David McCabe

All right, we are all agreed – the dollar is doomed. But I haven’t heard much talk about what’s going to come after it, except for mutterings about going back to a gold standard. Let’s look at some of the possibilities.

First, let’s consider a bit of history. Money was originally just coinage rather than currency, as the root of the word (and of the word mint) is Moneta, from the name of a temple that was used as a mint in ancient Rome. Coins throughout history have mostly been made of silver and gold. These have natural qualities that are appropriate for money, being durable, divisible, universally recognizable, of high rarity and of high intrinsic value due to their attractiveness for artifacts. It was only later when rulers got strapped for cash, they started producing ‘money’ that was not made from silver or gold – pretend money if you like. The paper versions were, in effect, credit notes for proper money, or currency. This word comes from the Latin currere, meaning to run or flow. And how it does run and flow nowadays – off the printing presses and down the fibre-optic cables! Of course it may simply refer to the way currency facilitates the flow of trade. Paper currencies are described as fiat, deriving from ‘an official sanction or decree’, from the Latin ‘let it be done’. Meaning that it’s worth something because the Government or ruler says it is. Its inherent worth is negligible, and so its value is entirely dependent on confidence and acceptance by the populace. In fact it is mostly dependent on the confidence of a few currency traders, and how they react to unfolding events. Fiat currencies are always over-printed, so they are not a very sound basis for an economy in a mature civilization. So what are the options after the dollar is worth only pulp and scrap value?

The obvious option is partial backing of one currency with gold, as with the dollar before 1971, when 25% of the money supply was allegedly backed. The new reserve currency would not necessarily be the dollar, because after a dollar crash people probably wouldn’t want anything to do with them, and America would not be seen as economically reliable. The Euro, Renminbi, or perhaps a new currency issued by the IMF are possibilities. Whichever currency it was, a problem with partial backing is that it allows room for sliding – why not 20%, or 15%, ‘just to get us through these hard times’? And without policing, we could not be sure that too much money was being printed compared to the gold reserves. Backing of only one currency perhaps gives the relevant country too much power and influence, as we have seen with the dollar, which even with its unbacked reserve status has allowed America to rack up huge debts at the expense of other countries. Having only one currency backed by gold, or indeed other precious metals, is that the other currencies are still at risk of having to be revalued and of being over-printed. Partial backing also allows uncertainty in the event of a collapse in confidence, as not all holders of the currency could redeem their money for precious metals.

100% backing would get round these problems, rather like the ‘Liberty Dollar’ currently in use in America, which is 100% backed by silver. This system does not allow the kind of over-lending and inflation problems that we have seen in recent years. Hardly anyone, except in times of economic crisis, would in reality bother redeeming their currency for metals, apart from those needing them for some practical use – the important thing is that the metals are there to back the currency. Having all currencies fully or even partially backed would bring more global stability, but this would need policing, and it would be difficult for countries starting off with small reserves of metals. This system would also tie up most of the world’s precious metals in bank vaults, creating shortages for their many real-world uses.

If all currencies were 100% backed by precious metals, you’d have to wonder why you were bothering, and why you didn’t cut out the middleman and just use the precious metals directly. This is the most honest and trustworthy system, and no doubt would be welcomed by many people whose wealth during a future meltdown had been destroyed by inflation. However, using precious metals directly is not without its drawbacks.

There is the age-old problem of forgery. In this day and age it would be no doubt be possible to produce highly convincing coin forgeries to pass off in everyday use. However, coin weighing machines are already widely in use, and it should not be too difficult to make these a little more sophisticated so that they can measure density and determine whether or not coins are genuine, and for every outlet to use one for all transactions. Measuring of electrical conductivity to a high degree of accuracy might also be informative. And in any case, it’s not as if paper notes can’t be forged is it?

