Why is gold valuable?

An article in today's Los Angeles Times reports that the price of gold has now hit $850 per ounce. This raises an interesting question: Why is gold so valuable?

Economists clearly have a point about supply and demand--$850 is the equilibrium price that results from the dynamics of the market place. That, however, does not explain why this heavy demand came about.

The substantive uses of gold as anything other than an investment in its own right are actually quite limited. Today, there is much more gold around than what is needed for jewelry. Gold, in its pure form, is actually too fragile to be used for jewelry, so an amalgamation with some other metal is needed, thus reducing the actual amount of gold used. There are some industrial uses of gold since it is a "cleaner" conductor than most other metals, but this need, too, is modest. The use of gold for dental fillings is also limited.

The truth of the matter is that most of the World's gold is sitting by idly in bank vaults across the globe.

Seemingly, the only reason why gold takes on such an exorbitant value is a circular one: Gold is valuable because it is valuable. If you have gold to sell, someone will actually pay you the market price. Gold, then, is valuable because we have agreed that it is. For some time, I have been trying to sell my house. I wish that real estate buyers would buy into the logic that my house is valuable because it is. The supply of real estate, relative to its practical use, is much more limited than the supply of gold relative to its practical uses.

For many years, I have been waiting for the day when a large number of consumers will wake up and conclude that Starbuck's is essentially a purveyor of highly overpriced coffee. Sure, there will always be some people who will pay for the convenience and mystique of the place, but I have been wondering for a long time how long the chain will hold much of its selling power. I also tend to wonder if investors one day would wake up and conclude that the actual value underlying gold is contingent on everybody continuing to agree that this commodity is, in reality, valuable.