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Both gold standard
advocates and detractors alike share one feature -- the majority of them have
no idea how to operate a gold standard. Of course they think
they do. So what else is new.
All currencies are
managed via adjustment of the total supply of base money. Base money consists
of paper bills and coins (typically about 90%), and bank reserves (10%). The
Fed adjusts base money every day, through its various open market operations.
The only difference between the Fed's present system and a gold standard, or
any other system -- currency peg, currency basket, commodity basket, CPI
target, monetarist aggregate target, etc. -- is when and how
much to adjust base money. The present system is a short-term
interbank interest rate target. When the market interest rate for interbank
credit is above the Fed's target, the Fed increases base money supply. When
the market interest rate is below the target, the Fed reduces base money
supply.
Simple, right? A gold
standard works much the same way, but the target is different. When the
currency's value is above the gold parity target, base money supply is
increased, thus depressing the value of the currency. When the currency value
is below the gold parity target, base money supply is reduced, supporting the
value of the currency.
This is how the Fed
works, but any institution (for example a private bank) that is managing a
paper currency would use a similar system, and did in the 19th century when
commercial banks were regularly engaged in currency issuance.
Needless to say, you
can't target both interest rates and gold parity. However, under a gold
standard, interest rates typically fall to very low and stable levels, so
there is no need to fuss with them.
Even in a situation where
the currency was wholly metallic, currency supply would adjust to demand via
natural means. Where more metal coins were demanded, as a tool for use in
trade, metal would naturally flow to those areas to be minted into coins. The
result would be that California would have a lot more gold coins (supply of
money) within its borders than Wyoming, because of the different sizes of the
economy (and consequently demand for money). The value of money, of course,
would be the same in either place.
We all know that the
Federal Reserve (or any currency issuer, such as a private bank) is able to
"print money" in any amount, if it wants to. What many people are
not aware of is that the Federal Reserve is also able to "unprint money" or reduce the supply of base money,
also in any amount. The Fed "prints money" by buying something,
typically a government bond, and giving "new money" (in practice bank
reserves) in return. The Fed "unprints
money" by selling something, typically a government bond, and making the
money it receives from the sale disappear. Since the Fed stockpiles bonds on
a 1:1 basis to the total amount of base money, the Fed is capable of "unprinting" every dollar out there.
So we see that, even in a
case where there is a great reduction in demand for dollars (as may be taking
place now as the dollar is replaced by the euro and other local currencies
for use worldwide), this does not pose a problem if the manager of the
currency (central bank) "unprints" money
correspondingly such that it maintains is value. In a gold standard, the
currency would remain pegged to gold.
That's pretty much it.
See how simple this is?
Only ten or so years ago,
you could take a hundred gold standard advocates, and a hundred gold standard
detractors (mainstream economists), and put them in a room, and I doubt you
could find five people that could accurately describe the process outlined
above. That is improving considerably these days, as people become more
sophisticated. But it illustrates what the state of knowledge has been on
these issues for many decades.
The gold standard
advocates remembered all the ageless principles regarding the superiority of gold-linked
currency. Also, they well understood the disaster that occurred when the
world left gold in 1971. However, many never quite understood what led to the
departure from gold in 1971 -- namely Arthur Burns' increase in base money
supply beginning in 1970, in an effort to bring the economy out of recession
and goose the economy enough that his patron Richard Nixon would be
re-elected in 1972. In other words, the problem was mismanagement of base
money supply, in a manner contrary to the operation of a gold standard. There
were a few who argued that the problem was large deficits related to Vietnam.
(No relation.) And, there were a few who observed that the amount of dollars
outstanding (base money) was in excess of the remaining gold holdings of the
US government, and therefore everyone was doomed. (I believe Jacques Rueff was a fan of this theory, but I could be wrong
about that.) As I've said many times, a currency manager does not need to
hold any gold at all to peg a currency's value to gold. It merely needs to
adjust the supply of base money appropriately. Also, putting a whole bunch of
gold in a box doesn't do anything for a paper currency either, if it is not
being managed properly. "Backing" of paper money is largely a
fictional concept. If, for example, the dollar is worth 1/40th oz. of gold
(i.e., $40/oz.), but I am willing to sell gold at $35/oz., then I will simply
sell all the gold I have. Big surprise. Just selling gold has no lasting
effect -- the important thing is to properly manage the supply of currency
through the adjustment of base money. In this case, the thing to do is to
reduce the supply of base money such that the value of the dollar rises to
$35/oz. If anything, selling bullion in the hope that this will affect the
currency's value is a good sign that the managers of the currency are
incompetent. When people figure that out, they sell the currency. Wouldn't
you? Thus, at the end of the exercise, the dollar would be worth $45/oz., and
you would be out of gold. (This is roughly what was going on in the late
1960s, until the US put a stop to gold outflows by introducing the Special
Drawing Rights in 1968.)