There is also the problem of fluctuation in the value of the metals, which in the past has led to coins going out of the country, but this is a problem only if other countries are not using precious metals as currency and buy up your good coins with their rubbish. In any case the exchange rate should reflect the value of the metals. A more difficult problem is if the relative values of silver and gold move substantially, then people start hoarding the more valuable coins, or selling them for scrap. This can be got round by just using one precious metal directly – obviously silver – or effectively having separate currencies in the different metals. This would mean that you would not have a fixed relationship between different metals as in the past, such as 1 gold unit equaling 30 silver units equaling 3000 copper units. The relative values would change with the markets, so prices of goods would be in a combination of metals such as 5 silver 650 copper. If you required change the retailer would have to check the latest relative market prices of metals before knowing how much to give you, and this could be automated on tills of course. Actually, for practical purposes you would probably need to use an alloy rather than pure gold in coins, to make them more hard-wearing – as is current practice. This would complicate any valuations, but again it could be automated.

Another problem, or rather inconvenience, is the weight and bulk of coins as opposed to notes – but  a benefit is that this also makes money more difficult to steal. And you would still have cheques, bankers’ drafts, credit and debit cards and electronic transfers for convenience. You could even have a hybrid system of large-denomination notes, fully backed by reserves of metals of course. The trend is in any case for most transactions to be done by card – it would just mean the banks would periodically have to physically send bullion to each other to settle up.

Notwithstanding the above, the big problem with any system involving precious metals is that in the 38 years of free-for-all since the gold standard was abandoned, the money supply has grown astronomically. Replacing fiat notes and electronically-recorded currency would show up how little these are worth in terms of the precious metals reserves of the issuing country, and would require extremely small gold or silver coins for buying everyday items. Let’s take the dollar as an example. In 2006 the figure for the M3 dollar supply was $10.3 trillion, but since then the Fed has stopped publishing figures on this to try and hide how much money it is printing. However, others have been keeping tabs on it, and reckon it is now about $15 trillion. America probably had a sneaking suspicion that it would eventually have to go back to a gold standard, as it has hung onto reserves of 8,133.5 tonnes (261.5 million Troy oz). This is much more than any other country, but doubts have been expressed as to the veracity of the figure. Anyway, this is worth only about $250 billion at today’s prices (gold is at $950 as I write). For the national gold reserves to be worth the current M3 figure, gold would have to be worth about $1844 per gram or $57,361 per ounce! Put another way, each dollar is backed by just 542 millionths of a gram (micrograms, or µg) of gold. A few grains of gold dust. You could even argue that US Dollar Bonds, Treasury Bills and Notes all represent real dollars, so should be counted. These would take the ‘money’ supply many trillions higher, and push the gold price into the stratosphere.

Ignoring this, even with the M3 figure, the dollar would have to be drastically devalued in order for gold or silver coins to be usable for everyday items. The smallest usable silver coin would weigh about 2g and be about ? of an inch across, and at current prices ($13) it would be worth about 84 cents. However, if the price of silver were to rise in line with gold as above, i.e. sixty-fold, a 2g coin would be worth about $50 in today’s money. The modern dollar coin weighs 8.1g (0.26 Troy oz), and to have a silver version at the same weight at the increased value it would be worth about $204. A Silver Eagle, (which has a face value of a dollar, so is probably what we should be aiming for!) weighs 31.1g (1 Troy oz), and would be worth about $780 in today’s money. A sixty-fold devaluation of the dollar against precious metals is an indication of how false its current value is, but far worse things have happened in pre-war Germany and in modern Zimbabwe. And this is conservative, because silver could be expected to rise faster than gold as it would be the more affordable investment, probably eventually reflecting its 15:1 ratio of rarity to gold in the Earth’s crust. As for gold coins, gold is currently about 70 times the price of silver. It is about 80% denser than silver so the smallest coin would have to be about 3.5g with a value of about a hundred re-valued dollars. Base-metal coins would make up denominations of less than a dollar of course.

If we were looking at just backing the M3 with the gold reserves rather than directly using the gold as coins, the basic unit of money would have to be as low as a milligram of gold. As all of the world’s economies and currencies would be devastated by a dollar meltdown, a fresh start might be needed, and the Gold Milligram could potentially become the standard world currency. It would currently be worth $1.84 on the basis of it being fully backed by the stated US gold reserves. As a milligram of gold is impractical to handle there would presumably have to be a minimum value of currency, say a gram, that could be redeemed for gold!

