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Ye Olde Gold Standard

One hears calls to return to "the gold standard" for currency periodically, but usually they arise during periods of high inflation and economic instability, not in times of strong, non-inflationary growth. The Presidential candidacy of Rep. Ron Paul, a staunch advocate of the gold standard, likely accounts for the most recent rumbling.

In addressing the question, we must first acknowledge that as far as assets to "back" a currency, gold stands alone. No other commodity even comes close. Gold's intrinsic value has been recognized for millennia, across all cultures. It stands alone in stability of supply, too, with an estimated 99% of the gold ever mined still accounted for today (the rest having been lost to shipwreck or other disaster), and only 1-2% is added to the supply each year through new mining.

Gold has been well described as a "constant store of value." In other words, over time your money is perfectly safe in gold: it will neither gain nor lose value. Generally, if the price of gold rises, it means the dollar is weaker; should gold fall, the dollar is gaining strength. Now, at first glance, it may seem odd that the price of such a stable commodity should be subject to speculatory binges, but it is simple economics. Because of the stable supply, increases in demand force the price up directly (as opposed to other objects of desire, where a rising demand and price would bring new supplies to market, no such thing happens with gold). Speculators rush to be the first on their block to buy gold at any sign of crisis or instability, secure in the knowledge the seekers of safety will follow and drive the price further.

As with all speculations, though, these bubbles eventually burst and gold returns to a more or less steady value. Even so, the variations in price of other commodities show far more volatility, leaving gold the best choice to back a currency.

Now, some of the advocates of a return to the gold standard promise outrageous benefits from the policy. They claim economic stability and growth unmatched, renewed confidence in the markets, and probably a cure for halitosis. History tells us otherwise, of course. We did have a gold standard for many decades, and under that standard we witnessed inflation, deflation, panics, recessions, booms and busts, and even the Great Depression. Gold hardly can claim to be a panacea for economic ills, based on experience.

The single question, though, proponents of a gold standard never seem able to answer is: Where does the gold come from?

The United States possesses the world's largest gold reserves, roughly 25% of the world's total supply. But even at today's speculation-driven prices, the value of our reserves would not back even 40% of our currency in circulation. So, precisely WHERE would the balance come from?

Of course there is no reasonable answer. The ONLY way a gold standard could be implemented would be through a tremendous deflation, which would plunge not only the American economy, but the entire world's into a depression of unprecedented depth.

The fact is that currency is a metaphor for wealth. Using gold to "back" currency provides a tangible metaphor, but it is still just a metaphor. Our wealth increases irrespective of how much our gold reserves increase or decrease, and our currency must reflect the current wealth. This is why we issued currency in excess of our gold reserves decades before Roosevelt outlawed the private ownership of gold specie. We had been on a "fractional gold standard" - meaning we held only enough gold to cover a fraction of the currency outstanding - for more than half a century before Nixon ended the charade.

But a "fractional" standard isn't a "gold standard," is it? Not if you are arguing that currency must be "backed" by specific amounts of gold in reserve, it isn't. The truth is that our government, nor any other government, would never allow its gold reserves to be depleted by exchange for currency. No matter what.

The "gold standard" is a fantasy. It was a fantasy long before we abandoned it, and it remains a fantasy today. Get over it.


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Comments (12)

"The ONLY way a gold standa... (Below threshold)

"The ONLY way a gold standard could be implemented would be through a tremendous deflation, which would plunge not only the American economy, but the entire world's into a depression of unprecedented depth."

Wrong.

Deflation occurs when the money supply is contracted. A gold standard that pegs the dollar to its current ratio in federal gold holdings, whatever that might be, would not force a contraction.

Please remember that a gold standard, or any other sort of specie standard, is just a promise of redeemability. It's not a complete substitution of the backing metal for the existing currency; it's just a guarantee that paper currency and other money proxies can be converted into the backing metal at an agreed-upon ratio, at the option of the holder. It's important because it limits the government's ability to expand the currency, because it would then have to face the possibility of a "run" on its gold reserves.

