NEMO at the blog Self-Evident posts this amusing exchange from Ben Bernanke's testimony earlier this week:

Amusement aside, the disappointing thing about Ron Paul's goldbuggery is the weakness of the analysis behind it. His support seems almost mystic in nature: that gold is money is a law of economics that's held for 6,000 years! In his defence, this quasi-mystical belief in the sanctity of gold in a monetary system was shared by the world's financial leaders for much of the industrial period. That's not much of a defence, though. Gold worship repeatedly drove the economy into ditches and off cliffs, but for a few lucky years in which the pace of new gold discoveries fortuitously matched growth in the global economy.

Is gold money? No. Money is the medium of exchange. Money is what we use to facilitate transactions in order to capture efficiencies unavailable in a barter economy. You could probably take a gold bar to a store and swap it for something, but that would be a barter-like trade rather than a money-facilited exchange. You and the shopkeeper would have to haggle over the value of one good—the gold—vis-à-vis another and jump through all the hoops money is designed to eliminate.

Gold is a store of value. It's an asset that can be and often is held as a store of wealth. But while gold is not money, it shares a very important characteristic with money: its value (apart from limited industrial uses) is derived from the market's perception that it has value. This is the nugget of truth in Mr Paul's comments. There's nothing all that special about gold except for the fact that over much of human history people have behaved as though there is something special about gold. That belief (and the fact that it's on earth in sufficiently limited quantities) is what makes gold a useful store of value. People think it's valuable because people think it's valuable.

But that's precisely the way that fiat money works. People believe the flimsy pieces of paper we call dollar bills are worth some basket of real goods only because everyone else believes the same thing. The crucial difference in the perception of value is that new gold can only be obtained at great difficulty while new bills can be produced by the truckload at virtually no marginal cost. Gold's inherent supply limitations supported the popular confidence in its value. And when economies began switching to paper money, the link between the new confidence-based currency and the old confidence-based currency was a very useful way to build public faith in the new confidence-based currency.

Across the rich world, the task of establishing sufficient confidence in the value of colourful bits of paper is finished. People are happy to keep their life savings in dollars despite the fact that the gold price of dollars may vary wildly. Central banks around the world gladly hold foreign currency as reserves. This is because central banks have demonstrated that they're basically as good as miners at keeping the value of a medium of exchange predictable.

I understand the view (though I think it's dead wrong) that central banks can't be trusted to keep up this predictability, and that a gold link is necessary to maintain discipline. What I don't understand is the argument for gold that falls back on the mystical, 6,000-year old Law of Economics that shiny yellow metal is somehow special. All Mr Paul is saying is that he prefers old faiths to new ones. It's a great triumph of economics that it's put quite a lot of analytical meat on the bones of monetary theory over the past century. It's a shame that Mr Paul seems not to understand it.