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Money: Pegging/backing to Commodities

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agrippa1

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There is already a Kruggerand with a troy ounce of actual gold content (and quite a bit of other metal added to make the gold more durable. (One bad pun deserves another.)

Thanks for the history lesson, but I didn't mean it as a pun. Once we get more capitalism and banks can issue their own notes to be used as currency, I think a unit called "one Rand" would be a great way of immortalizing Miss Rand in terms of capitalism and her advocacy of it. How much gold "one Rand" would mean would depend on the bank issuing the note, which would be a standard weight of gold -- or rather a weight of gold to be used as currency thus becoming the standard for that bank. Of course, since "Ayn Rand" is a registered trade mark of the Estate of Ayn Rand, only they would be able to issue such currency, once they form a bank <_<

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ounces ... cumbersome

What I find cumbersome is this pre-scientific, non-rational English system of weights and measures. My prefered unit is gg. (Grams Gold) It cannot be more difficult to measure gold than dollars with a base-10 system.

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Second, if the government were to print commodity-backed notes that are exchangable and 100% backed by the commodity, it would be a minor issue from an economic, free-market viewpoint, as long as there are no restrictions on private notes, nor on the tender in which private parties may contract.

I'm sorry sNerd, I just don't agree with this. When a commodity is used as money, I may accumulate an amount of that commodity because I am a thrifty saver. I will find it useful to pay for the storage of that commodity at a money warehouse, also known as a bank. My right as owner to my stored money is established by a warehouse receipt that I receive upon deposit of my property. This warehouse receipt is a title to my property which declares my right to redeem the receipt for my property at any time I desire. Now, when I go to purchase a good from Mr. Smith who stores his property in the same warehouse, him and I may find it convienient to simply transfer the title to my property to Mr. Smith instead of going through the trouble of physically moving it. In this way, the warehouse receipt simply acts as a substitute for money, but it is not literally money.

The problem with a government "printing commodity-backed notes" is that a government is not a money warehouse, i.e. bank. It is not providing a service of storing money, i.e. deposits. Thus if it prints receipts, i.e. notes, and claims they are backed by a commodity, the question is "Whose?" If no one enters into a contract with the government to store his or her property, then how does it print receipts that are titles to property? Answer: The receipts are fraudulent, i.e. titles to nothing, or property has been nationalized. I don't see this as minor.

How are merchants supposed to price their goods and services if there are so many good money notes out there?

In terms of gold ounces. Example: This car costs 100 gold ounces.

Edited by adrock3215
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OK, I got it...what some of you are saying is to scrap the nomenclature of the dollar all together as a unit of economic exchange, and go directly to the conceptual source -- i.e. weights of gold. So there would not be any special name for a certain weight of gold, it would just be, say, grams of gold. There would be no Dollar, Krugerrand, Rand, or any other special name, just weights of gold, and any banknote certificates would say that directly; there would be 100 gold gram notes, 50 gold gram notes, 10 gold gram notes, and 1 gold gram notes. And the notes could be in the form of either coins or paper, to make it easier to carry, and it would work so long as the bank printing out the notes could guarantee that each note could be convertible or redeemed for the face value in actual gold. Another alternative would be to simply make those grams of gold into coins, though actual gold is rather soft, which is why the Krugerrand has other metals mixed in to it.

However, I think something would happen along the lines of what happened that brought about the nomenclature of the Dollar. The bank that was most able to guarantee that their notes could be directly redeemed for actual gold would win out in the market place, and people would start calling trustworthy money whatever the name of the bank was -- i.e. Joe's Bank Notes would be shortened to Joe's or maybe even J's, so that the price most acceptable by merchants would be economic measurements in terms of Joe's. Because merchants are not going to be accepting any ole piece of paper or any ole coin that has "100 gold grams" written on it. And the only way a merchant would accept actual gold, as in say gold dust, would be if the assayed gold right there on the spot. What trustworthy coins and banknotes make possible is for the merchant not to have to assay gold right there on the spot, he can just look at the note or the coin, realize it is from a trustworthy source, and accept it. So, in the long run, I think a nomenclature would arise, that would reflect the most trustworthy bank gold warehouse source for coinage or notes. In other words, merchants would be selective as to who's banknotes they are going to accept -- probably the one that their own bank creates, unless their own bank would accept Joe's, Sally's, Harry's, and Paul's bank notes as actual gold redeemable notes.

