classical economics
for analysis,  forecasting
and policy design

New Gold Standard

Monetary Misconduct Worsens Fiscal Plight
By Wayne Jett © July 31, 2012

    A large gold hoard in the U. S. Treasury is unnecessary for a return to dollars with value reliably anchored in gold. Markets monitor the dollar’s value in gold moment-to-moment, and the Federal Reserve or (better yet) Treasury can adjust the supply of dollars so their value remains rock solid. This will leave prices of goods and services to be set by the markets, inflation-free, based on supply and demand.

The only things “lost” would be the Fed’s discretion to create trillions of dollars at will to bail out big banks or to lend to Treasury for deficit spending. In other words, a new gold standard would be a win-win-win outcome – ending inflation, bank bailouts and excessive budget deficits.

Bad Ol’ Days: 1971-2012

    The U. S. dollar is badly abused by the Federal Reserve and Treasury, allegedly to save us all from a “second depression.” But, oddly, their designs for “saving us” put trillions into coffers of international banks and government spenders. The Fed has expanded its balance sheet (loaned or spent money) in unprecedented amounts by creating new money out of nothing.

     The Fed’s newly created dollars gain their value by reducing the value of all other pre-existing dollars – those for which you and others have worked or invested. If the total amount of goods and services (gross domestic product) grows by the same total value as the number of new dollars, all dollars keep the same value as before the new dollars were created. But if GDP is not growing, or is shrinking, the new dollars get their value entirely by sucking value from all of the pre-existing dollars. This is called inflation, but it is just like a direct tax on dollars, except that it is silent, secret and you can’t vote the Fed out of office for doing it.

     Yes, a gold standard would stop this entirely. When the market price of gold in dollars does not change, there is no inflation, so no direct, silent secret tax on dollars occurs. Suddenly, the dollars you accept for your work, your production and your assets do not lose (or gain) value while you hold them. They are reliable and trustworthy again.
Gold Standards of Yesteryear

     Recently, a seasoned gentleman (in fact, three of them, each educated in Keynesian economics and unanimous in their views) expressed conviction that a gold standard monetary rule could not work in 21st Century global commerce. A gold standard sets the price of gold, he asserted, which effectively sets the price of all goods and services. This was certain to stop economic growth and end progress and prosperity. But none of this is so.

     Before 1933, the gold standard in the U. S. and elsewhere used an exchange mechanism to keep the value of the dollar and other currencies honest. Any holder of the currency could choose to exchange it for gold at the declared exchange rate. But that system was subject to manipulation by the U. S. and other nations. During war, gold shipments among nations were often suspended, and even in peacetime some nations (including the U. S.) violated the central rule that each participating nation must issue currency equal to the full value of its gold holdings.

     Keynesian economists commonly misunderstand and deride the gold standard. But the intellectual acclaimed both as Bill Clinton's mentor at Georgetown University and for his book Tragedy & Hope, Professor Carroll Quigley, wrote that the gold standard was “one of the greatest social instruments ever devised by man.”

     The gold standard of the 19th and 20th Centuries featured an exchange mechanism by which people were permitted to carry their currency or their gold to banks to exchange one for the other. This process adjusted the currency supply to correct levels and maintained its value. Today this adjustment can be achieved more efficiently, and without the need for vast stores of gold in a central bank, by central bank or Treasury operations to adjust the supply of currency. The market price of gold tells the public immediately if the government violates the stated target value.

                                                                        A Gold Standard for Today and Tomorrow

     A gold standard today should announce a target price for gold and achieve it in global markets by reducing or increasing the supply of dollars to stay on target. Supply and demand would determine the dollar’s value as measured by history’s most reliable yardstick: an ounce of gold. With the dollar’s value steady relative to gold (i.e., as good as gold), prices of all goods and services would be priced reliably by markets based on supply and demand – no inflation or deflation involved.

     It works even in wartime and is not subject to manipulation by governments withholding gold from the system. The only “problems:” the Fed cannot manipulate interest rates or create currency to hand out as it pleases, and, if Treasury borrows money from the markets, it must pay market interest rates. A gold standard rule would command the Fed (or Treasury) to supply only dollars sufficient to hit the gold price target – no more and no fewer. The Fed would no longer resolve financial crises because the Fed would no longer be permitted to create the crises.

      So what’s not to like? ~