Editorial
A Return to the Gold Standard?
Over the weekend of November 6-7, 2010, World Bank president, Robert Zoellick , proposed in a column written for the Financial Times that the global economy once more be linked to gold as an anchor to help maintain currency stability and reduce inflationary expectations in international markets.
A few days earlier, on November 1, Financial Times columnist, Martin Wolf, had written a piece precisely asking, "Could the World Go Back to a the Gold Standard?" Wolf pointed out, "It is not hard to understand the attractions of a gold standard. Money is a social convention. The advantage of a link to gold (or some other commodity) is that the value of money would apparently be free from manipulation by the government. The aim, then, would be to 'de-politicize' money."
But Wolf raised a number of objections to reestablishing a gold standard, including, (a) the fact that it would require a significant revision upwards in the official price of gold in terms of dollars, which seemed unfair to him since it would give an unearned windfall to current holders of gold; (b) it would impose additional transactions costs in international dealings since some trade imbalances would have to be settled through transfers of gold; and (c) it might inhibit necessary flexibility in the banking and financial system for the monetary authority to counteract recessionary forces that may lead to falling production and rising unemployment.
As Martin Wolf correctly observed, historically a primary advantage of a gold standard was that it removed the hand of the government from the handle of the monetary printing press. Over and over again, governments have used their power or influence over the monetary system to either debase coins or print up paper money to cover its expenditures in excess of the taxes collected from the citizenry.
But in spite of Wolf's concerns, it can be argued the costs of a gold standard are far less that the costs that have been imposed on society from a century of gross mismanagement of the monetary system by governments around the world. Since 1914, when the Federal Reserve System came into operation as America's central bank, and the beginning of the First World War that same year, the world has experienced severe inflations, including a number of hyperinflations, and the rollercoaster of several booms and recessions, including the Great Depression of the 1930s and the current global economic downturn.
Placing the fate of the world's monetary system in the hands of monetary central planners, who have had all the discretion imaginable through their control of paper money instead of gold, has not secured an inflation- or recession-free economic environment.
In the mid-1980s, leading free market economist, Milton Friedman, who for decades had advocated a paper money monetary system restricted to increasing the money supply within a narrow "rule" of three percent a year, admitted that he had been all wrong in believing that such a system could ever work. He said that he, now, realized that it would never be in the interest of governments or their central banks to resist the temptation of printing money to cover government spending, serve special interest groups, and advance other short-run political purposes. He concluded that, in retrospect, the costs on society since 1914 from inflations and the boom and bust cycle caused by central bank mismanagement were far greater than the costs that would have been associated with a real, politically-free gold standard from mining, minting and storing gold, and facilitating transactions through use of the yellow metal during the 20th century.[i]
The fact is, government-caused inflations, and fears of inflation, have already delivered a windfall gain to all those astute and entrepreneurial enough to investment in gold or gold-mining companies over the years. They have protected their wealth and assets from dollar depreciation and sometimes earned handsome returns from their holding of gold. But it was government monetary mismanagement that created this "opportunity."
If the Federal Reserve were to stop increasing the money supply, and if a new legal redemption rate between gold and dollars were to be established on the basis of the estimated total number of dollars in circulation in the world divided by the amount of gold held by the U.S. government, any financial "gains" made by the holders of gold would be all due to the avalanche of dollars that have been printed up by the Federal Reserve over the decades. Gold's dollar appreciate in value has been due to the dollar's depreciation caused by unlimited monetary expansion.
Finally, Wolf's concern that a real gold standard would tie the hands of governments and central banks from having the discretionary authority to manipulate the monetary system should be considered a "plus," not a minus. Only the most doctrinaire Keynesian can deny or fail to see that past recessions and the current economic downturn were all preceded by unsustainable booms resulting from monetary expansions and interest rate manipulations that threw savings and investment out of balance, artificially stimulated misplaced construction projects, and misdirected labor into employments that became unprofitable to maintain once the inevitable financial and investment bubbles burst.[ii]
Monetary-induced booms are the "cause" that precedes the inescapable bust that follows. Eliminate or radically reduce the possibility for central banks and governments from artificially creating such booms, and the likelihood of having to go through economy-wide downturns will have been dramatically reduced or done away with.