But I do like the idea of trading in Gold Grams. I think the gram is a small enough of a unit of weight that one wouldn't wind up having to do fractions of grams as change -- i.e. one wouldn't have to think in terms of 1/880 ounce of gold, but rather in whole numbers, which makes it easier.

The details as to which coinage or which banknotes wins out as the most acceptable for facilitating real trades would be taken care of by the free market.

And the only thing the government would be needed for would be to erradicate fraud or counterfeitting, there would not be any need to have a standardized weight of gold to be called "one dollar" as set by law, but rather if the coinage or the note was not convertable into actual gold, then the law would step in to investigate who printed it and who was responsible for it not being convertable into actual gold.

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But I do like the idea of trading in Gold Grams. I think the gram is a small enough of a unit of weight that one wouldn't wind up having to do fractions of grams as change -- i.e. one wouldn't have to think in terms of 1/880 ounce of gold, but rather in whole numbers, which makes it easier.

Well, you'd still be stuck at having 1 gram be worth about 28 or 29 dollars, but the nice thing about the SI units is that for smaller quantities, you can just have 1 mg, 5mg, 10mg, 50mg, 100 mg and 250 mg notes/coins. Those would be pretty close in value to what we have, today. 1 milligram of gold would be about 3 cents in today's economy, and you could easily use small coins that are redeemable for that value of gold. Either that, or use a second, less precious metal that is used for smaller quantities, and which forms the coin itself. You can probably still make small silver/something coins and use those, if one wanted to.

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The hazard of using two distinct precious metals is that their relative values fluctuate. This situation was the bane of all hard-money systems of the past. I'll walk through an example: Let's say a country defines their currency, the quatloo, as being one gram of silver. They want to mint both silver and gold coins, so they'd try to set the gold-silver ratio at 20:1 (say)--a gram of gold was worth 20 grams of silver--make coins with appropriate denominations stamped on them. The one gram gold coin says "20 quatloos" on it. Now the supply of gold takes a hit (or there is a new silver strike) and the "intrinsic" value ratio is now 21:1. That 20 quatloo gold coin is now worth 21 quatloos, once you melt it down; but its face value is still 20 quatloos. Gold coinage suddenly has the same life expectancy as a snowflake in a furnace.

The solution would be to define the quatloo as 1/20th of a gram of gold, instead, and let the silver coins decline in intrinsic value--making them subsidiary coinage. (This is in fact what happened with US silver coinage up until 1933, when we went off a meaningful gold standard. The silver in a silver dollar was worth much less than a (gold) dollar.) At least then, nothing will vanish from circulation. However, you must now take steps to ensure that everyone who owns some silver doesn't simply turn around and make it into kwatloo pieces according to spec; that would cause inflation. The US Mint formerly allowed people to bring in their bullion and would coin it for a nominal fee (or no fee at times), this had to stop when the value of silver dropped relative to gold.

If the ratio the metals are coined at gets too far out of whack relative to the ratio of market value, counterfeiting becomes an issue--if the ratio reaches 40:1, for instance, crooks can buy 50 quatloos of silver and coin it, and pass it as 100 quatloos.

Today we have the solution to this problem in hand--with the advent of electronic calculators, we can simply allow silver and gold values to float relative to each other. A shop can mark its prices in gold grams, but if what you have in your pocket is silver, they can figure out what the equivalent price in silver is that day. (They'd probably have a sign posted behind the cash register something like "55.67 grams silver = 1 gram gold"--that's the ratio as of this moment.)

Historically silver was actually more precious than gold in ancient Egypt (they didn't have a good source of silver); the ratio was 14:1 in the early 1700s, was more like 15:1 in the 1800s, then has dropped, and I've seen it at 100:1 at times in the 1990s. Today as mentioned it's 55.67 (913:16.4).

BTW I realized after I posted yesterday--the South African currency is named the Rand already; "Kruggerrand" simply means "Gold Rand" in Afrikaans. Needless to say a Rand is not worth 913 bucks; sticking a denomination on them is a fiction, just as the one ounce gold coins the US mints today are not worth $50. (I will buy as many of them as you are willing to sell me for the generous, twice-face-value of $100.)

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The hazard of using two distinct precious metals is that their relative values fluctuate. This situation was the bane of all hard-money systems of the past. I'll walk through an example: Let's say a country defines their currency, the quatloo, as being one gram of silver.

