Guest Post: The Unadulterated Gold Standard Part 3

Tyler Durden's picture

Authored by Keith Weiner,

In Part I , we looked at the period prior to and during the time of what we now call the Classical Gold Standard.  It should be underscored that it worked pretty darned well.  Under this standard, the United States produced more wealth at a faster pace than any other country before, or since.  There were problems; such as laws to fix prices, and regulations to force banks to buy government bonds, but they were not an essential property of the gold standard.

In Part II , we went through the era of heavy-handed intrusion by governments all over the world, central planning by central banks, and some of the destructive consequences of their actions including the destabilized interest rate, foreign exchange rates, the Triffin dilemma with an irredeemable paper reserve currency, and the inevitable gold default by the US government which occurred in 1971.

Part III is longer and more technical, as we consider the key features of the unadulterated gold standard.  It could be briefly stated as a free market in money, credit, interest, discount, and banking.  Another way of saying it is that there would be no confusion of money (i.e. gold) and credit (i.e. paper).  Both play their role, and neither is banished from the monetary system.

There would be no central bank with its “experts” to dictate the rate of interest and no “lender of last resort”.  There would be no Securities Act, no deposit insurance, no armies of banking regulators, and definitely no bailouts or “too big to fail banks”.  The government would have little role in the monetary system, save to catch criminals and enforce contracts.

As mentioned in Part I, people would enjoy the right to own gold coins, or deposit them in a bank if they wish.  We propose the radical idea that the government should have no more involvement in specifying the contents of the gold coin than it does specifying the contents of the software that runs a web server.  And this is for the same reason: the market is far better at determining what people need and far better at adapting to changing needs.

In 1792, metallurgy was primitive.  To accommodate 18th century gold refiners, the purity of the gold coin was set at around 90% pure gold (interestingly the Half Eagle had a slightly different purity than the Eagle though exactly half the pure gold content).  Today, much higher purities can easily be produced, along with much smaller coins (see  We also have plastic sleeves today, to eliminate wear and tear on pure gold coins, which are quite soft.

If the government had fixed a mandatory computer standard in the early 1980’s (some governments considered it at the time), we would still be using floppy disks, we would not have folders, and most of us would not be using any kind of computer at all, as they were not user friendly.  When something is fixed in law, it is no longer possible to innovate.  Instead, companies lobby the government for changes in the law to benefit them at the expense of everyone else.  No good ever comes of this.

We propose the radical idea that one should not need permission to walk down the street, to open a bank, or to engage in any other activity.  Without banking permits, licenses, charters, and franchises, the door is not open to the game played by many states in the 19th century.

“To operate a bank in our state, you must use some of your depositors’ funds to buy the bonds sold by our state.  In return, we will protect you from competition by not allowing out-of-state banks to operate here.”

Most banks felt that was a good trade-off, at least until they collapsed due to risk concentration and defaults on state government bonds.

State and federal government bonds are an important issue.  We will leave the question of whether and when government borrowing is appropriate to a discussion of fiscal policy.  There is an important monetary policy that must be addressed.  Government bonds must not be treated as money.  They must not become the base of the monetary system (as they are today).  If a bank wants to buy a bond, including a government bond, that is a decision that should be made by the bank’s management.

An important and related principle is that bonds (private or government) must not be “paid off” by the issuance of new bonds!  Legitimate credit is obtained to finance a productive project.  The financing should match the reasonable estimate of the useful life of the project, and the full cost must be amortized over this life.  If the project continues to generate returns after it is amortized, there is little downside in such a conservative estimate (though it obviously makes the investor case less attractive).

On the other hand, if the plant bought by the bond is all used up before the bond is paid off, then the entrepreneur made a grave error: he did not adequately deduct depreciation from his cash flows and now he is stuck with a remaining debt but no cash flow with which to pay it off.  Issuing another bond to pay off the first just extends the time of reckoning, and makes it worse.  Fully paying debt before incurring more debt enforces a kind of integrity that is almost impossible to imagine today.

With few very limited and special exceptions, a bank should never borrow short and lend long.  This is when a bank lends a demand deposit, or similarly lends a time deposit for longer than its duration.  A bank should scrupulously match its assets to its liabilities.  If a bank wants to buy stocks, real estate, or tulips, it should not be forcibly prevented, even though these are bad assets with which to back deposits.  The same applies to duration mismatch.