At one point in his article, Martin Wolf mentions that some have called for an even more radical monetary reform than even a government-managed new gold standard: the abolition of central banking and a full separation of money from the state, through a monetary system based on competitive, private free banking.
Wolf sets that alternative aside as well, thinking that the world is certainly not ready for such a change, even if it was workable. But, in fact, this is the ultimate and most reasonable of all the alternatives to the existing system of monetary central planning through the government institution of central banks.
Monetary central planning has worked no better than any other form of central planning over the last one hundred years. The world's central bankers – just like the central planners in the old Soviet Union – just do not have the knowledge, wisdom and ability to successful manage the monetary system of a market economy.
How can central bankers know what market rates of interest should be, better than the competitive interaction of borrowers and lenders for the use of scarce savings for various investment purposes? How can central bankers know what the quantity and types of money and credit should be in the market, better than those who wish to use various commodities for money purposes, and interact for various forms of lending and borrowing?
Money emerged out of market interactions, through people's search for ways to better facilitate their transactions. Governments did not create money; but governments have been highly creative in devising ways to monopolize its control over money, and manipulate its quantity and value for political purposes.
Banking and other forms of financial intermediation do not require government creation or oversight to function effectively to bring lenders and borrowers together for mutual advantageous exchanges. But government regulations and controls imposed on financial markets can generate anti-competitive practices; can result in distorted and misdirected uses of savings and capital; and can enable the wasteful siphoning off of a part of society's scarce resources to fund the insatiable appetite of government for spending other people's money.
Luckily, over the last twenty years, a number of free market economists have successfully demonstrated how a private, competitive free banking system can operate, and perform far better a variety of tasks and activities for which it has been presumed a central bank was needed.[iii]
The time has come to rethink the basic premises of the existing monetary order. And this needs to begin with thinking "outside the box" of the predominant macroeconomic policy framework.
The wisdom and insights of the classical economists must be given a new hearing, in terms of their argument in support of a market-based commodity monetary system, such as a gold standard.
Even more radically, we need to rethink the rationale for central banking all together. We need, in the phrase of Austrian economist, F. A. Hayek, to consider the "denationalization of money," and a monetary order based on private, competitive free banking.
The return to a market-based money such as gold, therefore, is both possible and desirable. And it would be most effective in acting as a barrier against any further government abuses of the monetary system, if such a return to gold was introduced through the freeing of banking and financial markets from the heavy-hand of government, as well.
The next phase of our post-communist world may very well require the end to monetary socialism, which is what central banking really represents.
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[i] Milton Friedman, "Economists and Economic Policy," Economic Inquiry (Jan. 1986), pp. 1-10; "The Resource Cost of Irredeemable Paper Money," Journal of Political Economy (June 1986), pp. 642-64-7; and, "Has Government Any Role in Money?" Journal of Monetary Economics, Vol. 17 (1986) pp. 37-62.
[ii] See, Richard M. Ebeling, "Market Interest Rates Need to Tell the Truth, or Why Federal Reserve Policy Tells Lies," in Richard M. Ebeling, Timothy Nash, and Keith A. Pretty, eds., In Defense of Capitalism (Midland, MI: Northwood University Press, 2010) pp. 57-60; and Richard M. Ebeling, Political Economy, Public Policy, and Monetary Economics: Ludwig von Mises and the Austrian Tradition (London/New York: Routledge, 2010), Ch. 7: "The Austrian Economists and the Keynesian Revolution: The Great Depression and the Economics of the Short-Run," pp. 203-272.
[iii] Kevin Dowd, Private Money: The Path to Monetary Stability (London: Institute of Economic Affairs, 1988); and, The State and the Monetary System (New York: St. Martin's Press, 1989); George Selgin, Theory of Free Banking: Money Supply Under Competitive Note Issue (Totowa, NJ: Rowman & Littlefield, 1988); and, Banking Deregulation and Monetary Order (New York: Routledge, 1993); Lawrence H. White, Free Banking in Great Britain: Theory, Experience, and Debate, 1800-1845 (Cambridge: Cambridge University Press, 1984); Competition and Currency: Essays on Free Banking and Money (New York: New York University Press, 1989); and, Theory of Monetary Institutions (New York: Wiley-Blackwell, 1999).
