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  • An Interesting Gold-Standard Proposal

    Posted by Jonathan on September 12th, 2008 (All posts by )

    At first glance, Congressman Poe’s plan looks pretty good:

    These calculations show that Ron Paul’s gold coin standard fails for the same reason that the classic gold standard failed-there isn’t enough gold in the world to prevent it from being wildly deflationary. Because all America has known for almost 70 years is inflation, many people have forgotten that deflation is much, much worse. The Great Depression was caused by deflation. People want stable money, but they aren’t willing to starve to get it.
     
    Fortunately, it is possible to stabilize the dollar and create an economic boom at the same time. Judge Poe’s bill, H.R. 6690, would do this. It would require the Federal Reserve to use its Open Market operations to bring the COMEX price of gold down to $500/oz and keep it there. H.R. 6690 would also give the economy a powerful supply-side stimulus in the form of “first year expensing” of all capital investment.
     
    H.R. 6690 defines the value of the dollar in terms of the market value of gold, but does not use gold as money. In this way, Judge Poe’s bill would not create a new and potentially unlimited source of demand for a scarce commodity. This is the key difference between H.R. 6690 and both Ron Paul’s approach and the classic gold standard.

    As Paul Craig Roberts (and other people, I am sure) pointed out a long time ago, there are no laws preventing Americans from using gold as currency. The fact that almost no one uses gold as currency suggests that there are strong reasons to prefer paper dollars. The US dollar isn’t bad as currency goes, but it could be improved, mainly by being made less-subject to political caprice. Linking the dollar robustly to the market price of gold would be a big step in the right direction. How well HR 6690 would accomplish this is a different question, however. The devil is always in the details and unintended consequences. Congress might find it difficult to avoid post-hoc tinkering with the rule and thereby returning us to dollar uncertainty. And this bill has no chance of being enacted in the current political environment. But, at first glance, it sounds like the best currency-reform proposal yet.

     

    25 Responses to “An Interesting Gold-Standard Proposal”

    1. david foster Says:

      I’m not very impressed with gold-standard proposals, but there is a lot to be said for first-year expensing (from a tax standpoint) of capital investments. The current policy really discriminates against all asset-intensive businesses, whether they are factories, railroads, or whatever.

    2. Shannon Love Says:

      It would require the Federal Reserve to use its Open Market operations to bring the COMEX price of gold down to $500/oz and keep it there.

      You cannot fix the true price of gold or any other commodity. The “price” of any commodity is the amount of that commodity one must give in exchange for certain amount of another commodity. That exchange amount fluctuates constantly.

      This plan will fail just like all the others because it tries to treat money as a commodity and not as a computational/informational system. Money needs to inflate in sync with rises in productivity or the information it stores and transmits gets erased and it no longer serves to transmit the exchange amounts between different goods and services. For this reason, any attempt to create a fixed currency will fail due to deflation. Any attempt to create a commodity based money that can inflate brings you back to the same state of affairs as with a fiat currency.

    3. Danny L. McDaniel Says:

      I believe that the entire gold stadard arguement deflects from the real debates concerning economics in the modern world. Similiar, to Catholics who argue over whether they should reinstate the Latin Mass. The proof is one works better than the other – deal with it. I suppose when you cannot talk about anything constructively in modern economics a person can revert back to the bygone past.

      Danny L. McDaniel
      Lafayette, Indiana

    4. Randy Says:

      Fix gold at 500 a ounce. I am buying all i can at higher prices. All this will do is empty the govenments gold vault and place it in the hands of private investors. Now what will you do? outlaw gold ownership? maybe thats why my etf are not in the USA.

    5. Jonathan Says:

      Somebody has to decide how much currency to issue. Currently, in the USA, we’ve got a committee that looks at whichever basket of economic stats it currently thinks is relevant, tacitly (usually) factors in political concerns, squints and decides what to do. The process isn’t transparent, the rationale for the committee’s decisions is often obscure and changes without notice, and the committee makes frequent policy errors that have costly consequences. The alternative proposed here aims to create a clear, simple, transparent decision process to do the same thing that the Fed does now, and might succeed if it were enacted.

      And yes, you can control the dollar price of gold. It’s like setting up a currency board, which is a successful method that countries have used to manage the exchange rate of their currency. The big advantage of using the gold price as the only money-supply input is that gold prices are difficult to misinterpret, difficult for anyone to manipulate, and react quickly to changes in the economic environment.

    6. Lexington Green Says:

      Of course, once you set a standard like this, then the standard itself becomes the target of manipulation.

