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There's a notion out there that,
to establish a gold standard, you take the existing monetary base, divide it
by the amount of gold the government has in storage, and then you end up with
a price of gold.
This is so idiotic that for a long time I figured I'd just leave it alone. Do
these people also think that babies are delivered by storks?
And yet, it is a testament to the extremely poor state of affairs these days
that these sorts of arguments exist, and indeed have been around for decades
apparently without anyone to call BS on them. When it got to the point that
Dylan Grice, economist for Societe Generale, started citing this sort of baloney I thought maybe it was time to say something. Grice
is actually a pretty good economist, willing to investigate matters in the
spirit of curiosity (instead of a pre-existing agenda) and come to real conclusions,
as opposed to the various barkers and shills of Wall Street known as
"strategists."
Unfortunately, these sorts of ideas were popularized by Murray Rothbard, in books like The Case Against the Fed.
You can read the whole text here:
Read The Case Against the Fed.
Don't take it too seriously.
The gold
stock of the Fed should be revalued upward so that the gold can pay off all
the Fed's liabilities—largely Federal Reserve Notes and Federal Reserve
deposits, at 100 cents to the dollar. This means that the gold stock should
be revalued such that 260 million gold ounces will be able to pay off $404
billion in Fed liabilities. ...
There is nothing sacred about any initial definition of the gold dollar, so long
as we stick to it once we are on the gold standard. If we wish to revalue
gold so that the 260 million gold ounces can pay off $404 billion in Fed
liabilities, then the new fixed value of gold should be set at $404 billion
divided by 260 million ounces, or $1555 per gold ounce. If we revalue the Fed
gold stock at the "price" of $1555 per ounce, then its 260 million
ounces will be worth $404 billion. Or, to put it another way, the
"dollar" would then be defined as 1/1555 of an ounce.
There are a lot of problems with this. Let's list a few:
1) Neither the British or U.S. gold standards of the last 300 years,
nor many of the others around the world, worked like this. Rothbard is just making shit up.
2) A gold standard is NOT dependent on the amount of bullion in a
vault. We saw that this was never the case.
January 9, 2011: The "Money
Supply" With a Gold Standard 2: 1880-1970
January 2, 2011: The "Money
Supply" With a Gold Standard
January 23, 2011: The Gold
Standard in Britain 1778-1844
January 30, 2011: Italy With the
Gold Standard 1861-1914
There were a few exceptions -- China used silver bullion exclusively as money
into the 20th century -- but in the Western European world that was the rule.
3) "Defining the dollar" at $1555/oz. (from perhaps $350/oz.
when Rothbard was writing) is a devaluation.
It's just the same as when Roosevelt "changed the definition of the
dollar" from $20.67/oz. to $35/oz. in 1933. You would think this would
be what Rothbard and the other hard money types
would want to prevent. (In fact the result of this devaluation was to make
the U.S.'s gold holdings worth more than the monetary base, for a little
while.)
4) This "100% backing" would be very brief. The normal
operation of a gold standard would soon cause base money to diverge from
whatever the bullion inventory happened to be. If you kept base money stable,
then its value would diverge from the gold target. You only get to target one
thing, value or volume, and the other is a residual. A gold standard is a
value target, not a bullion reserves/volume target.
5) Although a small country, like Fiji, could implement some sort of
"100% backing" system, there isn't enough gold in the world to do
this on a global basis. That is why goverments
tended toward "economizing on gold" for centuries. People who argue
that it is possible that you could do it by "revaluing gold" fail
to notice that this would be a devaluation. For
example, let's say you "revalued gold" at $14,000/oz. today. That
would be a 10x devaluation of the dollar. Eventually, prices would rise by
about 10x. Then, you would need ten times as many
dollars to do your business. So, the amount of dollars in circulation would
have to rise, which would mean that you wouldn't have "100%
backing" anymore.
6) What if the gold isn't there anymore?
However, these specific items fail to really explain the problem with this
proposal. The problem is that these people -- apparently including Rothbard -- have a fundamental lack of understanding of
how monetary systems work. Let's say you have a five year old child. You are
complaining about the price of gasoline. The child says: why don't you just
put water in the tank? It looks about the same, a clear liquid. Cheaper too.
