Last week, Unconventional Logic touched off a flurry of controversy by pointing out that Bitcoins are not money, and can never be money, in the sense of providing a viable alternative to the U.S. dollar for operating the American economy. Well, gold isn’t money either.
But wait! What about financier J. P. Morgan’s famous statement, made during testimony in front of the U.S. Congress in 1912, “Gold is money, and nothing else.”
Many people have assigned deep philosophical meaning to Mr. Morgan’s statement. They assume that Morgan was declaring that gold is (or should be) the only true money. However, Mr. Morgan was merely making an observation regarding the law at that time. If Morgan had been testifying before Congress in 2012, he would have said, “Federal Reserve Notes are money, and nothing else.”
In 1912, “the dollar” was defined by law as “23.22 grains of pure gold.” There were paper bank notes in circulation at that time, but they were not “dollars.” Rather, the notes were promises to pay dollars upon demand. Dollars themselves were gold (23.22 grains of pure gold each), and nothing else.
Note that while there was nothing esoteric about Morgan’s statement, it still expressed a very important insight. A businessman took a risk if he accepted anything other than gold as payment for an obligation denominated in dollars, and he had to be mindful of that risk.
The law regarding money is different now than it was in 1912. Today, the only thing that an ordinary citizen or company can possess that is a dollar is a Federal Reserve Note. (Bank reserves, which are deposit balances at Federal Reserve banks, are also actual dollars, but only banks can own them directly.)
Your checking account balance is denominated in dollars, but it does not consist of actual dollars. It represents a promise by a private company (your bank) to pay dollars upon demand. If you write a check, your bank may or may not be able to honor that promise. The poor souls who kept their euros in the form of large balances in Cyprus banks have just learned this lesson the hard way. If they had been holding their euros in the form of currency, they would have not lost their wealth.
So, if you have debts denominated in U.S. dollars, the only thing that you can possess that will absolutely guarantee that you can pay those debts is a pile of Federal Reserve Notes. This is not because of the so-called “legal tender laws,” but because, from a legal standpoint, Federal Reserve Notes are dollars, and nothing else (that a citizen can own) is.
If there is still anyone out there clinging to the notion that gold is money, take a bar of gold to the nearest Wal-Mart and try to buy something with it. They won’t accept it. You will find that before you can purchase anything, you will have to locate someone who will trade you dollars for your gold bar. And, this transaction will not be seamless or without cost, because the weight and purity of your gold bar will have to be determined via tests, and those tests will consume time and money.
But wait! Hasn’t gold been a better investment than Federal Reserve Notes? Yes, it has. Even with the recent plunge, an ounce of gold is worth almost $1400 today, up from $35 forty-five years ago. But being a good investment does not make something into money. By definition, all investment assets are supposed to deliver a greater return than money itself. What makes something money is the applicable law.
So, in 2013 America, gold is not money. Gold is gold, and Federal Reserve Notes are money.
Of course, the fact that gold is not now money says nothing about whether gold should be money. So, should gold be money? No. But the value of our money should be defined in terms of gold.
Anytime you hear someone refer to “the gold standard,” you are listening to someone who has not thought through the problem. There are many different types of “gold standards.” Some of them can be made to work, and some of them cannot.
The most fundamental issue that determines the workability of a gold standard is whether it attempts to use gold as money. Any gold standard system where the size of the monetary base is determined by the physical supply of gold will eventually suffer a deflationary collapse. The economic catastrophe that occurred in 1930 was inevitable, given the design of the gold standard system in use at the time.
Unfortunately, not everyone has realized that gold cannot be used as money. On the very first page of his book, The True Gold Standard, Lewis Lehrman advocates a return to a form of gold standard where, “…the United States dollar will be defined…as a certain weight unit of gold…” In other words, under Mr. Lehrman’s proposed system, gold would once again be money.
The deep conceptual flaw in The True Gold Standard is that defining the dollar as a certain weight of gold will not produce a stable real value for the dollar. This is because using gold as money destabilizes the real value of gold.