Banks must use their best judgment in making investment decisions.  However, the job of monetary scientists is to bellow from the rooftops that borrowing short to lend long will inevitably collapse, like all pyramid schemes.

There should be no price-fixing laws.  Just as the price of a bushel of wheat or a laptop computer needs to be set in the market, so should the price of silver and the price of credit.  If the market chooses to employ silver as money in addition to gold, then the price of silver must be free to move with the needs of the markets.  It was the attempt to fix the price, starting in 1792 that caused many of the early problems.  While “de jure” the US was on a bimetallic standard, we noted in Part I that “de facto” it was on a silver standard.  Undervalued gold was either hoarded or exported.  After 1834, silver was undervalued and the situation reversed.  Worse yet, each time the price-fixing regime was altered, there was an enormous transfer of wealth from one class of people to another.

Similarly, if the market chooses to adopt rough diamonds, copper, or “bitcoins” then there should be no law and no regulation to prevent it (though we do not expect any of these things to be monetized) and no law or regulation to fix their prices either.

If a bank takes deposits and issues paper notes, then those notes are subject to the constant due diligence and validation of everyone in the market to whom they are offered.  If a spread opens up between Bank A’s one-ounce silver note and the one-ounce silver coin (i.e. the note trades at a discount to the coin) then the market is trying to say something.

What if an electrical circuit keeps blowing its fuse?  It is dangerous to replace the fuse with a copper penny.  It masks the problem temporarily, and encourages you to plug in more electrical appliances, until the circuit overheats and set the house on fire.  It is similar with a government-set price of paper credit.

A market price for notes and bills is the right idea.  Free participants in the markets can choose between keeping their gold coin at home (hoarding) vs. lending their gold coin to a bank (saving).  It is important to realize that credit begins with the saver, and it must be voluntary, like everything else in a free market.  People have a need to extend credit as explained below, but they will not do so if they do not trust the creditworthiness of the bank.

Before banking, the only way to plan for retirement was to directly convert 5% or 10% of one’s weekly income into wealth by hoarding salt or silver.  Banking makes it much more efficient, because one can indirectly exchange income for wealth while one is working.  Later, one can exchange the wealth for income.  This way, the wealth works for the saver his whole life, and there is no danger of “outliving one’s wealth”, if one spends only the interest.  In contrast, if one is spending one’s capital by dishoarding, one could run out.

No discussion on banking would be complete without addressing the issue of fractional reserves.  Many fundamental misunderstandings exist in this area, including the belief that banks “create money”.  Savers extend credit to the banks who then extend credit to businesses.  The banks can no more be said to be creating money than an electrical wire can be said to be creating energy.

Another error is the idea that two or more people own the same gold coin at the same time.  When one puts gold on deposit, one gives up ownership of the gold.  The depositor does not own the gold any longer.  He owns a credit instrument, a piece of paper with a promise to pay in the future.  So long as the bank does not mismatch the duration of this deposit with the duration of the asset it buys, there is no conflict.

If people want to vault their gold only, perhaps with some payment transfer mechanism, there would be such a warehousing service offered in the market.  But this is not banking.  It’s just vaulting, and most people prefer the convenience of fungibility.  Who wants the problems of a particular vault location and a delay to transfer it elsewhere?  And who wants a negative yield on money just sitting there?

A related error is the claim, often repeated on the Internet, is that a bank takes 1,000 ounces in deposit and then lends 10,000 out.  Poof!  Money has been created—and to add insult to injury, the banks charge interest!  The error here is that of confusing the result of a market process (of many actors) with a single bank action.  If Joe deposits 1,000 ounces of gold, the bank will lend not 10,000 ounces but 900 ounces (assuming a 10% reserve ratio).

Mary the borrower may spend the money to build a new factory.  Jim the contractor who builds it may deposit the 900 ounces in a bank.  The bank may then lend 810 ounces, and so on.  This process works if and only if each borrower spends 100% of the money and if the vendors who earned their money deposit 100% of it, in a time deposit.  Otherwise, the credit (this is credit, not money) simply does not multiply as Rothbard asserts.

