By Alistair McConnachie & James Gibb Stuart
“The Gold Standard” means that there is a rigid relationship between a country’s gold reserves and its money supply and that gold is the only means of international payment.
So when people talk about “the gold standard” they are talking about it in two areas:
1) gold as the backing for the national money supply,
2) gold as an international trading currency.
Let us address both these areas.
First some history: The gold standard was widely established until 1914, but it was not completely abandoned until 1933.
Right up until the gold standard ended in 1933 there was a theoretical belief — some would say, a pretence — that a nation’s paper-money was “backed by gold” and could be exchanged for gold, but few really accepted it was possible in practice.
The reality was that during this time, and ever since, countries of the world were essentially running “fiat” currencies — that is, currencies not backed by gold.
However, under the gold standard every transaction between countries had to be settled in gold.
Imbalances of goods and services were equated by a realignment of gold reserves, with the debtor nation relinquishing, and the creditor nation receiving.
Consequently, nations which ran persistent imbalances faced the threat of losing all their gold reserves, and thereby losing both credit and credibility in the eyes of their trading partners.
That was the essential principle of the gold standard, and was standard practice until the Genoa Conference of 1922, which aimed to increase liquidity by allowing central banks to hold part of their reserves in foreign currencies such as sterling or dollars. This was known as the “gold exchange” system.
“GOLD EXCHANGE” REPLACES “GOLD STANDARD”
The “gold exchange” system meant that a country could settle its international debts in gold, or they could be settled in paper — currencies and Treasury Bonds.
In this sense, gold was still kept in the rear as a discipline to fall back on. By permitting a measure of “gold exchange”, (or substitution for gold) it lubricated the functioning of the international monetary system.
Winston Churchill put the UK back on the gold standard in 1925. This is widely regarded as a disaster however, since trade plummeted because countries which wanted to buy from the UK, just didn’t have the gold to do so. Britain came back off the gold standard in 1931 and went back to the “gold exchange” system.
“CLOSING THE GOLD WINDOW”
The “gold exchange” system ended in 1971 when President Richard Nixon “closed the gold window” — which is to say the USA no longer agreed to settle its international trading balances in gold at all but only in bonds or paper currencies, none of which had any backing beyond the credibility of the Authority which guaranteed their issuance.
President Nixon closed the gold window because General de Gaulle was demanding that the debts owed to France by the USA, were paid in gold under the terms of the “gold exchange” system and the fact was that the USA simply didn’t have the amount of gold required.
Today, a nation’s money supply is not backed by gold, and international exchanges are not settled in gold, but in paper — often the US dollar.
SHOULD A NATION’S MONEY BE BACKED BY GOLD?
So should we have a “gold standard” again, and have our national money supply backed by a quantity of gold?
Gold is a currency which can be convenient since it’s acceptable everywhere and probably always will be, because it has an “intrinsic value”. However, it should be noted that this “intrinsic value” only exists to the extent that everyone accepts it world-wide as “valuable” — as they do also with other precious metals and stones.
SOME SAY, “GOLD IS STABLE BUT PAPER-MONEY IS INFLATIONARY”
Consequently, some people will say that “fiat” money — that is, the sort of money we have today, which is not backed by any commodity, such as gold — is “intrinsically worthless” whereas, they argue, gold is “intrinsically valuable”.
They will say that paper currencies are inherently inflationary because “they are not backed by anything” and so there is no restriction — no discipline — upon the government and the banks in creating the money, as there would be if the money supply was based against a given quantity of gold, valued at a certain sum.
You can follow the logic, but it’s not practical.
100% GOLD-BACKING WOULD STRANGLE THE MONEY SUPPLY
It is natural to look to gold for some kind of stability. Gold has acted as a store of value since the beginnings of civilised society.
However, in modern times no-one has operated on 100% gold-backing, which is only common sense, since often the real intrinsic worth of a community grows to exceed the recognised bullion value, and there can be needless poverty and depression in consequence.
A money supply equated to the amount of gold you have in the vaults would constrain economic activity.
