Far too many people believe that gold serves no useful purpose. I am therefore publishing this response to The 10 Minute Gold Standard: It’s Much Easier than You Think by Nathan Lewis. Mr. Lewis, a professed advocate of the gold standard, argues that even if we have a “gold standard”, we don’t need actual gold. Indeed, according to David Ricardo (quoted in the article), gold’s only job is to regulate the quantity of paper.
Mr. Lewis notes that when the Fed buys bonds it increases the quantity of dollars and when it sells bonds it decreases the quantity. This is true enough, but it’s not the quantity of dollars per se that is causing our ongoing capital crisis, or if you prefer, our solvency crisis. But I get ahead of myself.
The 10-Minute proposal is simple: the Fed should tweak its central planning. Instead of buying bonds to control the interest rate, it should buy bonds to control the gold price. However the unstated assumption, that the price of gold is based on the quantity of dollars, is false.
Gold is money, and paper (the dollar) is credit. The ratio of credit to money is not constant. Nor is the price of credit, which depends on its quality. Trying to control the gold price by this indirect proxy would be like trying to steer a car by opening and closing the windows.
The fatal flaw in the proposal is that paper cannot perform certain functions that can only be performed by gold. One is to extinguish debt. Paper currency is itself a credit instrument. The dollar is the liability of the Fed. Paying in paper transfers a debt, but the debt itself does not go out of existence. Since interest is constantly accruing, total debt rises exponentially.
Another function of gold that cannot be served by paper is hoarding. This is half of the key to understanding how interest rates are set in the real gold standard. A saver can withdraw his gold from the bank. This forces a contraction of credit and an increase in the rate of interest. In contrast, in a paper standard such as the “10 Minute Gold Standard”, there is no reason to sell a low-yielding bond in exchange for zero-yield dollar bill; the saver is disenfranchised.
Economists speak of “bond vigilantes” and assert that no one would buy a bond yielding less than the rate of “inflation”. In reality, the interest rate has been falling for 32 years. This long-term decline has done three things. It has continually lured in new borrowers, increased the burden of each dollar of debt, and caused incalculable destruction of capital.
The final stage of the Ponzi scheme of paper money is when debtors can’t pay the interest out of income. They must sell new bonds to pay off the old ones. The Fed is the enabler; its own bond purchases encourage speculators to front-run them. So long as the Treasury market holds up, the pretense can be maintained that the government is in good financial condition. Greece was the first of many countries to learn what happens when the bond market fails.
The world is rushing towards mass insolvency. If we don’t change course, we face certain devastation.
We urgently need the unadulterated gold standard. Those few of us who promote gold face a daunting task: to bring the message to the people and change course. I can understand the appeal of a quick fix that seems politically pragmatic, but the unworkable “10 Minute Gold Standard” only undermines gold standard advocates.
Postscript: Since this article is about money, readers may be interested in my latest video: Is Bitcoin Money?
Dr. Keith Weiner is the president of Gold Standard Institute USA, and CEO of Monetary Metals. Keith is a leading authority in the areas of gold, money, and credit and has made important contributions to the development of trading techniques founded upon the analysis of bid-ask spreads. Keith is a sought after speaker and regularly writes on economics. He is an Objectivist, and has his PhD from the New Austrian School of Economics. He lives with his wife near Phoenix, Arizona.