CAN THE U.S. RETURN TO A GOLD STANDARD?

The growing disillusionment with politically controlled monetary policies has produced an increasing number of advocates for a return to the GOLD STANDARD - including at times president Reagan.

In years past a desire to return to a monetary system based on gold was perceived as nostalgia for an era when times were simpler, problems less complex and the world not threatened with nuclear annihilation. But after a decade of destabilizing inflation and economic stagnation, the restoration of a GOLD STANDARD has become an issue that is clearly rising on the economic policy agenda. A commission to study the issue, with strong support from President Reagan, is in place.

The increasingly numerous proponents of a GOLD STANDARD persuasively argue that budget deficits and large federal borrowings would be difficult to finance under such a standard. Heavy claims against paper dollars cause few technical problems, for the Treasury can legally borrow as many dollars as Congress authorizes.

But with unlimited dollar conversion into gold, the ability to issue dollar claims would be severely limited. Obviously if you cannot finance federal deficits, you cannot create them. Either taxes would then have to be raised and expenditures lowered. The restrictions of gold convertibility would therefore profoundly alter the politics of fiscal policy that have prevailed for half a century.

Even some of those who conclude a return to gold is infeasible remain deeply disturbed by the current alternatives. For example, William Fellner of the American Enterprise Institute in a forthcoming publication remarks "...I find it difficult not to be greatly impressed by the very large damage done to the economies of the industrialized world... by the monetary management that has followed the era of (gold) convertibility... It has placed the Western economies in acute danger."

Yet even those of us who are attracted to the prospect of gold convertibility are confronted with a seemingly impossible obstacle: the latest claims to gold represented by the huge world overhang of fiat currency, many dollars.

The immediate problem of restoring a GOLD STANDARD is fixing a gold price that is consistent with market forces. Obviously if the offering price by the Treasury is too low, or subsequently proves to be too low, heavy demand at the offering price could quickly deplete the total U.S. government stock of gold, as well as any gold borrowed to thwart the assault. At that point, with no additional gold available, the U.S. would be off the GOLD STANDARD and likely to remain off for decades.

Alternatively, if the gold price is initially set too high, or subsequently becomes too high, the Treasury would be inundated with gold offerings. The payments the gold drawn on the Treasury's account at the Federal Reserve would add substantially to commercial bank reserves and probably act, at least temporarily, to expand the money supply with all the inflationary implications thereof.

Monetary offsets to neutralize or "earmark" gold are, of course, possible in the short run. But as the West Germany authorities soon learned from their past endeavors to support the dollar, there are limits to monetary countermeasures.

The only seeming solution is for the U.S. to create a fiscal and monetary environment which in effect makes the dollar as good as gold, i.e., stabilizes the general price level and by inference the dollar price of gold bullion itself. Then a modest reserve of bullion could reduce the narrow gold price fluctuations effectively to zero, allowing any changes in gold supply and demand to be absorbed in fluctuations in the Treasury's inventory.

What the above suggests is that a necessary condition of returning to a GOLD STANDARD is the financial environment which the GOLD STANDARD itself is presumed to create. But, if we restored financial stability, what purpose is then served by return to a GOLD STANDARD?

Certainly a gold-based monetary system will necessarily prevent fiscal imprudence, as 20th Century history clearly demonstrates. Nonetheless, once achieved, the discipline of the GOLD STANDARD would surely reinforce anti-inflation policies, and make it far more difficult to resume financial profligacy. The redemption of dollars for gold in response to excess federal government-induced credit creation would be a strong political signal. Even after inflation is brought under control the extraordinary political sensitivity to inflation will remain.

Concrete actions to install a GOLD STANDARD are premature. Nonetheless, there are certain preparatory policy actions that could test the eventual feasibility of returning to a GOLD STANDARD, that would have positive short-term anti-inflation benefits and little cost if they fail.

The major roadblock to restoring the GOLD STANDARD is the problem of re-entry. With the vast quantity of dollars worldwide laying claims to the U.S. Treasury's 264 million ounces of gold, an overnight transition to gold convertibility would create a major discontinuity for the U.S. financial system. But there is no need for the whole block of current dollar obligations to become an immediate claim.

Convertibility can be instituted gradually by, in effect, creating a dual currency with a limited issue of dollars convertible into gold. Initially they could be deferred claims to gold, for example, five-year Treasury Notes with interest and principal payable in grams or ounces of gold.

