product of experience and logic, the value of your portfolio will only increase in the long run. Indicatively:
- Cash in the bank covering 12 months' needs
- Large position in T-Bills (as long as their yields stay this high)
- Mid-position in large-cap stocks offering a dividend yield of over 5%
- Small position in physical gold (5-10% of the portfolio’s value)
- Smaller position in Bitcoin (1-2% of the portfolio’s value)
Graph: Example of a basic portfolio distribution (average investor profile)
In life they say "Strength lies in unity", but when it comes to money, strength lies in distribution and diversification.
Sources:
- TradingCenter.org
- European Central Bank (ECB)
- Wikipedia.org
- Investopedia.com
■ Investigating Money -How Cash Compares to T-Bills, Gold, and Bitcoin
Giorgos Protonotarios, November 6th, 2023
for CarryTrader.com (c) -This article does not constitute investment advice
MORE ON CARRYTRADER
■ COMPARE PROVIDERS
► Brokers for Carry Traders
» Investigating Money
■ GLOBAL MARKETS
» Gold
