Guest Post: The Unadulterated Gold Standard

Tyler Durden's picture

Authored by Keith Weiner,

The Unadulterated Gold Standard

The choice of the word “unadulterated” is not accidental.  There were many different kinds of gold standard, including what we now call the Classical Gold Standard, the Gold Bullion Standard, and the Gold Exchange Standard.  Each contained flaws; each was adulterated.

 

For example, in the Coinage Act of 1792, the government forced the price of one thing to be fixed in terms of another thing.  The mechanism was in Section 11:

And be it further enacted, That ”the proportional value of gold to silver in all coins which shall by law be current as money within the United States, shall be as fifteen to one…”

 

Of course, people respond to such distortions.  When the government fixes the price of something too low, then people will hoard or export it.  If the price is fixed too high, then they will flood the market with it.

 

According to Craig K. Elwell, in his 2011 Congressional Research Service Report:

 

“Because world markets valued them [gold and silver] at a 15½ to 1 ratio, much of the gold left the country and silver was the de facto standard.”

 

Subsequently, the government changed direction.  Elwell notes:

 

“In 1834, the gold content of the dollar was reduced to make the ratio 16 to 1.  As a result, silver left the country and gold became the de facto standard.”

 

If the law dictates the ratio between gold and silver, then only one metal—the one that is undervalued—will be used.  It would be extremely difficult for the government to get the ratio exactly right.  And even if so, as soon as the market value changed the ratio would be wrong and only one metal would circulate.

 

The government should not attempt to force a price onto the market.  In the unadulterated gold standard, the market is allowed to set the price of silver, copper, oil, wheat, a fine wool suit, and everything else.  It allows people to use gold, or silver, or seashells as money if they wish (the market has not chosen seashells in modern history).

 

Throughout the 19th century, there were various state laws to impose new kinds of restrictions on the banks.  One popular restriction was that in order to obtain a charter (permission to operate as a bank), the bank had to buy state government bonds.  This theme—forcing banks to buy government bonds—was to recur later.

 

This is a pernicious idea.  Banks must have an earning asset to match the liability of the deposit accounts.  Why not make them buy some government bonds as a condition for permission to operate?  Because this is obviously blackmail.  In a free country, one should not need to ask permission to be in business and one should not be forced to do something in exchange for that permission.

 

This policy has two economic effects.

  • First, it pushes the price of the government bond higher than it would otherwise be, which means it pushes down the rate of interest.  This distortion ripples throughout the entire economy.
  • Second, it exposes the state-chartered bank to the fiscal irresponsibility in the state capitol.  And of course the state capitol is encouraged to borrow and spend by this very perverse policy, because they know that there is always a market for their bonds.  This lasts until they default, of course.  And when they do, the state-chartered banks become insolvent.  This is not a failure of the gold standard, or of the free market.  It is a failure of a deficit spending policy and central planning.

There is another problem with this scheme.  The bank takes in deposits, especially demand deposits, and it buys bonds, especially longer-dated bonds.  This is called “borrowing short to lend long”, and it is dangerous because if the depositors want to redeem their gold or silver, the bank may be in a position where it has only an illiquid bond.  Obviously, the depositor does not want a government bond, and so the bank can be forced to default in a “run on the bank”.

 

All borrowing short to lend long schemes, also called “duration mismatch”, collapse sooner or later.  This is because the depositor, who is the ultimate issuer of the credit, is signaling that he only wishes to extend credit for short duration.  But the bank has expanded long-term credit.  This is not the bank’s decision to make, and by disrespecting its depositors’ intentions, it makes itself vulnerable to a run.

 

In 1864, the National Banking Act imposed a tax of 10% on notes issued by state banks.  Needless to say, state-chartered banks responded to this threat of mass robbery.  There were 1466 state-chartered in 1863.  Five years later, 83% of them had either gone out of business or become nationally chartered.

 

One of the provisions of this Act was to require nationally chartered banks to hold US government bonds in order to issue nationally standardized bank notes and other liabilities.  One key reason for this was that the federal government was eager to finance the civil war (1861 - 1865).  In later years, when the federal government wanted to pay down its debt, this squeezed the banks and the result was deflation and panics.

 

The problem was exacerbated when the federal government resumed the minting of coins.  The “Crime of 1873" was the name many gave to the Coinage Act of 1873, which demonetized silver.  This was an enormous wealth transfer from the small saver such as the farmer who had silver stored at home into the hands of the wealthy who kept gold in the banks.

