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Should America Go For Gold?

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In the debate over the future direction of the U.S. economy, federal spending and inflation have once again entered the crosshairs of congressional Republicans intent on further removing the government’s influence on the economy. According to a report from The Financial Times, a proposal for a return to the use of a gold standard is in the works for debut at the party convention in Tampa, FL. Ideally, Republicans would use a gold standard to limit the ability of the Federal Reserve to increase the money supply beyond a finite ceiling and in turn, force greater fiscal discipline from the federal government. However, the use of gold standard goes too far in limiting the scope of the Federal Reserve and would harm the general economy by suddenly contracting the money supply.

So What’s A Gold Standard Exactly?

 A gold standard is used to link a fixed weight (usually in ounces) of gold to a specific demonination of paper currency. Under this system, consumers could go to banks and, at their choosing, exchange their paper money for an exact measure of gold. Since the total gold reserve in any national treasury would be some finite quantity, then the total amount of currency a central bank could print and issue into circulation is also a precise amount. For a more visual explanation of how a gold standard works, CNBC’s Steve Liesman does a good job here.

Have We Ever Used A Gold Standard?

Yes. From 1834 until 1933, the United States used some form of either gold or silver standard (see Bimetallism) to value and effectively collateralize the dollar. Prior to the Federal Reserve Act of 1913, the U.S. Treasury managed the printing of paper currency that could be exchanged for the gold in its reserves, but after 1913, the Federal Reserve System was established as America’s central bank and took over the resposibility of managing the money supply. 

Why Did We Stop Using It?

The U.S. has the Great Depression to thank for that. When the Depression hit in the 1930s, banks experienced serious shortfalls in capital as panicked investors retreated from the securities excahnges and consumers flooded banks attempting to exchange their paper currency for gold, fearing a devaluation of the dollars in circulation. The increase in conversion of currency to gold reduced the overall reserve held by U.S. Federal Reserve Banks hamstringing the central bank who couldn’t increase the money supply enough to prevent capitalize commercial banks against bankruptcy. In 1934, the Gold Reserve Act was passed, prohibiting the private ownership of gold and requiring that all privately held gold reserves be sold to the U.S Treasury including the reserves held by Federal Reserve Banks.

Why Shouldn’t We Go Back?

Three reasons:

First, a gold standard goes too far in restricting the ability of the Federal Resere system to lower interest rates and increase the money supply when the financial system needs additional liquidity. Remember, during the housing crisis American financial institutions had serious liquidity concerns after they had borrowed excessively to invest in speculative asset-backed securities. It was the Federal Reserve who increased the money supply to inject capital into U.S. financials to keep them from failing (see TARP and ARRA). Without this, it is likely that the U.S. economy would have witnessed a far greater number of bankruptcies in the financial system which would have deepened the recession, potentially into depression. 

Second, the U.S. economy is far too large to warrant the use of a gold standard. In GDP terms the U.S. economy is worth about $2.7 trillion, but the estimated value of all the gold ever mined (in metric tons) is around $6 trillion. So there’s literally not enough gold available for the U.S. Treasury to back the currency currently in circulation since the U.S. doesn’t actually own all the gold ever mined.  

Third, if a gold standard were implemented, the Federal Reserve would have to contract the money supply in accordance with the exachange value set for U.S. gold reserves. Remember, with a gold standard, the Federal Reserve can only print and issue currency until the value of bills in circulation equals the corresponding total weight of U.S. gold reserves. After two successive bailouts of the financial system, and two rounds of quantitative easing from the Federal Reserve, it stands to reason that the current amount of money in circulation would exceed the weight of gold that U.S Treasury has in reserve. Therefore, the money supply would contract accordingly, raising the low interest rates U.S financials are using to keep credit flowing through the economy. A sudden contraction in the money supply, combined with an equally sudden increase in interest rates would spark another panic in the financial sector effectively silencing the already slow recovery. 