We can cut the problem short by stopping here. A "country" does not define its currency. The medium of exchange is simply determined by market participants. As for the rest of the post, I am going to quote from Rothbard again, as he describes it perfectly:

Suppose that two or more moneys continue to circulate on the world market?say, gold and silver. Possibly, gold will be the money in one area and silver in another, or else they both may circulate side by side. Gold, for example, being ounce-for-ounce more valuable on the market than silver, may be used for larger transactions and silver for smaller. Would not two moneys be impossibly chaotic? Wouldn't the government have to step in and impose a fixed ration between the two ("bimetallism") or in some way demonetize one or the other metal (impose a "single standard")?

It is very possible that the market, given free rein, might eventually establish one single metal as money. But in recent centuries, silver stubbornly remained to challenge gold. It is not necessary, however, for the government to step in and save the market from its own folly in maintaining two moneys. Silver remained in circulation precisely because it was convenient (for small change, for example). Silver and gold could easily circulate side by side, and have done so in the past. The relative supplies of and demands for the two metals will determine the exchange rate between the two, and this rate, like any other price, will continually fluctuate in response to these changing forces. At one time, for example, silver and gold ounces might exchange at 16:1, another time at 15:1, etc. Which metal will serve as a unit of account depends on the concrete circumstances of the market. If gold is the money of account, then most transactions will be reckoned in gold ounces, and silver ounces will exchange at a freely-fluctuating price in terms of the gold.

It should be clear that the exchange rate and the purchasing powers of the units of the two metals will always tend to be proportional. If prices of goods are fifteen times as much in silver as they are in gold, then the exchange rate will tend to be set at 15:1. If not, it will pay to exchange from one to the other until parity is reached. Thus, if prices are fifteen times as much in terms of silver as gold while silver/gold is 20:1, people will rush to sell their goods for gold, buy silver, and then rebuy the goods with silver, reaping a handsome gain in the process. This will quickly restore the "purchasing power parity" of the exchange rate; as gold gets cheaper in terms of silver, silver prices of goods go up, and gold prices of goods go down.

The free market, in short, is eminently orderly not only when money is free but even when there is more than one money circulating.

What kind of "standard" will a free money provide? The important thing is that the standard not be imposed by government decree. If left to itself, the market may establish gold as a single money ("gold standard"), silver as a single money ("silver standard"), or, perhaps most likely, both as moneys with freely-fluctuating exchange rates ("parallel standards").

What makes you think so?

Because fractional reserve banking is fraudulent. If it is not deemed outright illegal, and some banks that use FRB are in business, then I suspect very few individuals would place their deposits with them due to the risks of insolvency.

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Actually my longish post was meant in part as a history lesson, bringing up one of the problems government has faced in trying to define a currency--the use of two (or three, I left out copper to simplify matters) in a mandated monetary system.

I even identified the same solution as Rothbard--allow them to float relative to each other. Government would probably hate to do this, wanting everything in one set of units, but I believe it would happen without government.

As for fractional reserve banking, it's an inevitable consequence of a system where people deposit their money in a bank with the understanding that the bank will lend it out for them and pay them interest. Some of the money is lent out at any given time, the rest is sitting in the bank vault (or as bits in a computer) and is the reserve. (The sort of system where you put your money in the bank and the bank keeps it in the vault is really a warehouse for your bullion, and typically you end up paying them an aggio fee to store it, since such a warehouse has no other source of revenue.)

The problem comes when it turns out both the depositor and the person who borrowed money from the bank can spend the same physical dollar (or whatever the monetary unit is), the depositor by transfering the money to another account or by writing a check, the borrower by spending the cash the bank gave him. The depositor is really spending the bank's debt to him, assigning it to someone else, but few actually realize this and that is where the "fraud" aspect comes in.

The way to solve this: reduce the options at a bank to certificates of deposit (unspendable), or bearer bonds that do not resemble "real" money. I deposit 100 grams of silver and get bearer bonds in return that add up to 100g Ag. Those should be spendable pieces of paper, assuming others trust the bank to be able to make good on them; they are an asset just like everything else albeit with an element of risk, just like any loan. Those bearer bonds would actually have to pay interest. So I could deposit my 100 grams and just sit on the paper, then cash them in later and get my interest, or spend them and let others collect.

That ought to allow banks to make loans (very important for businesses to be able to succeed), while removing the (perceived) fraudulent aspects of fractional reserve banking.

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I thought the main concerns with fractional reserve banking are that: (1) banks can inflate by issuing too much currency/debt; and (2) destructive bank runs are more likely to occur. As for the fraud aspect, I just don't see it. If a bank is honest about how it books reserves, there is no fraud. By analogy, would I say an insurance company commits fraud because it offers far more insurance coverage than it has reserves to pay claims? Of course not, because that is the fully disclosed and acknowledged nature of insurance. Fractional reserve banking is no more fraudulent than insurance is.

