A Proposal for a Gold Standard System for the United States
May 27, 2012
Today we have something a little special — a proposal for a gold standard system for the United States.
I’ve been making the point recently that a “gold standard system” is a system with two basic characteristics:
2) It has to have an operating mechanism which consistently and reliably achieves the policy goal, into the indefinite future.
Within this basic framework, you can devise a great many systems, each with their individual characteristics. That’s why the title of this piece is for “a gold standard system,” not “the gold standard.” We talked about this in greater depth earlier this year:
January 29, 2012: Gold Standard Technical Operating Discussions 3: Automaticity Vs. Discretion
January 15, 2012: Gold Standard Technical Operating Discussions 2: More Variations
January 8, 2012: Some Gold Standand Technical Operating Discussions
May 13, 2012: The “Gold Exchange Standard”
May 10, 2012: The Gold Standard System: Why and How?
February 9, 2012: What Is the Best Type of Gold Standard System?
July 28, 2011: Making Change: The Simplest Practical Gold Standard System
March 16, 2012: $100 Per Blender
Given this wide variety of options, what would be an appropriate system for the United States?
The United States is something of a special case, due to the very large size of the monetary base and the U.S.’s present leadership position in world monetary affairs. Some systems that could work for a small country, like Ethiopia or Sri Lanka, would become problematic for the United States.
I made the Federal Reserve the manager of the currency, as it is today. Although I am not unfriendly to an “end the Fed” policy and establishment of some other currency-managing body, we haven’t reached that point politically yet, I think. Maybe we will later, and at that time I would be happy to design some sort of Federal-Reserve-free gold standard system.
I decided to include full redeemability of all base money, which is banknotes and bank reserves recorded at the Federal Reserve. This is a traditional component of gold standard systems in the U.S. and Britain for the last two hundred years, particularly before 1930. Also, I think that many gold standard advocates today, particularly of the “Austrian” flavor, would insist on it. Technically, redeemability is not necessary. Any method that properly manages base money in accordance to a gold parity will work. Historically, redeemability seems to be a political necessity; whenever redeemability is suspended, monetary foolishness soon follows, even if this was not exactly the purpose of suspending redeemability in the first place. When the Bank of England suspended redeemability in 1914, the pound soon lost value, even though devaluation was not the purpose of the act at all. We tend to forget that the official suspension of redeemability for U.S. dollars, in 1971, was supposed to be temporary.
Base money management is the core of any gold standard system. This proposal has two parallel systems to manage base money; open-market operations in non-bullion assets (primarily government debt), and redeemability and monetization (buying bullion and giving base money, the opposite of redeemability) as another system. Either system would be sufficient on its own, so you could say it is a sort of belt-and-suspenders system.
The system of redeemability and monetization is instigated by the private market. In other words, the process of when to buy or sell assets (and, consequently, expand or contract the monetary base), and in what size, is decided by private market participants. The system of open-market operations in non-bullion assets is instigated by the currency managers, in this case the Federal Reserve. These open-market operations are discretionary in nature; in other words, the question of when and how much to adjust base money via open-market operations is decided by the currency managers. However, they must always operate in line with the principles of the gold parity policy. This means that base money can be expanded when the currency is higher in value than its policy target, and base money is contracted when the currency is lower in value than its policy target.
You could develop fixed rules for open-market operations, thus removing the discretionary element. However, this proposal is somewhat traditionalist in nature, so here we are basically mimicking how things were done by the Bank of England in 1910 or the Federal Reserve in 1925.
The process of open-market operations is designed to be the first avenue of base money adjustment. In other words, base money adjustments are to be done first and foremost by open-market operations. If this is done correctly, then the value of the currency should not diverge from the policy target so much that private market participants would be interested in either buying or selling bullion (redeemability and monetization) with the currency manager. Thus, proponents of “no-redeemability gold standard systems” in effect get what they wanted. The redeemability option would only be used if the value of the currency moved far enough away from the parity target that transactions in bullion became attractive. This primacy of open-market operations in non-bullion assets as the first avenue of base money adjustment is further reinforced by the introduction of an optional redemption fee not to exceed 2% of the parity value, and a monetization fee not to exceed 1%. By adjusting the fees, the currency manager can widen the “buy-sell spread” on bullion up to a maximum of 3%. In effect, bullion transport and storage would add a few more costs, thus widening the effective “buy-sell spread” a bit wider than the fees alone imply.
Bullion reserve holdings of not less than 15% of base money outstanding are mandated. However, this is structured as an annual average, giving the currency manager greater flexibility on a day-to-day basis. Bullion reserve holdings of greater than 15%, even up to or exceeding 100%, are allowed.
The ratio of bullion to non-bullion reserve holdings can be adjusted by transactions in bullion and non-bullion assets (high-quality debt). In other words, if the bullion reserves are deemed to be low (below 15% annual average), then the currency manager (Federal Reserve) would sell bonds, and then, using the proceeds of the sale, buy bullion on the open market. This does not change the monetary base. If bullion holdings are deemed to be too high, then the currency manager would sell bullion, and then, using the proceeds, buy debt on the open market. This does not change the monetary base. In principle, such transactions should be as least disruptive of market conditions in either bullion or debt as possible.
Some instructions on how the Federal Reserve would act as a “lender of last resort” — in the 19th century meaning of the term — within the context of the gold standard system are given. This is very much in line with the Bank of England’s operating principles during the 1860-1914 period.
All in all, this is a very traditionalist proposal, as mentioned much like the Bank of England operated in the 1880-1914 period or the Federal Reserve operated in the 1920-1932 period. I think this sort of system can certainly work today, with no particular drawbacks. Since it demonstrably did work for many decades, it avoids many criticisms. Also, I think there is strong political support for this sort of traditionalist system. It is somewhat complicated, and thus depends somewhat on the understanding and good judgement of the currency managers, i.e. Federal Reserve bureaucrats. Most everything you need to know is written here and in the proposal, so it is not really all that difficult. However, these people really are rather stupid, and I think it is important for a broad range of people to understand how this system works, to keep those bureaucrats in line and identify their mistakes if mistakes are made.
Even if you did want some other sort of system — and a great many other ones would work, and work well — I think it helps the debate if we at least understand how things were done in the past.
I included a little protocol to decide on a new parity value for the system. It is based on a Congressional committee. I have been told that this committee idea won’t be very popular in Congress. I’m not sure that is true, but there are a great many other ways you could find a reasonable parity value. It is not a hard problem to solve. So, if you don’t like my proposal, just make up your own. My only demand is that it works: that is, it comes up with a parity value that is not silly, and which would have broad political support.
So, with that, here’s the proposal, in .pdf format:
Click here to read the “Gold Standard Act of 2012”