imageBy Ralph Benko

Professor D. C. Innes of The King’s College in New York City had an exceptionally thoughtful blog entry.  He commences:

I hear people talking about returning to the gold standard so that money once again has real value, and so that governments are not able to manipulate the money supply as easily as they do. This sounds appealing to me. Whenever you see the price of gold going up, that generally means the value of your dollar is going down, especially as the U.S. dollar is the world’s reserve currency.

With astuteness, Professor Innes confronts what may represent the major misunderstanding constraining our ability to restore gold convertibility to our currency:  the fear that there is “not enough gold.”  This is a residual misunderstanding that achieved undue significance under the quantity-based old monetarism developed and propounded by the late, great, Milton Friedman. 

In a rather famous June 7, 2003 interview with the FT, Friedman stated: “The use of quantity of money as a target has not been a success.” He added: “I’m not sure I would as of today push it as hard as I once did.”  That was quite a powerful repudiation in a most prestigious venue.

And yet, our thought leaders do not seem to have taken the cue. 

As Keynes famously wrote, in The General Theory of Employment, Interest and Money:

The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back.

It is therefore of exceptional interest that our current “madmen in authority” still embrace a theory which Friedman, himself a man of irreproachable intellectual integrity, repudiated. 

At no time in its almost unbroken 200 year history — from its 1717 institution by Sir Isaac Newton, who converted his sinecure as Warden of the Royal Mint into a perch to create and institute the classical gold standard — to its destruction by World War I — was there ever 100% backing of the currency in gold.  No less a figure than Adam Smith, in Wealth of Nations, called for a fractional reserve of gold to pounds of 20% and, as columnist Nathan Lewis observed:

The amount of metal piled in a vault has little relationship to the value (or quantity) of paper banknotes. In 1779 the Bank of England held 953,066 ounces of gold in reserve. In 1783 this had fallen to 339,261 ounces. One year later, in 1784, it had grown to 1,683,724 ounces. A year after that, it was down to 703,692 ounces, but in 1786 it bounced back up again to 1,535,538 ounces. These gyrations had no effect on the value of the British pound, which was pegged to gold at 3.89375 pounds per ounce.

Nor did banks ever have a 100% reserve of gold. In 1888 U.S. banks had a gold reserve ratio of 34.86%. By 1895 it had fallen to 12.33%. In 1906 it had grown again to 42.42%. None of this mattered to the value of the dollar, which was pegged to gold at $20.67 per ounce.

A gold standard does not place some artificial limit on the supply of money, nor is the supply of money constrained to the output of gold mines. The supply of base money grows or contracts as necessary to maintain the currency’s value in line with the gold parity. Between 1775 and 1900, the U.S. base money supply increased by 163 times–in line with an expanding economy and a population that went from 3.9 million in 1790 to 76.2 million in 1900. Over this 125-year period, the amount of gold in the world increased by about 3.4 times due to mining.

The only thing that mattered was the value. The dollar maintained its link near $20.67 per ounce throughout the 19th century (with a lapse during the Civil War).

In short, the gold standard has entirely to do with the quality, rather than the quantity, of money.  And gold has proven, over centuries (some of the most interesting and fundamental foundational work on the subject was performed by no less a figure than Nicholaus Copernicus) to be the, well, “gold standard” of monetary quality.

The great thing about gold-convertible money is its constancy of value.  It is not subject either to dramatic inflations or deflations.  The U.S. Constitution provides the Congress with the power to regulate the value of money in the same clause, Article I, Section 8, clause 5, as that of its power to regulate the value of weights and measures.  So to argue that “there might not be enough gold” is akin to arguing that were the Congress to (as it has) constrain the length of a yardstick to 36 inches, no more no less, American industry would be at risk of running out of … yardsticks.  Or, even more risibly, inches.  Not so!

Historically, there is almost precisely as much refined gold per capita today as there was 100 or 1000 years ago.  And as to what the eminence grise of gold standard advocacy, Lewis E. Lehrman, with whom this writer is professionally associated, elegantly refers to as the “credit superstructure” — it is not fundamentally different today than it was under the gold standard itself. 

When my father was a young man he could walk into any bank with a $20 bill and receive a $20 ounce gold coin.  Gold has the quality of regulating — maintaining — the value of a currency, not of confining its quantity.  My father would most likely have paid his rent, bought his groceries, or even gas for his car with currency or checks.  Today a gold standard could be almost invisible—although there are integrity advantages to keeping it from becoming entirely invisible—as we still conducted most of our purchases in currency, checks, ATMs, an online transactions. 

As columnist Dominic Frisby astutely points out  gold is a wonderful store of value but an inconvenient medium of exchange.  Paper is a most convenient medium of exchange but a terrible store of value.  Thus under the gold standard we get the best of both worlds:  the convenience of paper and the value-integrity of gold.  It’s the real deal.

The fractional reserve aspect in no way impairs the classical gold standards as less than “true.”  There are those who argue for a 100% gold reserve.  While it makes for a fascinating academic exercise, such a gold standard has never, to this writer’s knowledge, existed in the world of commerce.  Therefore, it is hard to justify calling something pure but entirely theoretical “true” — while implying that the actual system which prevailed brilliantly in the world, for centuries, was somehow lacking in integrity.

After the Civil War, in the US, and again in 1925, under Churchill in the UK, the monetary authorities misjudged the correct convertibility price in restoring the gold standard, leading to painful (and, in the UK, yes catastrophic) deflation.  Proponents of restoring the gold standard are well aware of that contingency and have, again as most clearly articulated by Mr. Lehrman and by American Principles In Action’s chairman Sean Fieler, developed empirical mechanisms that of a certainty would prevent a deflationary bias.  This is far less of a moral hazard now than previously, as there is no thought to returning to the pre-repudiation convertibility amount ($35 an ounce).  Nevertheless, the mechanisms to avoid such a contingency are clear, simple, and extremely well understood.

There is, in fact, a clear path to move forward to the gold standard.  As this writer recently has written elsewhere, Nobel Laureate, inventor of the core doctrine of Reaganomics, and father of the euro, advisor to China’s economic miracle, Columbia University’s Professor Robert Mundell, recently has called for an international gold standard:

Mundell recently endorsed the gold standard on Pimm Fox’s Bloomberg Television “Taking Stock.”

Pimm Fox:  You’ve written about the role of gold in the world economy, Professor Mundell.  Do you think that we’re going to see any kind of return to the gold standard?

Mundell:  [T]here could be a kind of Bretton Woods type of gold standard where the price of gold was fixed for central banks and they could use gold as an asset to trade central banks.

The great advantage of that was that gold is nobody’s liability and it can’t be printed.  So it has a strength and confidence that people trust.  So If you had not just the United States but the United States and the euro tied together to each other and to gold, gold might be the intermediary and then with the other important currencies like the yen and Chinese yuan and British pound  all tied together as a kind of new SDR that could be one way the world could move forward on a better monetary system.

This writer has observed what he calls the emergence of the “New Monetarism,” monetarism based on quality not quantity.  When the dollar has once again been statutorily (and perhaps, eventually, Constitutionally) defined as a stated weight of gold, the stability of the world’s “numeraire” — measure of value — will (as it did before) turbocharge economic growth and constrain the spending of the federal government.  There is no shortage (or surfeit) of gold and, competently introduced, it will be a source of great prosperity.

Ralph Benko is senior advisor to the American Principles Project Gold Standard 2012 Initiative, editor of the Lehrman Institute’s Gold Standard Now, and author of The Websters’ Dictionary: How to Use the Web to Transform the World

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