      Hayek once proposed a commodity reserve currency, where a basket of commodities rather than just gold were used. When I read it, it seemed like a good idea. But no one talks about it. There may be technical reasons beyond my competence to understand which make this a bad idea. But I have not seen that, either.

    7. Jonathan Says:

      How would anyone manipulate the dollar price of gold? The government can do it, but that’s their job. The rule is: use the Fed to manipulate the price of gold to keep it at $500/oz. Doing so also manipulates the value of the dollar to keep it within a narrower range than is currently the case.

      The current system lets the Fed do whatever it wants, without consequence. Under this proposed rule, the Fed gets to do whatever it wants as long as the result is COMEX gold at $500/oz. That’s an improvement.

    8. Tyouth Says:

      According to this plan would the Fed. provide gold to all comers at $500/oz until the demand for the physical stuff was satiated? This would seem to be the only way to accomplish the $500/oz value.

      Wikpedia allows that the US has $241 billion in gold reserves while The Fed. Reserve of NY indicates that $829 billion of US currency is in circulation.

      It seems that not enough gold is lying about in this country to come anywhere near meeting such a demand if the value of gold is more than $500. Additionally, I expect that this couldn’t be done because government debt and public commitments couldn’t be “inflated away” (quotes mine) since the value of a dollar would be rather constant.

      If there was enough to meet the demand it would be a greatly benefit people who work, save and invest.

    9. Jim Bennett Says:

      Lex, the reason Hayek’s proposals (which also include allowing multiple private currencies so that different mixes of commodities can compete with each other) get nowhere is that governments find it convenient not to be constrained.

      Jon, the capital gains tax operates to prevent the private use of gold as a currency. If you convert the gold back into dollars, any gain (in dollar terms) is deemed a capital gain and taxed. So unless a critical mass of people and businesses willing to use the gold currency come into being, people would be reluctant to tie up their capital in gold currency when they might incur capital gains whenever they want to buy it. Of course, if it loses value against the dollar there are no gains, but you’ve lost money; if it stays the same value over time, what’s the point?

    10. Jim Bennett Says:

      In the above post “when they might incur capital gains whenever they want to buy it” should be “when they might incur capital gains whenever they want to buy something with it that they have to buy with dollars.”

    11. Jonathan Says:

      Tyouth and Jim,

      The author of the article I linked addresses the issue of limited gold supply, and agrees that it makes gold currency impractical. However, he is not arguing for gold currency. Nor does HR 6690 propose either gold currency or a conventional gold standard in which dollars must be backed by gold. As I understand it, HR 6690 proposes merely to substitute a gold-price targeting rule for Fed discretion in money-supply management. The resulting monetary regime would thus be similar to our current monetary regime in most respects, including in the tools (open-market operations, bank reserve requirements, etc.) that the Fed uses to manipulate the money supply. The main difference is that HR 6690 requires the Fed to target a specific market input, and specifies the target rate. The central issue is not gold but the removal of discretion from Fed operations. It just happens that the gold price is, with good reason, the specified indicator. (And note that the Fed already does an all-too-effective job of influencing gold prices under its current discretionary regime, which brought gold down to around $250/oz in the 1990s and then up to its current heights. Which is of course the central concern. HR 6990 is a vote of no-confidence in Fed management of the dollar, and proposes a more-reliable alternative.)

      HR 6690 probably won’t go anywhere but it’s a step in the right direction. Of course any bill that removes discretion from the Fed can’t possibly work unless it also imposes accountability on the Fed. I haven’t read HR 6690, so I don’t know if it considers such matters.

    12. Roy Lofquist Says:

      Dar Sirs,

      I kinda got skeptical of technical economic analysis a long time ago. They’ve been telling me for 60 years that deficit spending would damn us to hell. Well, from where I am sitting, sipping some very nice single malt and talking to you folks at the far ends of the earth, it certainly ain’t the hell that the Baptists talk about.

      The commodity based currency idea is mercantilism writ large. The Bretton Woods Agreement was the last desperate attempt to rejuvenate this dinosaur. As some commentators have observed, this system is open to manipulation.

      It happened. Our British and French friends used their dollar assets to purchase gold – they raided Fort Knox. Not very nice of them, but understandable.

      This forced Nixon to close the gold window. This had real consequences. The major energy suppliers were mercantilist. This is endemic to extraction dominated economies. Neither OPEC nor Carter were responsible for the economic problems of the 60’s and 70’s. The closing of the gold window was a massive devaluation of the dollar in the eyes of those who we depended on for a vital commodity.

      I am much more fond of history than theory for real problems.

      Regards,
      Roy

    13. Robert Schwartz Says:

      Problem number 1. How does the legislator know that gold is or should be worth $500/oz. Right now the market thinks that gold is worth about $765/oz. That is 50% higher.