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Posted by Dave Redick on 12/04/10 10:45 AM
Many of the prior comments on Ebelings fine work miss the key point that in a free-market money system the unit-of-account would be WEIGHT of gold, and there would be no PRICE (in dollars, etc) and thus no forex issues (and gov't meddling) whan all nationms convert to gold, which they would have to once the US does, or no one would accept their trash fiat paper. See text of my 'Monetary Revolution' book at parts 1 and 2 in the left margin of my site Click to view link
Regards, Dave
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Posted by Breck on 11/16/10 09:05 PM
I don't begin to understand the ins and outs of returning to a "gold standard". I get caught up on what would happen if one country backed its currency with gold and the others didn't. Would not we have the same basic situation as pertained in 1970-71 leading to the U.S. repudication of its obligation to redeem in gold all debts foreign?
Moving on to something that is quite elementary but at the same time quite amazing to me; I was in my local coin shoppe today and on a whim I asked the clerk to pull out a St. Gaudens $20 gold piece minted 1927, just to hold you know? And then it occurred to me, "This was worth $20.00 in 1927 and it contains approx. one ounce of gold. What is an ounce of gold value in FRNs today? $1337.40?" And since gold pretty much holds its value over time, wouldn't it be fair to say that in 1927 $20.00 bought one as much goods and services as $1337 does today? If one ever needed to explain fiat money to someone that little object lesson would go a long way, don't you think?
Reply from The Daily Bell
Yes.
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Posted by RICHARD on 11/15/10 12:19 PM
Dear Al Kyder,
I thought it was great, and so instead of merely shooting your loud mouth off, just pick one error, of all the many errors you think you see, and expose your ignorance by arguing against it.
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Posted by Dave Redick on 11/15/10 05:02 AM
Bravo !! It's all in my Monetary Revolution-USA book at my site
Click to view link and on Click to view link (print and Kindle)
Regards, Dave
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Posted by Mr Riv on 11/12/10 11:37 AM
@Al Kyder, I agree with you. This guy needs get out of the gold bug echo-chamber and step into reality.
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Posted by Matt on 11/10/10 01:07 PM
@Zenbillionaire
Forgot to agree with your second point. You can't have sound currency and fractional reserve banking. Even if the Fed is prevented from printing more cash than they have gold, the banks will be able to create more digital currency than the Fed has gold.
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Posted by Matt on 11/10/10 01:05 PM
@Zenbillionaire
Couldn't agree more. Those that criticize the gold standard as unworkable are dead wrong. That's the problem: there would still be too much room to meddle in monetary policy, even with a gold standard. There's a huge spread between the market rate ($1,400) and what would be the redemption rate ($10,000). That leaves room for another 700% in inflation. Additionally, if the Fed did piss away the spread, they could just increase it by changing the redemption rate to $11,000, then $12,000, and so on. We probably won't audit the Fed, we will merely make them promise to sell gold at $10,000/oz on demand. Historically speaking, gold is seldom demanded, which will embolden the Fed to print beyond the ratio.
In short, as long as the government controls the currency, we will be forever played by monetary alchemists trying to create something out of nothing.
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Posted by Bionic Mosquito on 11/10/10 12:46 PM
@Zenbillionaire
Thanks for your patience.
"If we fix the "price" (exchange rate) of gold without fixing (or completely eliminating) the fractional reserve requirements for lenders, it would seem to me we accomplish nothing."
I agree completely, if the box we continue under is a state-sanctioned box (which, despite my desire for a market to decide, I recognize is the most likely outcome). Then, someone must apply rules by dictate ' a central bank or Treasury Department or whatever.
However, like a broken record, I keep coming back to the market (if only for my desire to see the conversation broadened to the possibilities, not the probabilities). And if a free-market derived system of money and banking, different entities can develop money backed (or not backed) by whatever they want and in whatever proportion they want. As long as there isn't government sanctioned force behind any one of them, it is no harm to me as I can choose to use whatever form I want.
So the "we" in your quote above means something different to me, depending on if "we" refers to a state-enforced system, or if "we" refers to each of us as individual actors in a free-banking environment.