With the passage of time and several issues of these notes we would have a series of "new monies" in terms of gold and eventually, demand claims on gold. The degree of success of restoring long-term fiscal confidence will show up clearly in the yield spreads between gold and fiat dollar obligations of the same maturities. Full convertibility would require that the yield spread for all maturities virtually disappear. If they do not, convertibility will be very difficult, probably impossible, to implement.

A second advantage of gold notes is that they are likely to reduce current budget deficits. Treasury gold notes in today's markets could be sold at interest rates at approximately 2% or less. In fact from today's markets one can construct the equivalent of a 22-month gold note yielding 1%, by arbitraging regular Treasury note yields for June 1983 maturities (17%) and the forward delivery premiums of gold (16% annual rate) inferred from June 1983 futures contracts. Presumably five-year note issues would reflect a similar relationship.

The exchange risk of the Treasury gold notes, of course, is the same as that associated with our foreign currency Treasury note series. The U.S. Treasury has, over the years, sold significant quantities of both German mark - and Swiss franc denominated issues, and both made and lost money in terms of dollars as exchange rates have fluctuated. And indeed there is a risk of exchange rate loss with gold notes.

However, unless the price of gold doubles over a five-year period (16% compounded annually), interest payments on the gold notes in terms of dollars will be less than conventional financing requires. The run-up to $875 per ounce in early 1980 was surely an aberration, reflecting certain circumstances in the Middle East which are unlikely to be repeated in the near future. Hence, anything close to doubling of gold prices in the next five years appears improbable. On the other hand, if gold prices remain stable or rise moderately, the savings could be large: Each $10 billion in equivalent gold notes outstanding would, under stable gold prices, save $1.5 billion per year in interest outlays.

A possible further side benefit of the existence of gold notes is that they could set a standard in terms of prices and interest rates that could put additional political pressure on the administration and Congress to move expeditiously toward non-inflationary policies. Gold notes could be a case of reversing Gresham's Law. Good money would drive out bad.

Those who advocate a return to a GOLD STANDARD should be aware that returning our monetary system to gold convertibility is no mere technical, financial restructuring. It is a basic change in our economic processes. However, considering where the policies of the last 50 years have eventually led us, perhaps there are lessons to be learned from our more distant GOLD STANDARD past

it is sort of disconcerting to see so many here not understand economics. It seems there is a lot of dogma.

the US trade deficit is caused by a simple fact: It isnt unfair trade practices, or NAFTA or even low wage competition. It is this: THE UNITED STATED IVESTS MORE THAN IT SAVES. THE NATIONAL POOL OF DOMESTIC SAVINGS IS TOO SMALL TO PAY FOR ALL PRIVATE AND PUBLIC INVESTMENT I > S.
So we must import capital. That causes the dollar to appreciate hurting exports and making imports cheaper.

Fact is today trade is more "fair" than it was in the 1950s, wages between the US and third world countries like India today are closer than they were in the 1950s. But today US savings is much lower than it was in the 1950s and investment as a % of GDP today is lower in Europe and Japan today than it was in the 1950s.

If the US wants to have a trade surplus, it needs to increase S or reduce I or a combination. But it will cause a recession in the short term.

In 1992, year when GHW Bush lost the election cuz it was the economy stupid, the Merchandise Trade Deficit fell to about $65b from $150b in 1989. I dont recall the country being better off because of it.

Section. 10. No State shall enter into any Treaty, Alliance, or Confederation; grant Letters of Marque and Reprisal; coin Money; emit Bills of Credit; make any Thing but gold and silver Coin a Tender in Payment of Debts; pass any Bill of Attainder, ex post facto Law, or Law impairing the Obligation of Contracts, or grant any Title of Nobility.

Hey, thanks for pointing this out, Jim. Something I had overlooked. And, off topic, but AHA - here is where the South was explicitly forbidden from seceding from the Union: No State shall enter into any ...Confederation; ...emit Bills of Credit (click here to see Confederate notes), all, ironically, totally against the same Constitution that the South was so upset that it claimed the North wasn't following. Berry interesting!

My only difficulty with that is that there is a differential between what the government will pay you for land and what you could get for land on the private market. Also, there have been instances where the government will assess land at one value to maximize there ability to collect revenue, while they will then turn around and eminently domain the land for a lower price.