Last Words

Government spending isn’t really the problem. The Federal Reserve is forced to expand its balance sheet to keep cash flow in the economy stable because financial institutions are not lending! The purpose behind QE and the bailout bills was to capitalize banks enough to lend at lower interest rates, which would help fuel economic growth. But if the financials continue to essentially hoard the cash instead of putting it into the economy, the Federal Reserve will have to continue pumping cheap cash into the economy. The Gold Standard is a ludicrous idea and just another reason not to trust the guidance of the economy to Republican politicans. 

 

 

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About Alexander J Smith III

  • Glenn Contrarian

    Another thing our resident gold bugs don’t realize is the reason Nixon took us off the gold standard was because France was buying and selling gold in such a way as to manipulate the value of U.S. currency…and going back to the gold standard would open the dollar back up to manipulation by other nations.

  • pablo

    and my friends could create trillions of dollars out of thin air, and then lend it to the government and banks at interest I could no doubt take over the world.

    Alan Greenspan said it best before he sold his soul to the devil, and quite succinctly too, I might add.

    “In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. If there were, the government would have to make its holding illegal, as was done in the case of gold. If everyone decided, for example, to convert all his bank deposits to silver or copper or any other good, and thereafter declined to accept checks as payment for goods, bank deposits would lose their purchasing power and government-created bank credit would be worthless as a claim on goods. The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves.

    This is the shabby secret of the welfare statists’ tirades against gold. Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists’ antagonism toward the gold standard.”

    Gold and Economic Freedom

    by Alan Greenspan 1967

  • Igor

    Greenspan is a fool. He admitted as much.

    All money is fiat money. It is only worth what someone will pay for it. Gold is NO protection against inflation or anything else.

    It has nothing to do with Greenspans gothic nightmares about ‘welfareism’ or anything else.

  • Glenn Contrarian

    pablo –

    So you think it’s okay for other nations to be able to manipulate the value of our currency? Because that was one of the main reasons Nixon took us off the gold standard.

  • Igor

    Gold is not really such an attractive holding anymore.

    A friend of mine (in Texas, naturally) inherited a huge fortune in gold when his rich uncle died. What a headache! The gold was in a vault and Jim had to transfer it to a vault of his own, so he had to rent a gold vault thru his bank, then pay a gold mover to move the gold to his new vault. All very costly and dangerous. Lots of big paperwork duties every time Jim cashed in a bit of his gold.

    But gold is pretty portable, and it’s fungible almost everywhere. But there IS a cost to convert gold almost everywhere, too. The value per ounce is pretty high, IIRC about $1700 per ounce, so that $10,000 is only 6 oz. of gold. But I have a stack of 100 $100 US bills in front of me, and it seems to me like it’s about 6 oz., too. Too bad I don’t have a scale handy (but I could make a balance beam and scale that stack against the 8 oz. coffee bag in the pantry; maybe I’ll even do that).

    But the Benjamins are probably a better bet for portability and fungibility since it’s probably easier to hide the Bennies to get thru airport screening, and every shop owner in the world recognizes a Benjamin and knows how to check for a counterfeit. Have you ever paid for dinner in a Berlin cafe with a hunk of gold, or even a Krugerrand? It’s easy with a USA $100 bill, they just go in the backroom with it and their expert checks serial numbers, etc., against bank theft records, and checks for counterfeit, and signs off on it for the Boss. Takes about 2 minutes.

  • Alexander J Smith III

    Pablo-

    Thank for the comment first and foremost as to your position, Glenn actually asked the very question I was going to. Gold Standards leave the currency open to manipulation, both for
    Foreign banks purchasing reserves and consumers converting paper currency into gold domestically. In addition, I disagree with Greenspan that Fiat money is inherently less subjective then money backed with gold. Greenspan assumes that using weight is a less subjective measure, which on its own is, but markets still have to determine what weight equals what amount of currency which isn’t any less subjective than determining what paper currency should be worth based on how much of it is in circulation

  • pablo

    Glenn,

    I am sure that the USA doesn’t manipulate other countries currencies, whats good for the goose is good for the gander.

    Igor you miss a very important premise in your assertions.

    The FED is not a bank or a holdiing facility per se, it is a private economic monster that creates trillions out of nothing, and then lends it out to us at interest.

