Gold News

New Standard? Gold Bullion Currency Board

Gold bullion could be part of a currency board just like the Bulgarian Lev...
A FRIEND noted that I seemed to have changed my views a bit about how to implement a gold standard system, writes Nathan Lewis at New World Economics in an article first published on Forbes.
He's right.
This was the result of writing my new book, Gold: the Monetary Polaris, which outlines the many ways you can design and implement a gold standard system. Each one has some advantages and disadvantages, using more or less gold bullion as part of the currency system. I ended up thinking about it a lot.
Two years ago, I was something of a traditionalist, usually suggesting that a gold standard system be set up in roughly the manner that the Bank of England managed the British Pound in the pre-1914 era. (I call this an "Example #5 hybrid system" in the book.) One problem with this system is that it can be very complicated, and rather opaque in its operation.
Today – in part due to the influence of Chuck Kadlec – I would probably trend toward a more automatic currency-board-type system using gold bullion. (An "Example #2″ system in the book.)
What this means is: the currency manager (which could be a central bank, or could be a different organization working in a "free banking" or "parallel currency" framework), would exchange only gold bullion and base money (banknotes and bank reserves). This is how currency boards, like the Euro currency board used by Bulgaria, work today. There would be no "open market operations" in non-bullion assets.
Bulgaria's currency board is very simple. You can trade Euros for Bulgarian Lev, or Lev for Euros, at the established parity ratio of 1.95583 Lev per Euro. (It originally had the much more sensible parity of one Lev per deutschemark.) Substitute "gold" for "Euros" and you have a gold standard system.
Indeed, the man who established Bulgaria's currency board – Johns Hopkins economist Steve Hanke – now proposes a " currency board based on gold."
You could still have a separate "lender of last resort," serving the role of the Bank of England's Banking Department pre-1914, and in fact Bulgaria has exactly this arrangement. However, Bulgaria's Banking Department does not itself have the ability to alter the base money supply.
A disadvantage of this currency-board-type system would be that it would require potentially rather large and frequent transactions in gold bullion. This could be an issue with a very large currency, like the Dollar or Euro, but it is much less of an issue for many smaller currencies around the world, like the Vietnamese Dong or the Chilean Peso.
An advantage of the currency-board-type system is that it is easy to understand, and intrinsically transparent. It is fully automatic, with no discretionary element, unlike the Bank of England-style "hybrid" system where there is a bewildering array of potential actions and errors. The currency managers themselves would be less likely to make a mistake. Others would be able to understand how it works, and observe if there was an operational problem, or if the currency managers are being naughty.
Also, this system is not dependent on "market prices". You have to show up with real gold bullion if you want base money; likewise, base money is exchanged for gold bullion. It is not dependent on a market for Comex gold futures, or the unallocated "gold accounts" of London Bullion Market Association banks, or ETFs, or any other variety of "paper gold" that can be tweaked or manipulated by unscrupulous financial operators.
This system would not require very much gold. Even though base money can be redeemed for bullion on demand – in any quantity – bullion may constitute only 5%-20% of actual reserve holdings, the remainder consisting most likely of government bonds. This is how the Bank of England's Issue Department actually operated in the latter 19th century.
There is no one perfect answer. Each system has its own advantages and disadvantages, and each country's situation is different. However, in one particular case, one proposal might be better than another.
Over time, I hope that more people will begin to master these particulars of gold standard system construction and operation. It is really not that difficult. It will help clear away the miasma of misunderstanding that obscures the topic today. Most of what we've heard over the years – from both the Keynesian academics and gold standard advocates alike – is...rather unfortunate.
It's time to step up. Join the big leagues. We're waiting here for you.

Formerly a chief economist providing advice to institutional investors, Nathan Lewis now runs a private investing partnership in New York state. Published in the Financial Times, Asian Wall Street Journal, Huffington Post, Daily Yomiuri, The Daily Reckoning, Pravda, Forbes magazine, and by Dow Jones Newswires, he is also the author – with Addison Wiggin – of Gold: The Once and Future Money (John Wiley & Sons, 2007), as well as the essays and thoughts at New World Economics.

See the full archive of Nathan Lewis articles.

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