This view of money multiplication does not consider time as a variable.  Gold  payable on demand is not the same as gold payable in 30 years.  It will not trade the same in the markets.  The 30-year time deposit or bond will pay interest, have a wide bid-ask spread, and therefore not be accepted in trade for goods or services.

This process involving the decisions of innumerable actors in the free market may have a result that is 10x credit expansion.  But one cannot make a shortcut, presume that it will happen, and then assert that the banks are “swindling.”

If one confuses credit (paper) with money (gold), and one believes that inflation is an “increase in the money supply” then one is opposed to any credit expansion and hence any banking.  Without realizing it, one finds oneself advocating for the stagnation of the medieval village, with a blacksmith, cobbler, cooper, and group of subsistence farmers.  Anything larger than a family workshop requires credit.

Credit and credit expansion is a process that has a natural brake in the gold standard when people are free to deposit or withdraw their gold coin.  Each depositor must be satisfied with the return he is getting in exchange for the risk and lack of liquidity for the duration.  If the depositor is unhappy with the bank’s (or bond market’s) offer, he can withdraw his gold.

This trade-off between hoarding the gold coin and depositing it in the bank sets the floor under the rate of interest.  Every depositor has his threshold.  If the rate falls (or credit risk rises) sufficiently, and enough depositors at the margin withdraw their gold, then the banking system is deprived of deposits, which drives down the price of the bond which forces the rate of interest up.  This is one half of the mechanism that acts to keep the rate of interest stable.

The ceiling above the interest rate is set by the marginal business.  No business can borrow at a rate higher than its rate of profit.  If the rate ticks above this, the marginal business is the first to buy back its outstanding bonds and sell capital stock (or at least not sell a bond to expand).  Ultimately, the marginal businessman may liquidate and put his money into the bonds of a more productive enterprise.

A stable interest rate is vitally important.  If the rate of interest rises, it is like a wrecking ball swinging into defenseless buildings.  As noted above, each uptick forces marginal businesses to close their operations.  If the rise is protracted, it could really cause the affected country’s industry to be hollowed out.  On the other hand, if the rate falls, the wrecking ball swings to the other side of the street.  The ruins on the first side are not rebuilt.  But now, capital is destroyed through a different and very pernicious process: the burden of each dollar of (existing) debt rises at the same time that the lower rate encourages more borrowing.  From 1947 to 1981, the US was afflicted with the rising interest rate disorder.  From 1981 until present, the second stage of the disease has plagued us.

Today, under the paper standard, the rate of interest is volatile.  The need to hedge interest rate risks (and foreign exchange rate risk, something else that does not exist under the gold standard) is the main reason for the massive derivatives market.  In this market for derivatives, which is estimated to be approaching 1 quadrillion dollars (one thousand trillion or one million billion), market participants including businesses and governments seek to buy financial instruments to protect them against adverse changes.  Those who sell such instruments need to hedge as well.  Derivatives are an endless circle of futures, options on futures, options on options, “swaptions”, etc.

The risk cannot be hedged, but it does lead to a small group of large and highly co-dependant banks, who each sell one another exotic derivative products.  Each deems itself perfectly hedged, and yet the system becomes ever more fragile and susceptible to “black swans”.

These big banks are deemed “too big to fail.”  And the label is accurate.  The monetary system would not survive the collapse of JP Morgan, for example.  A default by JPM on tens or perhaps a few hundred trillion of dollars of liabilities would cause many other banks, insurers, pensions, annuities, and employers to become insolvent.  Consequently, second-worst problem is that the government and the central bank will always provide bailouts when necessary.  This, of course, is called “moral hazard” because it encourages JPM management to take ever more risk in pursuit of profits.  Gains belong to JPM, but losses go to the public.

There is something even worse.  Central planners must increasingly plan around the portfolios of these banks.  Any policy that would cause them big losses is non-viable because it would risk a cascade of failures through the financial system, as one “domino” topples another.  This is one reason why the rate of interest keeps falling.  The banks (and the central bank) are “all in” buying long-duration bonds, and if the interest rate started moving up they would all be insolvent.  Also, they are borrowing short to lend long so the central bank accommodates their endless need to “roll” their liabilities when due and give them the benefit of a lower interest payment.

