Don’t “Kitchen Sink” the Monetary Debate. Gold-Based Money Is Simple.
August 7, 2014
(This item originally appeared in Forbes.com on August 7, 2014.)
What is a “gold standard system”? Since the United States had a gold standard policy for most of its history, 1789-1971, you would think a basic question like this would be easy to answer. But, I think most people – and even, sadly, most supposed experts – would struggle even with this.
The answer is simple: A “gold standard system” is one in which gold is the “standard of value.” In other words, it is a value link. The currency’s value has a certain parity with gold, such as 20.67 dollars or 35 dollars per troy ounce. It is the same basic policy as is used today by at least 25 countries, which connect the value of their currency to the euro. The best way to do this is a currency board system, such as is used by Bulgaria, or the eight African countries that use the West African CFA franc.
These are “euro standards.” The only basic difference between a “euro standard” system and a ”gold standard” system is that a “gold standard” system uses gold as the “standard of value,” not the euro. Given the recent acrobatics by the European Central Bank to prevent a wave of sovereign defaults in Europe, using gold as a “standard of value” instead of the euro might make a lot of sense to some of these countries in the not-too-distant future.
These countries have also decided that using an external “standard of value,” like the euro, makes a lot more sense than having some home-grown money bureaucrat try to operate an independent floating fiat currency.
That’s pretty much all there is to it.
Unfortunately, a great many gold standard advocates, and other vaguely libertarian types, seem to want to combine this basic notion with all kinds of other ideas which are not really related. I call this “kitchen sinking” the debate — bundling up all of one’s personal hobby-horses in one take-it-or-leave-it package. While these other notions might be worthy in their own right, it makes talking about money itself needlessly complicated. This confusion in rhetoric is inevitably accompanied by equivalent mental confusion, which is why everyone is so confused all the time.
And if the so-called expert writing this stuff is confused, imagine where that leaves the reader.
Let’s name a few things:
Government balanced budgets. A gold standard system has no direct relation to government finances. It’s just a standard of value!
“Balanced Trade.” Gold standard systems have no direct relationship to international capital flows, also known as “trade imbalances.” While some countries can have quite dramatic capital flows with a gold standard system, such as most European countries before 1914, you can also have gold-based money with hardly any international capital flows, as was the case for Soviet Russia and communist China in the 1950s and 1960s.
Gold coins. Some people don’t like paper banknotes. There’s a long tradition of this in U.S. history, including people like Thomas Jefferson who didn’t trust “international bankers.” However, by the latter 19th century, paper banknotes were used for most transactions. You can have a gold standard arrangement with no gold coins at all, as was the case in the U.S. in the 1950s and 1960s. It’s a separate topic.
“Fractional reserve banking.” Despite the comically sinister tones in which this term is often pronounced, it just means “banking,” as it has been done in Europe and elsewhere for about the last 500 years, since the Renaissance. This has indeed caused a lot of problems throughout that time, and is causing more problems today. It might be better to use a different system. But, given that almost all of those five centuries of financial history since the Renaissance also coincided with the use of gold-based money, in the world’s leading financial centers, it is obviously a separate topic.
“Pure” or “100%” gold reserve systems. There are a lot of different ways you can set up a gold standard system. Using a 100% bullion reserve is one possible option, although one that has not been very popular in the last three centuries. During the United States’ 182 years with a gold standard policy, 1789-1971, 100% reserve systems were never used.
“Gold exchange standard” or “reserve currency” systems. This term basically denotes an arrangement where, instead of using gold itself as a “standard of value,” a currency is instead linked to a major international “reserve currency” like the British pound or U.S. dollar, which is itself linked to gold. This was common from 1870-1970. This system actually works pretty well in practice, although it does have some problems and should perhaps be avoided. But, again, that is a separate topic.
“No central banks.” The model “central bank” in the 19th century was the Bank of England, which adhered to the gold standard principle for over two centuries. The imitation of the Bank of England by countries around the world, in the latter 19th century, produced the arrangement that is today known as the “Classical Gold Standard Era” of roughly 1870-1914. So, obviously, central banks and gold standard systems have historically gone together like peanut butter and jelly.
The term “central bank” has a number of implications, however. One implication is a currency monopoly, very different from the “free banking” multiple currency issuer system that the United States embraced in the 19th century. Some people have blamed the widespread use of printing press finance in World War I on this currency monopoly, thus ushering in three decades of currency chaos before things settled down again with the Bretton Woods agreement of 1944. There are a lot of reasons to avoid currency monopoly – but it has nothing to do with the choice of the “standard of value.”
“Credit creation.” At the end of the day, “credit creation” is just people making deals – namely, borrowers and lenders coming to an agreement. This doesn’t actually have much direct link to the currency itself. People make credit agreements with a gold standard system, or a euro standard system, or an independently-floating fiat currency, or whatever happens to be available. Certainly, the conditions for credit can be greatly influenced by monetary conditions, but so is everything else – that’s why money is so important. But, a “gold standard system” is just a system that uses gold as the “standard of value.” It’s really that simple.
These are all good and worthy topics of discussion, upon which intelligent people can have differences of opinion. But, they are, for the most part, not directly related to whether or not one should have a currency system that uses gold as the “standard of value.”
Currencies are actually very simple. Perhaps it takes a lot of experience and insight to understand how simple they really are. Don’t complicate things by trying to debate everything at once.