As for the twin concerns of fractional reserve banking, I would suggest that the market historically has, and in a future laissez faire world would, solve these problems. Of course, if they are not solvable, so what? In that case, free market competition would ensure that there would be few, if any, fractional reserve banks, with most or all of them being 100% reserve banks instead.

However, there is a tremendous economic benefit to fractional reserve banking. The principal benefit is that it allows credit to be created more cheaply and flexibly. Fewer gold reserves are needed to create a given amount of credit. Moreover, it allows the amount of credit to be adjusted by the bank in response to market conditions. For example, if a new seed variety is invented that lets grain farmers in the Midwest plant more grain, a fractional reserve banker there could lend more money for seed. He could do so prudently because farmers in his region have gained a greater economic ability to pay back the loan because of the improved productivity of their seeds. By keeping reserves for only a fraction of his loans, and not having to back his loans 100% with gold, he can lend out the additional funds.

Regarding the second problem mentioned above, banks solve this problem in part by having large scale. During most of U.S. history, branch banking was restricted or banned by the various states. As a result, the U.S. had thousands of small, one or several branch banks located in different regions. If a particular region experienced an economic slowdown, it would drag the local banks down with it. For example, during the U.S. Great Depression, thousands of these small banks went bankrupt, accompanied by frequent runs by depositors trying to get their money out before the banks collapsed. In contrast, Canada, which had only five national banks (Canada had no restrictions on branch banking) reportedly did not have any large-scale bank collapse during the Great Depression. Large numbers of banks spread across a wide region ensured that regional economic problems could not collapse a bank.

Although they could not develop national banks, American bankers in the days before deposit insurance and the Federal Reserve did develop a solution that was similar to the reinsurance market that protects insurers against large claims. That solution was clearinghouses where banks would agree to aid each other and operate as if they were a large nationwide network. These clearinghouses worked reasonably well until outlawed and made obsolete by the establishment of the Federal Reserve Bank.

Finally, if fractional reserve banks are not fraudulent and do have an economic advantage, what is the worst case if they fail to have sufficient reserves to pay a depositor withdrawing funds or a banknote holder desiring gold? The worst case is that the bank fails to provide the funds. In that case, the bank may be able to shut temporarily and secure financing that will allow it to resume convertibility, if the bank's charter permits it (similar to how the large U.S. banks are securing emergency investments from foreign investors to shore up their balance sheets following losses in the sub-prime mortgage markets). Or, the banks go bankrupt and liquidate.

Bankruptcy is a risk faced by anyone purchasing a product or service. Why is banking different that such a risk becomes unacceptable? In the end, the unfettered market and the actions of unfettered entrepreneurs who operate within it will determine which bank best balances the economic advantages of its mode of handling reserves versus the risks of inconvertibility or bankruptcy, whether that bank is a 100% reserve bank or a fractional reserve bank. My opinion is that the advantages of fractional reserve banking would make it likely to dominant a laissez fair world, but in the end the market will determine that.

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The way to solve this: reduce the options at a bank to certificates of deposit (unspendable), or bearer bonds that do not resemble "real" money. I deposit 100 grams of silver and get bearer bonds in return that add up to 100g Ag. Those should be spendable pieces of paper, assuming others trust the bank to be able to make good on them; they are an asset just like everything else albeit with an element of risk, just like any loan. Those bearer bonds would actually have to pay interest. So I could deposit my 100 grams and just sit on the paper, then cash them in later and get my interest, or spend them and let others collect.

I think there is a better way to solve it. There would be two options.

1.) If I desire a location to store my money, i.e. my property, then I simply pay a warehouse a set fee for storage for a set amount of time. The warehouse will give me a receipt redeemable at any given time for my property and in exchange I will give him my committment to pay my storage fees at my time of redemption. The enforceability of this commitment is protected by the state. The warehouse will have the obligation to keep my money safe, i.e. stored in a vault or something of that nature. My warehouse receipt will be accepted in trade as a substitute for actual money, but only if the party I am trading with will accept my receipt. Otherwise, I will need to redeem my receipt for money and pay him in the actual commodity.

