Mock Gold Standard

July 3, 1961

How does it come about that not only the present Administration, but some of our private bankers, now think it would solve our monetary problems to abolish any legal requirement to hold a gold reserve?

For a full answer we need to go back to the origin of banking and of fractional reserves. The original goldsmiths, or banks, kept gold for safe-keeping and loaned it out at interest. But depositors or borrowers seldom drew out the entire amount to which they were entitled. They merely signed drafts or checks ordering the bank to pay over specific amounts to third parties. These third parties in turn were often content to leave their gold on deposit and draw checks only as they needed to make payments.

Thus bank deposits subject to check came into being. And the volume of this bank-deposit money was much greater than the gold “base” into which it was all nominally convertible on demand. The system worked as long as everybody accepted the deposit credits as being “as good as gold” itself. The system, in brief, rested on confidence—confidence that it would never be abused, and that individual banks would be at all times not only solvent but liquid.

INVERTED PYRAMID

Then governments stepped in, and based national currency systems on the fractional reserve principle. They developed further “economies” in the use of gold. In other words, they developed a system by which a still bigger inverted pyramid of bank notes and bank credit could be based on the available supply of gold. This was the central bank. The central bank was authorized to issue its own bank notes (which were made legal tender) against its gold stock. It could “centralize reserves” by ordering “member” banks to leave gold or cash reserves permanently on deposit with it. It could make loans to these member banks which they, in turn, could count as “reserves” against which they could issue still more deposit money.

In the United States, in 1932 and 1933, the confidence of holders of Federal Reserve notes that they would be able to convert into gold at any time they wanted collapsed. They rushed to convert. Their distrust proved justified. Gold redemption was suspended. The government did not blame its own monetary policies. It denounced the people who had lost confidence and had demanded gold. It devalued the dollar, thus breaking faith with everybody who had relied on its most solemn pledge. It not only terminated the right of its own citizens to demand gold for their notes; it made it a crime for them to buy or own gold no matter where they got or held it.

WATER IN THE MILK

But the government wanted to maintain the new parity for the dollar in terms of other currencies, so it allowed foreign governments and central banks, and them alone, to demand gold. Our official monetary authorities found that by following this restricted convertibility they could build up a still bigger inverted pyramid of credit on their existing gold supply. But now that they have built the inverted pyramid and the wage-price level so high that even foreign central banks have begun to lose confidence, the Administration and a few bankers now ask: Why have any gold reserve at all? Isn’t the whole thing an economic waste, an outworn superstition, a “barbaric relic”? Why can’t we leave it to “able and responsible men” to regulate our money supply, which will consist purely of engraved slips of paper?

What this demonstrates is that once you begin diluting the money supply, the pressure grows for more and more dilution. The milkman who has been caught watering the milk then tries to convince his customers that they are better off with plain water. As the connection between the gold basis and the currency outstanding against it becomes increasingly remote, tenuous, and purely symbolic if not fictional, people begin to ask why it cannot be abolished altogether. The answer is that when the unit of money represents no real tangible value, but a scrap of paper whose supply is determined by the mere discretion or caprice of the politicians in power, history shows that the inevitable end result is monetary instability and uncontrolled inflation.