Annual production of gold is equal to only about 1.5% the world’s total gold stockpile. True consumptive use of gold is even smaller. As a result, if gold is left alone and allowed to be just a commodity, its real value could be expected to be extremely stable. However, if we were to start using gold as money, we would be adding a new, and potentially unlimited demand for gold, without doing anything to increase its supply.
The use of gold as base money would quickly become the biggest single source of demand for gold, just as was the case during the years prior to the Great Depression. Sooner or later, this new demand for gold would cause the real price of gold to start rising. This would automatically cause the real value of the dollar to rise, precipitating a financial and economic crisis.
Our highly leveraged financial system simply cannot tolerate monetary deflation. During a financial crisis, everyone tries to become more liquid at the same time. That is, everyone tries to increase their holdings of money, because the possession of money itself is the only thing that can guarantee that you will be able to pay your debts.
If gold is money, and money is gold, this means that, once a liquidity crisis started, the demand for gold would increase. This would drive up gold’s real value even farther, intensifying the crisis. A destructive feedback loop would develop, leading to a complete meltdown of the financial system and the real economy. This is exactly what happened in 1930.
Other than that, though, Mr. Lehrman’s system is a fine idea.
America does not need to return to using gold as money, it needs to stabilize the value of its fiat dollar against gold.
On April 16, Congressman
The monetary control system proposed by H.R. 1576 would require no gold to operate, and it would not impact the supply of, or the demand for, gold itself. Accordingly, monetary operations would have no impact upon the real price of gold. If the entire world were to dollarize, it would not increase world gold demand by a single ounce.
H.R. 1576 would also provide no way for speculators to “attack” the system, in an effort to their hands on America’s gold reserves.
Under H.R 1576, the Fed would be required to use its Open Market operations to keep the COMEX price of gold in a narrow range (plus or minus 2%) around a target price. If the gold price were to start rising above the target, the Fed would sell assets and contract the size of the monetary base. If the gold price were to fall below the target, it would do the reverse.
Some people mistakenly believe that this would amount to “price control” for gold. It would not. The price of gold is merely the ratio between the market value of an ounce of gold and the market value of a dollar. By using Open Market operations to adjust the supply of base money, the Fed would simply be regulating the market value of the dollar, which is its most fundamental responsibility.
H.R. 1576 includes a carefully designed approach for setting the target gold price. The Fed would designate a “target week,” commencing no less than 90 days and no more than 120 days after the enactment of the law. It would then employ a random process to select a “target moment” during that week. The target moment would be kept secret.
When the target moment arrived, the Fed would fix the target price at the COMEX price of gold at that point in time. It would thereafter stabilize the value of the dollar in terms of that target gold price, as described above.
If H.R. 1576 were enacted, the market price of gold would plummet. On April 17, the COMEX price of gold closed at $1377.50/oz. Gold is not worth $1377.50/oz in today’s dollars. Even after the large gold price drop in the past week, today’s gold price still includes a huge speculative premium, reflecting gold’s value as a hedge against inflation and societal collapse.
One reason to return back to a gold-defined dollar would be to eliminate the fears that people currently have regarding inflation and economic collapse. In the absence of such fears, gold may well be worth less than $500/oz.
Here is the math on the gold price. The fundamental validity of a gold standard rests upon the premise that the real value of gold remains constant over time. During the heyday of the International Gold Standard (1879 – 1914), the GDP deflator averaged 5.17 (with 2005 = 100.00). If gold was truly worth its statutory price of $20.67/oz during the 36 years from 1879 to 1914, then it should be worth $463.91/oz in today’s (actually, 4Q2012’s) dollars.
This having been said, the monetary control system described by H.R. 1576 is indifferent to whether its target gold price is $463.91/oz, $1377.50/oz, or any other number. The most important thing about a unit of measure is that it be constant. The absolute magnitude of the unit does not matter.
The gold standard system described in H.R. 1576 would work. It would be safe and stable in operation, and it would provide the stable dollar that America—and the world—so desperately needs.
Gold is not money, and it should not be money. However, we can and should use gold to define the value of the dollar. A truly stable dollar would provide a solid foundation for a stable economy, stable financial markets, and a new era of economic growth and prosperity.