Thursday, March 29, 2012

Some Thoughts on the Gold Standard

Chairman Bernanke gave a lecture on the origins and mission of the Fed where he criticized the gold standard.

George Selgin, who is a bit of a fan of the gold standard (though skeptical of the desirability of returning to it,) takes Bernanke to task.

I broadly agree with Selgin, though I my understanding of the gold standard comes closer that of Glasner, who also criticizes Bernanke. Sumner sees things in much the same way.

One issue has to do with the resource cost of a gold standard. Bernanke takes the old Friedman approach, and assumes a 100% reserve gold standard. Gold must be mined out of the ground to serve monetary purposes is a cost.

In reading through some discussion of this debate at Marginal Revolution, I added to the discussion two thoughts.

First, focusing on the resources used to mine gold is a mistake."Fractional reserve" banking means that we can use lots of gold for jewelry, dental work, and electronic circuitry.
Relatively little of the gold that has already been mined out must be stored in vaults as "backing" for paper money or used to make coins.

Second, suppose gold coins were minted about the size of the old $10 coins but denominated as $100,000? (I think those coins are about 1/2 ounce and so the metal value today would be about $800.)

Now, further further suppose that there is no free coinage. The mint issues these in a quantity sufficient to keep nominal GDP on a 3% growth path. (The Mint could target a constant CPI, a 2% inflation rate, or any number of other things.)

New coins are issued to purchase outstanding government bonds. The bonds are then retired, if the Mint balance sheet is consolidated with the rest of the Treasury, or they could be held by the Mint as intergovernmental lending.

Excess coins are withdrawn from circulation by issuing new government bonds, selling them for the coins, and retiring them. (If the Mint held government bonds, then it could sell them on the market.)

Federal Reserve notes (and balances at the Federal Reserve banks) are redeemable in these coins. Perhaps commercial banks could be permitted to issue banknotes and the clearinghouse function of the Fed privatized.

Is it a gold standard?

Is free coinage a necessary condition for a gold standard?

How much seignorage is allowed? Can the seignorage vary?

I think it is pretty clear that the "gold standard" I have described requires very little gold to operate.

I have been thinking about this system in the context of the monetary provisions of the U.S. Constitution. Would this system be consistent with the power of Congress to coin money and determine its value?


  1. The mint issues these in a quanttiy sufficient to keep nominal GDP on a 3% growth path. (The Mint could target a constant CPI, a 2% inflation rate, or any number of other things.)

    Isn't the whole point of a gold standard to kill this sort of thing?

  2. A gold standard is like a currency peg with gold as the foreign currency. Modern gold advocates want a hard peg, meaning that dollars are fully backed by gold - or alternatively, get rid of national currencies.

    What you describe is a fiat money system where the coins happen to be made of gold, but gold is not the base money.

  3. I have always assumed that people who talk about a "gold standard" want 100 percent reserve banking.

    At fractional reserves set by free markets, who knows what would happen?

    I do worry that one bank run (not enough reserves to cover deposits, and depositors smell that) would lead to widespread bank runs, wiping up the free market banking system.

    There is an advantage to having a central bank that can just print money.

    More than that, I think the Market Monetarist approach offers a more-sensible path to prosperity.

    I happened to be researching the Constitution lately, in regard to bankruptcy law, and so for fun read again the section on "coining money" and setting the value thereof.

    Coining money does not sound like printing paper money, true.

    But then, the "right to bear arms" does not sound like the "right to bear semiautomatic rifles."

    In times of economic stress and depression, oddball ideas take on savior-type roles.

    Really, I think a sound monetary policy is all we need. Along with sensible regulatory and fiscal policies.

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