Whatever the total gold holdings of the federal government are at this time, let that figure be divided into M2, and set the redeemability of the dollar at the resulting ratio. Neither inflation nor deflation would result. However, the Fed would be inhibited from further inflation of the dollar, safeguarding the savings of Americans and all others wise enough to keep their savings in dollars.

Of course, that redeemability ratio would have to be guarded from legislative alteration, too, but one problem at a time!

Uranium Standard soon.... (Below threshold)
kim:

Uranium Standard soon.

A gold mine is a hole in the ground with a liar at the top.
====================

As economic wars are now ra... (Below threshold)
epador:

As economic wars are now raging (and receiving little press), I think the increased vulnerability to disaster that a metal standard leaves a country is an ever better argument against the gold standard.

One nuke over Fort Knox with and without a gold standard - what are the implications?

A Chinese run on US currency with and without Gold Standard?

"the value of our reserves ... (Below threshold)
C Moore:

"the value of our reserves would not back even 40% of our currency in circulation" What an amazing claim! What is your source for this astonishing assesment? Because I am under the impression that the M3 (i.e. the report that says how much money is actually in circulation) has not been published for years by the Federal Reserve Board.
I can't wait to see gold prices at $2000 an ounce slap the ignorance out of your opinion. Don't take my word for it, just listen to a young Alan Greenspan in 'Gold and Economic Freedom'.

http://www.321gold.com/fed/greenspan/1966.html

Enjoy Mr. Fiat!

If you're not careful I'll ... (Below threshold)
kim:

If you're not careful I'll invoke Poe and Stephenson. Ahoy there, maties.
==========================

If I remember correctly, th... (Below threshold)
Strick:

If I remember correctly, the last major nation to attempt to adopt a gold standard was Britian back in the 30s. It was a complete disaster. Of all people, Winston Churchill was held responsible and I seem to recall it was the reason he was out of government for most of that decade.

Any politician who proposes a gold standard is instantly branding themselves economically illiterate. If here's anything the prosperity of the last couple of decades teaches us, it's that the monetary supply needs to ebb and flow with the needs of the economy, not the static supply of an inert metal kept in some vault.

Invest in some gold coins if you like to play the comodity markets. Just don't expect the rest of us to make the economy hostage to it.

And to think, I thought Ron... (Below threshold)
Veeshir:

And to think, I thought Ron Paul was against Italian car companies making money (why shouldn't Fiat make any money? I mean, every business has to be profitable to stay in business), I didn't realize it was something ridiculous.

Francis W. Porretto ~ Firs... (Below threshold)

Francis W. Porretto ~ First note what you propose is NOT a "gold standard," but a "fractional standard" under which only a portion of the currency is "backed" by gold. So, we will redeem a dollar for twenty (if you use the "total outstanding" figure of over $1 trillion) or twenty-five cents (if you use the $776 billion actually currently "in circulation")? That's hardly making the dollar "good as gold," now, is it?

But suppose for a moment we did enact such a plan, and the estimated 2/3 of the currency in circulation which is held by foreign sources were to redeemed, even at a fraction, for gold. The necessary contraction of the money supply to account for the depleted reserves would be deflationary.