2.) I may desire to save my property, i.e. money, and acculumate interest on it as I save. I will take my money to a firm that will pay me a set amount of money (interest) for the privilege of using my property, i.e. money, as if it was its own. The goal of the firm will be to loan my property out at a higher rate of return then it pays me, and therefore gain profit. I could likely do this myself, but I decide that my time is better spent pursuing other activities, and I am content with a lower rate of return in exchange for my time. When I enter a contract with this firm, I will receive essentially a bond, as you stated. This bond will state my coupon (interest rate) and the date upon which the bond will be redeemed and I can withdraw my property. This enforceability of this bond is protected by the state. If a great amount of people believe they are dealing with a bucket shop operation, and they are skeptical of the bonds issued by such a firm, then bond insurerers (like MBIA and Ambak today) will provide the service of insuring the bonds of this firm. But the key difference between this option and the first is that these bonds are not receipts, they are IOU's, and they are spendable only if the individual I trade with wants to accept them. This would be extremely unlikely because when an individual or firm sells a product it typically wants to be paid immediately, and therefore it will not want to accept IOU's as payment for its goods.

Galileo Blogs: I have to run, I will address your post at a later time.

Edited by adrock3215
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Adrock, the two firms you identify historically have been one and the same. For example, the great banking houses of Middle Age and Renaissance Italy were begun by goldsmiths who would also store gold for their customers. Then they began lending out gold and then claims for that gold, while accepting gold deposits. Thus, they became banks.

But the key difference between this option and the first is that these bonds are not receipts, they are IOU's, and they are spendable only if the individual I trade with wants to accept them. This would be extremely unlikely because when an individual or firm sells a product it typically wants to be paid immediately, and therefore it will not want to accept IOU's as payment for its goods.

Au contraire, such bonds (bills) were widely accepted by Americans and effectively became money. They were bearer instruments, sometimes paying interest (payable upon presentation to the issuing bank). In other cases, they paid no interest but were convertible on demand into gold.

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I was going to reply to your post on fractional reserve banking, but that is a somewhat different topic, and a conversation perhaps reserved for a different thread so I'll leave it for another one.

Adrock, the two firms you identify historically have been one and the same. For example, the great banking houses of Middle Age and Renaissance Italy were begun by goldsmiths who would also store gold for their customers. Then they began lending out gold and then claims for that gold, while accepting gold deposits. Thus, they became banks.

You're right. This is fine as long as the firm offers option 1 and option 2. I may not want my property to be loaned out, because I may want it at any given time in the near future. Likewise, I may want it loaned out because I have no practical use for it within the foreseeable future. Therefore I would like someone to pay me for the use of it. But only with my advance permission would this be acceptable, otherwise it would be fraudulent, i.e. the bank transferring temporary rights to my property to another individual without my consent.

Au contraire, such bonds (bills) were widely accepted by Americans and effectively became money. They were bearer instruments, sometimes paying interest (payable upon presentation to the issuing bank). In other cases, they paid no interest but were convertible on demand into gold.

Ahh. The point here is that the instruments paying interest are IOU's that are redeemable for gold at some time in the future, while the instruments instantaneously redeemable for gold on demand are receipts. And we both agree that neither one is actual money, just a substitute for it. Whether or not one or the other will become the most widely accepted medium of exchange is a trivial issue.

Edited by adrock3215
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This is fine as long as the firm offers option 1 and option 2. I may not want my property to be loaned out, because I may want it at any given time in the near future. Likewise, I may want it loaned out because I have no practical use for it within the foreseeable future. Therefore I would like someone to pay me for the use of it. But only with my advance permission would this be acceptable, otherwise it would be fraudulent, i.e. the bank transferring temporary rights to my property to another individual without my consent.

If fractional reserve banking was practical, it is unlikely you would readily be offered option 1. Yet any bank would guarantee you immediate convertibility into gold. They would do it while maintaining fractional reserves. How can they make that guarantee? The same way an insurance company can guarantee to pay your claim even while maintaining reserves for only a small fraction of potential claims. In both cases, the firm takes advantage of the statistical likelihood that not all claims will be demanded at once.

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There still would be a role for government in the sense I was referring to earlier, to enforce weights and measures -- i.e. a gram would be a gram, and not some fraction thereof (not 3/4 gram and not 1.2 gram). If a particular money coiner printed 100 grams on his banknote, but would only exchange it for gold based on some arbitrary measure of weight, that wouldn't work, and would constitute fraud.

Now that we've gotten all of that figured out, how do we get the Feds to stop printing money and how do we get the gold in Fort Knox re-distributed to those of us using dollars? A fair means of getting the gold back would be to divide the total amount of gold by the total amount of currency, and transfer it to private banks to back up dollars. That may not be the fair market price for gold, but it would be better than nothing, and as it is now any kind of gold as money standard would leave most all of us broke, because we ain't got no gold folks; we certainly don't have enough gold to back up our own currency. It would be like Dagny Taggart landing in Galt's Gulch only to find out she is penniless, even for those of us who are wealthy.

