Sometimes people ask me: “How do we transition to a gold standard system?”
People think it’s really difficult.
Actually, it can be very easy. The easiest, simplest, fully-operational form
of a gold standard system could be implemented in ten minutes. It doesn’t
cost anything, and doesn’t require any gold bullion.
I don’t think it is the best system. But, it is fast and easy, and fully
The better classical economists have always known that gold bullion itself is
not really necessary for a gold standard system. Gold is the “standard,” in
other words, the “standard of value.” It is just something you compare
David Ricardo wrote in 1817:
“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.”
In other words, when the value of the currency is too high compared to the
standard, you increase the supply. When the value of the currency is too low
compared to the standard, you decrease the supply. It really is that simple.
Here’s John Stuart Mill, on the same topic in 1848:
therefore, the issue of inconvertible paper were subjected to strict rules,
one rule being that whenever bullion rose above the Mint price, the issues
should he contracted until the market price of bullion and the Mint price
were again in accordance, such a currency would not be subject to any of the
evils usually deemed inherent in an inconvertible paper.”
The Federal Reserve has the responsibility today of increasing or decreasing
the base money supply. Only the Federal Reserve can do this.
The Federal Reserve already increases and decreases the base money supply on
a daily basis. However, this is not done according to a gold standard system
operating framework. Rather, it is done according to an interest rate target
framework, or today a “quantitative easing” framework.
To implement a gold standard system — in ten minutes — you simply have the
Federal Reserve stop managing the base money supply according to an interest
rate/quantitative easing framework, and start managing it according to a gold
standard framework. All this means is that the base
money supply is adjusted at different times, and in different quantities.
To increase the base money supply, the Federal Reserve typically buys
something, usually a bond of some sort. This is paid for by newly-created
base money. Thus, the total amount of base money in existence increases.
To decrease the base money supply, the Federal Reserve typically sells
something. The money received in payment disappears, which shrinks the base
Unfortunately, although this method is certainly quick and easy, it is also
prone to eventual corruption and failure. This is not because the basic
methods don’t work – they do – but rather because it is all too easy for the
managers of the system to deviate from what they are supposed to be doing.
Immediately after confirming that such a system is indeed possible, John
Stuart Mill then describes its inherent problems. This is an extended passage,
but he puts it as succinctly and clearly as anybody can:
such a system of currency would have no advantages sufficient to recommend it
to adoption. An inconvertible currency, regulated by the price of bullion,
would conform exactly, in all its variations, to a convertible one; and the
only advantage gained, would be that of exemption from the necessity of
keeping any reserve of the precious metals; which is not a very important
consideration, especially as a government, so long as its
good faith is not suspected, needs not keep so large a reserve as private
issuers, being not so liable to great and sudden demands, since there never
can be any real doubt of its solvency.
“Against this small advantage is to be set, in the first place, the possibility
of fraudulent tampering with the price of bullion for the sake of acting on
the currency; in the manner of the fictitious sales of corn, to influence the
averages, so much and so justly complained of while the corn laws were in
force. But a still stronger consideration is the importance of adhering to a
simple principle, intelligible to the most untaught capacity. Everybody can
understand convertibility; every one sees that what
can be at any moment exchanged for five pounds, is worth five pounds.
“Regulation by the price of bullion is a more complex idea, and does not
recommend itself through the same familiar associations. There would be
nothing like the same confidence, by the public generally, in an
inconvertible currency so regulated, as in a convertible one: and the most
instructed person might reasonably doubt whether such a rule would be as
likely to be inflexibly adhered to. The grounds of the rule not being so well
understood by the public, opinion would probably not enforce it with as much
rigidity, and, in any circumstances of difficulty, would be likely to turn
against it; while to the government itself a suspension of convertibility
would appear a much stronger and more extreme measure, than a relaxation of
what might possibly be considered a somewhat artificial rule.
“There is therefore a great preponderance of reasons in favour
of a convertible, in preference to even the best regulated inconvertible
currency. The temptation to over-issue, in certain financial emergencies, is
so strong, that nothing is admissible which can tend, in however slight a
degree, to weaken the barriers that restrain it.”
Mastery of these concepts means understanding all the options. Ricardo
understood them. Mill understood them. We need more people today with the
kind of mastery that people had in the mid-nineteenth century. The gold
standard system of the time – the most perfect monetary system ever created –
was a reflection of their mastery.
originally appeared in Forbes.com on January 31, 2013.)