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Gold Money Confusion

Returning to a gold standard...

THIS is a nice, straightforward paper, writes Nathan Lewis at New World Economics, reviewing Chapter 9 of The Gold Standard: Retrospect and Prospect, entitled 'International Monies: The Gold Standard, Currency Boards and Dollarization' by Nicolas Cachanosky.

It begins by making comparisons between the gold standard of the past, and countries today that link their currencies to an external standard of value, typically the Dollar or Euro, in the process giving up domestic macroeconomic manipulation ambitions.

"Consider the best case for an independent, central bank-managed fiat money. An independent, central bank-managed fiat money does not generally promote international trade by reducing exchange rate risk. Its value floats against other monies; or, at the very least, is pegged to some other money with the potential to deviate markedly. An independent, central bank-managed fiat money does not generally encourage fiscal discipline, either, since the government might always turn to the printing press in hard times.

"Hence, those who prefer an independent, central bank-managed fiat money over a gold standard today are effectively limited to arguing that (1) a gold standard would perform worse than its admirers insist or that (2) the supply of an independent, central bank-managed fiat money would be managed sufficiently better to make up for its shortcoming on the other two margins.

"If historical experience is any guide, the superiority of independent, central bank-managed fiat monies is far from clear. In Chapter 5, Thomas L.Hogan has shown that the Federal Reserve (Fed) reduced the stability and predictability of the price level in the United States, without noticeable improvements in real gross domestic product (GDP) growth or volatility. The Fed, in other words, has not obviously managed the supply of money more effectively than the gold standard – let alone managed it sufficiently better to warrant the shortcomings of an independent, central bank-managed fiat money noted above."

This is exactly the kind of simple and clear explication that is notably missing from the rest of this book.

The author then goes on to explain how to achieve this fixed-value goal, preferably by a currency board, which works very well.

For some reason, people have no problem today explaining how to properly connect a currency to an external standard of value (like the Euro), via currency-board-like mechanisms, which is exactly how it was done, very successfully, in the pre-1914 era as well. But, when you ask them to do the same thing with gold, for some reason they collapse into incompetence and confusion.

I also think it is important to imagine how a proposed currency regime would work on an international basis. Most floating fiat central bank policy proposals, such as NGDP targeting, have a very domestic focus. What would the exchange value of the USD be, under this regime? What would it mean to the 40+ countries who link their currencies to the USD? What would it mean to all those who are using the USD and USD-denominated contracts worldwide – when 60%+ of all USD banknotes are thought to be circulating outside the country?

If the US gave no care about the concerns of international users of USD, would we be surprised to find that the USD was abandoned as an international currency, somewhat as the GBP was in a series of steps between 1914 and 1970? Isn't that exactly why all the world delinked its currencies from the USD in 1971 and 1973? It is not hard to tell exactly where the "unexpected problems" would erupt if any of these ill-conceived schemes were actually tried.

Some of the reasons the gold standard worked, on an international level, are:

  • It provides sufficient stability of value to serve as the basis of a shared system. There are many advantages to using a single currency standard, or in other words, having fixed exchange rates. However, these advantages aren't worth much if the shared standard of value is unreliable. You wouldn't want to have a "shared standard of value" with an unreliable or even hyperinflationary currency – and this is exactly why the European countries and Japan delinked from the USD in 1971;
  • It is politically neutral. A country with some ambitions to be more than an economic satellite does not want one of its main macroeconomic policies to be determined by the political wrangling of the Federal Reserve, which is paying attention solely to US-centric concerns. In other words, it doesn't want its policy to be determined in Washington DC. This can easily lead to a loss of sovereignty on a number of levels, as we have seen in Europe.

"At the moment we have to depend upon the US Dollar but the US Dollar is also not stable," said Malaysia's then prime minister Mahathir bin Mohamad in June 2019.

"So the currency that we propose should be based on gold because gold is much more stable."

Mahathir's proposal has many similarities to proposals that he has made at least as far back as the Asia Crisis of 1997-1998, when many Asian currencies collapsed. Then, and continuing at least through 2007, Mahathir proposed a "gold Dinar" again for international use among Islamic countries (in Asia this includes Malaysia and Indonesia, along with many countries of the Middle East). The Islamic countries have a very long history of a gold Dinar, a gold coin containing 4.5 grams of gold. The Dinar (and its precursor, the Byzantine solidus) was the basic currency of the Islamic Caliphates from the seventh century through the thirteenth century, and the tradition carried on after that as well.

