The Daily Reckoning PRESENTS:Those who champion the reinstatement the gold standard in the United States are often brushed off as delusional fanatics – often with good reason. However, in the essay that follows, Nate Lewis has created an alternate universe in which the dollar is rejected – and a viable gold standard is introduced. Read on…
It appears that we are slowly drifting into a period of monetary turmoil. Turmoil leads to change, and ideally the result of a widespread desire for change will be the establishment of a new gold standard. Indeed, there are some indications that this may be achieved by the end of this year, although it may seem unlikely at this moment.
Gold Standard: Stable Value
A necessary condition of a new gold standard is that at least a small group of people must understand what a gold standard is. So let’s start with that.
Humans have used gold (and its adjunct silver) as money since prehistory because it is the one item best suited for this role. The primary reason being that gold’s monetary value is stable, or at least more stable, than the alternatives.
It follows that anything whose value is linked to that of gold must, by definition, be as stable in value as gold. It is not particularly a stretch to link the value of a paper currency to gold. In fact, the world’s first gold-linked “paper money” was made of clay, during Sumerian times, around 3500 BC. Clay tablets were used as warehouse receipts for gold, and traded among third parties.
It is not difficult to link the value of a paper currency to gold, even if the issuers of currency own no gold whatsoever. This is accomplished via the adjustment of the supply of currency, much like a currency board operates. Currency boards, such as those in use in Hong Kong or Estonia today, can just as easily and reliably link to gold instead of another currency.
Gold Standard: Economies and Currencies
One of the most straightforward ways to link the value of a currency to gold is to, quite simply, make the currency out of gold. In the past, when economies and currencies collapsed, people sometimes just started doing their business in gold and silver coins. Most of the dollar bills in the world today are actually being used outside the United States, and it appears that most of them are being used in under-the-table or even illegal activities of one sort or another. The popularity of the dollar outside the United States has been in steep decline in recent years, and many people that had used the dollar for their business have been transitioning to euros or other currencies. Apparently, some of these underworld elements have even begun to do their business in gold coins.
However, there really isn’t enough gold in the world today to run today’s economy with gold coins. And since all of the existing gold is already owned, the question is: what is everyone else going to use? Unless we are going to have a worldwide collapse of the most dramatic proportions, which would make the Great Depression look like a hiccup, it will be necessary to establish a paper currency linked to gold. A few governments have indicated a willingness to step up to the plate, including a number from the Islamic world who share the tradition of the gold dinar. Russia has also shown some interest. These incipient attempts have generally foundered on a lack of confidence in the technical ability to actually get the job done right – a conclusion which appears to be correct. It is better to have no gold standard than one that soon collapses due to incompetence. Operating a proper gold standard is easy, but it does take more than simply declaring a hope and crossing fingers.
Gold Standard: Maintaining Value
That said it is also necessary to know how to create and maintain a viable gold standard. That is a subject rather more complicated than we can deal with in these pages, but at least we can now identify the steps along path from the present state of worsening chaos to the land of monetary milk and honey. If the man-in-the-street has the knowledge of why and how to operate a gold standard, governments will likely follow along. People get the government they deserve, it is said, and by increasing the average person’s understanding they will come to deserve a better monetary system as well.
Another crucial stage will be to sweep away the encrustations of generations of misunderstanding of what a gold standard is supposed to accomplish. Many of today’s gold standard advocates cling to the most implausible notions decade after decade, just as today’s lovers of floating fiat currencies spout their own brand of ridiculous nonsense.
Gold Standard: Budget Deficit
Here are some fallacies debunked:
A gold standard does not prevent a government from running a budget deficit. For example, the British government piled up impressive amounts of debt in the 18th and 19th centuries under a gold standard. A gold standard does not prevent a current account deficit, which is another term for the importation of capital. The United States ran a current account deficit in every single year of the 19th century, with a gold standard, as European capital flowed to the New World. In fact, a gold standard makes both government deficit financing and capital importation easier, because it tends to lead to lower interest rates and currency stability. As governments and other economic actors are forever engaged in all sorts of reprehensible behavior, and it is foolish to expect a gold standard to solve all those problems – just as it is foolish for the floating-currency advocates to think that the Fed can make any economic difficulty disappear by waving its magic wand over interest rates.
What can you do today? Imagine that a world of gold-linked money already exists. Things are considered politically impossible, but when they happen, and the historians call them inevitable. In this alternate universe, you can’t even remember when Europe was a grab bag of over a dozen currencies. Now the euro is more commonly used in the world than even the U.S. dollar.