 

These problems occurred under the Classical Gold Standard.  Even before the Federal Reserve Act of 1913, we saw the following adulterations:

  1. A fixed gold:silver price ratio in a bimetallic monetary standard.  The unintended consequence was that first gold, and later silver, fled the country.
  2. Laws forcing banks to seek permission to operate.  Big-spending governments, needing a market for their bonds, forced banks to buy their bonds in various schemes in exchange for permission to operate.  This exposed banks to bank runs and bankruptcy when the bonds defaulted, and created a new problem when the size of the banking system was restricted by the value of government bonds outstanding.
  3. Demonetizing one metal shifts wealth from one class of saver to another.
  4. Duration mismatch causes the business cycle.  The boom occurs due to credit expansion beyond the intent of the savers.  The bust begins when there are significant redemptions by depositors who need their money.  A full panic occurs when other depositors realize that the bank is not holding either money or short-duration assets such as Bills.  The bank holds illiquid long-term bonds and cannot pay depositor redemptions.  The run turns into bankruptcy.  The panic turns into a wide scale depression.

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Newsboy's picture

Maple Leaf Standard.

knukles's picture

A "Yah, hey dere, gotta smoke, eh?" standard?

trentusa's picture

I don't know about the maple LEAF, but maple SYRUP is certainly an expensive & tradable commodity. Unadulterated Maple Syrup Standard anyone?

In 'Hitchhikers Guide to the Galaxy' remember the citizens tried to make leafs the national currency, after crashing landing on prehistoric earth... long time since I read it but i believe there was rampant inflation, but people never learn. Somehow McDonalds keeps their dollar menu alround (and it's not by adding sawdust!!)

m0w0g's picture

They "ran into a small inflation problem" which had five major deciduous forests buying one ship's peanut. So in an effort to re-value the Leaf, they embarked on an aggressive defoliation program and burned down all the forests.

Whereupon Ford Prefect called them a "bunch of raving nutters" and shouted "How can you have money if noe of you actually produce anything?"

fuu's picture

<pours one out for Doug>

BigJim's picture

 ...Whereupon Ford Prefect called them a "bunch of raving nutters" and shouted "How can you have money if noe of you actually produce anything?"

Thus proving once and for all that Douglas Adams had a sounder grasp of monetary theory than ('Nobel prize winning'!) Paul Krugman.

Ayn NY's picture

Think of Krugman and his ilk as if they were a religious cult - which they are.

My Keynsian Econ professor was shocked when I proved to him that there was never a Clinton surplus - he's a PHD, I'm an art student.....

Silver Bug's picture

A lot of people don't realize that we have never been on a TRUE gold standard.

 

http://schiffblog.blogspot.ca/

Motorhead's picture

Sure, why not?  Better than what we got now...much better.

CH1's picture

Screw the "standard" - let peopole use whatever currencies they damn well please.

dermus's picture

The answer is very simple. No more currency units. Gold should be denominated in - wait for it - weight. If all nations coin to an agreed to standard, say, 9999 purity, and denominate in say, grams, you would have a gold standard in which nobody can cheat by playing with the currency unit to weight ratio, because there would not be one.

1 US Dollar would no longer mean (for example) 1 Dollar x (1 oz Gold / 35 Dollar) = 1/35 Oz Gold.

1 g Gold US Dollar would mean 1 g of Gold as minted by the US.

Currency units must be eliminated. It's the only way to fix the system.

stirners_ghost's picture

Or simply have no standard currency, i.e. no legal tender laws. Let bank notes live and die and compete with each other on their merits (including, but not limited to, how many tons of gold are locked up in the vault).

DoChenRollingBearing's picture

Yes, and see freegold post under here by lasvegaspersona...

lasvegaspersona's picture

Freegold standard...coming...

dlmaniac's picture

You are in free gold RIGHT NOW. Free gold is nothing but another banker scheme to create money outta thin air and therefore steal from the public. 

Zero Debt's picture

Freegold looks like pro-gold but is actually a horrific paper scam. Read between the lines.

JPM Hater001's picture

This is why you need to have your next country of residence already picked out.  If we dont get it right when this BS is over I'm outta here.

Been hearing really good things about Chile and Argentina.  I hear they have gold in reserve...in their country.

A Lunatic's picture

Mars is unsullied too.........

RacerX's picture

Plus, Mars needs women.

CashIsTrash's picture

How about having a MARKET STANDARD???

Poor Grogman's picture

How about the law just makes it illegal for the government to interfere at all in what people freely choose to use as currency.