At some future date, the Federal printing presses must be legally destroyed. I say legally destroyed because I am not advocating merely destroying the physical capacity to print, but it would be illegal for the government to do what it is doing now. And this would have to be done in a legally orderly manner, rather than a mob or a domestic terrorist attack on the printing presses.

So, we've got some work to do, including making it legal to print private money. If we could make it legal to print private money that was actually back by gold, then that standard might take off on it's own, except that bad money drives out good money (it becomes a lot easier to get and to distribute fiat money).

But that is one reason why an educational program must come before political action could be taken. I have had discussions along these lines with people unfamiliar with Ayn Rand for the past 30+ years, and they just don't get it -- they have no idea what is wrong with the dollar because it still buys them groceries and cars, so why worry about it they say. ;)

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We actually have part of option one already; it's called the safe deposit box. What you cannot do with a safe deposit box is transfer the items within it to someone else (other than by going and physically retrieving them) as you could with the receipt.

The option 1 described above (which I referred to as warehousing your gold rather than banking it) would consist of the bank pre-printing receipts for standard quantities of bullion (presumably coined by somebody), then handing them out to those who deposit the bullion and pay an additional fee. The bank would simply put the gold in their vault; on presenting the receipt you'd get an equivalent coin (or coins) back, not necessarily the same one. (Conceivably an institution that offers both options could offer the service for free to large customers of option 2.)

What that tells me is banks would be willing to offer option 1, but for a price--maybe enough of a price that there would be not enough of a market for it to justify the hassle.

[This won't work well unless gold coins come in standard amounts and with standard imprints that people have learned they can trust. Imagine going to a bank, storing an ingot of 27.11 grams of bullion, getting receipts for 20, 5, 1, 1, 0.1, and 0.01 grams, then going to spend them--say you spend the 0.1 gram receipt and decide to redeem the rest. Now the bank has to give you 27.01 grams and has to find a chunk that size. Surely standard coins will work better. Heck the bank might even coin your bullion for you if you want--for another fee. Actually they'd probably exchange it for coins they have on hand (minus comission) and coin the gold later at their leisure.

I can imagine a private organization setting diameter, thickness, and purity standards (pure gold and silver are impractical due to their softness, 90% alloy works better) for coinage to be produced by its member firms, complete with assayers coming by to do surprise inspections. That way B of A gold grams and Chase Manhattan gold gram coins can be interchangeable, looking identical except for the bank logo.

End digression.]

I would want receipts to look different from bonds which in turn would look different from actual "hard" money, to avoid any possible confusion.

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What that tells me is banks would be willing to offer option 1, but for a price--maybe enough of a price that there would be not enough of a market for it to justify the hassle.

I suspect that would be the case. If people are paid interest on their gold deposits and if banks are operated under laissez faire principles such that failures are exceedingly rare events, few people would choose "option 1" where they have to effectively pay interest to the banks rather than receive interest in exchange for depositing their gold at the banks.

The broader point is simply that banking would be far better in a laissez-faire society than it is today. There would be no inflation and far fewer, if any, instances of banks systematically making dubious loans, such as with today's sub-prime mortgages. Given the history of banking in this country and around the world, and an understanding of the economics of banking, I am thoroughly convinced that the case has been made that in a laissez-faire society banking would be highly efficacious and far more efficacious than it is in today's centrally banked and regulated world.

Would it be gold-based? Most likely yes. Would it be a fractional reserve system? In my opinion, yes, but it really doesn't matter, as long as it is the result of free market forces.

On the issue of government involvement, I do not see any special role for government in the realm of banking. Government would not even define "gram." It would merely acknowledge the definition that has been generally accepted such that if anyone stated that a different measure was a gram, he would be committing fraud. All standards ultimately arise from market interactions while the government merely acknowledges established practice as it goes about its job of enforcing contracts.

I am also not worried at all about whether gold coins or currency would have a standardized form and appearance. They would. I know this because industry already has standardized the sizes of credit cards, compact disks, shoe sizes, etc. It is in the interest of business executives to create standards because standards facilitate commerce. Such principle would also apply to banking.

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I think Galileo and I are substantially in agreement here. It would be interesting to see how this would play out if it happened; I've put out some ideas as to how things would end up working.

