Tuesday, May 19, 2015

What is the Gold Standard ?

What is the Gold Standard ?
Thomas Allen

    Much confusion exists about the gold standard. Under the true gold standard, which is also called the gold-coin standard and the unadulterated gold standard, gold does not back the money. Gold is the money.

    Most promoters of a gold standard promote a monetary system that does not constitute a true gold standard.

    First, gold is used to back a currency that is irredeemable. For example, between 1933 and 1968, Congress required federal reserve notes to have some gold backing. Yet citizens of the United States could not redeem their federal reserve notes for gold. With a few exceptions, they could not even own gold.

    Second, the government issues paper money that is redeemable in gold. The government buys gold and uses it, either as coins or bullion, to back its paper money. Often it issues more notes than it has gold backing it. An example of this type of money is the U.S. note between 1879 and 1933.

    Third, the government buys gold on its own account and coins it. This type of monetary system looks like a gold-coin standard, but it is not. The government arbitrarily decides the quantity of coins to issue. An example of this system in the United States involved silver dollars between 1873 and 1900. After 1873, the U.S. government no longer allowed the free coinage of silver. Instead it bought silver bullion on its own account and coined it into silver dollars, which it declared legal tender and standard money and which was not directly redeemable into gold until 1900.

    Fourth, some supply-side economists recommend requiring the central bank to expand or contract the money supply and credit to keep the price of gold within a specific range. This is obviously not a gold standard. It is a fiat monetary system where the price of gold becomes the index by which to adjust the money supply.

    Fifth, Irving Fisher’s plan to make dollars redeemable in gold based on purchasing power as determined by an index instead of weight is not a true gold standard.

    Although these systems use gold, they are not a true gold standard. They are forms of fiat money because the government or its central bank arbitrarily controls the money supply. The quantity of money does not expand or contract to meet the needs of commerce; the law and the  government’s collections and disbursements fix the quantity.

    Two other forms of standards that use gold are sometimes promoted. They are the gold-bullion standard and gold-exchange standard. However, gold coins do not circulate under either of these standards.

    Under the gold-bullion standard, paper money is redeemable only in large bars of gold bullion. The country’s money is not redeemable in gold coins. Consequently, it is considered a rich man’s standard. Because redemption is in large high-value bars, few besides specialists in foreign trade redeem notes for gold. Gold bullion presented to the government or its central bank is not coined. Instead the government or its central bank pays the presenter in government notes or bank notes.

    Under the gold-exchange standard, gold can only be used to transfer payments in gold to approved foreign institutions. Governments created the gold-exchange standard. It is a politically created system and not a product of the markets. The gold-exchange standard allows governments and their central banks to manipulate international gold flows for political reasons. The government holds the reserves of its foreign claims in gold. Most of the world’s gold ends up in the vaults of a few central banks. The gold-exchange standard offers little resistance to the desires of governments to inflate their currencies. Gold is subordinated to governmental policies and goals. Because of domestic inflation, against which it offers little resistance, the gold-exchange standard becomes unstable and dysfunctional. Most of the world operated under a modified gold-exchange standard between 1944 and 1971. (This standard was more of a dollar standard as foreign currencies were pegged to the dollar, which was pegged to gold at $35 per ounce.)

    A common misunderstanding about the true gold standard is that the government fixes the price of gold. For example, if an ounce of gold exchanges for $20, the government has fixed the price of gold at $20 per ounce.

    Under the true gold standard, the government does not fix the price of gold. It defines the monetary unit, such as the dollar, as a specific weight of gold. That is, the dollar is a specific weight of gold. For example, the dollar is defined as 1/20 of an ounce of gold or 24 grains of gold. The dollar is 24 grains of gold. It is a unit of weight like the pound or gram. It is just limited to money. By declaring the dollar to be 24 grains of gold, the government has no more fixed price of gold than it has fixed the price of a pound by declaring it to be 7000 grains.

    Thus, a fundamental principle of the true gold standard is that the price of gold is not fixed. The monetary unit is a specific weight of gold. Furthermore, gold does not back the money. The money is gold.

    Moreover, under the true gold standard, the government does not monetize gold. Gold does not have to be in the form of a coin minted by the government to function as money. Privately minted coins can function as money as well as those minted by the government. Furthermore, gold often functions as money in the form of bars. Thus, coining by the government does not monetize gold. To the extent that gold is monetized, the markets, and not the government, monetize it.

    Under the true gold standard, regulation of the money supply is automatic and decentralized. Supply varies to suit the needs of the people and commerce. Governmental intervention is unnecessary and would cause more harm than good. The true gold standard automatically optimizes the quantity of money to suit the needs of the people and the economy.

    In summary the true gold standard has the following attributes:

    1. Gold does not back the money; gold is the money.

    2. The price of gold is not fixed. The monetary unit is a specific weight of gold.

    3. Gold coins circulate as money.

    4. The value of a coin is the value of its metal content.

    5. There is the free coinage of gold: Anyone can bring any amount of gold to the mint, which does not have to be owned by the government, and get it coined.

    6. Anyone can melt coins without restriction and use the metal for nonmonetary purposes.

    7. No restrictions are placed on exporting or importing gold.

    8. All paper money is redeemable in gold on demand.

    9. The supply of money is self-regulating and automatically adjusts to meet the demand for metallic money. The government does not manage or otherwise manipulate the money supply. No monetary policy is necessary, and none is desirable.

    10. The government does not buy gold and coin it on its own account.

    11. Gold coins are the property of the individual holding them; they are not the property of the government. No restrictions or controls are placed on the private ownership of gold.

    12. Legal tender laws are unnecessary and undesirable.

    13. The government’s monetary duties are limited to defining the monetary unit, coining all gold presented to it for coinage and guaranteeing the weight and fineness of such coins, punishing counterfeiters of such coins, punishing issuers of paper money who fail to redeem their paper money on demand, and punishing acts of fraud and enforcing contracts in monetary matters.

Copyright © 2013 by Thomas Coley Allen.

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