A child would accept the explanation that "it just wouldn't work,"
but an adult is more stubborn. Especially an adult to already thinks they know the answers. Hey, they studied Rothbard for years. And there are all these people
who agree with them. The Mises Institute.
You would have to explain all the workings of an internal combustion engine,
and why gasoline can be used as a fuel and water cannot. And during the whole
time they would smile smugly and say you were wrong, water does indeed work,
they are quite sure of it. (You can see why I tend to avoid these people.)
That is why I often say that you should think of a gold standard like a
"currency board linked to gold." In fact all gold standards operate
like this, whether you have a lot of gold in a vault somewhere or not.
March 11, 2011: A Currency Board
Linked to Gold
It is on
this principle that paper money circulates: the whole charge for paper money
may be considered as seignorage. Though it has no
intrinsic value, yet, by limiting its quantity, its value in exchange is as
great as an equal denomination of [gold] coin, or of bullion in that coin. .
. .
It will be seen that it is not necessary that the paper money should be
payable in specie to secure its value; it is only necessary that its quantity
should be regulated according to the value of the metal which is declared to
be the standard.
David Ricardo, Principles of Political Economy
and Taxation, 1817
He said that the quantity should be regulated
according to the value of the metal which is declared to be the standard.
That is the currency-board-type mechanism I am talking about. He did not say
that the "quantity should depend on the amount of gold in a vault",
or imports and exports of bullion, or any other such quantitative measure.
The proper target is value -- namely the value of the standard, which means
gold. (In Ricardo's day it occasionally meant silver.) Specie (bullion) is
not necessary. You might have it. You might not. It's the quantity-regulation
aspect that allows the value of paper bills to be linked to gold. Ricardo was
the premier reference for monetary matters in England during the 19th
century. In fact, he played a key role in re-establishing the gold standard in
Britain in 1821, at the prewar parity, after a period of floating currencies.
In fact, in 1822, just after the gold standard was re-established, the Bank
of England had £18.665m of banknotes outstanding and £11.057m of
gold bullion. There was no "revaluation" to make them balance. A
few years later, in 1837, the BoE had £18.165m of banknotes and
£4.077m of bullion. There weren't even close to being equal. So what.
The amount of gold is largely irrelevant. The value of the pound remained pegged
to gold until 1914.
And what of the U.S.? In 1855, a time of "free banking" in the U.S.
which is much loved by libertarians (there was no Federal Reserve or even a
standardized national currency) there was an estimated $394 million of
banknotes outstanding, and $59 million of gold bullion held by issuing banks.
In other words, a bullion/banknote ratio of 14%. Of course, all of these
banknotes were pegged to gold. The U.S. left the gold standard during the
Civil War, and returned to gold in 1879, at the prewar parity of
$20.67/ounce. In 1880, there were about $746m of banknotes outstanding, and
$139m of gold bullion held by issuing banks. The coverage ratio was 20%.
There was no "revaluation." There was no "100% reserve."
It didn't matter. The whole Rothbard thing is a fairy
tale.
So there are two examples of returning to a gold standard, from an extended
(23 years in Britain, 19 years in the U.S.) period of floating currencies.
Worked fine. No problem. It's a piece of cake.
January 27, 2011: What Is a Gold
Standard?
(By the way, a short-form version of January 27, 2011: What Is a Gold
Standard? should be
appearing in the print version of Forbes this week. Look for it!)
When people talk about "returning to a gold standard" today, they
often mean, "doing what Rothbard and his
hallelujah choir suggest." This has nothing to do with any historical
gold standard system. It is a sort of miasmic fantasia. But, if that is all
that people have to offer today, then that is what "returning to a gold
standard" would mean. It would mean instant failure and horrible
economic turmoil as these ideas are proven to be laughably flawed in real-world
implementation. The Bernankes, Krugmans
and other Keynesians of the world are really not so hot, but the fact is that
they would be better than the Rothbardian clown
brigade. People sense this, which is one reason why they have stuck with the
Keynesians for decades.
That is why we need a new group, of at least a dozen people or so, who have
mastery of this material. How can you have a new gold standard if there is
nobody -- not one single person -- who knows how to implement it? You can't.
Yes, I know there are hundreds who say they know how, but you aren't
fooling me.
Nathan Lewis
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