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Posted by Zenbillionaire on 11/10/10 11:19 AM
@Bionic M
I don't think you misunderstood my question, but I may have misunderstood your answer :)
What I was getting at in my own wandering way was that there seem to be two distinct names for controlling asset backed currencies. The first we call the exchange rate, this is the fixed rate at which a currency will be exchanged for some physical asset that backs it. Feedbackers have supposed that tying the dollar to gold might result in an exchange rate of about $10,000/oz given the simple math of dividing the number of ounces of gold presumed to be in the US Treasury by the number of dollars in current circulation as reported by the M3 number. All is well in my mind with this calculation, I understand it, and assuming it remains fixed indefinitely I also understand how it improves our current situation WRT government debasement of dollars through unchecked "lending" by the Federal Reserve.
But it seems to me there is a second factor to consider that the DB alludes to and that Mr. Ebeling does not address in his treatment, which is the practice of fractional reserve lending. In my mind, fractional reserve lending is identical in function to exchange rate adjustment, in that a lender who is restricted to lending no more than say 60% of reserves is essentially allowed to print ore money when that rule is changed to allow him to lend on no more than 70%; he has in effect been given a license to inflate the money supply by an additional percentage of his base holdings.
If we fix the "price" (exchange rate) of gold without fixing (or completely eliminating) the fractional reserve requirements for lenders, it would seem to me we accomplish nothing.
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Posted by Jacob on 11/10/10 02:31 AM
When did a theoretically superior idea ever win out in society? When it worked to the advantage of those in control. This proposal, that proposal, does it ever really matter? It appears to me that the world is on the brink of global digital money obliterating all currencies.
Power elements will continue to work to retain their economic control through legislation and enforcement of ingenious new schemes. Continuing the Federal Reserve paradigm, digital money will decreasingly serve as a repository of wealth. Excepting secret barter, those who hoard gold and other apparent wealth preservation assets will likely have to contend with confiscatory rules and regulations over exchange of such assets for this new digital money.
Alternate exchange media will be prohibited. These people, the power elite, are brazen and don't seem to care much anymore that we're onto them. They call us "the chattering class."
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Posted by Huh on 11/10/10 01:13 AM
I have been wondering what is going on with the mainstream references to gold, such as made by Zoellick.
My humble guess is that by "legitimizing" gold in high places of officialdom, the PE are making an attempt to divert the attention of curious skeptical people away from the real reasons why a gold standard would be desirable i.e. to limit the power of the state.
The PE probably wants naive folks to believe that "the officials are finally in charge". With this subterfuge, they probably gain cover for pushing a global currency with a tenuous link to gold.
DB elves, get on the case and report back here ASAP! (Just kidding)
Reply from The Daily Bell
They've got to do something. Gold at 1500 or 2000 is going to call everything into question. Memes have been crumbling in the 21st century. But nothing creates situational awareness like a monetary dysfunction.
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Posted by Ernest Marth on 11/09/10 11:40 PM
Thank you Dr. Ebeling for your wonderfully lucid and logical argument.
It is vitally important that we rid ourselves of the current monetary systems. I believe the ongoing Middle-East wars and the wars of the twentieth century would not have been possible had not the U.S. Congress granted the exclusive rights for the creation and control of a credit based monetary system to a private cabal. The adoption of an unfettered gold or commodity based national or even world based monetary system would be a blessing to humanity. In the future adventurous wars of the type that the U.S. has engaged in over the past 45 years simply would not happen.
The reason being is that in any society with such a monetary system the people would have to be asked to contribute their hard earned savings to finance such unnecessary or adventurist wars and of course they would not. On the other hand the continuation of the current paper money based systems probably dooms humanity to a nuclear Armageddon.
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Posted by Bionic Mosquito on 11/09/10 10:06 PM
@Zenbillionaire
If I understand your post correctly, in a sense you are correct " if a gold standard is a) managed and backed by the state in the various fashions that the current banking system is, and/or b) is not open to free-market competitive forces.
I read Dr. Ebeling editorial in a way that he suggests he is open to free-market, fully competitive banking. In such a scheme, I am not worried about reserve requirements or if a particular currency is backed by gold or nothing. As long as people within a given jurisdiction are free to transact and/or store wealth in whatever manner the market "decides", the market will provide all the "control" necessary.