Muammar Gaddafi of Libya also made similar comments in favor of a common gold-standard policy for Islamic North Africa, and Africa as a whole. Some people think that the perceived threat of this plan, to the hegemony of the floating fiat US Dollar, was one motivation for the invasion of Libya by US-led Nato forces in 2011, which cemented Gaddafi's downfall.

Mahathir noted that, in Asia, the idea of adopting another country's currency (such as the Yuan or Yen) is not popular, due to fears of a loss of sovereignty. Thus, the idea of an "international currency" is apparently to defuse such fears. However, in time, if the project is popular, local currencies could also follow the policy of linking to gold, which would thus bring all of Asia under a common currency standard. This solution would also maintain domestic currency sovereignty without the need for centralized institutions like the European Central Bank, and all the supranational superstructure that has accompanied it.

Now let's continue to Chapter 10 of The Gold Standard: Retrospect and Prospect, 'Digital Gold: The Case for Cryptocurrencies' by William Luther. As promised in the title of this paper, the author looks at "digital" forms of gold-based transaction mechanisms, instead of coins or banknotes. One early example was e-Gold, launched in 1996.

The search for digital gold began long before the launch of Bitcoin. In 1996, Douglas Jackson and Barry Downey founded E-Gold, Ltd., which enabled its customers to transfer titles to warehoused gold on the Internet. The company had secured more than one million users by 2005, when Jackson and Downey, along with co-owner Reid Jackson, were indicted for money laundering and operating an unlicensed money transmitting business. Rather than risk spending decades behind bars, the defendants accepted a plea deal. But doing so precluded them from securing the requisite licenses to operate E-Gold. The gold transfer site never reopened.

Cryptocurrencies like Bitcoin have little in common with E-Gold. They are not claims to gold or any other asset. They do not rely on a trusted third party to process transactions. But, like E-Gold, they offer the hope of a new monetary system that improves upon the shortcomings of physical commodity and fiat monies.

e-Gold was followed by GoldMoney, which was intended to serve as more of a transaction mechanism. This also ran into regulatory difficulties, such that GoldMoney is more of an investment platform today.

After criticising Alexander Salter in Chapter 8 for misrepresenting the arguments of William Luther, who also wrote Chapter 3, now I will criticize William Luther in Chapter 11 for misrepresenting the arguments of William Luther in Chapter 3. No kidding.

"The classical gold standard was not without its downsides, however. The natural scarcity of gold, which enabled the decentralized, self-adjusting mechanism to function, also meant that the monetary system was costly to maintain and slow to adjust. To increase the supply of gold coins, one must employ workers and machines to dig up gold and mint it into coins. Those workers and machines could be used to produce other valuable goods and services. Moreover, the adjustment period could be quite long. While the purchasing power of gold was relatively stable over the long term, it was quite volatile over short periods of time. With the shortcomings of commodity monies in mind, it is easy to see the allure of fiat monies. Fiat monies lack natural scarcity. The marginal cost of creating a Dollar is effectively zero, as it is accomplished with a mere keystroke. Fiat monies are made artificially scarce by their issuers, typically a central bank. If a central bank were to manage the supply of a fiat money well, then, it could provide a credible long-run nominal anchor similar to that of the gold standard with a much shorter adjustment period and at a much lower cost."

Here we go from "gold as a stable standard of value" to "money supply determined by gold mining production," which was never the case even in the era of 100% coinage, and certainly not since the spread of paper currency in the seventeenth century.

It has nothing to do with the institutions of the nineteenth century, as I have already pointed out. But, this is what happens when you spend too much time in Fantasyland.

What follows is a decent explication of some of the properties of cryptocurrencies, including some interesting details. The author concludes that the stable supply/wild variation in market value characteristics of first-generation cryptocurrencies make them unsuitable as a standard of value or unit of account, although they have some use as a means of payment. Then he goes on to recent "stablecoin" efforts, such as the USD-linked Tether. Some of the basic options for cryptocurrencies include:

  • "Stable supply" systems like Bitcoin, which have had tremendous volatility of value. This was actually "first generation Monetarism", or stable growth in the base money supply, which was popular in the mid-1960s. "Second-generation Monetarism" uses banking-sector metrics such as M2, and "third-generation Monetarism" uses nominal GDP;
  • Make it up as you go along. The crypto supply, and crypto value, is determined by whatever the operators of the system like, according to their whims and wishes. This is the normal state of affairs for central banks today, but it is hard to imagine any independent cryptocurrency being managed in this fashion, and generally they are not;
  • "Stable Value" systems like Tether. Here, the supply of cryptocurrency is variable, as a residual of the activities to maintain the stable value link.

