The Gold Standard in a Nutshell

The Gold Standard in a Nutshell
June 24, 2007


My new book Gold: the Once and Future Money is now available at It should be considered required reading for fans of this site. There is a huge amount of material in the book that I don’t cover on this site, in the same way, as that would be repetitive. Also, I assume some familiarity with the principles in the book.

The book is a lot of things, but one of its primary purposes is to serve as a stand-alone how-to guide for creating and maintaining monetary systems. There is a body of knowledge, which today very few (I mean less than a dozen people) truly and properly understand. I wanted this knowledge to be in a form where it could be passed down through generations, if necessary, awaiting the time when it would “fall off the shelf” for someone who had an interest in understanding, building and maintaining monetary systems. No matter what chaos and ignorance may ensue over the years, a person could pick up this book in, say, 2150 AD, and they would have everything they need to put together a properly functioning world monetary system, as well as the tools to solve a wide variety of other economic disorders. As the book shows, this knowledge has been available in some form or another for hundreds or even thousands of years, but even the most superficial understanding of history will indicate that very few have had any grasp of its full implications.

If that all sounds a bit serious, the book is also quite a bit of fun, as we look at the utterly preposterous situations people have gotten themselves into over the years. Investors will find quite a bit to add to their toolkit. I use these principles myself in the markets, and they work time and time again. Whatever your personal interests, I figure it makes good beach reading.

My great thanks to everyone at Agora Publishing, for making this book available to such a wide audience.

I have noticed a certain trend towards renewed interest in gold as a monetary basis. The knee-jerk disdain, which was so common over the past twenty years or so, has softened. More people are beginning to understand the principles on which a gold standard is based. For example, over the years it was quite common for people to see gold as an “inflation hedge.” When there’s more inflation, gold goes up. The imagined causal relationship was more like “money creation” leads to a higher government CPI leads to higher gold prices. In this understanding, gold is a mere speculative toy, vaguely related to inflation. Not much different than rhodium or molybdenum, really. Today it is becoming better understood that gold is a benchmark of value — or, as it was said, that gold is money. Thus, gold’s value is stable, and a “rise in gold” primarily indicates a drop in the value of the currency measured against gold. The causal relationship is gold rise/currency fall leads to inflation/higher government CPI.

On a more practical note, we see the Shanghai exchange now opening a market in gold-denominated bonds. The bonds are targeted primarily towards gold miners. However, we may at some point see a wide variety of companies interested in issuing bonds in gold, especially as their interest rates are likely to be very low. (Gold investors will enjoy the chance to make a modest rate of return on their gold.) I have also heard that the president of Panama, Martin Torrijos, indicated some interest in a gold standard for his country. I’ve thought recently that the world’s next gold-linked currency won’t be coming from the US or the EU, but rather from a small country with a meaningful population of international financial sophisticates, like Dubai, Panama, or perhaps Switzerland.

A gold standard is really a very simple concept. Here it is:

1) Gold’s value is stable, or at least as stable as anything we can find in this uncertain world, and demonstrably stable enough to serve as a foundation for monetary systems. Gold’s suitability for use as a monetary benchmark has been proven over hundreds and even thousands of years of experience.

2) If you link a currency’s value to gold, then the currency’s value will be, ergo, as stable as gold.

3) A stable currency brings all sorts of wonderful positive benefits. The most obvious is the avoidance of monetary distortion caused by changes in the value of currency, which we know as inflation and deflation. As a result, interest rates tend to be low (under 4% for government borrowers) and stable over decades and centuries. If you have two stable, gold-linked currencies then of course their exchange rates must also be stable, which brings its own suite of benefits.

Technically, the second item is perhaps the most perplexing for many, as there have been numerous unsuccessful attempts at managing currencies via some sort of “peg.” The answer to this is the proper understanding of base money adjustment. “Base money” is the commonly accepted term for currency (coins and bills) and bank reseroves, which is to say, money. There are other measures that people today call “money” but which are really forms of credit, not money. Base money adjustment is laughably simple. When a currency is too high compared to gold (for example $99/ounce of gold instead of a target of $100/oz.), then you add a little base money to bring the value of the currency back down. It’s basic supply and demand. When the currency is too low compared to gold ($101/oz. instead of $100/oz.), then you subtract a little base money to support the currency’s value. When properly executed, this system is extremely robust, and in no way resembles the various ad-hoc, poorly-designed “pegs” which have a nasty habit of breaking under stress. I liken it to a “currency board linked to gold,” which is precisely what it is. Note that there is no discussion of interest rates. Interest rate manipulation is not necessary to maintain a gold standard. Also, there is no discussion of hoarding gold reserves, or coins made of gold, or whatnot. These are optional and perhaps desirable elements, but not required. As long as base money is properly adjusted in relation to the gold target, it is not necessary to hold any gold at all.

That’s really all there is to it. People will be baffled to discover the technique is so simple — though, it must be said, the process of understanding why and how it works is not trivial. The builders of the next gold standards must understand these things deeply and fundamentally, in the way that an automobile mechanic understands how cars work, rather than following along some form of dogma, mine or anyone else’s. Such people do not yet exist on this planet, excepting the tiny handful I mentioned, but this book now makes it possible for people to make that leap.

Asset markets are now quite high and economies (outside the US) are generally burbling along nicely. During these times, there is little incentive to change. Why rock the boat when things are going so well? However, it appears to me that we have entered a new era of inflation. We may arbitrarily define the beginning of this era in late 2005, when the US dollar broke beyond $500/oz. of gold for the first time in 24 years. So far, this inflation — that’s what it is — has led only to a certain artificially elevated economic activity, today’s version of the final Go-Go Year of 1972. However, I think it is likely that our little episode of inflation has quite a few more acts to play out, as we see currencies around the world steadily (or suddenly) lose value against gold. Central banks around the world have already started to react with modest rate hikes. A dollar decline to $1000/oz. is likely within 12 months, in my opinion, and that would likely be accompanied by crude oil over $100/barrel. When it is generally accepted that Something Is Going Wrong, even if there is disagreement about what that something is, we will see new interest in alternatives to today’s condition of gross monetary stupidity.