The problems of the irredeemable dollar system are intractable.  Halfway measures, such as proposed by Robert Zoelick of the Bank for International Settlements that the central banks “watch” the gold price will not do.  Ill-considered notions such as turning the IMF into the issuer of a new irredeemable currency won’t work.  Well-meaning gestures such as a gold “backed” currency (price fixing?) might have worked in another era, but with the secular decline in trust, why shouldn’t people just redeem their paper for gold?  One cannot reverse cause and effect, trust and credit.  And that’s what a paper note is based on: trust.

The world needs the unadulterated gold standard, as outlined in this paper, Part III of a series.

In Part IV, we will look at one other key characteristic of the Unadulterated Gold Standard: The Real Bill…

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
TheSilverJournal's picture

The world doesn't need a gold standard. The last thing the world needs is putting the monetary system in the hands of central planners who think they know what the world needs. Capitalism and free markets work best.

Just as there's a seperation of church and state, there should be a seperation of bank and state. The ONLY thing the state should be doing with money is coining it, or penalizing counterfeiters.

trav777's picture

gold standard is a dumb idea.  There's no reason gold should get a Real Bill and coal shouldn't, or any other real thing.  Let Real Bills be what are traded as paper

SAT 800's picture

my goodness you get confused, easily.

Boris Alatovkrap's picture

Better is vodka standard. If is fail, so what, drink and be happiness!

Yen Cross's picture

You and your Vodka. What a lame excuse for a liberal you are? You loft loner! At least Trav has some nuts, you giant labia!

goldfish1's picture
'I gather not all the bars belong to us': Queen's solid gold quip about bullion sell-off
  • Comment said to George Osborne at Cabinet meeting the Queen attended
  • It was in reference to Gordon Brown selling half the country's gold reserves
  • He sold them for £2billion in 1999 when price of gold was at a 20-year low

TwoShortPlanks's picture

I've been buying physical for a small group of buyers over the past few years, you know the deal, BTFD (Physical) by racing out there with cash in hand before the traders bounce it while these guys/girls are at work. Well, very recently I was approached by two entities, one from Sri Lanka and the other the USA. They were looking to buy with long term secure storage in a third separate country. The Sri Lankan buyer was after at least 10,000oz per month ongoing (obvious reason); the USA was three trial buys followed by a one-off 3,000kg buy from a very specific seller. I did intros for the Sri Lankan deal and walked away, but the second deal, because of the origin of the product, I decided to step well away from. Looks like the dirty Gold is being sucked into the vacuum; we're cavitating.

Recommend you listen to the following two (amazing) podcast interviews with Andrew Maguire on KWN.

Part I:
Part II:

Boris Alatovkrap's picture

Why is to think Boris is liberal!? Boris has nuts is make Yen Cross to be jell-o™

Yen Cross's picture

You're just plain retarded! My goodness, do you teach kindergarten? What exactly do you have to offer in a financially redeeming way?  Beat it!

Yen Cross's picture

 You might be right.  The silver (xag) standard works for me. Regarding "Truth in Faith" vs natural resources/  Remember Fukushima?

 Arnie Gunderson ate you for lunch..      I wish the Skipper ate all the libtards.

Yen Cross's picture

Hey fuck head! Yea you!  I gave you a green arrow earlier/ fuck off!

Banjo's picture

Try putting $1000 of coal or oil in your pocket. Or how to store $100,000 of coal for 50 years (once mined of course)

dlmaniac's picture

What the world needs is a form of hard money that cannot be created outta thin air. That way you force people to earn it so cheaters cannot just pop it outta thin air and then abuse it to create collapses everywhere. Hard money genuinely flows into the hands of productive people as productive people produce things that people are willing to pay for. Once in productive hand that money tends to be well spent to create legitimate growth.

SAT 800's picture

People like you are very discouraging to people like the author; and myself; who actually know what we're talking about. It's difficult to tell if you can't read, or you just can't think. A Gold Standard is the only thing you have ever heard mentioned to you that is a free market; and does NOT involve central planners. That;s the essence of the whole idea. How did you mange to mis-understand this?

BlackSea's picture

The gold standard was flawed from the beginning and only worked when governments passed laws stopping redemption on specie.

