Monday, October 15, 2007

The Gold Standard

A friend of mine the other day asked me if I thought the Gold Standard would be a proper replacement for the current money system we have in the U.S. I answered him saying that we should revert to Gold and Silver coin – hard assets, but did not get a chance to explain myself further.

I’m not an expert on economics and finance. However, I have been familiarizing myself with economic systems, governments and the like while following the Ron Paul presidential campaign. In this essay I will attempt to explain a monetary system known as the ‘Gold Standard.’

In this essay I will attempt to explain ‘the Gold Standard’ as I understand it. I don’t expect to reflect a perfect or academic understanding, but I believe I have a working knowledge. If I present some erroneous notions, any corrections from better educated readers would be most welcome as they would certainly add to my knowledge.

What is the Gold Standard? The Gold Standard is a monetary system in which value of products and services is measured in terms of gold, usually by weight. In the movie, “Fiat Empire – How the Federal Reserve Violates the U.S. Constitution,” G. Edward Griffin explained that in Ancient Rome a single gold coin would buy you a nice garment, a belt and some sandals. Today, a single one-ounce gold coin, worth about $750 today, could buy you a nice suit, a belt and some good dress shoes. His point was the value of an ounce of gold hasn’t changed much over the millennia. The price appears to make similar items more expensive, but that is because of inflation.

How did man start trading with gold? The use of gold coin as money goes back at least as far the early Mesopotamian civilizations. Ancient Egypt and Rome also traded in Gold.

Why was Gold used as a monetary standard? The secret of money is that it can be anything two people agree on. To illustrate this, in the movie “Trading Places” brothers Randolph and Mortimer Duke, played by Walt Bellamy and Don Ameche, wagered over putting a poor street beggar played by Eddie Murphy into a high level executive position in their commodities trading firm in place of the current man who was very competent and successful, played by Dan Akroyd. The bet was whether the beggar would become a success and that the executive would sink to the lowest depths of despair and depravity. The Duke brothers discreetly agreed on the amount of the wager - $1.

Primitive cultures used things like bird feathers, sea-shells and seeds for trading. In a direct barter situation both parties would trade something of theirs without money. A skin trader would exchange skins for wood from a woodsman. Bartering like this works great when both parties have something the other party needs. Money came into existence to provide a medium currency, something that could be used over and over in trades where one party wants something from another party, but the one party does not have something the other party needs. The skin trader needs wood from the woodsman, but the woodsman has no use for skins. The skin trader offers some form of money, which the woodsman can use to acquire tools for his trade.

Getting back to gold. So why gold? Although gold is known as the heaviest of metals, it is also very soft and malleable. Gold can be easily smelted into liquid form and then molded to take any shape desired. It’s fairly easy to mint coins with gold. Because of its weight and value, it doesn’t take many coins to buy things with it. Remember the suit, belt and shoes analogy? Gold carries its value as a monetary standard because of its weight, beauty and the fact that it takes human energy to mine it and shape it for use in trade. With gold coin, one could take them to a goldsmith who could smelt them and re-shape them into jewelry.

What are the problems with using Gold as money? Carry enough gold around on your person and you may begin to notice some inconveniences. Gold is heavy and the more gold you carry the more conspicuous it becomes, thus making you a target for theft. If one is buying relatively cheap items, let’s say vegetable produce, a single gold coin will probably buy you more vegetables than you can eat before they spoil. Buy a smaller amount with the coin and you will need some other form of currency, like silver coin or paper bills for change. In an economy where gold is exclusive, this becomes highly impractical. The only way to make change with gold is to mint smaller coins or carry gold dust.

Another problem with Gold coin is that its currency can be easily inflated. In ancient Rome, goldsmiths, under the direction of the Roman government mixed their gold with other metals, diluting the gold and creating a much larger number of coins for circulating in the markets. Rome went from its humble republican ways toward empire by inflating gold. Armies needed to be raised and weapons and other supplies were needed for missions of conquest. Additional coins made it possible to keep the empire agenda rolling, but this resulted in another problem – inflation. The inflation led to the downfall of the middle and lower classes of citizens and ultimately for Rome itself.

The point of this is that because Gold is so malleable, gold currency can be easily inflated. The only way to prevent this from happening is for whoever supplies the gold to maintain strict standards. If the supplier is a government, they have to enact policies to ensure the Gold not be diluted in any way. In a free market, competition becomes the strongest deterrent to diluting gold.