I'll say it again: all the
gold in the world won't help if the managers don't know how the manage the
currency. If the managers manage the currency properly, via base money supply
adjustment, no gold at all is necessary.
There is a subset among
the gold standard advocates that tends towards these "gold backing"
theories. They want a 100% reserve backing of paper bills, i.e., base money.
Even this, however, does not really accomplish anything. If you stuck a huge
amount of gold in a vault, that does not mean that the supply of currency
(base money) is being properly managed. The currency can still fall apart.
Even redeemability (selling gold at $35/oz. for
example) doesn't solve the problem. The vault holding of gold would simply be
sold off at below-market prices. What could work is if, whenever a dollar is
redeemed for gold, that dollar disappears permanently. In other words, base money
supply is reduced. Actually, this is exactly the process I outline above,
where the central bank sells a bond and makes the money received disappear.
The only difference is that they would sell gold instead of a bond. Actually,
you can sell anything -- gold, domestic bonds, foreign bonds, etc. -- and the
result is largely the same, namely a reduction in base money. This kind of
"warehouse chit for gold" could work for a small economy, like that
of New Zealand or Singapore. However, it wouldn't work for the eurozone, because there simply isn't that much gold out
there. And even if there was, would you want the government to keep it all in
a vault? That practically guarantees that, someday, they'll say "we'll
just keep this gold, thank you, and why don't you all get stuffed?"
These sorts of gold
standard advocates can see that, if there is $1 billion out there, and
there's only 100 oz. of gold in the vault, then if people want to redeem
their dollars for gold at $100/oz., a lot of people would get left out. Which
is true. But that sort of widespread "dumping of dollars" implies a
loss of dollar value. If the currency is being properly managed, then the Fed
(or other manager) would busily "unprint"
dollars by selling bonds, so that the value of the dollar wouldn't fall. And
if the value of the dollar was stable (i.e., pegged to gold), and the
managers of the currency have proven to be competent, then why dump dollars?
Which brings us again to the basic principle, which is that a gold bullion
hoard is no substitute for competency in the practice of currency management.
If you know how to play
the game, you don't need gold. If you don't know how to play the game, you're
going to end up in a whole heap of trouble one way or another.
Some gold standard advocates
like to talk about the "Classical Gold Standard", by which they
usually mean the processes in operation during the 1870-1914 period. In those
days, currency managers, whether quasi-governmental (Bank of England) or more
private (in the US), never held much gold reserves. They didn't have to,
because they understood the supply adjustment processes described earlier.
This "100% reserve holding" type system is extremely antiquarian,
and appears to have gone extinct in the 17th century.
* * *
Go Ron Paul!!!
Ron Paul, the Only
Candidate Worth a Damn, has now won five straw polls:
FIRST PLACE (5)
New Hampshire Taxpayers, July 7 ~ 1st 65.3%
North Carolina, Gaston GOP, August 13, ~ 1st 36.6%
New Hampshire, Stafford, NH, August 18 ~ 1st 72.7%
Alabama, August 18 ~ 1st 81.2%
Washington State, August 21 ~ 1st 28.1%
He placed second in five
more:
SECOND PLACE (5)
Utah GOP, June 12, 2nd 5.4%
LibertyPapers.org conference, June 16 ~ 2nd 16.7%
Georgia, Cobb Co. GOP, July 4 ~ 2nd 17%
South Carolina, Georgetown Co., July 28 ~ 2nd 18%
West Lafayette, Indiana, August 18 ~ 2nd 11.7%
And this is all in the
face of often blatant cheating:
Nathan
Lewis
Nathan Lewis was formerly the chief international
economist of a leading economic forecasting firm. He now works in asset
management. Lewis has written for the Financial Times, the Wall Street
Journal Asia, the Japan Times, Pravda, and other publications. He has
appeared on financial television in the United
States, Japan,
and the Middle East. About the Book: Gold:
The Once and Future Money (Wiley, 2007, ISBN: 978-0-470-04766-8, $27.95) is
available at bookstores nationwide, from all major online booksellers, and
direct from the publisher at www.wileyfinance.com or 800-225-5945. In Canada,
call 800-567-4797.
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