The gold standard needed repeated government intervention during each and every crisis period in order to stay alive. Eventually it was done away with as unworkable.

That does not mean that gold will not have a major role to play in the future monetary system, but it will be as a reserve asset only, not as currency. Think of it as the new floating gold standard.

AUD's picture

The gold standard...... only worked when governments passed laws stopping redemption on specie.

And that's about the dumbest fucking thing that anyone has ever posted on ZH in the couple of years I've been a reader.

StychoKiller's picture

Get thee to skool:

"The Creature From Jekyll Island, a Second Look at the Federal System", 5th Ed., G. Edward Griffin, ISBN:  978-0-912986-45-6

TheSilverJournal's picture

How do you feel about silver? Or would you like to centrally plan gold as the must-use money?

Bindar Dundat's picture

This Silverjournal guy is as dumb as an old tennis shoe.  Troll maybe?

TheSilverJournal's picture

Nice personal attack without even presenting an idea. Move along.

StychoKiller's picture

Silver is gradually being consumed via industrial usage(s).  Poof, there goes yer munny.

Of course, this means that the $/(Ag Toz) should be perpetually rising.

Sean7k's picture

Did you read the article? Or are you so intent on giving your opinion, you wallow in ignorance. The author pointedly asserts there must be a free market in money. 

TheSilverJournal's picture

The author also pointedly asserts a gold standard. Which is it?

Sean7k's picture

Both. You have a gold standard, not determined by government with other commodities and or bank currencies competing as money. A gold standard doesn't mean other commodities cannot eclipse its' position as silver often did in the 1800's. It is the free functioning of these competing currencies that make sure gold is not manipulated.

TheSilverJournal's picture

That all sounds good if that is truly the case the author is presenting. He then should be calling it "free banking" and not a "gold standard." Names matter. Ideas matter. Most consider the Bretton Woods System being on the gold standard, which is very dangerous.

StychoKiller's picture

Gold serves the same purpose as an Intertial Frame of Reference.  All else is using rubber measuring implements to determine prices.

ball-and-chain's picture

Eventually, gold is going to really break out.

There's no getting around it.

You might see it climb to more than 5,000 dollars an ounce.

But that could be years down the line.

If the powers-that-be have the skills to keep Japan afloat for the past two decades, then they are certainly good at their jobs.

No denying that. 

However, how long can you keep fooling the markets?  That's the real question.


TheSilverJournal's picture

I expect gold to hit at least $10K, but silver will outperform gold by at least 5X over the next few years.

JeffB's picture

True dat. The government should just get out of "the money business" altogether and let the individuals and the free market determine what will be used as money.

Prof. George Selgin had an interesting book on the history of coinage. Private minters' coins were preferred over the government issued ones.

While not a full treatment, here's one article he wrote:


A video on the privatization of money:

Murray Rothbard on private coinage:

Audio version:


III. Government Meddling With Money
6. Summary: Government and Coinage


rg's picture

Rep. Ron Paul sponsored Selgin's Congressional lecture on Why Was the Federal Reserve Created? Selgin expounds on the banking issues in the latter 19th century that led to the creation of the FED.

Selgin's talk with EconTalk host Russ Roberts about free banking with historical examples.

boogerbently's picture

Find "separation of church and state" in the Constitution.

It is the ongoing separation of "church" from "state" that has spawned the NEED for separation of bank and state.

Doña K's picture

You just need competing currencies no matter what they are.

knukles's picture

Mary looks out her kitchen window and sees that a mole has practically destroyed the back lawn, so she tells her husband, Paddy, to go out and kill it and to show no mercy. After ten minutes, Paddy comes back into the house with an evil grin on his face.

"So," says Mary, "did you drown the feckin' mole then?"

"Nah," says Paddy, "much more cruel than that. I buried the little fecker alive." 

BlackSea's picture

Wow, so many fantasies in one post...

One would need a huge police state to enforce all the "don't"s in here.

Not too mention obvious business killers as : "sorry, we can't lend today, regardless of how good your project sounds because we have no coins" or depositors not getting their money back on bank failure even when initially the bank was very prudent in lending (see oil financing during 80s, after 20+ years of risk-free )

Conclusion: fantasy, not real world. You need a reserve used in international settlement that is not currency, is finite, and floats in currency terms. So gold will be that, and currency will be whatever. Currency it's not for saving, reserves are.

