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There is a certain sort
of gold-coin fundamentalist, who insists that we must not consider any sort
of system that uses any sort of paper money, and only a metal-coin system
will do. I'm sure you know the sort I'm talking about.
I often feel like I play
economic psychologist, as it is interesting to think about why people are so
devoted to these sorts of impractical niche ideas. I figure that one thing
that has happened is that the gold standard advocates have become very aware
of the general unpopularity of their ideas, and have compensated by offering
ideas that are so extreme as to deserve unpopularity. Then, they are not so
disappointed when people don't take them seriously, because they never
expected to be taken seriously. It's the dissonance between a sensible idea
and the ridicule it receives that causes psychological stress. If you offer a
ridiculous idea, then you are not so surprised if it receives ridicule. Thus,
gold standard advocates today tend toward extremist views which have no
political chance of success, and, actually, no practical chance of success
either, as we will show today.
Another reason for this
phenomenon, it seems to me, is that most gold standard advocates today don't
really have a sufficient understanding of monetary economics, in the sense
that a mechanical engineer understands the machining of metal. Instead, they
have a series of platitudes and vague principles, punctuated by periodic
references to the Holy Mises. Platitudes and
principles are fine, but they don't serve in the fundamental engineering-like
process that creates a working monetary system. They are aware of their
insufficiencies, in the same way that mainstream central banker types are
also aware of their insufficiencies, which makes them cling to the existing
interest-rate manipulation system rather than proposing sensible
alternatives. The mainstream central banker types are equally impotent at
creating a working monetary system, because they also lack the fundamental
nuts-and-bolts understanding that would allow them to create functioning
systems with any sort of features they desire.
The gold standard
advocates have thus migrated somewhat toward the "let's all use gold
coins" system, because it seems like there is nothing to manage. You
just make coins out of gold --which, you have to admit, is a pretty simple
rule, and doesn't require a paper-currency manager as would be required with
a gold-linked paper money system.
The other favorite is the
"let the free market figure it out" system, which means "I
have no idea but maybe someone else does." In the 19th century, there
was no government monopoly on currency production, and indeed many hundreds
of private commercial banks distributed their own paper currencies, which
were linked to gold. You can still see this system a little bit in Hong Kong
today. However, all of these hundreds of private commercial banks had to have
someone, on their staff, who understood the nuts-and-bolts of how to link a
paper currency to gold, if they were going to be successful. So, the
"let the free market figure it out" solution doesn't escape the
need for a monetary engineer to make the system work.
As I've argued, the
bullion coin system is not a particularly bad system, when used in a small
area. Ecuador could probably adopt a bullion-coin system with no particular
ill effects. However, it is not a system that is suitable for the world as a
whole. Let's try to understand why, which is also the reason why paper monies
were widely adopted during the industrial 19th century.
The fact of the matter
is, there really isn't that much gold out there. Gold is hardly ever used up
or thrown away, and as a result, about 85% of all the gold ever mined in all
of history still exists in human possession. Over these many thousands of
years of gold mining, humans have been able to extract about four billion
ounces of gold. Historically, this amount has risen by about 2% per year due
to mining, but recently, world gold production has been falling off rather
dramatically despite recent economic incentives to produce more. It looks
like we may have hit "Peak Gold," running into the physical
limitations of availability in economic concentrations the Earth's crust.
So, four billion ounces
is about all we're going to be able to work with. There are almost seven
billion people in the world. So, if they all use gold coins, how many gold
coins are they going to own?
A traditional problem
with gold coins is that they are simply too valuable. A 1/10th oz. coin is
about the smallest coin that is practical. There was a 1/20th oz. gold coin
in the U.S., but it was really teeny and thus rather impractical and
unpopular. A 1/10th oz. gold coin today would be worth about $100. When is
the last time you saw a $100 bill? Although they are used commonly outside
the U.S., particularly in illegal cash transactions, within the U.S. the $100
bill is very rare. The reason it is rare is not that the government refuses
to make them -- the government is willing to trade a $100 bill for five $20
bills at any time -- but that people don't like to use them.
Traditionally, smaller
transactions were carried out with silver and copper coins. This introduces
new problems. The smallest practical silver coin is perhaps 0.05 (one
twentieth) oz. The old silver dime of the 1950s had about 0.07 oz. of silver,
and was 90% silver by weight. Using the traditional 15:1 silver:gold
value ratio, at $1000/oz. gold, the value of the 1950s silver dime would be
about $4.60 today. So, even the smallest silver coin is of rather high value,
which necessitates the introduction of copper coins. Now, we've got a
three-metal system, if you're going to make the coins have a bullion value
equivalent to their face value. The actual market values of the metals drift
over time, which introduces all kinds of new problems.
The point is, a
"gold coin system" is really a silver-and-copper coin system.
Today, there is about 1 billion oz. of silver in the world that could
conceivably be made into coins. Remember, most small-scale transactions would
be done with silver coins. You wouldn't see gold coins very often, but silver
coins would be used every day, at the grocery store for example. How are
seven billion people going to make a monetary system with one billion ounces
of silver coins? Today, if we use the 15:1 silver ratio, that billion ounces
of silver would be worth about $60 billion. There are about $800 billion of
U.S. notes and coins in the world, not to mention the notes and coins of
other governments. We can see that there isn't a whiff of a chance of making
a silver coin system that would serve the world -- although maybe Ecuador
could get away with it.