Government would not have much of a regulatory/standardsetting role. (My first lengthy post covered the historical situation--and problems therein--the last time the world used "hard" currency and was NOT intended as my vision of how it would work in an Objectivist world!)

With government out of the way, but some mechanism for industry standards in place, we might very well see some sort of intermediate coinage (imagine 90% silver 10% palladium) to cover the gap between a small gold coin and a large silver one (and a silver-dollar sized coin (about 25-28 grams) is cumbersome). If such were started and became popular, it would be fairly readily adopted by the industry as a new standard, as painlessly as 3.5" floppies were.

----

Another how-it-might-work:

One other financial service provided by banks would be "moving" large sums of money, like say to buy a house. A relatively cheap house today (at least around here) is 200 ounces of gold (~$180K). The bank you borrow the money from has to give to the seller, or his mortgageholder, or a combination of the two, that rather weighty, but not too sizeable brick (20 cubic inches). (I've had the opportunity to heft 1200 ounce bars of gold; the stuff is HEAVY at 19.3 grams/cm3.) It's basically impractical to transport that kind of money cross country. Enter clearinghouses. Banks might even deposit their gold at much more secure facilities, taking advantage of economies of scale, and simply send each other receipts at that place rather than physically shipping the money. (I suppose there could be rhodium coins at $7000/oz but those sorts of metals are very volatile in price; rhodium was $450 an ounce only a few years ago. (Yes, I *do* kick myself when I think about that.) Presently the exotic precious metals simply are not made in bulk form, powder only.)

The alternative to this is physically lugging the money or some sort of paper token--but paper tokens are precisely how we got into this mess. Paper may be easy to inflate but it is *convenient* and that's how it, over the centuries, got foisted upon us.

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Paper may be easy to inflate but it is *convenient* and that's how it, over the centuries, got foisted upon us.

It is only irredeemable paper that is easy to inflate. If your $1 paper bill (or bank balance, etc.) is guaranteed to be convertible into a fixed amount of gold at any time of your choosing, then its value is, and will continue to be, equivalent to that amount of gold. Under the gold standard, the purchasing power of money will always be the same as the purchasing power of gold.

The phrase "foisted upon us" implies some kind of force being involved, but there is no force in people choosing the more convenient of two solutions. If you can buy a house by hauling 200 ounces of gold or by handing over a $180K check, the rational--and therefore moral--course of action is to use the check. It is not something that gets foisted on you; it is something you choose to do as the best way to further your life. Force only entered the picture when the government began to interfere with the process, ultimately resulting in the present situation where the only thing guaranteed about dollar-denominated bills and checks is that you will need them in order to pay your taxes.

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  • 3 weeks later...

Does anyone worry about the limitations that gold reserve would have on the economy?

It seems to me that a gold-backed currency would be limited by the amount of gold available to back the currency. The amount of gold available would be a fraction of the total amount of gold in existence (a fraction, because as gold was sold to a bank in exchange for currency, the value of gold would rise due to scarcity, and eventually selling would end.)

If the economy grew faster than the gold supply, the only way to keep from throttling the growth would be to lower the cost of goods to make the same amount of money cover more economy. This would tend to draw more gold into banks as the relative value of goods and services increased, with respect to gold, but there would still be a limit. It would also tend to lower demand for goods as people slowed down their buying to wait for lower prices. So the throttling effect would seem to still be there.

Is this desirable? Or would we prefer a monetary system that expands with increasing national productivity? It seems clear to me that fiat currency is the means to deficit spending, which is the cause of inflation, and that fiat currency does not necessarily lead to inflation. A fiat currency that expanded with the productive capacity of the economy would tend to hold its value wrt gold and other commodities, as long as the government spent only what it took in, and limited its growth to a percentage of an objective valuation of the economy.

If gold was used as that objective standard, the currency could be pegged to gold without risking a run on gold. If a run did start, the government would have to shift to surplus budgeting (increase taxes, decrease spending - yeah, right) in order to draw down excessive currency from the economy, until the demand for currency balanced the demand for gold. This would take more self-discipline than could reasonably be expected from a government, but it would seem to optimize free-market growth.

Any thoughts on this?

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If the economy grew faster than the gold supply, the only way to keep from throttling the growth would be to lower the cost of goods to make the same amount of money cover more economy.

The velocity of money tends to naturally increase with the growth of the economy. But, yes, if V * M grows slower than economic output, the price level is going to decline. While many contemporary economists would have you think that deflation is some kind of a disaster, it actually is not. The prices of products at the cutting edge of technology keep coming down all the time (think computers, cell phones, GPS devices), and yet their producers still manage to make a profit. If the prices of bread rolls and sewing kits were falling too, their producers would survive as well--because the price of everything else would also be falling.