SAT 800's picture

Sir; the gold standard has been tried in the real world and it works perfectly. Your fantasies about understanding economics are understandable; human egoism is universal and universally delusional.

BlackSea's picture


With all due respect, it was tried and it failed. Because that which is lent is devalued. And using gold as the government's currency inevitably leads to abuse of the gold's role as store of value. Not to mention saving(soon to be called hoarding) in gold when gold is currency removes currency from the market and creates a liquidity squeeze that no government has or ever will tolerate.

Let gold be a wealth asset, break the good derivatives paper market but don't shackle it again as currency.

zhandax's picture

sorry, we can't lend today, regardless of how good your project sounds because we have no coins

Edit:  That opening had me so worked up, I failed to read your last two sentences.  If you are in favor of real-asset backed reserves, we can agree.  But re-read the article.  There was credit paper used to facilitate trade in the 1800's.  It had it's flaws (and most of them, greedy-banker induced), but it helped generate the most radically prosperous economy the world had seen to date.

Yen Cross's picture

How do you sleep at night? 16.3 Trillion in debt. 5 trillion spent in 4 years/ You're delusional!

AnAnonymous's picture

How do you sleep at night?

'Americans' solved this issue. All kinds of drugs to be taken to sleep well.

akak's picture

No, he's just been making more frequent visits to the People's Liberation Opium Parlor and Internet Cafe.

Sean7k's picture

I wish people would read before commenting. This article clearly states: no government involvement whatsoever. Actually, it was government involvement that allowed banks to forego specie redemption while requiring debts be paid in specie that caused problems with a gold standard. It was monarch's diluting the composition of coins or shaving them. It was government determining value that caused problems.

The gold standard  has done quite well- much better than the current system of fiat debasement. Therefore, why defend the undefendable, when a better alternative is available? 

The reason you change its' status is the effects it has on government spending and war. It sharply reduces both. Not to mention the criminality of bankers and traders. 

The only time a good idea has been want for funding has been the abuse of state power at the behest of a competitor. 


TheSilverJournal's picture

Yes, central planners love to counterfeit in order to gain from the inflation tax.

Why not then call this system the "no government involvement whatsoever" system instead of the "unadultered gold standard," since the rules outlining the system really have nothing to do with gold except that it allows the free market to work and the free market will choose gold as a main component of the monetary system? A better name than "gold standard" would be "the unadultered gold, silver, and platinum standard." And an even better name for this system would be "free banking."

Sean7k's picture

Probably because that is what an "unadulterated" gold standard is. It is not influenced by government or a central banking system.  I try not to get hung up on the semantics and look at the components to the system. 

I don't know why he wants to emphasize gold so much, probably because it has been used historically, personally I would just like to see legal tender laws eliminated. 

TheSilverJournal's picture

Me too. The author only drops a couple sentences in the entire article that an unadultered gold standard = free banking, but he's right on track. The inflation tax is the single most destructive force to productivity, and therefore humanity, and I would really enjoy living in a place without government sanctioned siphoning of wealth through counterfeiting ponzi schemes.

Silversinner's picture

Gold (not the gold standard) worked for a thousand years

in the Byzantine empire,case closed.


Ctrl_P's picture

Not too mention obvious business killers as : "sorry, we can't lend today, regardless of how good your project sounds because we have no coins"


And we lent it out to all those economics students for their PhD's that we wont get paid back because they are all working min wage at McDonald's.


There fixed it for you.

DoChenRollingBearing's picture

I think FOFOA's idea is better.  Just unshackle the roles of gold and fiat$.  Gold needs fiat$.  Spend currency.  Save in gold.  Gold is best thought of as pure wealth, a store of value.  As it has few other uses, yet people want it, it is good as, or better than, anything else (land, etc.) for holding wealth.  FOFOA explains (at length though) this far better than a Bearing with a hole in the middle where a brain would normally be...

No to a gold standard!

Let a thousand currencies compete! (TM)

JeffB's picture

I don't think gold need "fiat", or "money" created out of thin air. The free markets in the past, however, did have a role for paper notes issued by banks that could be redeemed for gold or silver or whatever the parties freely agreed to.