fredag, februari 15, 2008


The supposed cost of a gold standard

I quote professor Michael D. Bordo's article about the gold standard.

"Finally, any consideration of the pros and cons of the gold standard must include a very large negative: the resource cost of producing gold. Milton Friedman estimated the cost of maintaining a full gold coin standard for the United States in 1960 to be more than 2.5 percent of GNP. In 1990 this cost would have been $137 billion. "

In my opinion the notion that it would be costly to support a gold standard is probably the absolutely worst and most nonsensical argument against the gold standard ever put forward.

In order to explain why the notion that the gold standard is a waste of gold is unvalid, I would like to present an example. A precondition for understanding the example is a basic understanding of the function of a currency board system. For this reason I start with a brief explanation of how a currency board works.

A currency board works approximately as follows. Registred banks in a jurisdiction with a currency board neither borrow nor lend legal tender from and to a Central Bank, but instead registred banks buy and sell legal tender from and to the Government's Bank of Issuance at a rate defined in terms of a foreign currency. The Government's Bank of Issuance holds assets sufficient to repurchase all currency in circulation.

Suppose that for some reason the people in a jurisdiction with a currency board arrangement would prefer to use debit cards instead of legal tender. What would happen? Well, notes and coins issued by the Government's Bank of Issuance would be returned to the banks and since the banks would like to earn interest, the banks would return these notes and coins to the Government's Bank of Issuance and present them for payment in the foreign currency on which the system is based.

It is therefore theoretically possible to imagine a currency board without assets nor debts.

Suppose that thereafter, the Government would like to lower the definition of one unit of the national currency from £1 Sterling to $1 US. As long as the exchange rate is not raised, that could be easily done through a Government's decree.

In the same manner the Government could issue a decree stating that from now on one unit of local currency is at par with a specific quantity of gold. Would that be associated with any waste of physical gold? No, it would not.

However: After this reform it is likely that registred banks would start to keep physical gold available for their customers, but in a society with a pure paper currency gold is also kept in storage, although not by banks but by wholesalers of gold. There is no reason to believe that banks would hold more gold in storage than wholesalers of gold already do. In addition to that, there would be no reason to hold gold as an inflation hedge in a society where the monetary system would be based on gold, since debt currency issued by solvent institutions would be "as good as gold".

The truth is therefore that a gold standard would make gold now kept as inflation hedge available for non-monetary purposes and that thus the purchasing power of gold would tend to fall if gold were given it's proper role in the monetary system.

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