Gold: Near-perfect money

In the broadest sense money must be three things...

  1. Medium of exchange
    - it must be widely accepted for indirect exchange.
  2. Unit of account
    - it must be uniform to aid in economic calculation.
  3. A store of value
    - it must be as riskless as possible to aid stability and market confidence.

Modern currencies fulfil the first two, but rarely fulfil the third criterion. Many things can be money but gold is money for the following reasons...

Limited in supply and has a high value to weight ratio

Only 165,000 tonnes of gold have ever been mined in history. That is a cube 20m by 20m by 20m and would fill just over 3 olympic swimming pools to a depth of 2 m. That may sound like a lot of gold but to put it in perspective we mine and consume that much iron every 1 hour and 50 minutes...

Requires effort to obtain more

It has to be dug out of the ground and refined at great expense, making it difficult to increase the supply quickly.

Fungible

Diamonds are rare and very valuable but they are useless money because each diamond is different and would require assaying to determine value.

Durable

In barter times the people who produced non-durable goods like wheat etc. had to swap their produce for something durable before it rotted. Gold doesn't degrade, rot or rust.

Highly divisible

Metal can be melted down into whatever weights are required. In time of barter it was hard to give change from a cow without killing it.

High stock to flow ratio

Because very little gold is consumed the amount of new gold mined is less than 1.5% per year which just happens to be very similar to the rate of population growth. But regardless, this large stock of gold means that its quantity stays pretty constant over time which lends itself to being a stable numéraire. In fact it is said there is the same amount of gold per person existing above ground today as in Roman times.

Universally desired for 6,000 years

Presumably people originally desired gold because of its beauty and rarity. That desire caused a feedback loop as described by Menger and clarified by Ludwig von Mises' regression theorem so it was accepted as a means of payment by people who didn't want the gold but knew it would be accepted by others - very much like cigarettes in prisons.

http://mises.org/daily/1333

It has an incredibly rich history of being money. It was money yesterday and today, so people believe it will be tomorrow.

The choice of the people

Gold evolved as money voluntarily by the market. It didn't require government decree and legal tender laws. The same cannot be said for today's currencies which all started out as commodity money and via bait and switch evolved into the instruments of fraud they are today.

So... it's not true to say other things can't be money but as you can see gold just happens to be a pretty perfect money.

There are some other additional attributes relevant to the modern world allowed gold to remain as money...

It is private

Gold, privately owned can be used in trade without being subject to government oversight. The black market would be quite happy to use gold. You can give your kids gold coins as an inheritance without the government getting involved and charging inheritance/estate tax.

It has almost no industrial use at its monetary value.

Aside from its small use in electronics it isn't used much in industry - probably because there are cheaper alternatives. As J. P. Morgan said "Gold is money, nothing else." - it is most useful as money and that reinforces its use as money as described above.

It's global and under very little political control

Gold is found all over the world - palladium and platinum are mostly found in South Africa and Russia. This sounds arbitrary but governments in the past demonetised silver because South America had it in abundance and they wanted to maintain their monoply.

Some people will argue that gold has no instrinsic value. It certainly is less risky than paper currency but it's true that its production cost isn't that important because most of what has been produced is still in tact and it's industrial value is less than its monetary value.

Some people will argue that it isn't money because it is not legal tender in most places and is subject to capital gains tax. It's hard to argue with that except to say that those measures were imposed deliberately to reduce its role in monetary affairs and at the stroke of a pen could be reversed. Also, as mentioned above, gold can be used as money in private transactions no one needs to know about.

Other things can be used as money and a backing for a currency but you'd struggle to find a money perfect money than gold.