Gold Standards; C. Curley

The earliest and simplest form of gold standard is trading for gold in the form of gold dust or gold bullion. There are no banks or money substitutes whatever, and the total money stock is simply the total amount of gold in the trading area. This form of gold standard requires no government interven tion in the economy at all, and re quires of the government only the prosecution of fraud, which is easy to prove since contracts (written Charles Curley is the author of The Coming Profit in Gold (Bantam), and is a founding member of the National Committee to Le galize Gold. or verbal) are defined in terms of a specified amount of gold in a specified form. Gold for this purpose is con stantly being provided by gold mines or foreign trade and refined into recognizable forms by known refiners. If the purchasing "pow er"* of money (gold) increases, then it will become profitable to mine or import more gold (by ex porting more products). This will bring about an expansion of the gold stock, which, other things be ing equal, will reduce the purchas ing "power" of money until the profitability of mining or import ing gold is comparable to the prof itability of other activity, and the marginal mines and importers will cease production.

* I put the term "power" in quotes to avoid confusion with political power, which purchasing "power" is not. 353 354 THE FREEMAN June This is one example of how, with no government intervention, a com modity standard money tends to keep a constant purchasing "pow er" by a simple market mechanism, based on the profit motive of the people involved. Notice that neither gold Ininers nor anyone else are concerned with such things as the stock of money or other esoteric economic concepts, yet it is they who act to stabilize the purchasing "power" of money when it becomes necessary. Primitive and Inconvenient This gold standard is rather primitive, as it requires the incon venience of weighing out amounts of gold for each purchase, and the fact that one must carry one's gold around with him, an obvious temp tation to muggers. The solution to the first problem is to manufacture slugs of gold in uniform amounts with a uniform purity so that one can tell at a glance how much gold is in the slug. Since the gold content is known, the manufacturer can alloy the gold with other metals to hard en the coin, thus reducing wear.

The manufacturer's name and the weight of fine gold are stamped on the coin. A modern example is the Krugerrand, which is minted by the South African Chamber of Mines (all the government does is provide the dies). It carries the legend, "FYNGOUD 1 OZ. FINE GOLD" (in Afrikaans and Eng lish) . Because the gold is what is val ued, and not the alloy or fancy de signs on the two faces, the unit of weight of fine gold becomes identi fied with the coin. For example, the dollar was at one time defined as 1/ 20th of an ounce of gold sim ply because the United States coin of one ounce was labeled "20 Dol lars." Of course, there is always a pos sibility of fraud on the part of the minter, and the objection is usu ally raised at this point: "Why, we can't trust people to mint coins! That function has to be turned over to the government!" We can trust private manufac turers to mint coins according to the market's specifications just as we can trust private firms to manu facture nuts and bolts to specifica tion, or carry the mail. Advocates of the free market maintain that private enterprise can provide every other product or service bet ter than the government can. Why not coins?

But the introduction of coins still leaves two problems: storage and convenience. The convenience problem is two-sided. In the case of large purchases, one must trans port a lot of gold around to make the payment. One runs into the problems of transportation and se1975 GOLD STANDARDS 355 curity. Small purchases, say a piece of bubble gum, would require the availabilty of a coin small enough to pay for it or make change if a large coin is presented. This problem would be solved by the market by the use of a bimetal lic system, as where gold and sil ver circulate side by side. Bimetal/ism Bimetallism here simply means that the market accepts either gold or silver as money. This is a deci sion that must be left to the mar ket. It is like having two curren cies. The idea of having two (or more) currencies is far more dis turbing to Americans than to Eu ropeans, who might have to deal in sterling one minute, Swiss francs the next, and then dollars. It sim ply requires that people express their prices in terms of both gold and silver, just as many European shops express their prices in both dollars and the local currency. The bimetallic system simply means that the monetary metal with the lower purchasing power per unit of mass would be used to make the smaller purchases, such as bubble gum.

Another innovation solves sev eral problems. The introduction of warehouses for money solves, of course, the problem of safely stor ing one's money. The warehouse would store your gold fora fee and give you a receipt for the gold. It is still your gold, and the fact that it is in someone else's storehouse does not mean that title to the gold passes to him or that he has any other claim to the gold (except possibly to ensure payment of the storage fees). Because it is your gold, the warehouse has no more right to use it for any purpose than an employee in a furniture warehouse has to sit on your chair. Also, the warehouse must deliver your gold upon demand, just as the furniture warehouse must deliver your chair when you want it. The receipts are usually in the form of bearer receipts, which means that the warehouse will de liver the gold to whoever presents the receipt for redemption. This carries with it the obvious impli cation: don't lose your receipts!