Even if a massive devaluation isn't necessary for such a fractional standard, as it would be for a true "gold standard" where every dollar in circulation is backed by a dollar's worth of gold, what you suggest is indeed deflationary anyway. As Strick points out in #6, currency must expand with economic growth. Otherwise, deflation MUST occur.

~~~~~~~

C Moore ~ Of course the circulation figures ARE regularly published. I do not propose to become your research assistant, but anyone with a search engine could find the Treasury figures.

My "40%" is indeed inaccurate, though - I was giving gold the benefit of the doubt. The World Gold Council estimates the value of US reserves at $197 billion as of June of this year, so the accurate figure would be 19.4% (based on "total outstanding") or 25.4% (based on "currency in circulation"), not 40%.

Mr. Greenspan's 1966 views are interesting, but irrelevant to the numbers we are crunching today, of course. When I was young and idealistic, I also thought the gold standard was viable. At the time, though, we were experiencing double-digit inflation and uncertainty. The Fed certainly had contributed to this - up until Carter was forced to appoint the hard-liner Volcker as Chairman, and the Fed began to do its job as regulator of the money supply instead of serving the political needs of the Administration in power.

For those who are so opposed to the FRB having the authority to regulate currency supplies, here's a bit of trivia: In the decade or so before the FRB was assigned the responsibility, the currency in circulation was issued based on the recommendations of one private banker, J.P. Morgan. Which demands the question, if not the FRB, then WHO should regulate the issuance of currency? (Recognize that even under the deflationary plan advanced by Francis W. Porretto above, bills will wear out and need replacement).

WHO, then? The Congress? The President, or an appointee he can fire at will? Yeah, that would keep politics out of the money supply, wouldn't it?

A few years ago I read a ... (Below threshold)
Arthur:

A few years ago I read a wonderful essay by a Fed Reserve Chairman (either Greenspan or the one before him) that laid out the whole history of monetary standards in a fairly easy to understand way. I'd link to it now but I can't find it.

We've gone from no economy to barter to warehouse receipts to commodity-backed currency (which would include gold as one variant) to fractional reserves to what we have now - fiat money. Backed by nothing at all except the average man's faith in the whole system. Each step was a major improvement over the previous one. Going back to the gold standard puts the expansion of the economy at the mercy of rate of discovery of new gold mines.

Here's a link to a basic history of currency.

It's not the essay I mentioned earlier which had really good arguments* supporting fiat money but at least it provides the foundation for understanding what we're arguing about.

*Good enough to convince me!

Yeah, this could be the worst case of "argument by pointing to authority" ever (since I can't even point to the authority!)
I'm just saying I support Addison's post but I can't make a good argument or give a source that makes the good argument. So Trust Me. [grin]


There are a number of inacc... (Below threshold)
_Mike_:

There are a number of inaccuracies in the article.

But a "fractional" standard isn't a "gold standard," is it? Not if you are arguing that currency must be "backed" by specific amounts of gold in reserve, it isn't.

The term 'gold standard' implies a fixed ratio between paper money and gold. So, whether or not the ratio is fractional doesn't change the fact that it's a fixed ratio.

The fact is that currency is a metaphor for wealth

A drive shaft is a mechanism for transferring torque. Currency is a mechanism. It's a mechanism of transferring wealth - it is not wealth. Currency is, in essence, a claim on the wealth of others. Wealth is that which is necessary to sustain or to improve the quality of life.

At the most basic level, one exchanges one's work for currency. One then exchanges the currency for food and shelter. Again, currency is simply a mechanism for transferring wealth.

If one produces more wealth than one consumes, one accumulates wealth. A fiat currency is subject to devaluation by the government that produces it; hence, it makes a poor choice for a method of storing accumulated wealth.

The argument in favor of a gold standard is essence based in the desire to store accumulated wealth in currency.

Money is a socially defined... (Below threshold)

Money is a socially defined form of energy. It causes social things to happen; the transfer of goods (and/or license to use goods) from one owner to another; it causes providers of services to provide services.

It can be exchanged for energy in different forms: gasoline, electricity, rocket fuel.

The source of this energy is, ultimately, sunlight. Using photovoltaic cells, you can turn sunlight into electricity, into money. Using plants, you can turn sunlight into food into money. Using mining equipment, you can dig up transuranic elements, rare crystals, and valuable metals, theoretically generated originally by the sun.

Sunlight is the true gold standard...

Betty Casey si for Obama.</... (Below threshold)
Jimbob:



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