It is precisely because gold has been used as a currency for centuries without any government body dictating it’s value, or ‘agreeing it was’ (in your language above) that makes it important.
The government doesn’t dictate the value of gold. It dictates the value of its own scrip relative to gold.
This is a often overlooked point, but an extremely important one. Currency has always spontaneously arisen in advanced societies without any government intervention.
There are many, many historical cites (e.g. US pre-19th century) where gold and other coins made of precious metal were exchanged as a currency between parties. This was done voluntarily. Nobody dictated that this had to be the case.
It is only when a central government starts printing pieces of paper, and dictating ‘This piece of paper is worth 1 ounce of gold’ that things start to get interesting. The citizenry might say ‘OK, sure. Whatever you say. Can I get 1 ounce of gold in exchange for it, then?’ Any maybe for awhile, the government allows this to happen.
But then, when it starts printing too many pieces of paper, it passes laws saying that it will no longer exchange them for gold. And then sometimes it passes laws saying the citizens don’t even have the right to keep significant amounts of gold (other than jewelry) in their own homes. Usually this is because it needs to hoard as much gold as it can to pay off foreign governments who have no interest in taking briefcases full of little pieces of paper as payment. A quick search of United States history will turn up these examples.
So nobody has to dictate anywhere that gold is worth something for it to serve as money. If you simply do nothing and remove restrictions on its use as currency (which still exist today…try minting your own gold coins and using them as currency downtown at Starbucks) you might be suprised at what happens.
But the Starbucks isn’t going to take your homemade gold coins, not because there’s some law against minting your own gold coins, but because they want US dollars. They also aren’t going to exchange their lattes for chickens, deerskins, cowrie shells, cacao beans, whiskey, cigarettes, or cattle.
You are certainly free to create small gold ingots and offer to exchange them for goods and services, the problem is that most people would refuse to accept your gold ingots. And if people don’t accept your gold ingots, then suddenly they don’t act as money anymore. Not that your gold ingots don’t have value, they have value, but if they don’t act as money then they aren’t money.
I have the cite here now. I don’t have it electronically, but I will only repeat a short version here.
From ‘The Case Against the Fed’ by Murray Rothbard. Chapter 8, ‘Problems for the Fractional-Reserve Banker: The Criminal Law’
…In the final culminating case, Foley vs. Hill and Others, decided by the House of Lords in 1848, Lord Cottenham, repeating the reasoning of the previous cases, put it lucidly if not astonishingly:
‘The money placed in the custody of the banker is, to all intents and purposes, the money of the banker, to do with as he pleases; he is guilty of no breach of trust in employing it [IdahoMauleMan: or loaning it out as a multiple of its value]; he is not answerable to the principal if he puts it into jeopardy, if he engages in hazardous speculation; he is not bound to keep it or deal with it as the property of its principal…’
Isn’t that amazing? And to think at one point people deposited their money into banks and assumed it was theirs. We know differently know, don’t we?
Maybe. I think it might happen differently. In prisons, for example, cigarettes spontaneously arise as currency even though some of the payors and recipients don’t smoke. One of the reasons is that possession of US currency is restricted within the walls of many prisons.
There would certainly be inefficiencies inherent in dealing with gold at the beginning. I would have to bear the cost of that inefficiency. But I think it would erode over time.
For example, if I took a pound of gold into Starbucks this morning (value: about $15,000) and plopped it down on the counter for coffee, what do you think would happen? They might say No.
Or, the barista behind the counter might look around, see if the manager was there, take the pound of gold and stuff it in her backpack, and then put $3.50 of her own scrip in the till and hand me a delicious mocha with whipped cream. Actually, extra whipped cream. I love that stuff.
That little transaction contains a bunch of transactional inefficiencies and inherent legal risk. But it still happened.
The barista goes home and realizes that she has something worth 15 large. She is happy.
The next morning, I plop down an ounce of gold (about $900). A little bar 1/16th the size of the bar before. But she does the same thing without blinking an eye.
The next morning, I plop down a quarter-ounce of gold. She might look it over a little more carefully, since the amounts are getting smaller and smaller. But she sees little markings on it that look important and she judges the risk of it being fake are worth taking for another $3.50. This morning, however, she doesn’t have $3.50 so she has to borrow it from the manager. In order to do that, she needs to tell him the story about me and my gold, and let him know what’s going on.
Now the manager might get angry. Or, he might want a piece of the action. And a quarter-ounce of gold is still worth about $200. So he will go along with the little game and happily loans me $3.50 in US scrip to put into the till so he doesn’t get into trouble. He subdivides the little gold bit into two pieces with a hammer and screwdriver back in the office, gives half to the barista, and goes home happy.
As time goes on, I put down smaller and smaller amounts of gold. The barista and manager educate themselves more and more on what ‘real gold’ looks like, how to identify it, how to offload it if need be, and how much I really need to put down to buy my mocha.
I expect there to be a cost inefficiency evident to me of course, since there is a transaction that needs to take place between the Starbucks dudes and the rest of society if the government dictates that under no circumstances will gold be allowed as legal tender (which of course it does). So I need to bear the cost of that by putting down my gold.