But· it also carries the implication that, instead of trading the physi cal gold, clients of warehouses can trade the receipts back and forth. But, still, as with the coins, the value is attributed to the gold, not the piece of paper. A Modern Example A modern example of the gold warehouse is the gold certificate offered by the Bank of Nova Scotia. Although the certificates are issued in ten-ounce lots with a mInImum purchase of twenty ounces, the principle of the gold 356 THE FREEMAN June warehouse is maintained, as the Bank of Nova Scotia keeps on hand all the gold which its certifi cates represent. The storage fee is defined as 3¢ per hundred ounces per day, or $10.95 per year for up to one hundred ounces. An alternative to issuing one or several receipts which would cir culate in place of gold is to have the warehouse give the depositor a. book of checks which he could use to make payments of exact amounts of gold, limited only by the availability of coins or bullion to make the exact amount of the check. (If the smallest amount of gold available is 5 grams, it does no good to write out a check for 9 grams, because no one makes small enough gold bars to pay the check.) This makes it· easier to make pur chases in that the buyer need only fill out the check for the exact amount of the purchase. However, the purchaser must not only estab lish the trustworthiness of his warehouse, but also whether he has enough gold in his account, to cover the check.

Full Reserves What I have described here is called 100 per cent reserve banking, which means that for every ounce worth of receipts outstanding, the warehouse has an ounce of gold in the vaults. The receipts are sub stitutions for rather than additions to the gold in the vault, and the money stock stays the same as gold flows into or out of the warehouse. The 100 per cent reserve banking system also differs from other bank systems in that the gold is considered to belong to the holder of the receipt, not to the bank or warehouse. Because the warehouse operator is in the business of handling money, it is only natural that he should make a. market for the use of it. When a warehouse operator matches up savers and borrowers so that the savers can earn interest on their savings, he becomes a banker. He facilitates this money market by accepting deposits of gold over a specified time and lend ing the money out over the same or a lesser period of time. He charges the borrower a higher rate of interest than he pays the depos itor, the difference being the bank er's profits. A modern example of this is the certificate of deposit, where the bank can pay you .a higher interest rate than on a reg ular checking or savings account because it knows that you are go ing to leave the money on deposit for a specified period of time.

However, soon enough a banker will notice that most of the gold on deposit in his bank, even though in demand deposits, will be left in the bank for years, as the receipts are traded back and forth. If no one is 1975 GOLD STANDARDS 357 going to redeem this gold, he rea sons, why shouldn't I lend it out to someone else? Of course, the fact that he is lending out money that doesn't belong to him, that was en trusted to him, doesn't bother him; no one will find out, will they? Even easier is to continue to hold the gold in his vault and in stead lend out receipts for gold that doesn't exist. Noone will find out; our banker won't lend out so much money that receipts brought for redemption will remove the en tire gold stock from his vault. Of course, the fact that he is lending out gold that doesn't even exist doesn't bother him in the least, even if it is fraud. Fractional Reserve When the banker lends out the gold in his v3:ults, or lends out false receipts, he obviously no longer has enough gold in his bank to payoff the obligations of the bank. He has gone from 100 per cent reserves to fractional reserve banking. He also has created more circulating medium (money) than there was previously, but without the limiting device of the costs of mining or importing gold. It costs less than an ounce of gold to mine an ounce of gold, but, as more gold is mined than lost through wear, and as the purchasing "power" of money goes down, eventually the marginal mines find that it costs more than one ounce to mine one ounce of gold, and so they cease production. With pseudo-receipts, the limiting cost of production is the cost of printing!

Thus, when a bank goes off 100 per cent reserves, its action results in more circulating media, which tends to lower the purchasing "power" of money. In other words, while 100 per cent reserve banking cannot be inflationary, fractional reserve banking must be. Governments benefit from infla tion. A very simple example is where politicians promise to "stim ulate the economy" and proceed to inflate the currency in order to do so. Sometimes they are under the mercantilist mistake tha t more currency is the same thing as more wealth, so they encourage banks to create more currency. Obviously, in order to create more currency, the banker has to resort to fraction al reserve banking. Usually, when the government is in on the deal, it will help out by giving banks a special status. The government simply removes the title to the gold from the holder of the receipt and gives the title to the bank.

