Gold News

Soft Money Paradigm Breaking

Disaster. Catastrophe. Go on – admit it holds a certain appeal...
IT MIGHT seem that today we are deeply devoted to the Mercantilist paradigm in monetary affairs, writes Nathan Lewis at New World Economics.
That is the notion of a floating fiat currency managed by a panel of bureaucrats, to address an ever-changing menu of issues including unemployment, exchange rates, financial markets, government funding, and the interests of one group or another.
Some people call this the Soft Money paradigm, characterized by the "Rule of Man".
But, I think it is important that quite a few governments have actually abandoned this paradigm. They do not attempt to manage their economies by jiggering their currencies.
Rather, they adopt a simple fixed-value system: the value of the currency shall be X. There is no domestic discretionary element. This is the Classical paradigm, the Hard Money paradigm, in which the "Rule of Law" is primary.
But what is "X"? In the past, it was gold. A "gold standard system" is a system in which gold is the "standard of value," ie, "X".
A "Dollar" was once worth 23.2 troy grains of gold. Today, lots of countries have the same sort of arrangement, but they use the Euro as "X" instead of gold. This includes the eighteen members of the Eurozone, all of which have given up any avenue of domestic money-jiggering.
It is true that the Euro itself is a floating fiat currency, and that the ECB does take into consideration the concerns of Eurozone member states during its funny-money decision-making process. However, we also know that the ECB doesn't really take orders from any one state, not even Germany, which is a little miffed at the central bank's latest money-printing scheme.
We also know that there are many Mercantilist economists who declare loudly that any state that gets itself into trouble should have its own independent currency, which can supposedly be jiggered by its own independent board of incompetents to make all the boo-boos better, really we promise.
Thus, I would argue that the Euro is basically serving as an external monetary benchmark for these states, much as gold did in the past.
In addition, there are another ten small states and territories that use the Euro but are not officially part of the Eurozone. Also, there are twenty-eight countries, mostly in Africa, that have some sort of Euro link, mostly via a currency board system.
In total, there are fifty-five states and territories that have a Classical fixed-value system based on the Euro. The only difference between these "Euro standard systems" and a "gold standard system" is the choice of the "standard of value."
The Classical ideal in money is very common today. But why use the Euro as a "standard of value" instead of gold?
The most basic reason is stability of exchange rates, or what I call the "terms of trade." The smaller countries of Europe have always had a high degree of trade with each other. This does not only include imports and exports, but also financing and investment. Whatever the potential benefits of using gold as the "standard of value," the fact is that to do so would introduce a lot of chaos into exchange rates with other Euro-using states, and other countries as well, which would be completely intolerable to businesspeople.
One of the primary attractions of a Classical fixed-value arrangement, rather than an independent floating fiat currency, is to gain all the advantages of stable trade relationships. That's why Europe gave up their independent currencies and created the Euro in the first place.
This problem did not exist in the past. Before 1971, the major international currencies, and most minor currencies, were fixed to gold. Thus, a country that adopted gold as a "standard of value," or "X" in a fixed-value system – the role the Euro plays today – would also have stable exchange rates with most major trading partners. There was no conflict.
At some point, the Euro may be so debauched as to render it completely unacceptable as a benchmark of value in a Classical fixed-value system. At that point, a government might either adopt another major international currency as its monetary "standard of value," or it might use gold.
If the Euro reaches such a state – ECB chief Mario Draghi recently said he intends to make another trillion Euros appear out of thin air, I kid you not – then other major currencies would also likely be close behind, except for the Japanese Yen, which would be far ahead.
Thus, other major currencies would not likely satisfy those fifty-five former Euro enthusiasts either.
Then they might turn to gold – which actually has a rather lovely track record, and which actually was the monetary benchmark for most of those countries for a very long time already.
But when might that happen? History suggests that such a changeover does not happen until the former benchmark currency has been abused beyond all hope of renewal.
Disaster. Catastrophe. I admit it holds a certain appeal.
However, there is an alternative: to introduce gold-based currencies today, but to make them optional instead of mandatory. Thus, the present Euro-based and other fiat currencies would continue, but there would also be a gold-based alternative.
At first, this gold-based alternative might not be very popular. It would have a lot of exchange-rate volatility with the fiat Euro, Dollar, Yen and pound. Let's be a bit Germanic and call it the goldmark, and give it the traditional value of 2790 goldmarks per kilogram of gold.
As today's fiat currencies gradually lost their viability, people might decide, incrementally, that they want to keep at least part of their savings in terms of goldmarks, not Euros or Dollars. Borrowers find that they cannot issue debt or borrow money unless denominated in goldmarks; suppliers want to be paid in goldmarks; workers demand wages in goldmarks; and producers demand goldmarks in payment for their goods and services.
As more and more people use goldmarks (and other similar currencies that emerge), for their own personal interests, they find that they can also engage in trade with all the other people that use goldmarks, without the issue of unstable exchange rates. Thus, the issue of chaotic trade relationships gradually melts away.
But what if everything is fine? What if there is no disaster? People can still use goldmarks as they see fit – perhaps as an investment product much like the gold ETFs popular worldwide – but perhaps they would continue to use fiat Euros for most commercial situations. It works both ways. There is no downside.
The only problem, it seems, is that people are not aware that such a thing is possible, and in fact rather easy to do. Also, they don't know how to do it. But, these are minor issues, really.

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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