Saturday, October 3, 2009

What The Hell Is the Gold Standard?

I got into a discussion a week or so back about the gold standard, and I think at that time I did a very poor job of explaining my position and why the gold standard is important. Hopefully I can do better today.

First the basics. The Gold Standard is when a country’s monetary supply is tied to the value of an asset, typically gold. I guess a little monetary history is in order as well.

Did you know that the only legitimate United States money is gold or silver coins? Paper currency has come about from the early days of the country, when actual Federal money was basically non-existent. In order to conduct commerce wealthy men would issue letters of credit, which could be redeemed for a specific amount of a commodity. In the South, it was usually tobacco. These letters were traded both locally and country wide (in the 1700’s) just as Federal Reserve notes are now. The face value of the letter was sometimes accepted, but if the maker was relatively unknown, or was widely known as bankrupt, the letter could be traded at a discount.

These letters gave way to banks issuing similar letters, but printed in specific denominations and in bulk. Each of these letters of credit was as valuable as the deposits of gold that were held by the individual bank. If the bank printed more certificates than actual deposits, they could be in trouble. A lot of early bankers were wealthy men, not because of the bank, but because you needed inordinate wealth to start one.

There were several attempts at a National Bank early on, the second National Bank was disbanded by Jackson in 1828 I believe, but it wasn’t until the early part of the last century that the Federal Reserve was created. Basically, the United States of America has deposited all of its money in one specific bank, which it controls. This bank issues, under the auspices of its largest depositor, all of our paper currency.

As long as we limit the amount of currency in circulation to what the government can back up with real money, we have a finite amount of currency available. This means currency will maintain its value. We also need to draw a distinction between money and currency. Money is gold or silver; hard assets that have an intrinsic value. Currency is the non-asset we trade instead of money.

For years the value of our currency was fixed to a certain amount of gold, and a silver coin was made from the exact amount of silver the denomination of the coin was worth. Silver started to become more expensive in the 1960’s, and in 1965 the US started to ‘sandwich’ a piece of copper between two sheets of silver to enable the coins to remain the same size (because of vending machines), yet not be worth more than its face value. The ratio of copper to silver has constantly increased until today we have just a skin of silver on a copper coin. Coins, originally a face value commodity, are now more currency than actual money.

The problem with the Gold Standard (for governments) is that it limits the currency available for circulation. If I borrow 30 dollars for 30 years plus interest, I am paying back 30 dollars, plus interest, in real money. If I borrow 30 dollars for 30 years without a fixed standard, as the money supply increases each dollar is worth less, and I am paying back less than 30 dollars, including interest, in real money. A gold standard favors a creditor; floating currency favors a debtor. A floating currency also favors the government; because they can control the supply of money easily.

You have hard news reports where they reference the Federal Reserve Board meeting to increase the money supply? What they are actually doing is devaluing the dollar. They don’t actually print more dollars (although sometimes they do), what they have done is increased the amount of money on that is available for loans.

Think about all of the money that changes hands daily with a single piece of currency having changed hands. Checks and bank wires are just two ways that billions of dollars move around the country daily; dollars that are available because of the size of the money supply, if not actual currency.

Remember back in February when Congress voted to spend $787,000,000,000.00? If we were on a gold standard this expenditure would have been impossible, as the money would not have existed, and could not have been created out of thin air.

Well, out of thin air is not exactly correct. The government voted to spend the money, so te Federal Reserve had to create it. Which they did by borrowing the money, which we have to repay with interest. It’s not that governments couldn’t borrow while on a gold standard; it’s just that he standard made the repayment expensive. As long as we were a creditor nation having a standard was a good thing.

But now we are a debtor nation; we want to make the money cheaper so we can repay less than we actually borrowed, over time. Before we can go back to being on the gold standard, we need to repay our massive debt. I don’t see that happening in my grandchildren’s lifetimes.

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