What Is the Best Kind of Gold Standard System?
February 9, 2012
(This item originally appeared on Forbes.com on February 9, 2012.)
I’ve been discussing recently the idea of different kinds of gold standard systems. There are a lot of different options as to how you set up and operate these things.
They all have the same goal: to maintain the value of the currency at a certain gold parity. And, they all must be functional; that is, it has to work. But, within those constraints, we can do things a number of different ways.
In the past few weeks, I’ve been discussing a lot of these options on my website at newworldeconomics.com. I won’t repeat that discussion, because it is a little too detailed for this venue.
To summarize, we could establish systems with a 100% bullion reserve, or perhaps a 20% reserve. We could have bullion redeemability or not. We could even have a system without redeemability, and no bullion reserves at all. We can mix aspects of different systems into a hybrid system. We could decide whether to have a fully automatic system, or one that has an element of daily discretion by its managers and operators.
Naturally, this raises the question: which is best?
At some level, it doesn’t really matter that much. The important thing is that people can have an informed discussion on the topic, and come to some rational decision. In the process of having this discussion, you would learn all about the various technical operating procedures and options, which is knowledge that is sorely lacking today.
I find that there is no “one best” system. Each has some advantages and disadvantages, which might be attractive or unattractive depending on the situation.
I often chide others for being religiously attached to the “100% bullion reserve” idea, although this has been almost unknown historically. The gold standard systems in the U.S. and Britain were never “100% bullion reserve” systems.
However, there are some situations where this can be a good option. For example, let’s say there’s a small country, like Bulgaria, which decides that it wants a gold standard system to go along with its new flat tax system. Bulgaria is so small (population 7.3 million) that its bullion needs would be relatively tiny. Also, people’s trust in the ability of the Bulgarian administrators to manage a gold standard system would be, perhaps, rather low, at least at the beginning. Probably this doubt is justified.
Here, we might want the simplest, most rudimentary, most secure system possible. A 100% bullion reserve system would be fine. It is the easiest to manage, has the fewest moving parts, and is the most robust. Perhaps after five or ten years, having proved themselves able to manage this simple system, the Bulgarians could then move to more complicated systems.
However, this wouldn’t work for the United States. The amount of bullion necessary to provide a 100% bullion reserve would be very, very large. The United States would be better off with more like a 20% average bullion reserve, which is what the United States indeed used for the entire 182-year history of gold standard usage, from 1789 to 1971. The U.S. Treasury still has enough gold bullion to reinstate a system like this without a lot of preparatory activity. They claim to, anyway.
I know that Murray Rothbard says otherwise, but — I’m sorry to inform you — he was a bit of a klutz on these matters. His proposals, alas, fall in that category of non-functional gold standard proposals. Let’s get over that and move on.
What if, let’s say, the United States Treasury doesn’t have all the gold bullion they claim? What if every last ounce of it was sold, leased, or otherwise distributed in recent decades, leaving nothing but empty vaults and some paper claims?
In that case, it might make sense to introduce a gold standard system that doesn’t have a redeemability element, and uses solely open market operations in bonds rather than in gold bullion to manage the currency value. Maybe, over time, redeemability could be introduced as bullion reserves are rebuilt. The no-bullion, no-redeemability system has some potential problems, but it is a lot better than standing around with no gold standard system at all.
This idea of a no-redeemability, no bullion reserve system attracts a lot of people. Indeed, I think it is imperative to understand how such a system works – as David Ricardo and John Stuart Mill did – before you attempt to set up any system at all. However, the history of non-redeemable gold standard systems is not very good.
When the Bank of England suspended redeemability in 1797, in the midst of the Napoleonic Wars, the pound soon floated from its promised parity although there was no overt policy to do so. A similar thing happened in 1914. When the southern banks of the United States suspended redeemability in 1812, the value of their banknotes soon floated. When redeemability was effectively suspended during World War I in the U.S., the value of the dollar sagged. A similar thing happened during World War II. Effective suspension of redeemability in 1968 (with the introduction of SDRs or “paper gold”) was followed by an official end of the U.S. gold standard in 1971. With this in mind, I recommend a redeemability element for political reasons, although technically it is unnecessary.
I don’t know of any extended historical examples of such a non-redeemable, no-bullion system, that operated independently. There are many examples of countries that linked their currencies to another gold-linked currency, such as the British pound, via a currency board. They had an effective gold standard system, without bullion reserves or bullion redeemability.
You could even have a system with no bullion reserves, but which has redeemability. The administrator would simply buy the bullion in the open market, when necessary. This might not be recommended for a very large currency, like the dollar or euro, but Vietnam could probably get away with it.
As for automaticity vs. discretion, I think that full automaticity is probably the better ultimate solution, but it is a topic that only a very, very small number of people – including exactly zero central bankers — are able to even discuss coherently. I think we need to lay some groundwork regarding an intellectual base before people would even understand what we are talking about. I have tended to suggest a system with a discretionary element, because we have a long history of these things in the U.S. and Britain, which we can point to. However, the discretionary element definitely has problematic aspects.
If there were just ten more people, in the entire English-speaking world, who were able to have an intelligent and informed discussion about these topics, it would be, I think, a major step forward for the entire human race. How are you going to establish and manage a gold standard system, lasting decades and centuries, without the knowledge of how to do so? You can’t. So, let’s start there.