Of course, if one or more Governments sought to back their currencies with gold, they would seek to increase their gold holdings dramatically so that they could maximize the value of each unit of currency. The price would rocket, and we would see the widespread melting-down of less important artifacts, and no doubt the passing of laws, ‘in the national interest’, like Roosevelt’s 1933 Gold Confiscation Order banning the private holding of gold for investment purposes. Gold mines would be nationalized. Prices would be so astronomical that the other precious metals – silver, and possibly platinum and palladium – would be dragged along too, and might also come into use as standards. Even copper’s status and price could be elevated. However, the rise in precious metal prices could mean no more catalytic converters, gold fillings and wedding rings. The cost of electronics would rocket due to all the silver electrical contacts that they need. These are good reasons for having just one strong currency backed just by gold, with the other currencies pegged to it. However, this would still leave leeway for the other countries to grow their money supplies and cheat people. Ultimately it’s difficult to shake off the attractiveness of money just being simple and incorruptible gold, silver and copper coins everywhere in the world. Indeed, after a dollar crash it might be a long time before people trust paper money again.

However, it’s also difficult to see Governments giving away ‘their’ hoarded gold to people they see as peasants in exchange for their worthless fiat notes, so my money is on a cosy agreement between Governments for the IMF to create a new fiat currency that everybody has to use. How they would allocate it is another matter.

David McCabe

April 7, 2009

David McCabe
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  • Ken

    Nice work, Mr. McCabe. Reminds me of the end of Rothbard’s _The Case Against the Fed_, except that at the time Rothbard wrote, the revaluation would have put gold at something like $1550/oz, if memory serves. :-)

    I suspect you’re right about the IMF-issued currency, if they can make it stick.

  • http://www.corporatephoenix.com Bill

    This of course might lead to an increase in barter exchanges with small (100,000 or fewer) memberships, much like the ones we see today, trading goods or services for an agreed value, but without currency. governments would hate this as they are more difficult to regulate and tax.

  • froggy

    David, I agree with you. If goverment’s give up their currency they lose their power. I have this theory that the currency of a country is backed by it’s military. Without the one the other is worthless. The military is essential in the equation as the force to keep the population in control. We can see an extreme example of this in Zimbabwe where the military had to be used to keep the population in control when they saw their hard earned ZIM dollars evaporating by the minute. And as you know the population has left the country, it was the only way that the people of Zimbabwe survive.

    It appears now theres an active program to suppress the value of gold by western governments. At the G20 meeting it was decided that they the IMF needs to sell all it’s gold reserves and distribute as aid to third world country’s in dollars. I believe a sudden spike in the gold price is going to trigger panic as everyone doubts the long term viability of the dollar. So they the Americans and the rest of the world is actively going to suppress the gold price and support their currencies. It is going to be interesting to what extent they are going to get this right, will they succeed better than Mr Robert Mugabe? Will they use their military to enforce their strategy on the people?

  • rancherlady

    Very deep thanks, Mr. McCabe. A marvelous presentation, and a real relief since I had been meaning to write just such an article myself and wouldn’t have done nearly as well!

    A couple of days ago I started with someone’s calculation that the physical gold putatively held by the US was worth $269 BN at a thousand an ounce, which is not the current price, posited $31 BN in silver lying around just to make the math easy for those who can’t do such things in their heads, and I began whimpering when considering just the $2 TN owed to China and the recent $1 TN created out of thin air. Not even taking into account the other trillions of FRNs littering the planet, just paying off China and a bail out or two would require dividing $3 TN by $300 BN and adjusting the price of gold upwards/revising the dollar downward just a tad. Just to swap even on “minor” debts would require devaluing our currency to a point where the entire world would descend upon us via armada, ballistic missiles, boat people, and swarms of bankers armed with pitchforks.

    Wedding rings would be replaced by lifesavers and earrings with plastic because it would be worth your life to appear in public with a genune fortune on ears and fingers.

    I soothed myself by buying more silver.

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