"Yes, but....,"
you say, "you could make the coins into token coins, and make them
redeemable for gold on demand." This was the case for the silver coins
in the U.S. after 1875 or so. Their contained silver value was less than the
face value of the coin. The $1 silver coin had about $0.50 of silver in it.
However, you could trade twenty $1 silver coins for a $20 gold coin with the
government, which is why the coins maintained their value above their
commodity value. You could even make a $1 silver coin with $0.001 of silver
in it, really just silver plating over aluminum or something like that. This
would work just fine as well. It's how coins work today. However, we can see
that a $1 silver coin with $0.50 or $0.001 of silver in it is a token coin,
which is functionally equivalent to paper money. A paper $1 bill is like a
silver coin with no silver in it at all. So, once again, we have the need for
a token coin/paper money manager, who manages the supply of coins/bills to
maintain their value at the proper parity.
The bullion-coin
advocates like to imagine that bullion coins cannot be devalued. Baloney.
Governments were devaluing coins two thousand years before paper money was
invented. Just take the $20 gold coin, containing an ounce of gold, and stamp
it as a $1000 gold coin, containing an ounce of gold. This is what the Roman goverments did to their silver coins in the fourth
century. It's what the colony of Massachusetts did in the 18th century. It is
as common as water. "Yes, but...," you can hear the gold coin
advocates argue already,"at least the coins you
own already wouldn't be devalued." That's true. But, the government
could just declare holding such pre-devaluation coins to be illegal. The U.S.
government did this in 1933, which was the first permanent devaluation in the
dollar in U.S. history. Gold coins stayed illegal until 1974.
Actually, you could have
a $20 gold coin and a $1000 gold coin, both containing an ounce of gold,
trade side-by-side. The $20 coin would have a commodity value of $20, and the
$1000 coin would be a token coin with a commodity value of $20. "But,
wouldn't everyone take the $20 coin instead, since they both have the same
commodity value?" Well, the five-cent coin in the U.S. now has a
commodity value of $0.07 or so. The $20 bill has no commodity value at all.
But, they still trade side by side at their face values.
* * *
How much money do you own
today? I mean real money -- base money -- notes, coins, and bank reserves.
Probably no bank reserves unless you are both very, very wealthy and also
very, very financially creative. So, notes and coins. Look in your wallet. I
bet it is less than $500.
Most of what people think
of as "money" is really a loan to someone else, like their banker.
What happens when you buy something with a debit card, check or credit card?
In this case, your banker pays the recipient (actually the recipient's bank)
in real money, in this case a transfer of bank reserves through the bank
clearinghouse at the Fed. All monetary transactions take place with base money,
which is to say, real money. We must deal with the real world here, not some
fantasy world in which people buy houses, or stocks and bonds, with a leather
sack of doubloons. We've already talked about replacing token notes and coins
with bullion. A bullion-based system could replace these bank reserves, which
are now electronic, with bullion bars stored in the Fed's basement. The Fed
already does this for central banks around the world. Instead, there would be
a cage in the basement with Citibank's bank reserves in the form of gold, and
the bars would shuffle around each day as banks made their payments. You
could even make a pooled system, whereby the banks would have an unallocated
claim on bullion stored at the Fed, and then you wouldn't even have to move
the bars around.
The amount of bank
reserves is really not very much -- about $80 billion in the U.S. -- and this
could conceivably be replaced by bullion. You have to admit, it is a very
efficient system, considering the volume of transactions in dollar terms and
the very small amount of acutal money (bank
reserves) used to make the transactions. Theoretically, if everyone made
their transactions in this fashion, using debit cards and such, rather than
in bullion coins, then a relatively small amount of bullion could serve.
However, this also means that nobody really owns any bullion coins, and that
all the bullion is owned by the large banks. In effect, we've substituted a
paper dollar, linked to gold, with an electronic bank account linked to gold,
which is not really any different. In reality, both would be necessary
anyway.
What if all transactions
were done with "electronic money" (actually bank accounts)? Then
nobody would own any bullion coins, although the banks would make payments in
bullion to each other. Thus, ironically, you could have an all-bullion
system, which is really a no-bullion system. "M2" consists of notes
and coins, demand deposits and banks, savings accounts and money market
funds, and small time deposits. In May 2008, U.S. M2 was $7.676 trillion.
Theoretically, you could go to the bank and ask for your loan to the bank to
be repaid in bullion coin. However, if everyone tried to do this, or even a
small number of people tried this, the bank would shut its doors and say
"sorry, no can do," for the simple reason that such a quantity of
bullion does not exist on this planet.
* * *
I think we can see why an
all-bullion system is impractical to the point of impossibility on any kind
of large scale. Thus, we would need to have a currency manager, who knows how
to manage supply to maintain a currency's value at its bullion parity. This
is not really very hard to do, but you aren't going to escape that need by
making silly claims about bullion coins or the "free market." The Holy
Mises is not going to fly down from heaven and
smite your enemies for suggesting that it's time to move beyond empty
platitudes to real solutions.
I am actually a fan of Mises. He was without a doubt one of the 20th century's
greatest economists. If you took all of Mises'
self-proclaimed followers and heaped them in a pile today, it wouldn't even
reach to Mises' knee. It's too bad that he's not
around today to say: "You guys are a bunch of goofs."
Such people account for
99% of gold standard advocates today. The number of people who could set up
and maintain a proper, functioning system -- the mechanical engineers of
money -- are extremely rare. Actually, it's really not all that complicated.
We're going to need some people who know how to play this game, or otherwise,
the game will never be played.
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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