Can you trade with something other than gold in a gold standard? Surprisingly, yes. During the years of European exploration goldsmiths figured out a way to keep their customers’ gold safely stored by printing voucher receipts for the gold. This was the beginning of paper money. There’s a section in the video “Money As Debt” that tells of the “The Goldsmith’s Tale,” which shows the progression of how Goldsmithing evolved into modern banking. When Goldsmiths began printing receipts for gold, their customers would take these receipts and trade with them in the markets as though they were the gold itself. Paper was easy and convenient. Goldsmiths also discovered that people were so content to trade this way that they felt no need to visit the goldsmith to claim their gold. Once in a while that would happen, but not enough to deter goldsmiths from exploring another idea. Goldsmiths figured they could just print up the paper and lend it to other customers at interest. The next stage in this development involved printing receipts that vouch for more gold than what actually sat in the goldsmith’s vaults. This was the beginning of fractional reserve banking. It made the Goldsmith very rich as it provided funding for a lot of commercial enterprises. This practice continues in the Federal Reserve system we have in the United States today, although gold no longer serves as the backing for new money.

So the gold standard also includes the printing of paper money. Paper money represents the value of Gold and can be redeemed for its declared weight. The problem here is that when there are too many receipts in circulation and not enough gold, the banker runs the risk of having customers lining up at his bank to ask for their gold back. This is known as a bank run and they’ve crashed many banking systems and rattled public confidence in banking as well.

Would we be better off with a gold standard? Not necessarily. It depends on the way the standard is managed by the suppliers. The U.S. Constitution in Article 1, Section 8 says:

To coin money, regulate the value thereof, and of foreign coin, and fix the standard of weights and measures;

And then section 10:

“No State shall … coin Money; emit Bills of Credit; make any Thing but gold and silver Coin a Tender in Payment of Debts; …

In 1913 Congress abdicated its monetary function by handing it over to the banking cartel that operates the Federal Reserve Bank. At the time the U.S. was on a gold standard and the fledgling Federal Reserve managed the currency under a gold standard. However, passage of the Federal Reserve act gave the bankers a monopoly on printing money, giving it the power to inflate and deflate the currency as they saw fit.

The intent of the Constitutional assignment of coining money to Congress was to give the people their say in monetary policy as expressed through their representatives in Congress. The article’s weakness was that it said nothing about printing paper money and this allowed private banks to print paper money.

The benefit of trading with gold coin is that you are trading the actual commodity. The value is indisputable, you are trading the actual thing that has value, not something that represents value. As long as the Gold is as pure as it was mined from the earth, its value will stand the test of time.

The problem with having the government managing the currency is that even under the best of conditions where the government is truly accountable to the electorate, the processes would likely move very slowly. Needed changes in policy would get bogged down in debate and bureaucracy. This would eventually motivate special interests to either create or strengthen the role of a central bank. The benefit of following the Constitution and its intent is that Congress is directly accountable to the people. If the money is not handled properly, the people could vote the rascals out.

I believe the best option is a free and competitive market. There are other precious metal commodities like silver, platinum and copper that could compete with gold. In a truly free market, suppliers of these commodities would compete with one another and the consumers of these commodities would be able to decide which commodity suits their unique needs and purpose. Competition will also promote honesty and fairness. A gold coin supplier may find his customers going elsewhere if they discover he is diluting his coins with lead and inflating his volume.

The other benefit is that it would limit the influence of politics on the money supply. Problems that occur in the market would be solved by market forces, namely consumers and competitors. Bad behavior would more likely get rewarded by lost business or by criminal or civil court actions.

Is a precious commodity standard more preferable than the current debt system? If so why? In my opinion, it is absolutely more preferable. In the current system, money comes into existence as a result of debt creation. Technically speaking, those Federal Reserve Notes that everyone carries around in their wallet do not belong to them. They are on loan by the Federal Reserve and are payable with interest through our taxes. Since the Federal Reserve Notes represent credit for paying loans, they do not represent the interest on those loans. Where does the money come to pay the interest? The Federal Reserve has to print more money, thus maintaining persistent debt that cannot go away.

By contrast a precious commodity standard indicates outright ownership of the commodity. When you trade with gold or silver coin, you are trading something that has value for something that has equal or more value. The coin can remain in circulation instead of flowing back to the source of its issue. Economically this is the most ethical and humane way to trade. It’s what everyone believes should happen, but under the current system, is not actually happening. With authentic coins, their value does not change and cannot be inflated and cause prices to rise. It gives everyone who earns the right to trade with it, the fairest and most equal opportunity to better his or her own life, while the inflatable currency continually diminishes its spending power and places undue advantage to those closest to its entry into the market.

It is my hope and dream that we return to a precious commodity standard. It is a standard that supports human liberty and prosperity to the greatest number. It favors no one particular interest except those that serve society best. It motivates suppliers to deal more fairly and honestly with the demand side of the economic spectrum. It promotes natural ‘rule of law’ principles where no one controls the actions and behaviors of ethical people. And finally, it is the paradigm where people become the masters of money rather than the other way around..

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