Different Kinds of Gold Standard Systems
April 8, 2011
(This originally appeared in Forbes.com on April 8, 2011.)
http://www.forbes.com/2011/04/08/gold-standard-dollar-opinions-nathan-lewis.html
It is popular among some people to describe “different kinds of gold standards.” They make up all sorts of terminology such as a “gold exchange standard” or a “pure gold standard” or a “classical gold standard” or a “Bretton Woods gold standard” or a dozen different terms.
I would say there are really only two kinds of gold standard systems: those that work and those that don’t.
The ones that don’t work are not really gold standard systems. Just like a “car that doesn’t work” due to design flaws isn’t really a car, it is a metal sculpture in the shape of a car. (Many “gold standard” proposals today are, you could say, nonfunctional rhetorical sculptures in the shape of a gold standard system.)
This limits us to gold standard systems that work. This, in turn could be divided into many different subcategories. Maybe a hundred. Maybe a thousand. The fact of the matter is, every gold standard system was a little different.
The U.S. did things differently than Britain, which did things differently than France, and Russia, and Italy, and Holland, and Argentina, and the Philippines. The U.S. alone had all sorts of different systems over the years, ranging from free banking systems, to free banking systems with a large national bank, to free banking systems with Treasury participation, to free banking systems with Treasury oversight, to systems with both free banks and the Federal Reserve, to a Federal Reserve monopoly, and on and on and on.
How about China, and its 2,000-plus-year experience with gold- and silver-based monetary systems? Do you want to hear about the paper money system used by Szechwan merchants in the year 1015? How about the Sumerian use of gold warehouse receipts, in the form of clay tablets, in 3500 BC? And what about India and Japan? We’re going to have to fill a whole encyclopedia with “different types of gold standards.”
Even then, most of the existing descriptions are incorrect. I’ve read probably fifteen different descriptions of the “classical gold standard,” which presumably means the system used by Britain in the late 19th century, all of them wrong.
With a little time I could make up another dozen gold standard systems which have probably never existed, but would work.
It makes more sense to talk about gold standard principles. Once you know the principles, you can design all sorts of systems that will work, and also identify systems that won’t work.
A system that is appropriate for the 21st century would probably be a little different than any historical example. You can tweak it however you like. Once you know the principles, it’s easy.
Here are the principles:
–A “gold standard system” is a value peg. Your goal is to make the value of a paper chit (“currency”) equivalent to a specified amount of gold. It is not some sort of quantity link, in which the quantity of currency is determined by the quantity of gold held in storage, or imports and exports of gold, or current account balances, or some “3% per year” rule, or held at some unchanging figure, or subject to some imaginary “price-specie flow mechanism,” or this or that or the other. It is a value peg. This value peg is typically expressed as a “price of gold,” like the $20.67 per ounce used by the U.S. for many decades.
–The mechanism by which the value of a paper chit–otherwise worthless–is held at a fixed parity with gold is the adjustment of supply in response to changes in demand. If the value of the currency is a little low, supply is reduced. If the value is a little high, supply is increased. The currency’s value is not maintained by executive order, or unsterilized “intervention,” or coy hints dropped by monetary authorities at a press conference, or empty blather about a “strong dollar policy,” or sales of gold bullion at nonmarket prices, or manipulations of interest rates, or any other variety of wishing and hoping, or some other such thing. In the past, purchases and sales of gold bullion, and the Bank of England’s discount rate, were indeed part of the gold standard systems of that time. However, if you look closely, you will see that the effect of these things was to increase or decrease the supply of currency. That’s why these systems worked. You could design systems that also had purchases or sales of bullion, and various interest rate mechanisms, and they wouldn’t work if they did not have this supply adjustment element.
This supply-adjustment process is inherent in today’s currency boards, which is why I say that a gold standard is like a “currency board linked to gold.”
David Ricardo was the 19th century’s premier reference on monetary matters. In 1817 he wrote:
It is on this principle that paper money circulates: the whole charge for paper money may be considered as seignorage. Though it has no intrinsic value, yet, by limiting its quantity, its value in exchange is as great as an equal denomination of [gold] coin, or of bullion in that coin. …
It will be seen that it is not necessary that the paper money should be payable in specie to secure its value; it is only necessary that its quantity should be regulated according to the value of the metal which is declared to be the standard.
“It is only necessary that the quantity should be regulated according to the value of the metal which is declared to be the standard.” That is the necessary and sufficient condition of a gold standard system–in 1817, and also today, 194 years later. Nothing has changed.
To put it in slightly different terms: The perfect supply of money is that which causes the currency to have the specified gold parity value. This “perfect supply” is always changing. A gold standard system that has a mechanism to produce this “perfect supply” will work. A system that does not have such a mechanism will fail.
This supply adjustment process takes place even in a system which uses only bullion coins. If people want to hold lots of coins (i.e. there is increasing demand), then bullion is imported or mined and minted into coins. If people don’t want to use so many coins, then the excess coins eventually end up in the hands of foreigners, or are melted down and converted to other uses.
The reason that people talk about various systems so much is that they don’t understand the principles. It is like a machine they don’t understand. If you wanted a certain machine, but you didn’t understand how it worked, you would conclude that you should replicate it exactly. In practice however, even if you thought you were replicating it exactly, the fact that you didn’t understand how it worked would probably lead you to make a terminal error.
However, if you know how a machine works, you can design dozens of variants. We know the principles behind the automobile–internal combustion of fossil fuels driving wheels. Because they know the principles, the automakers can churn out dozens of “different kinds of automobiles” every year, each one a little different, and they all work.
A gold standard system is much simpler than an automobile. It’s just a paper chit. One moving part!