In fact why don't governments just take a leaf out of Belgiums book and go on holidays for a while.

goldenboy's picture

Freegold or death... 

dlmaniac's picture

Free gold = another paper scam.

lasvegaspersona's picture

maniac

get edumicated before you rant

dlmaniac's picture

Put down the cult crack to grasp some econ 1-2-3 so that you would not be conned by something like free gold. 

Zero Debt's picture

Beware of freegold, Fofoa is just trying to fool you to accept another paper standard. And we all know how that will work out.

Ghordius's picture

I feel you should beef up your point of view. I understand what you want to say but some of it is scenario-dependent and quite debatable

waviator's picture

"Freegold or death... "

Can I have your stereo?

SWRichmond's picture

In a free country, one should not need to ask permission to be in business and one should not be forced to do something in exchange for that permission.

The licensing and regulatory state disagrees with you.

donsluck's picture

As do I. You should not be free to polute my air or water. It goes on from there. The absence of regulation is barbarism, or at least barter, which is very inefficient and eliminates the incentive to produce things of value, such as cars. How many chickens to buy that car?

Try and think of all the "businesses" you could be in without regulation. Such as protection. Such child prostitution...

SWRichmond's picture

No libertarian is unfamiliar with the tragedy of the commons.  What does that have to do with professional and business licensing?

BigJim's picture

 ...The absence of regulation is barbarism, or at least barter, which is very inefficient and eliminates the incentive to produce things of value...

Er, what? You can't have money without 'regulation'? Are you using 'regulation' to mean enforcement of contract?

Cause if you are... no one else here is, in the context of this thread.

 

Mr. Magniloquent's picture

Why does abolishing The State's licensing monopoly permit personal damages of private property?
Why would removing barriers to entry in any industry result in less production and competition?
What evidence do you have that governments predate money?
Does prohibition (regulation) of drugs and prostitiution prevent these trades in any meaningful way?

ListLincolnBismarkRoosevelt's picture

"Why would removing barriers to entry in any industry result in less production and competition?"

(1° Private compagnies own Europe for centuries during the middle age. The venitian private empire did well totaly control finance, PM and army power, not any state. Wath happen then in de 14° century ? So at least there is an opposition to full private economy an free market.)

2° The protectionisme movement like Hamilton, List, Lincoln, Bismarck and their succes tell us that in a first time you need barrier to have à thrue competition ! You can compare Germany before an after Bismarck if you want ?   

SILVERGEDDON's picture

Brass, copper, lead, charcoal, sulphur, saltpetre, fulminate of mercury.

Gooberment doesn't care about these strategic elements - now.

Stock up on yours today, prior to Nov. 15th.

National Buy Ammo Day.

Seriously.

Google that shit up, bitchez.

PUD's picture

Money should not be tied to a nearly useless metal that causes great environmental destruction in its mining. Money should be tied to a basket of real world goods...a unit of corn, wheat, soy, a unit of oil and gas, a unit of labor or some measure of service...real things that are needed and valued by real human beings. The basket should be broad and diverse and comprised only of things that are actually required for basic survival. The money unit would never be subject to the ravages of inflation then, at least so far as basic needs are concerned.

Joebloinvestor's picture

It is called the CFTC.

 

See how well that works?

Poor Grogman's picture

Show me where that ridiculous idea has ever worked without the use of state sponsored force?

UnpatrioticHoarder's picture

Actually having an otherwise useless metal as money is a great idea. It means when demand for real money takes off, the inflationary effect is felt in the price of a metal no-one eats, lives in or otherwise really needs. Commodity speculation is actually dampened.

PUD's picture

If money was tied to the real world needed goods then there could be no inflation regardless of speculation...if ags doubled for example the money would still be worth the same unit of measure.

In addition, I would outlaw all "speculation" in all critical commodities. They are the essence of life and should not ever be speculated upon. Trading between farmers and processors would be allowed as it was originally intended but there would be no outside gambling on the stuff people depend on for their very existence

Poor Grogman's picture

This system would be gamed to death in about 30 seconds flat.

As usual the squid would milk it, while the people starved.

Try separating trading and speculating, especially as they often represent two sides of the same trade. ...

lasvegaspersona's picture

Grogman

try separating  the medium of exchange from the store of value. Whatever the MoE is it will be lent and therefore debased. That is fine if the MoE is fiat and everyone knows it is just a MoE to be held a short period. The store of value should be unlent. It will not get debased...that is freegold in 4 sentences.

Poor Grogman's picture

Even holding the MoE while you make various exchanges is plenty of time for you to get "inflation taxed" on it. Therefore why not just exchange the store of value itself?

This is why free-gold will not work, in two sentences.

Bullionaire's picture

 

Poor grogman dumbass troll. Gesundheit.