Notice that fractional reserve banking in all its variations re quires this invasion of property rights, this intervention in the market. At this point, the biggest thing that the bank has to fear is the 358 THE FREEMAN June possibility of a bank run, where all the depositors line up to retrieve their gold (that isn't all there). In order to avoid the temptation to create so much paper money that a bank run is precipitated, the gov ernment steps in, not to enforce the fraud laws, but to set reserve requirements, which specify what per cent of outstanding notes the bank must have in gold in its vaults. For example, if the govern ment sets a reserve requirement of 25 per cent and a bank has $250, 000 in outstanding currency, then the bank must have at least $62,500 in gold in its vaults. The lower the reserve require ment, the more money the bank can create and lend out. If the gov ernment raises the reserve re quirement, then banks may have to call in outstanding loans in order to meet the new requirements.

Debtors Gain A government in debt (like any debtor) has much to gain from in flation. A rate of price increases of 10 per cent means that the gov ernment gains 10 per cent while the lender loses by that amount. As the federal government is the largest single debtor in the U.S., it obviously has much to gain by inflation: both in reduced value of the debt, and in having available newly created dollars which it can borrow without the politically objectionable side effect of higher in terest rates. One way to decrease the reserve requirements without running the risk of a bank run is to make it more difficult for people to redeem bank notes in gold. By raising the minimum lot for which one could trade his paper, banks make it harder for note holders to get gold. Thus, Britain, after World War l and a great decrease in reserve requirements - changed the mini mum amount of gold from a sov ereign (a fraction of one ounce) to 400 ounces.

This restrictive gold standard is called a gold bullion standard, and stands in opposition to the origi nal U.S. gold standard, where one could get gold for as little as $5, ·which was called a gold coin stand ard. The gold bullion standard al lowed the Bank of England to continue ,vith its wartime reserve requirements ·of 18 per cent in stead of returning to the pre-war level of 52 per cent. This, in turn, meant that the British banking system did not have to deflate in order to return to the level of credit imposed by a 52 per cent reserve requirement. Restricted Redemption Another way to limit gold out flow is· to limit the people to whom the bank will give up the gold. The U.S. did this quite abruptly in 1933 1975 GOLD STANDARDS 359 by prohibiting Americans from owning gold, and hence, from turn ing in their paper for gold. This meant that only foreigners could trade their dollars for gold.

Although still nominally tied to gold, at this point the dollar was really a fiat currency; at any time the link between the dollar and gold could be severed, as we saw in August of 1971. In the late 1960's, it became apparent that Europeans were willing to buy all the gold that the U.S. would offer on the London gold market. Rather than deflate, the U.S. authorities ceased selling gold on the free market, and established the two-tier mar ket in 1968. The free market price of the dollar soon moved down to 1/42nd of an ounce of gold, while central banks continued to trade gold at the old price of 1/ 35th of an ounce. Then, in 1971, even the central banks were banned from trading their dollars for gold. The U.S. had, for the first time since the 18th century, a completely fiat currency, in both the economic and legal sense. It was during this period that the concept of a "price of gold" first came into use. When a cur rency is divorced from gold so that its purchasing "power" becomes different than that of the amount of gold which the currency origi nally was defined to be, then it can be said to be a fiat currency. It still may have ties. to gold, such as the rather tenuous link between the dollar, the SDR, and gold from 1971 to 1973; but these are mere legalisms. As the fiat currency loses purchasing "power" relative to gold, then an ounce of gold will buy more and more units of the currency. This readjustment can be done occasionally and abruptly, via the mechanism of devaluations, or over a period of time via daily quotes on an organized private market such as the London Gold Market or the Commodity Ex change in New York. Thus, the monetary unit was divorced from gold in the eyes of the market as well as the government, and the dollar, for example, became defined as . . . well, a dollar, instead of 1/20th of an ounce of gold. Once this mental division is made, it is possible to talk of a "price of gold"

