A Gold Standard System Based on Bullion Coins Is No Longer Practical

A Gold Standard System Based on Bullion Coins Is No Longer Practical
November 1, 2013

(This item originally appeared at Forbes.com on November 1, 2013.)


I’m kind of a big picture guy. I would like to see the government of China issue a parallel gold-based currency, in the form of banknotes and coins, for widespread use within China and around the world — or, at least, to sanction some private institutions to do so, as Hong Kong does today. Full banking operations, using the new currency, would be immediately available.

Then we wouldn’t have to talk about it. You could use it if you wanted to, just as you might use the dollar or euro today. Or, don’t use it.

In the U.S., however, people seem to like the grassroots, neighborhood approach. Along those lines, many people seem to think that making full-weight bullion coins is the way to go. This mirrors the system that indeed was in widespread use in the United States at its inception in 1789.

This is fine. You can have both options, simultaneously. Unfortunately, the full-weight bullion coins approach isn’t going to get very far, in my opinion.

Why not? Besides the very important considerations regarding de facto legality within the U.S., and various taxes and so forth, we don’t really have a shortage of high-quality bullion coins.

We have gold bullion coins from many issuers, including South African Krugerrands, Canadian Maples, Chinese pandas, and the U.S. Mint’s own Gold Eagles. All are available at excellent prices.

We also have plenty of silver coins, whether leftover 90%-silver dimes and quarters from the 1950s, or newly-minted Silver Eagles from the U.S. Mint.

We even have plenty of copper pennies, although they are called “nickels” today. (The 5-cent “nickel” is 75% copper and 25% nickel.)

Unfortunately, this system, which worked reasonably well enough in the pre-1800 era, hasn’t been feasible since the mid-1870s.

The “bimetallic” (silver and gold) system worked because the market value of silver was very closely linked to gold for centuries, meandering gently between a ratio of about 15:1 and 16:1. They were effectively two different versions of the same thing. This allowed silver to be used as “small denomination” money and gold to be used as “large denomination” money.

This 15:1 ratio goes back to Greek times, and earlier.

In the mid-1870s, something unprecedented happened: the market value of silver dropped dramatically compared to gold. In effect, silver was “demonetized” by something like a consensus vote of humanity. Governments had to follow along, but they didn’t instigate the change. Some governments (notably China and India) stayed on a silver-based system.

Today, silver is no longer usable as a small-denomination version of gold (or gold as a large-denomination version of silver). The bimetallic coinage system doesn’t work today. That’s why the world’s governments went to a “monometallic” gold-only system in the 1870s.

Rather, what we need today is a currency system that has a full range of denominations, from largest to smallest. This is really only achievable with paper banknotes and token coins, which is what happened after the 1870s. If the gold parity is $20.67/oz., as it was in the U.S. in those days, you could either take $20 of banknotes and coins to the currency issuer, and get a 0.97 troy oz. gold coin (the $20 double Eagle) in return, or take gold bullion (or coins) to the currency issuer, and get $20 of banknotes and small change, which you could use in your daily errands as small-denomination money.

Silver was no longer needed as small-denomination money. Silver coins continued, but as token coins, whose metal value was less than the face value of the coin.

You could use such token coins today, instead of paper banknotes. The main problem seems to be that they are easier to counterfeit than banknotes, so they are usable only for very small denominations.

Along with banknotes, you can have the full range of banking services, including demand deposits and payment systems. Today, this would include debit cards, personal checks, ACH transfers, online payments, credit cards, Paypal, wire transfers, and all the rest.

You could even have a variety of encryption mechanisms, such as used by Bitcoin. Indeed, you could have a “crypto-currency” like Bitcoin, whose value is linked to gold, and have no banknotes and coins at all. I wouldn’t recommend this, but it can be done. (GoldMoney had services such as these for a while, with no physical banknotes and coins.)

Unfortunately, simply making gold coins, such as the “gold dinar” produced by the Malaysian state of Kelantan, is really not much more than superstition, or perhaps a political show of support. A new monetary system can certainly include gold coins, as it did in the U.S. before 1933, but that alone wouldn’t be enough. It wasn’t enough in the 1890s either.

In 1890, the U.S. currency system had a total of $1,429 million of banknotes and coins. Within this, there was $484 million of bullion coins, including $374 million of gold coins. The other $946 million was paper banknotes — redeemable in gold bullion on demand.

The United States’ 1800-style currency system wouldn’t work very well today. But, the 1900-style currency system would probably be just fine.

Despite promising moves on the state level, such as Texas’ recent move to remove taxes and endorse the use of gold and silver as money, the U.S. Federal government will probably remain opposed to any viable alternative to the now-dominant fiat dollar.

But other governments are already anxious to replace King Dollar with something better. I’m hoping the Chinese government can figure this out. They have such a great opportunity.