It would also tend to lower demand for goods as people slowed down their buying to wait for lower prices.

By the same token, interest-bearing deposits and investments in the stock market are also a bad thing, aren't they, since they make people slow down their buying and wait until they have more money? This idea that saving is bad for the economy is based on the primacy of consumption and you've probably got it (indirectly) from Keynes.

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The velocity of money tends to naturally increase with the growth of the economy. But, yes, if V * M grows slower than economic output, the price level is going to decline. While many contemporary economists would have you think that deflation is some kind of a disaster, it actually is not.

If we had a gold based economy, whereby the amount of gold remained more or less at the same level -- i.e. the money supply would be stable -- then it would not be a period of deflation. Deflation could only occur if the money supply decreased -- i.e. there is less gold out there as money than there was the year before, and the only way this could happen is if gold was taken off the market; that is, if it was lost to the economy (like the gold was literally lost at sea or something like that).

In a gold based economy, increased production would lead to lower prices across the board and throughout the economy -- i.e. the economic value of gold would steadily increase in terms of the goods and services that could be bought with a specific quantity of gold that one had. This would be true for the producers as well, the gold they would get in exchange for their offering of goods and services would increase in value.

A producer lowering prices does not translate into him getting less money. By increasing his means of production -- i.e. making, say, ten widgets instead of five per production run -- he can increase the number of products and services that he is selling, and thus make more money then he would have if he would have kept his prices the same or had raised them. The increased means of production translates directly into higher profits, which is why we have mass production. Making one cell phone and selling it for many tens of thousands of dollars to one rich guy makes the cell phone producer less money than he can get by making them at a higher production rate but a lower cost, thereby getting more customers and making a lot more money.

None of the "pit falls" that some economists claim would happen in a gold economy would happen. The quantity of money does not have to match increased means of production; it is precisely the increased means of production and the lowering of prices that leads to an improving economy, whereas an increase in the money supply hurts the economy.

Let me put it this way. Had you bought gold back in 1970 and saved it, that gold would now be worth ten times what it was worth back then in terms of dollars. This discrepancy was brought about due to inflating the fiat money supply by over ten times in the past thirty years. If you did not save gold for all of that time, then your greenbacks are now worth 1/10th what they were worth back then.

Now, what would you rather have; your money continuing to increase in value relative to goods and services or your money continuing to decrease in value relative to goods and services? If your money becomes worth more and more because the money supply remains stable while goods and services fall in price, wouldn't you rather have that?

Let's take computers. Due to the means of production steadily increasing, one can buy a more and more powerful computer for the same amount of dollars. Under a fiat monetary system, we actually could have a much higher rate of inflation, whereby the computer, even after the increase in the means of production, would not cost less. Fortunately our inflation isn't that high. However, if we were on a gold monetary system, the increasing means of production for computers versus price would truly be astounding; computers would be coming down in price much, much faster than they are now; but because the means of production is improved at little cost versus profit, everyone wins -- producer and consumer -- even though the price is steadily coming down. Basically, an increase in the means of production means that the producer is saving money while producing more even though he is lowering his prices (otherwise he wouldn't be lowering them so much).

Having a more or less stable money supply means that this increased in the means of production is more directly translated into the lowering of prices. And people aren't going to wait forever to get a computer or a cell phone. Cell phones are flying off the shelves even though their price is continuing to come down and the integrated packages of cell phone, Internet, and every other means of communications in one service bill continues to increase the value of those services to any given customer. And the producers are making loads of money.

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If gold was used as that objective standard, the currency could be pegged to gold without risking a run on gold. If a run did start, the government would have to shift to surplus budgeting (increase taxes, decrease spending - yeah, right) in order to draw down excessive currency from the economy, until the demand for currency balanced the demand for gold. This would take more self-discipline than could reasonably be expected from a government, but it would seem to optimize free-market growth.

The government would have nothing to do with: 1) Money, 2.) Banking, 3.) Economics, 4.) Monetary Policy, other than, of course, the traditional legimate functions of Objectivist government, i.e. police, courts, etc.

Each gold coin will be able to purchase more goods. A relatively static money supply is not a problem; I say relative because as the purchasing power of gold increases, there will be greater incentive to mine gold. This will cause more firms to set up shop mining, which will increase the gold supply. But this effect would be relatively small...so the short answer to your question is that as productivity increases, prices will generally decline.

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