Question about Gold Standard and Tariffs

Factual Questions
141

So…you don’t think banks should be required to keep 100% reserves?

Don’t you see that fractional reserve banking creates money out of thin air, money that is not backed 1:1 by gold?

I deposit 100 grams of gold in the bank, or to put it another way, I lend the bank 100 grams. The bank has 100 grams in their vault, a debit in their ledger saying they owe me 100 grams, and I have an asset in my ledger saying the bank owes me 100 grams.

If the bank is required to keep 100% of deposits on reserve, that’s the end of the story. They can’t lend out the 100 grams of gold, because they have to keep 100 grams in reserve in case I cash out my account.

However, if the bank can take the 100 grams and lend 90 grams to someone else to start a business, the bank has created money out of thin air. There used to be 100 grams of gold. Now even though there is still only 100 grams of gold, there is money valued at 190 grams of gold. The guy they lent 90 grams to deposits it in his bank, and they lend out 81 grams and keep 9. And so on and so on, and eventually with 10% reserves required 100 grams of physical gold has created money worth 1000 grams of gold out of thin air, all based on trust in the banking system.

If that trust disappears, and everyone demands their gold back, then the system collapses because there isn’t enough gold to cover all accounts.

So allowing banks to lend money from their deposits means that you can’t have what you say is the most desirable feature of gold based currency, a 1:1 correspondence between a paper certificate and a particular bar of gold.

This is what I’ve been trying to get across. Any time you allow business to extend credit without making sure that their customers have specie on hand to pay their bills, any time you allow banks to borrow and lend without requiring the borrow to have specie on hand to repay the loan, you create money out of thin air, money that is not physical gold or silver, but rather entries in ledger books. This is what you say should not be allowed, money that is not gold or silver, yes?

Again, a promise to pay gold or silver some day is not gold or silver, but a promise to pay gold or silver can be used as money just like gold and silver can be. Any time we allow someone to promise to pay gold or silver some day, when they don’t have gold or silver on hand to pay that off that promise immediately, we allow the creation of paper money.

Is this OK with you? Or should it only be the government that isn’t allowed to promise to pay gold unless they have enough gold on hand to cover each and every promise to pay?

Thing is though, no government will agree to such a thing, and when we were on the gold standard for really-real before the Great Depression, the government only had a small fraction of the amount of gold required to pay off all dollars.

Fiat money is honest, because it honestly acknowledges that it is only worth anything because the government promises it is worth something. And when governments create too much money–the unlimited money you’re worried about–their currency devalues accordingly. Government’s can’t create unlimited money out of thin air, because if you double the amount of money in circulation without doubling the amount of goods and services available then that money is only worth half as much. So yes, governments can keep the (metaphorical) printing presses humming, and create more and more money. The only thing keeping them from doing that is common sense. If you get a government that doesn’t have common sense, like, say, Brazil in the 80s/90s, or Zimbabwe recently, the value of the currency collapses, and the government is worse off than before.

Well, they get a small boost at first by effectively confiscating all savings denominated in that currency. But very very quickly nobody keeps any savings in the inflating currency, so it can’t be eroded. And then creating more money doesn’t help because, supply and demand, creating more money when there is no demand for new money decreases the value of that money.

But take a look at what is happening in our current economy. Inflation rewards borrowers and spenders and punishes lenders and savers. Therefore, if the money supply is increasing, people want to borrow money (to spend today) and pay it back later when it is worth less. And they don’t want to lend money, because when it gets paid back later it is worth less.

So take a look at your bank account. Do you see banks clamoring to borrow your money by offering you high interest rates on your deposits? Back in the days of high inflation you could get decent interest on your savings account. That was because by the time you earned that interest your money was worth even less.

Now, take a look at interest rates today. They are at rock-bottom lows. What does that tell you? It tells you that our economic problems today are not caused by inflation, are not caused by governments creating too much fiat money.

When banks are offering to lend you money at extremely low interest rates, there’s your proof that inflation is not a problem. Because if it was, you could borrow money at low interest rates, buy stuff today, and then pay off the loan in the future at dollars on the dollar, the future dollars being worth pennies.

142

The amount of fiat currency is limited. Not by the size of a gold reserve but by the size of the entire economy. As the economy grows, the demand for money grows and the government issues money to fill that demand.

Yes, it is possible for the government to abuse this system. The government can decide to issue fiat money that isn’t supported by the economy as a whole. And when that happens you have hyperinflation and a currency collapse.

But that isn’t the norm. Most countries (including the United States) maintain their fiat currency system within reasonable limits, decade after decade. You don’t throw out a system that works and is useful just because it could theoretically be abused. The disadvantages of fiat currency are avoidable; the disadvantages of gold-backed currency are unavoidable.

143

This is really the simple answer. Do you understand it, mmmbeer?

Think of it this way. Think all of your possessions. What is worth more, all of those possessions or only the amount of gold you own? Right, it’s all of the possessions.

So, why, when you issue IOUs (or money) should you be restricted to all of your gold? You could just as easily repay in refrigerators, washing machines, land, clothing, etc. The “You” in this example is the economy. Our economy would be hamstrung if we decided that only the gold that we have it in has a store of value.

144

Here’s a metaphor that you’re probably familiar with: the board game Monopoly.

Monopoly comes with thirty-two houses and twelve hotels. According to the official rules, that’s a fixed amount. You’re not supposed to substitute pennies and nickels for extra buildings.

So you’re playing and you’ve just bought Boardwalk and Park Place and you’re flush with cash. You want to develop your properties and start reeling in the big rents.

But you can’t. Because your brother and sister have bought up all thirty-two houses. So there’s none for you to buy. And, again according to the official rules, you can’t build a hotel unless you buy the houses first - no houses, no hotels.

So you’re stuck. You have the deeds and you have the money in your possession and you want to develop your property and build houses and hotels and make the world a better place. But you can’t - because the economy of the game is tied down to a fixed finite supply of houses. The game economy cannot expand beyond this thirty-two house limit.

That’s what a gold standard does in the real world economy. It ties the size of the economy down to a fixed finite resource (gold) just like the Monopoly economy is tied down to its fixed finite resource (houses). The economy can’t grow past this limit.

Switching to a fiat currency is like adding a house rule that says you can add extra houses to the game if people want to buy them.

145

Fiat currency is theoretically limitless. But the powers that be would have to be desperate to want to expand the money supply much faster than the economy grows. This has happened occasionally because things got very bad.

Likewise, the powers that be would have to be desperate to debase gold, or decrease the amount of gold a dollar will buy or go off the gold standard entirely. This has also happened when things got very bad.

Both systems are based on trust, but the former doesn’t hamstring the economy. Again, I don’t know how easy it is to increase the gold supply, but it’s a hell of a lot easier to bump up a ledger entry.

Also, borrowing is a promise to create wealth. It just doesn’t always work out.

Rob