In this hypothetical world, the euro may be in turn replaced by the gold dinar, which got its start in Dubai in the autumn of 2007. The gold dinar was equivalent to one gram of gold. The Dubai Commerce Bank – it was supported by the government, which provided deposit insurance on amounts less than 5 kilograms – offered certificates of deposit in gold dinars, which proved popular as they paid 1% interest and were redeemable in gold bullion. (Exchange-traded funds based on these CDs almost immediately appeared worldwide. After deducting management fees, they paid a 0.80% dividend.) The bank then lent at 4.5%, in gold dinars. The gold dinar was quickly adopted as payment for oil exports throughout the Middle East, especially since the oil futures exchange in Dubai priced its crude oil contract in gold dinars. Soon the Middle Easterners were anxious to reinvest their oil revenues, leading them to make loans to governments and corporations around the world – loans (and bonds) denominated in gold dinars, of course.
Gold Standard: Interest Rates
Consequentially, governments and corporations were eager to borrow in gold dinars because they bore interest rates of only 3.5% for a ten-year bond for governments, and 4.5% for corporates, rates that were common in the 19th century. This was far better than borrowing in dollars or other local fiat currencies, which bore rates in excess of 15% due to worsening inflation. The trade-dependent countries such as Korea or Malaysia, which had always linked their currencies to those used in international trade, soon gravitated towards the gold dinar (local corporations were doing more and more of their financing in dinars), and eventually finalized their links via currency boards. China’s sheer size and international ambitions were too great for that country to become a monetary vassal of Dubai, so China established an independent gold-linked currency. The gold yuan soon became popular in Africa, where it was received in payment for commodities exports. Because both the gold dinar and the gold yuan were linked to gold, their exchange rates were effectively fixed. Russia followed soon thereafter, with an independent gold ruble. Japan and Switzerland were next.
The Federal Reserve eventually raised its interest rate target to 85% in an attempt to support the dollar, but that policy was not able to counteract the dollar’s worldwide rejection. Cindy Sheehan camped out in front of the Federal Reserve building, asking for a meeting with Chairman Bernanke. “I just want him to explain what ‘In God We Trust’ is supposed to mean,” she told the media. She was soon joined by over two hundred others.
Despite becoming the first Chairman of the Federal Reserve to win a Nobel Prize in economics only six months earlier, Chairman Bernanke stepped down in disgrace, in the middle of his term. He then became president of the World Bank, replacing Paul Wolfowitz. Hyperinflation in the United States eventually led to a new political party, formed by dissatisfied Congresspeople from both the Republican and Democratic parties, which took a strictly Constitutionalist approach to monetary affairs. The unused Federal Reserve building in Washington DC was eventually converted into a museum of Native American art.
The Daily Reckoning
Editor’s Note: Nathan Lewis was formerly the Chief International Economist of a firm that provides investment advice to institutional investors. Today, he is part of the investing team at an asset-management company. He has written for the Financial Times, Asian Wall Street Journal, Daily Yomiuri, Japan Times, Pravda, Dow Jones Newswires, and other publications. He has appeared on financial programs in the United States, Asia, and the Middle East.
He writes about economics and other matters from time to time at his website:
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“Between sky-high U.S. debt levels and the Fed’s knee-jerk reaction to flood the world with dollars, it’s not hard to see a bright future for our favorite yellow metal. But what about in the near term?”
The Dismal History of Phony Money by Addison Wiggin
“The fall of the dollar is like a car accident…you want to cover your eyes and walk away, but you can’t help but watch it with a sense of amazement. And if you look through the history of currencies, you’ll find that all printed money eventually ends up the same way: practically worthless.”
Gold Crosses the Rhine by Dan Denning
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Seasons of Gold by Doug Casey
“Given the current gold trend, International Speculator’s Doug Casey explains why smart investors should give gold and gold stocks an appropriate place in their portfolio.”
Here are some resources about the Gold Standard:
Answers.comThe ultimate answer engine, with quick accurate dictionary, thesaurus, encyclopedia, bios, tech terms, news, sports, weather, and much more.
Econ Browser Analysis of current economic conditions and policy.
Gold Standard Awards Incisive Media, specialist business information provider operating in eight core markets, financial risk management, retail investment, etc., announces the winners of the Gold Standard Awards 2006.
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