From here, the author suggests, somewhat similar to Friedrich Hayek in the 1970s, that we could have a number of experiments in currencies. Now we are getting to the punch line.

"While existing stablecoins, algorithmic or otherwise, leave something to be desired, it is not too difficult to imagine how they might lead to the development of more promising cryptocurrencies. Ideally, a cryptocurrency's supply would be preprogrammed, to prevent issuer risk; but preprogrammed in such a way to eliminate the downside risk of existing algorithmic stablecoins. Its supply would expand and contract to meet demand. However, the objective would not be to stabilize its purchasing power relative to the Dollar or Euro or some other currency. Instead, its purchasing power would be kept equal to..."

Is it...a four-letter word starting with "G" that is on the cover of this book?

Is it, perhaps, the "digital gold" that is promised in the title of this paper, and explicated in the first paragraph?


"...some broad basket of commodities a la Robert Greenfield and Leland B. Yeager or the price of a nominal income futures contract a la Scott Sumner. A cryptocurrency with these attributes would not only enable private, secure, and near-immediate transactions like Bitcoin. It would also anchor long-run expectations and make pricing goods and services in terms of the cryptocurrency more convenient."


And that's it. The author never mentions the prospect of perhaps tying one of these "stablecoins" to gold, even though this is already happening, with Tether Gold the largest example.

In 2012, at the invitation of Ron Paul, I gave a presentation in Congress about gold-based alternative currencies – even, as I argued, state-issued alternative currencies based on gold.

So, it is not like this topic hasn't been discussed before.

The author doesn't mention Hayek, but the author's conclusions are eerily similar to those of Hayek, in his "alternative currency" proposals of the 1970s. Most people aren't aware that Friedrich Hayek was never, at any time in his career, a gold standard fan. He mostly adhered to commodity-basket proposals, while consistently criticizing the gold standard throughout from the 1920s to the 1970s. This is really rather strange, when you consider that, during that time, the gold standard was the regular policy of all the world's major governments and central banks. In other words, Hayek played the role of a subversive. Was this on purpose? It is hard to tell, but as I mentioned then, his connections to the London School of Economics and the Rockefeller Foundation definitely smell funny. Some of Hayek's comments are similar to NGDP Targeting arguments. Hayek encouraged a variety of experiments in his proposed "multi-currency" environment, except for one...guess what it was.

In the first instance indeed, as you all would expect, people would from their own experience be led to rush for the only thing they know and understand, and start using gold. But this very fact would, after a while make it very doubtful whether gold was for the purpose of money really a good standard. It would turn out to be a very good investment, for the reason that because of the increased demand for gold the value of gold would go up; but that very fact would make it unsuitable for money.

Gold has always worked, because it has always been reliably stable in value, but this time it definitely wouldn't work, because it definitely wouldn't be stable in value, because reasons. I think a little trepidation is natural – there was trepidation in the 1920s and 1940s as well, as the world went back to gold standard currencies after a period of floating. But, these worries did not pan out. Gold was fine.

Hayek again conflated the idea of "purchasing power" and "stable value" – which the better economists, including Adam Smith, David Ricardo and Ludwig von Mises, explicitly rejected. Therefore, the basic contention, on which the validity of my further argument rests, is that, if people were wholly free to choose which money they wished to use in their daily transactions, it would soon appear that those did best who preferred a money with a stable purchasing power. This aspect of liquidity which is usually indicated with the term stability of value is normally expressed as an index number of prices. It is often taken for granted that a good money should be approximately constant in purchasing power. That means that it should be approximately constant in terms of its average prices.

The rest of the paper consists of what the world might look like using Hayek's commodity basket standard. And so we wrap up this little exploration of Hayek's brain, and I find it a rather odd place, given Hayek's reputation. Naturally I disagree with his conclusions; but also, I disagree with his methods, which rely upon empty assertion and definition rather than any real argument, which was conspicuously absent, apparently through his whole career. The nice thing about real "currency choice" is that you can indeed let the market decide. I am pretty sure I know which one would win; because it has always been the winner, the Final Standard, over millennia of history. And the reason for that is: it always worked.

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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