Thursday, June 2, 2011

The What, Why, and When of a Modern Gold Standard

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.

Nonetheless, the proposal leaves me with unanswered questions. For example, if the world economy is growing by leaps and bounds but the stock of gold in the world remains relatively stable, how can gold supply the money required to circulate through such an economy?

A reporter from The Street asks precisely these questions (follow the link to the video) of Peter Schiff who says the coming dollar crisis will force us back onto the gold standard. Nothing else can prevent successive governments printing more and more money and moving us closer and closer to national bankruptcy. Sadly, he doesn't give me or the reporter the answers we were looking for.

This interviewer on Hard Asset Investor explains briefly how a movement to the gold standard would be catastrophically deflationary because all the gold ever mined from the earth is worth just over $4 trillion, whereas the world economy is worth about $60 trillion. (By the way, there are about $600 trillion in derivatives hanging out there. Scary thought. But one thing at a time.) But Schiff is undeterred.

Back in May, Steve Forbes told Human Events that he predicts a return to the gold standard within five years. Here is a sober account from of what the gold standard does and what it does not do. The same author explains the paper to gold relationship here.

The same reporter from The Street who interviewed Peter Schiff later interviewed Steve Forbes on the same subject with more satisfying answers, it seems to me.

So, it seems that a "true" gold standard is, as suspected, impossible. The amount of U.S. currency in circulation is $9 trillion. But the U.S. owns only $400 billion in gold. All the gold in the world at $1500 an ounce amounts only to $4 trillion. A "gold standard modern" would simply peg the dollar at, for example, $1500 an ounce of gold.

[W]hen the price rises above that level the Federal Reserve must raise rates and when it falls below the Fed can loosen monetary policy. Gold, in essence, would act as a check for the central bank and help regulate the U.S. dollar. "We don't need to own one ounce of gold," says Forbes in an exclusive interview with TheStreet, "you just keep it in a narrow range."

When the consequences of our debt catch up with us, and especially if there is a serious threat of the American dollar losing its global status as the reserve currency, the default currency of international transactions for things like oil, we may have no choice but to go this route.

John Nadler of argues that there is no path back to a gold standard. I don't know if the fact that his company sells gold has anything to do with the position he takes on the subject.

I'm learning too.


Ralph Benko of the Lehrman Institute’s Gold Standard Now cites this post in "Memo to our Madmen in Authority. The Gold Standard is the New Monetarism, featuring the Quality, not Quantity, of Money" (Caffeinated Thoughts, July 17, 2011).

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