But what if there was no restriction imposed by the government? What might happen then? Especially in a highly inflationary society?
Thanks for all your responses. I guess the real interesting part of it all, to me at least, is when I first got a bank account and all that, the idea was always that this money in the bank was safer and even more real than stuffing it in the mattress. That the bank was going to protect the money.
I always thought when I was younger than bank robbers took the money that was perhaps associated with my account when they stole a certain amount of cash but now I see that the situation after a bank robbery is that the bank has the same amount of liabilities (all the depositors) and less cash on hand.
My other question is this, normal depositors to a bank keep their deposit as basically a number which is a liability the bank owes them. But how does a bank keep their money? What happens if a bank gets too much paper money, or too little? Can they exchange paper money for liability money with the Fed, or how do they manage such things?
Sure, given a currency collapse and sufficient incentive, I’m sure you could get your local Starbucks to take gold coins. I’m talking about today, with you walking into a random Starbucks with a gold coin worth $20 (this is gonna be a pretty small coin) and asking for a latte with extra whip.
Eventually if you add enough gold to sweeten the deal, somebody’s gonna accept, even if as you say it is the barrista essentially buying the gold from you and putting her own government scrip into the till.
But it would be a lot more efficient on your part to take your gold coins to a coin shop or assayer and exchange it yourself for government scrip, then take that government scrip down to the Starbucks instead. You’re going to get a lot more latte for your gold if you take the gold to someone set up to buy and sell gold.
Now if the government scrip becomes worthless or restricted somehow, then people find alternate forms of money. But if the US dollar becomes wastepaper I still wouldn’t predict a return to the use of gold as money. More likely people will use some other currency and Euros will become a de facto currency, like some countries around the world where people would rather have US dollars instead of their local currency. Of course, with the US dollar worthless who knows if the Euro is still standing. But if we imagine a total collapse of all major currencies, then I suspect you aren’t going to be using your gold to buy lattes, but rather canisters of nitrogen-packed wheat. Sure, a collapse of the fiat currency system doesn’t neccesarily mean a Road Warrior scenario, but we still looking at an economic downturn worse than the Great Depression.
Other than the benefits of having tiny, shiny coins lending a comfortable weight to our pockets, IdahoMauleMan, what would be the point of switching back to gold currency? Massive deflation?
You may or may not have a point about government-backed money versus a collective agreement. I haven’t thought of it too much, but it seems like in the end it is the same. We all agree that something (gold, paper) is worth money, or we collectively vote in politicians to decide that for us. Either way, we’ve collectively made a decision to spend and accept paper money these days.
But in a thread about the ‘real-ness’ of finance, my argument is that gold is just as real or fake as paper. Whether you are playing Monopoly in meatspace, with tangible tokens and money, or on a computer with virtual pieces, it is still just a game.
Gold is less flexible than printed money and won’t expand with the economy. Therefore, about a hundred years ago, we all agreed to change the rules and go to a gold-less currency. It may, depending on your point of view, have been a bad decision. But it doesn’t change the fact that it was simply a small rule change in a very old game, not the start of a new game entirely.
Yes. This is where the armored trucks come in. I forget the exact details, but basically the bank sends its excess currency back to the Fed and the Fed destroys currency that is too worn out and recirculates the rest. The bank gets a credit to its account with the Fed.
Is that what’s he’s arguing for? I was just skimming, but I didn’t notice an argument in there. If that’s true, DrCube’s post is a great starting point of why we should never go to a gold standard ever again.
I don’t think it’s necessary for the US government to go back to the gold standard, or any other hard standard, right now. It’s too complicated, there are too many transactional inefficiences that would have to be dealt with, and with proper control over the printing and management of dollars we could accomplish much the same purpose.
You can cut-and-paste gold above with silver. Or oil. Or wampum. Or cigarettes. Anything that stands behind the value of the paper so that when someone is about to be handed a piece of paper that they don’t trust 100% they say ‘Thanks, but I’ll take <xxxx> instead’.
And my argument is that <xxxx> doesn’t need to be dictated by anyone. It has spontaneously arisen in advanced societies many different times, and has taken the form of cigarettes in prison.
Of course I wouldn’t actually use gold to make the transaction at Starbucks. I was trying to illustrate how quickly different forms of currency can come into being. But yes…the reasonably low inflation of the US dollar combined with the transactional efficiencies of its use suggest it would be pointless for me to do anything else for the time being.
What the gold standard (along with 100% reserve banking) does do is constrain how much credit can be extended, and how many dollars can be printed. You can’t fake those things if there is a hard standard behind the extension of credit or the printing of money.
You can’t have 10 ounces of gold in the vault, and lend out the equivalent of 1000 ounces, without putting your reputation and total bankruptcy on the line.
You can do it, however, if you are lending out something called ‘dollars’, and once you and your banking brethren are on the verge of collapse the Treasury can print more things called ‘dollars’ and give them to you.
I could not possibly disagree more with the statement that
‘Gold is less flexible than printed money and won’t expand with the economy.’
