The Persistence of the Bizarre
March 26, 2011
There's a notion out there that, to establish a gold standard, you take
the existing monetary base, divide it by the amount of gold the
government has in storage, and then you end up with a price of gold.
This is so idiotic that for a long time I figured I'd just leave it
alone. Do these people also think that babies are delivered by storks?
And yet, it is a testament to the extremely poor state of affairs these
days that these sorts of arguments exist, and indeed have been around
for decades apparently without anyone to call BS on them. When it got
to the point that Dylan Grice, economist for Societe Generale, started citing
baloney I thought maybe it was time to say something.
Grice is actually a pretty good economist, willing to investigate
matters in the spirit of curiosity (instead of a pre-existing agenda)
and come to real conclusions, as opposed to the various barkers and
shills of Wall Street known as "strategists."
Unfortunately, these sorts of ideas were popularized by Murray
Rothbard, in books like The Case
Against the Fed. You can read the whole text here:
Read The Case Against the Fed.
Don't take it too seriously.
The gold stock of the Fed should be
revalued upward so that the gold can pay off all the Fed's
liabilities—largely Federal Reserve Notes and Federal Reserve deposits,
at 100 cents to the dollar. This means that the gold stock should be
revalued such that 260 million gold ounces will be able to pay off $404
billion in Fed liabilities. ...
There is nothing sacred about any initial definition of the gold
dollar, so long as we stick to it once we are on the gold standard. If
we wish to revalue gold so that the 260 million gold ounces can pay off
$404 billion in Fed liabilities, then the new fixed value of gold
should be set at $404 billion divided by 260 million ounces, or $1555
per gold ounce. If we revalue the Fed gold stock at the "price" of
$1555 per ounce, then its 260 million ounces will be worth $404
billion. Or, to put it another way, the "dollar" would then be defined
as 1/1555 of an ounce.
There are a lot of problems with this. Let's list a few:
1) Neither the British or U.S.
gold standards of the last 300 years, nor many of the others around the
world, worked like this. Rothbard is just making stuff up.
2) A gold standard is NOT
dependent on the amount of bullion in a vault. We saw that this was
never the case.
There were a few exceptions -- China used silver bullion exclusively as
money into the 20th century -- but in the Western European world that
was the rule.
3) "Defining the dollar" at
$1555/oz. (from perhaps $350/oz. when Rothbard was writing) is a devaluation. It's just the same as
when Roosevelt "changed the definition of the dollar" from $20.67/oz.
to $35/oz. in 1933. You would think this would be what Rothbard and the
other hard money types would want to prevent. (In fact the result of
this devaluation was to make the U.S.'s gold holdings worth more than
the monetary base, for a little while.)
4) This "100% backing" would be
very brief. The normal operation of a gold standard would soon cause
base money to diverge from whatever the bullion inventory happened to
be. If you kept base money stable, then its value would diverge from
the gold target. You only get to target one thing, value or volume, and
the other is a residual. A gold standard is a value target, not a
bullion reserves/volume target.
5) Although a small country,
like Fiji, could implement some sort of "100% backing" system, there
isn't enough gold in the world to do this on a global basis. That is
why goverments tended toward "economizing on gold" for centuries.
People who argue that it is possible that you could do it by "revaluing
gold" fail to notice that this would be a devaluation. For example,
let's say you "revalued gold" at $14,000/oz. today. That would be a 10x
devaluation of the dollar. Eventually, prices would rise by about 10x.
Then, you would need ten times as many dollars to do your business. So,
the amount of dollars in circulation would have to rise, which would
mean that you wouldn't have "100% backing" anymore.
6) What if the gold isn't there
However, these specific items fail to really explain the problem with
this proposal. The problem is that these people -- apparently including
Rothbard -- have a fundamental lack of understanding of how monetary
systems work. Let's say you have a five year old child. You are
complaining about the price of gasoline. The child says: why don't you
just put water in the tank? It looks about the same, a clear liquid.
Cheaper too. A child would accept the explanation that "it just
wouldn't work," but an adult is more stubborn. Especially an adult to
already thinks they know the answers. Hey, they studied Rothbard for years. And there are all these
people who agree with them. The Mises
Institute. You would have to explain all the workings of an
internal combustion engine, and why gasoline can be used as a fuel and
water cannot. And during the whole time they would smile smugly and say
you were wrong, water does indeed work, they are quite sure of it. (You
can see why I tend to avoid these people.)
For example, by the time you get this far, usually there is some guy
who claims that we can just revalue the real value of gold higher. I
don't mean that the dollar drops in value, but rather that gold rises
in real value.