    This is why a fiat currency particularly one that is issued by private ownership is so malignant.

    As to the manipulation of the currency by foreign interests, I guess it is ok for Bernanke and company to suddenly create trillions more fiat currency and debase the value of working americans money, what a joke.

    Igor’s assertion in number 5 comment is so absurd its not even funny. Huh? Gold not an attractive holding anymore?? Sure Igor that’s why its gone from 300 and oz to 1700 in less than ten years. That’s why China is buying it as fast as it can, and if the Chinese are smart enough, they may well issue the Yuan soon backed by gold.

    I am sorry however Igor for your friend’s headache, I feel sorry for his troubles. I hope he does better soon!

  • Alexander J Smith III

    So you’re position is that because the Federal Reserve doesn’t manipulate other currencies, other countries wouldn’t do it to the U.S? That’s reaching. No the federal reserve system is not explicitly a bank, but the money supply it circulates is no less subjectively valued than if it were issuing currency backed by gold. Not to mention there’s still the issues of foreign currencies that use dollars as a reserve and the quantity conces that cant be adequately resolved by markets.

  • Igor

    The price of gold was in the doldrums for years and has only risen quickly the last few years.

    Gold is really inconvenient as a money. It comes in all kinds of forms: bars, gold dust, jewelry, krugerrands and other coins (which are generally alloyed with other metals for toughness), old teeth, etc.

    There’s no Gold God who administers the price of gold and who has the power to declare gold as the one and only true money.

    ALL money is fiat money.

  • pablo

    Igor I suggest you consult a dictionary before displaying your ignorance in such a blatant manner.

    You of course miss my point completely Alexander. If I could enter into an agreement with the federal government, that my business could issue money out of thin air then lend it out to them at interest, I too could take over the world. The FED system is a scam and ponzi scheme through and through.

  • Igor

    All money is fiat money.

    All financial schemes are Ponzi schemes: there’s never enough money to pay off investors. But each of us hopes to cash out before the roof falls in.

  • pablo

    I think you mean with the introduction of fractional reserve banking Igor.

  • Alexander J Smith III

    Pablo,

    I understand what you’re saying on that issue, and in that scenario, your ability to lend that money out and how much of it you could lend would be determined not by you, but by market confidence in your institution. The Federal Reserve System does take advantage of the flexibility of un-collaterized paper currency but my question on subjectivity still stands.

    Fractional Reserve Banking didn’t invent fiat money, all currency paper and non, is and has been fiat currency. Money only has value when people believe that it has value as a medium of exchange. Using gold essentially as collateral to issue paper money is a way of augmenting the perceived value of that paper money, which grants that it has value to augment. So what then is the real difference? The Federal Reserve System isn’t perfect, but you don’t hamstring the central bank that manages money in your $15 trillion economy.

  • Igor

    IMO all grownup banking is Fractional Reserve Banking; maybe some non-fractional banking is possible among muslims, or Grameen Bank, etc. How else can a banker aspire to prosper if he can’t lend out more money than he actually has? The only questions about Fractional Reserve are : what fraction, and who administers it?

  • pablo

    Igor 3
    “Greenspan is a fool. He admitted as much.”

    No Igor Greenspan has never been a fool, he just knows who butters the bread, and changed his tune accordingly. Your assertion just a weeee bit naive there buddy.

    Again Igor:

    “There’s no Gold God who administers the price of gold and who has the power to declare gold as the one and only true money.”

    Tell that to the Rothschild family Igor who controlled the price of gold for several centuries.

  • Igor

    Gold is inferior to $100 bills for portability. Gold is worth about $1700/troy ounce and there are 12 in a pound, so a pound of gold is worth about $30,000. By contrast a million dollars of $100 bills weighs about 22 pounds, so a pound of Ben Franklins is worth more than $40,000. Bills are worth more than gold.

    $9900 can be carried through customs, but the danger is that drug-sniffing dogs may detect your stash (because they had been possessed by drug dealers). That amount will fit nicely, if tightly, in a single Ziploc sandwich bag (to avoid water damage).