If the amount of gold in the world is fixed at 1 ton for all eternity, for example, it doesn’t matter. It doesn’t matter how many physical units of gold there are in the world. In a free market, price levels will adjust accordingly to gold-weight equivalents without any intervention. A fixed amount of gold is not going to prevent someone from producing more goods, just because they think there isn’t any more gold to buy them. The price will just drop accordingly based on supply and demand.
As an aside, you might want to plot the price of a barrel of oil over the past 3 or 4 years against the weight-of-gold required to buy that barrel. Pretty interesting.
You don’t even need to create a dollar:gold ratio, if you don’t want to. Just have things priced in grams or troy ounces or whatever of gold. In a society with continual productivity increases this would lead to price deflation over time, to which investors and consumers would need to adjust. But there have been many extended periods of price deflation in US history. It would also encourage saving, since your money would buy more stuff later on down the line. Sort of like waiting 6 more months to buy the computer you want right now.
Look, all of this somewhat academic. And as I stated above, moving the US to a gold standard now would be an incredibly complicated exercise that I don’t advocate. An independent central bank with strong inflation-fighting objectives and credentials will probably suffice just fine.
But reasonably-well developed countries have, in the past, moved sort-of to the ‘gold standard’ via currency boards (as I discussed above in Argentina’s case). In that case the ‘gold’ was the US dollar (which is doubly interesting, given the subject matter of this post) which they perceived as a stable source of value.
Other developing countries in Africa, Eastern Europe and the Middle East have many transactions where the parties involved will refuse to take their own currency as payment. Including governmental functions. They will only take US dollars or euros. I haven’t been to Zimbabwe since the 1990s, but back then I could only exit the country if I paid US$20, in cash, at the airport. And by US$20, I mean an Andrew Jackson or an American Express travelers’ check. Not Zimbabwean currency. They wouldn’t accept that.
Here is the first link I could find that illustrates the price of oil in dollars and weight of gold. Weight of silver is also thrown in for good measure.
I’m not really sure what problem a return to the gold standard is supposed to solve. Inflation hasn’t really been an issue in the US and recent price increases are due more to increasing energy costs than anything else.
The US dollar, despite a few warning signs and hints over the past 18 months or so (such as foreign governments saying they are ‘full up’ with US dollars and starting to hold euros instead) the dollar remains the reserve currency of choice. And inflation is quite benign in a historical sense.
You might want to take a look at that oil/gold link that I posted a bit above. Inflation due to ‘increasing energy costs’ is the same thing as inflation due to loose monetary policy in the minds of many folk, at least right now. There is an argument to be made for basic supply/demand dynamics over the past year or so as well. I’m not an expert on oil supply/demand so I won’t offer an opinion.
What I do know, however, is that I traveled extensively in Europe over the past 18 months and gas prices didn’t move all that much higher in the local currency (GBP and euros) during the time people started screaming about them in the US. And those currencies, of course, strengthened considerably against the dollar from 2006-early 2008. So what caused that?
And my question is why do people not realize that gold is just as arbitrary as ‘fiat’ money?
The only difference is that the government can’t manipulate the money supply when it is based on gold; they just can’t. It is set by existing gold supplemented by mines. That is why we have paper currency, and that is why we have the Federal Reserve. Now, argue against the Fed or monetary policy in general, but arguing over currency by itself seems to be missing the point.
If you don’t like paper money, it isn’t because it’s not real; it’s because you’re upset somebody gets to twiddle the knobs and indirectly influence its worth.
Here’s another way to look at it: all money, even gold itself, is basically a promise. That if you give me something worth having, like food, and take these bits of yellow metal in exchange, even though the metal isn’t really good for much except looking pretty, someone else will give you something YOU want, like say some wine, in exchange for them. The whole system only works when the promise is a credible one, and as long as people create goods and services worth having, and trade them. But a promise is only as good as the people giving it. Since neither gold nor notes nor entries in a database can be eaten, the only reason the promises of the people issuing them are credible is because other people owe them, and are continually paying them back. If you’re clever you can promise more than you can actually make good on, but then it becomes a juggling act to maintain a good face on your reputation.
The one point I would keep emphasizing (that may seem trivial to some) is that gold has arisen as a standard, time and time again, voluntarily. That is, citizens and merchants and bankers have voluntarily agreed to ‘buy into gold’ as a money standard for centuries. It must be for a reason. Let’s leave it at that for now.
And despite all of the stress it has suffered over the past few years, the US dollar is still in a near-unchallenged position of strength. The US cranks out about 20-25% of global output and wealth. To get access to that wealth, or to get access to the US markets, folks need to convert whatever-it-is-they-have into dollars. And as long as we keep the supply of dollars relatively constant, and don’t allow our dollar-based banks to overextend credit, we should be fine. We have a 3-touchdown lead with 4 minutes to go. We should just make sure we don’t blow our lead.
We have shown signs that we might blow it, however, with recent events. Freddie and Fannie, for starters. Massive current account deficits. The recent unpleasantness surrounding the price spikes in oil, although that may have subsided for awhile. I actually chalk a lot of the recent drop in oil prices up to market mechanisms (e.g. lower demand, and/or expectations of lower demand) working the way they are supposed to.