If I misunderstood your post, well...never mind!
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Posted by Zenbillionaire on 11/09/10 05:25 PM
My difficulties understanding the preference for a gold based currency are too numerous to itemize here, but I could use some help with a couple of the really big ones. The first has to do with the idea of fractional reserve banking that DB brings up. It seems to me the essence of what the Fed is doing as we speak is nothing more than reducing the fractional reserve requirements for the US. If you assume we have some (unknown) amount of gold in reserve a the US Treasury, and that there is a current free market valuation of that gold, expressed in dollars, then all Ben has done is change the exchange rate.
How does going to a fixed gold standard control this problem? What stops a government from deciding that they will print money at $10,000/oz today and $20,000/ox tomorrow? All they've done is change the reserve requirements.
I don't see this proposal fixing much of anything unless it somehow includes controls on the nominal exchange rate, and there are at least two ways to create credit; one is by fixing the dollar/gold exchange, but the elephant in the room nobody seems to talk about are the fractional reserve requirements for lenders. Controlling one without controlling the other is pointless; it leads to exactly the same system we have today.
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Posted by Matt on 11/09/10 02:47 PM
Gold holders would not necessarily experience a windfall if the US Dollar were to return to a gold standard, and the government could retain some monetary policy authority (not that I want it to).
Let's assume total currency units / gold owned by the government comes to $10,000 / 1oz.
First, the purpose of a gold backing is to prevent debasement and encourage trust in the stability of the currency. To do this, the government would be required to redeem dollars for gold (i.e. required to sell gold) at a rate of $10,000 / 1oz. There is no need, however, for the government to purchase gold at this price. Ask yourself, "What's the benefit of printing an additional $10,000/oz to purchase gold from all the people that will flock to sell to the US Government? How many people will sell? How much cash will that inject into the system?"
IMO, the gold redemption rate is supposed to function as a value floor for the dollar, not as the market price of gold. In the same way that gold as jewelry is worth more than gold as an industrial metal, gold as money should also be worth more than gold as an industrial metal.
Secondly, the government could retain some power to inflate so long as it retains some slack between the market price and the redemption rate. For instance, the government could buy industrial gold at the market price of $1,400, coin it, and would have license to print another $8,600 to use for whatever purposes it deems appropriate.
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Posted by Bionic Mosquito on 11/09/10 02:45 PM
@Bill
His footnote: "[iii] Kevin Dowd, Private Money: The Path to Monetary Stability (London: Institute of Economic Affairs, 1988); and, The State and the Monetary System (New York: St. Martin's Press, 1989); George Selgin, Theory of Free Banking: Money Supply Under Competitive Note Issue (Totowa, NJ: Rowman & Littlefield, 1988); and, Banking Deregulation and Monetary Order (New York: Routledge, 1993); Lawrence H. White, Free Banking in Great Britain: Theory, Experience, and Debate, 1800-1845 (Cambridge: Cambridge University Press, 1984); Competition and Currency: Essays on Free Banking and Money (New York: New York University Press, 1989); and, Theory of Monetary Institutions (New York: Wiley-Blackwell, 1999)."
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Posted by Bill on 11/09/10 12:56 PM
Luckily, over the last twenty years, a number of free market economists have successfully demonstrated how a private, competitive free banking system can operate, and perform far better a variety of tasks and activities for which it has been presumed a central bank was needed.[iii]
WHERE?
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Posted by Ian Mathers on 11/09/10 10:02 AM
It isn't surprising that the head of the World Bank now wants to see a return to the gold standard in one form or another.
For several decades, the primary dealers (GS, HSBC, JPM, et al) have swapped, borrowed, leased and otherwise claimed gold the US was supposed to have in their Fort Knox depository (and have done so in many other nations), replacing bars with 'gold certificates' " otherwise known as IOU's " and other colourful bits of paper.
Now that the Bankers have taken possession of the only true store of wealth, they will want to abandon the paper fiat currency system that enabled them to siphon it away from the general population. It's the dawn of the new Dark Ages.
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Posted by Victor Barney on 11/09/10 09:38 AM
I see a Marxist/Islamic(both Anti-Messiah by definition) "cashless society" in the making and I believe by by January 2013 we'll know just how close I came to being correct?
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