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I sometimes read things like college textbooks because, when the
author is presenting basic ideas to a general audience, their most
foundational misconceptions are on clear display. Recently, the
Federal Reserve put out a brief
description of a gold standard system – the policy used, in
principle, by the United States from 1789 to 1971, and also by the
Federal Reserve itself from its founding in 1913 to 1971. It’s a
nice way to understand today’s conventional wisdom on the topic,
including all the errors inherent.
A gold standard system is very simple. The goal is to maintain the
value of the currency equivalent to some defined amount of gold. In
the past, the value parity for the dollar was 1/20.67th of an ounce
of gold, and later 1/35th of an ounce. Thus, it is a variety of a
fixed-value policy. Today, fixed-value
policies are very common, but are typically used with a major
international currency, like the euro, as the “standard of value”
instead of gold. I count at least fifty-five countries with some
variant of a fixed-value policy with the euro today.
Once you have a goal, you need a way to attain that goal. Just
having a press conference doesn’t do it. Also, storing a bunch of
metal in a box doesn’t do it. The most effective way to obtain the
fixed-value link is something that resembles a currency board, such
as the currency board systems linked to the euro today. I would
argue that successful historic gold standard systems, such as those
in use by the Bank of England or hundreds of smaller note-issuing
banks in the United States in the late 19th century, resembled a
currency board in their basic operation although their outward forms
were somewhat different. (There are a lot of wrong ways to do it too
– don’t do those.)
Once we see that a gold standard system is a fixed-value policy, we
also know what it is not. It is not, for example, a system that has
any relationship to imports and exports of gold bullion, because the
value of gold bullion is the same everywhere whether you import it
or not. The amount of gold in a vault has no direct importance,
because the value of gold is the same whether there is a lot of it
in a vault or a little. There is no “price-specie flow” mechanism
(assuming free trade in bullion), because whatever the “price level”
and whatever the “specie flow,” the value of gold is the same
everywhere.
In practice, historical gold standard systems were almost never
“100% reserve” systems, where there are bullion reserve
holdings equivalent to 100% of currency (base money) outstanding. In
U.S. history, bullion
reserve holdings were typically around 20% during the 19th century.
Some countries (Russia
and France) had a tendency to hold a lot of bullion, and
others (Britain and Germany) did not. Their gold standard systems
worked either way.
We can see that it doesn’t matter whether there is a “current
account deficit” or “current account surplus,” or any other
“balance of payments” issue, because the value of gold is the same
either way. Mining production might have some small effect on gold’s
value, but since existing aboveground gold is about fifty
times greater than annual mining production, it doesn’t make
much difference whether mines have a good year or not. In the past
150 years, mining supply has varied between about 1.50% and 3.0% of
global aboveground gold supply, and it typically takes many years or
decades to go from one extreme to the other.
You can also have all the short-term “elasticity” or longer-term
expansion in the money supply that is appropriate — and
historically, monetary bases did vary by quite a bit during the gold
standard era, in both the short and long term – as long as it is
compatible with the fixed-value policy. (The term “elasticity”
actually comes from discussions during the late 19th century
regarding the short-term operations of the Bank of England –
obviously, compatible with the gold standard policy.)
It’s not really that complicated.
For a longer discussion of these topics, including all the
historical statistics, you can read my books Gold: the
Monetary Polaris (available in free eBook format), Gold: the
Once and Future Money, the website newworldeconomics.com,
and – for the audiovisually inclined – a thirty-minute
presentation on YouTube.
Now, let’s see what the Fed has to say:
With a gold standard, the value of a country’s money is
tied to its stock of gold reserves. That is, each unit of currency
(e.g., a dollar) is tied to a specific amount of gold and is
redeemable for that specific amount of gold. The government’s
ability to increase the money supply is then restrained by its
gold reserves. And since gold is naturally limited and the global
gold supply grows relatively slowly, this system seemingly
protects against high rates of inflation.
While there is a thread of truth here, I think it is appropriate to
call a spade a spade; or, to say that this is a bunch of hooey. In
the U.S. example, the total currency supply grew by 163 times
between 1775 and 1900, while the global gold supply grew by about
3.4 times due to mining production.
If I am not quite clear, let me simplify: 163 is not the same as
3.4.
Nevertheless, the value of the dollar was basically the same during
that period. (There was a small adjustment in 1834.) So, we see that
a gold standard system can accommodate any degree of expansion that
is appropriate, while also maintaining the fixed-value parity
policy.
And what were the gold imports, exports, domestic or world mining
production, balance of payments, investment flows, bullion reserve
coverage ratios and so forth for the United States during this
125-year period? They were this, that and the other – during that
period of time, most everything that could happen did happen. None
of it mattered. The dollar was still worth $20.67/oz., its
fixed-value parity until 1933.
Between 1775 and 1900, Britain had a completely different pattern of
bullion imports, exports, mining production, current account
balances, reserve holdings and changes in the monetary base. Yet,
the British pound nevertheless maintained its own fixed-value gold
parity, at 3 pounds 17 shillings 10 pence per ounce.
If you have managed to read this far (966 words, by the way), you
now know more about how the world managed its monetary affairs
pre-1971 than the majority of academic specialists, and also the
Federal Reserve. I know you don’t believe me when I say that, but
later you will look back and agree that it is true.
The reason we don’t have a gold standard policy today is not because
it doesn’t work – the last twenty years of the gold standard era,
the 1950s and 1960s, were the most prosperous of the last century –
but because people forgot what it was for, and how it operated. The
world gold standard era didn’t end because it was producing bad
results, but because it was left in the hands of people who blew it
up out of sheer
ignorance and stupidity.
Don’t believe me? Just read what the Federal Reserve itself has to
say about the topic, while citing recent academic work. Obviously,
these people are clueless. Clueless people break things, and then
point fingers elsewhere.
I think there has been a bit of disinformation over the years. It
serves some people’s interests if people don’t understand the most
basic concepts of gold-based money. In any case, if we are to create
a viable alternative to today’s floating-fiat madness, we need to
have a strong
foundation regarding these core principles.
At least at the Federal Reserve, that
foundation is not yet in place.
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