This is contrary to the most basic tenets of a gold standard system. It
is also contrary to reality. Do you see what I mean about trying to run
an automobile by putting water in the tank? There is a fundamental
missing of the point involved here. The purpose of a gold standard
system is to produce a currency that is stable in value. The means of
accomplishing this is to link the value of the currency to gold. Why
gold? Because gold is stable in value. Governments rise and collapse.
Wars come and go. But gold is stable in value. Has been for 2500+
years. And even if it is not, perhaps, perfectly stable in value, it is
close enough that we can treat it as such. We've been running this
experiment for a long time. The Greeks used gold (and silver) as money.
So did the Romans. So did the Chinese and Japanese. So did the Africans
and Persians. So did the United States only a few decades ago. And when
the Conquistadors crossed the ocean, in search of gold, they found that
the Aztec kings hoarded gold just like the Spanish kings. At no point
did anyone say: "well, we thought gold was stable in value, but we were wrong." Gold is stable
in value no matter what some blockhead says. It's something we
discovered by experimentation, just like any other fact of the physical
So you have to laugh when someone figures that they can change the
value of gold, by some large amount, just by moving their mouth and
saying something. This little ship of fantasy would be instantly
crushed against the rock of reality. But it also shows that they missed
the whole point of a gold standard. The whole point of a gold standard
is that gold doesn't change its value just because of some guy saying
blah blah blah. Unlike the floating dollar today, which changes value
due to Ben Bernanke's latest press conference.
I often say that you should think of a gold standard like a
"currency board linked to gold." In fact all gold standards operate
like this, whether you have a lot of gold in a vault somewhere or not.
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.
David Ricardo, Principles of Political Economy and
The quantity should be
regulated according to the value of the metal which is declared to be
That is the currency-board-type mechanism I am
talking about. Notice how Ricardo and I are on the same page about
this. I am not making this stuff up. Ricardo did not say that the
"quantity should depend on the
amount of gold in a vault", or imports and exports of bullion, or any
other such quantitative measure. The proper target is value -- namely
the value of the standard, which means gold. (In Ricardo's day it
occasionally meant silver.) Specie (bullion) is not necessary. You
might have it. You might not. It's the quantity-regulation aspect that
allows the value of paper bills to be linked to gold. Ricardo was the
premier reference for monetary matters in England during the 19th
century. In fact, he played a key role in re-establishing the gold
standard in Britain in 1821, at the prewar parity, after a period of
In 1822, just after the gold standard was re-established, the
Bank of England had £18.665m of banknotes outstanding and
£11.057m of gold bullion. There was no "revaluation" to make them
balance. A few years later, in 1837, the BoE had £18.165m of
banknotes and £4.077m of bullion. There weren't even close to
being equal. So what. The amount of gold is largely irrelevant. The
value of the pound remained pegged to gold until 1914.
And what of the U.S.? In 1855, a time of "free banking" in the U.S.
which is much loved by libertarians (there was no Federal Reserve or
even a standardized national currency) there was an estimated $394
million of banknotes outstanding, and $59 million of gold bullion held
by issuing banks. In other words, a bullion/banknote ratio of 14%. Of
course, all of these banknotes were pegged to gold. The U.S. left the
gold standard during the Civil War, and returned to gold in 1879, at
the prewar parity of $20.67/ounce. In 1880, there were about $746m of
banknotes outstanding, and $139m of gold bullion held by issuing banks.
The coverage ratio was 20%. There was no "revaluation." There was no
"100% reserve." It didn't matter. The whole Rothbard thing is a fairy
So there are two examples of returning to a gold standard, from an
extended (23 years in Britain, 19 years in the U.S.) period of floating
currencies. Worked fine. No problem. It's a piece of cake.
(By the way, a short-form version of January
Standard? should be appearing in the print version of Forbes this week. Look for it!)
When people talk about "returning to a gold standard" today, they often
mean, "doing what Rothbard and his hallelujah choir suggest." This has
nothing to do with any historical gold standard system. It is a sort of
miasmic fantasia. But, if that is all that people have to offer today,
then that is what "returning to a gold standard" would mean. It would
mean instant failure and horrible economic turmoil as these ideas are
proven to be laughably flawed in real-world implementation. The
Bernankes, Krugmans and other Keynesians of the world are really not so
hot, but the fact is that they would be better than the Rothbardian
clown brigade. People sense this, which is one reason why they have
stuck with the Keynesians for decades.
That is why we need a new group, of at least a dozen people or so, who
have mastery of this material. How can you have a new gold standard if
there is nobody -- not one single person -- who knows how to implement
it? You can't. Yes, I know there are hundreds who say they know how, but you
aren't fooling me.