It could lead to the horror situation where all economic activity was stopped because there was no gold to back the additional currency needed!
A money supply which depends upon 100% gold-backing would be a mistake because it would create a depression when there was not enough gold around.
A gold-backed money supply would be too stable — in the sense that it would simply paralyse economic activity.
GOLD-BACKED MONEY CAN STILL BE INFLATIONARY
The route to economic success and stability is complex. It seems to depend on leadership, political and economic competence, national temperament and so on.
For example, the Spanish kingdom was drooling in the gold of the Incas but economic mismanagement, extravagant royal ventures and careless misuse of national resources destroyed the substance, and Spain got its depression, inflation and economic woes, despite the gold-backed currency.
So what matters in the end is the proper utilisation of real resources, and their application to national needs and requirements.
Wealth comes from tapping into a country’s greatest intrinsic resource — its people — and from the production of goods and services. It does not come from, nor does it depend upon, the quantity of yellow metal which happens to be sitting in the bank vaults!
History tells us that gold-backing for a currency does not exempt the economy from depression, economic downturn and inflation and that there is nothing intrinsically wrong or “inflationary” about a fiat currency — what matters is that it is managed properly.
AND GOLD CAN BE MANIPULATED TOO
Some say that fiat currencies can be “manipulated”, but gold can be manipulated too.
The price of gold on the market varies according to supply and demand. The supply can be manipulated by…surprise, surprise…the people who mine the gold in the first place! The market can be flooded with gold, or it can be held back, or it can be illegally traded.
A world “gold standard” would give more power to the gold barons who could manipulate the supply, and consequently the price. Another example of immense power, concentrated, with no democratic control.
In addition, the price of gold can be manipulated by various speculative instruments.
THE INTERNATIONAL SITUATION TODAY
Is America to go on sucking in the raw materials and resources of a poverty-stricken Third World, paying for them by writing Treasury securities, or printing more and more US dollar bills? (See Prosperity Nov 2003)
Is there never to be a day of reckoning when like will be compared with like in terms of goods and services, and chancellors will once again steer their economies towards an approximate balance in their trade with other nations? Is the super-abundance of good things always to be at the disposal of the financially powerful?
Is eternal grinding poverty to be the lot of hapless millions who have an equal right to peace and plenty on this bounteous Earth?
The USA is the world’s biggest debtor nation, but she is also its only super-power. So long as her creditors are willing to go on accepting payment in bonds and paper money, that state of affairs will continue.
But will there be an end to it?
Some commentators are forecasting a period of disillusionment when the dollar will crash, and international traders will look desperately around for another yardstick.
Prime ministers and chancellors of Third World nations have stared into the abyss, and realised that a system dominated by the Almighty Dollar puts them in permanent bondage.
NATIONS SHOULD CREATE THEIR OWN MONEY
So what’s in this for the modern Money Reformer, whose main concern is to see that what is socially desirable, and physically possible, should also be made financially possible?
That has been the privilege of free peoples throughout the ages, and has more to do with their domestic social and political structures than with international trade.
As for international trade: Could gold be used again as an international trading currency to bring a measure of stability and trade justice? It’s difficult to see how.
The US deficit, for example, is quite beyond the ability of the USA to settle in gold. That was the case in 1971 and is considerably more so now!
However, nations should first look at what they can do in their own particular circumstances. In Prosperity September 2001 we suggest five broad policies for national economic sovereignty here.
These are: Stopping the haemorrhage of national reserves by means of exchange controls; reversing the liberalisation of financial markets; rejecting the privatisation of public assets; avoiding foreign loans or further borrowing; and steadfastly maintaining social programmes, with government created debt-free money.
For international trading arrangements it may be worth considering the idea of a neutral international trading currency such as Keynes’ “Bancor” explained here as well as stabilising national currencies by aligning them according to the value of a basket of commodities explained here. On the latter, see also the appendix to the paperback edition of The Money Bomb available for £5 payable to Prosperity, address below.