Resolving this difficulty could lead to a movement to abolish private real property, in order to stabilize the currency baseline.

Resolving this difficulty could lead to a movement to abolish private real property, in order to stabilize the currency baseline.

Which would lead to a armed revolution, in which case the house of cards still falls to the ground.

I notice that economic cycles were vastly more prevalent and steeper during eras where the US economy was on a Specie-Backed Currency. I wonder if a commodity-backed currency endangers the economic wellbeing of the country by tying the currency to a commodity whose value can widely fluctuate.

The Constitution gives the Congress the power to coin money. They have to refine the ore themselves, right there in the Capitol. Even their aides cannot participate

Works for me.

At least if they are out working manual labor, they won't be passing laws to subvert the document that they took an oath to protect.

Why does the house of cards necessarily have to collapse?

I think our economy was more prone to bipolarity, meaning it
s depressions were worse, when our currency was specie-backed. There may or may not be a connection between the cycles and the currency valuation method, but I'm not convinced that the gold in Fort Knox should be anything other than an emergency measure.

However, if I were POTUS for a month, or so, I'd want to be fully briefed and prepared to reintroduce a currency based on that gold in the event of one of the proverbial 'Doomsday' scenarios occurring.

It was a speech given by William Jennings Bryan on July 9, 1896 at the Democratic National Convention in Chicago. Read it here.

Thanks. I read the speech. It appears to be based more on rhetoric instead of facts. He also mentions his support of an income tax. Based on those facts, I have to question his economic credentials.

Why does the house of cards necessarily have to collapse

Even if the revolt is supressed, by nationalizing even a small factions of property, you cause a default on the debt owed to banks on that land (through morgages and other types of debt) causing those banks to default, causing those banks debts to be defaulted and so on in a domino effect which causes the ecomony to crash in on itself, thus no money for taxes, thus the government collapses in on itself.

We have fiat currency today and yet we are worried about deflation not inflation

How can you have deflation with a massively increasing money supply?

It's seem to me that the "deflation" really isn't that at all.

Instead, we are actually seeing inflation (the value of the dollar is decreasing).

The reason prices haven't risen is that moderately expensive American labor has been replaced by cheap third world labor.

Both (sending jobs overseas and a cheap dollar) are very bad things.

youre right that there is commodity inflation that hasnt yet come thru to the consumer. Sending jobs overseas is a bad thing especially for those who lose their jobs.

But a weak dollar counteracts the off-shoring of jobs by making it more expensive to send jobs to other countries. I would bet that most companies that planned large off shoring of jobs did so before the dollar began to fall.

I read a study by a consulting form, cant remember which one, that showed many firms expecting to save over 50% on their costs by offshoring have realised saving of only about 15% due in part to a weaken US Dollar but also due to the fact that the offshore workers need a lot of supervision, more so than american workers

It isn't a book...it's a VERY famous speech. You mean to tell me that you've never heard about it ?

I've never heard of the speech, until you mentioned it.

I was aware of William Jennings Bryant to some extent, however. IIRC, he was left of center, but an honest man who resigned from Wilson's cabinet over the lies surrouding the Lusitania and how America was sucked into WWI.

I read the speech and really don't see why it's so famous.

But a weak dollar counteracts the off-shoring of jobs by making it more expensive to send jobs to other countries. I would bet that most companies that planned large off shoring of jobs did so before the dollar began to fall.

That makes sense. But what is the 'end game' here? Are they going to continue devaluing the dollar to the point where it is truly worthless?

It seems to me that, at best, the 'weak dollar' policy is nothing more than a short-sighted and short term attempt at a fix to a long term problem.

First things first to see if this is where we need to go! Start off with a audit of the Federal Gold Reserves at Ft. Knox and all the other repositories and open the accounting to Public review and scruitany. Is it here or there? Only an audit will tell! Then we will know what the Gold fix is or has it been as many have speculated "Smoke & Mirrors"!

You NEVER heard of the speech until I mentioned it?

You don't know anything about William Jesnnings Bryant?

You've read the speech and don't understand WHY it's so famous, or why it's pertinent to this discourse?

Then there's no point in trying to debate or discuss anything with anyone as obtuse and ill educated as you are.

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