just as one can talk of a "price of Swiss francs" or a "price of roast beef": each is a separate commod ity from the unit of account - the (fiat) dollar. Central Banking During this century, the United States also moved away from free banking by modifying the reserves that banks could use for their de posits. Before the establishment of the Federal Reserve (in 1913), banks used gold, either bullion or coins, as reserves. However, with 360 TIRE FREEMAN June the establishment of the Fed, banks were allowed to deposit dol lars with the Fed and count these deposits as reserves (still frac tional) . The Fed learned rapidly how it could manipulate these reserves. Not only could it modify reserve requirements, but it could change the level of reserves in the banking system. The mechanism is very simple: the Fed buys an asset, any asset. To pay for it, the Fed writes out a check to the seller. The seller deposits the check in his bank, and the bank credits his account with the proper amount. Then, the bank presents the check to the Fed for collection. Instead of simply pay ing the bank so many dollars, the Fed credits the bank's reserve ac count with the Fed with the amount of the check. The bank's reserves are now expanded by the amount of the check, and the bank can now create and lend out addi tional dollars.

Any Debt Will Do It is important to note in pass ing that the Fed can expand re serves by buying any asset. The most popular assets with the Fed are Treasury debts; and why not: they are buying the obligations of their parent organization, the U.S. government. But simply balancing the Federal budget will not de prive the Fed of assets to buy; simply balancing the budget will not stop inflation. After all, if the Fed couldn't get Treasurys, it could always buy New York Citys ! This system of expanding re serves means that the banking sys tem can expand its reserves with out regard to gold. Now, the Fed can inflate the money supply when ever anyone wants to go into debt, a not uncommon event! Even if the U.S. were to sell off all the gold in the 'Treasury stock, the Fed could continue to inflate, sim ply because someone would be will ing to go into debt to buy that -gold, or something else.

We have traced an evolution away from free banking toward the completely state-managed mon ey system. Each step in between has been given a label, such as "gold exchange standard" or "gold bullion standard," each calculated to imply that the new setup was some form of gold standard. Even the Bretton Woods system was called a "gold-dollar standard" (not that the central banks even traded gold among themselves un less they had to - Gresham's Law applies to central bankers too). Market Money or Political Money The essence of the gold standard is that the gold in a bank's vaults regulates the credit that it can ex tend, and that the stock of money 1975 GOLD STANDARDS 361 is regulated by the free market (specifically, the profitability or lack of profitability of gold min ing) , and not by the decisions of the bankers, especially the central bankers! Each step that was taken away from a 100 per cent reserve gold standard also made it both more necessary and easier to take the next step toward regulation.

Each step also reinforced the idea that every time the banking sys tem got into trouble, the govern ment could bail it out, and do so by changing the banking system. Thus, later standards were gold standards only by virtue of a formal, legal link to gold. There was no commitment to gold, so whenever the banking system got itself into trouble, it was bailed out by the government - by an other step away from gold. Each step was supposed to make the banking system "more flex ible," to make it easier to "meet the legitimate needs of business." But, as we have seen, each step has really had the effect of making it easier for the banking system to inflate. If we turn this around, we can see that each step was a step away from sound money, market controlled, toward money con trolled by a government with a vested interest in inflation. It is in the interest of the free market advocate to understand the different varieties of gold stand ards and mixed gold-fiat standards that have existed. This is the only way in which one can answer the many myths that surround money and banking. For example, careful study shows that it was not capi talism that failed in the 1930's, but central banking that failed in the 1920's. , IDEAS ON LIBERTY The Highest Impertinence IT IS the highest impertinence and presumption, therefore, in kings and ministers, to pretend to watch over the economy of private people, and to restrain their expense, either by sumptu ary laws, or by prohibiting the importation of foreign luxuries.

They are themselves always, and without any exception, the gr~atest spendthrifts in the society. Let them look well after their own expense, and they may safely trust private people with theirs. If their own extravagance does not ruin the state, that of their subjects never will. ADAM SMITH, The Wealth of Nations ~TheAutumn of OUf Discontent AL BRAUN ONCE UPON A T'IME there was a great department store where peo ple could buy any product they chose. This store· had all of the latest scientific devices, medical aids, autos, washing machines, tel evision sets-everything from soup to nuts. Customers were offered numerous options: you could go into the store just to browse, or you could buy on time, pay cash, or write a check, whatsoever you vvished. People came from great distances to shop and to partake of the great assortment of products at reasonable prices. Somewhat unique among the goods and services offered was one that went pretty much unnoticed: police service. Yes, at each of the store's many entrances and exits stood a man in blue with his shiny badge~ The only time the police man was noticed was when some body tried to rob the store or take something out without paying for Mr. Braun is an engineer in Creston, Iowa. This article is from his recent speech before the Toastmasters group there.