      If the Fed were to attempt to peg the price of gold 33% under market, it would have to shrink the currency supply. (think about it. Dollars are liability entries on the Fed’s balance sheet. Gold buyers would give the Fed dollars, thus extinguishing them) Shrinking the currency supply in the midst of a recession is a bad idea. The Fed tried it in the 1930s.

      Problem number 2. Price stability is a good thing. I think the Fed should always make price stability its priority. But, the stability of which prices? Prices measure the relationship between all possible transactions in the economy. Price changes may reflect all sorts of factors. Prices for technology equipment are in a secular decline. I was in MicroCenter earlier today and they are selling 500GB external drives for under $100. Oil soared to over $140/bbl this year. It is now dropping, and just as fast as it rose.

      Housing prices having shot up in the first years of this decade, well ahead of commodities, are now plunging. The impact has destabilized credit markets and financial institutions. I think that it has driven much of the economic disaster meme that the Donks hope will carry them back into power.

      Should the Fed work to prop up house prices? or to hold down commodity prices. Are we in a inflationary environment or a deflationary environment?

      Problem number 3. Gold is a commodity. Its pricing trend has shared much of the same trend as commodities like oil. However, Gold is not guaranteed to move at the same velocity and in the same direction as the rest of the economy. Silver used to be an important monetary commodity. In recent years, it lost its classic relation to gold (15:1 in the ancient authorities) and it now trades at $11/oz a ratio of about 70:1. Why gold? Why not silver? Why not aluminum, or plywood, or nitrate fertilizer?

      More importantly, in an economy where most of the production is services, why a commodity? College tuition and medical care are far more important to my standard of living than any commodity.

      My bottom line. I don’t think that any mechanical rule can tell the Fed where to go. What we need is to ensure that the Fed’s unambiguous goal is monetary stability and that it is insulated from the political cycle.

      Note: The Fed carries gold on its balance sheet in the amount of 11 Billion Dollars. It is carried at the price of $42+$(2/9). That means the Fed has about 260 million oz of AU which is worth $200 Billion at current market prices. Before Nixon abandoned the Breton Woods gold standard, the Fed was required to hold gold equal to 25% of the outstanding currency. On the Fed balance sheet linked above, there is now $834B of currency outstanding. So the Fed is not far off. If memory serves me well, during 1979/80 when Gold was at $800/oz, the Fed could have replaced the then outstanding currency with gold certificates and liquidated solvent.

    14. Craig Says:

      “If the Fed were to attempt to peg the price of gold 33% under market, it would have to shrink the currency supply.”

      Precisely! That’s the point — *that* would become the new market price.

      As has been pointed out several times in the comments (but ignored by others,) the bill is not suggesting a “commodity-based” currency which would cause a return to mercantilism. It’s merely an attempt to stabilize the dollar thus providing a dependable business and investment climate where the future could be planned for more easily.

    15. Jonathan Says:

      -$500/oz might be a good target price, but how we get from here to there is important. The Fed can’t contract the money supply quickly without causing problems that would be at least as bad as the ones the bill aims to remedy. A well-designed reform of this type would therefore need to specify incremental price targets, with the first target being close to the current gold price. I don’t know if the bill addresses this issue.

      -The price of gold is not the only possible standard for a dollar targeting rule, and it’s not perfect, but I think it’s better than the alternatives. Things such as computer hard drives and services are either not standardizable or not liquid, crude oil supply is too easy to manipulate, currency baskets link us to other countries’ policy errors, economic indices are too subject to measurement errors. The idea here is to remove discretion from monetary policy. Given discretion’s poor track record, I would think that gold-price targeting would be more popular. (A lot of people benefit from dollar uncertainty and volatility, but overall we would probably be better off greater predictability and stability.)

    16. LotharBot Says:

      We’ve had successful Federal Reserve policy in the past that wasn’t directly linked to gold. What did they do that worked so well?

      I like the idea of the Fed having some sort of clear policy. It doesn’t necessarily need to be “target price of gold”, it just needs to be predictable and stable. One of the worst things you can do to an economy is make the money supply unstable and unpredictable — because lenders aren’t willing to lend, and borrowers aren’t willing to borrow, if they don’t have a good idea of the future value of their money. And the economy doesn’t work without investment of capital.

    17. Steven Danderson Says:

      There is, perhaps another solution to the inflation or deflation cycle that we’re in.

      At present, we have three ways for the Fed to manipulate the money supply–all of which mess with the interest rates or some part of the economy. This, frankly, sends erroneous and bad signals to economic actors, which got us into this mess.

      Better would be to announce–publicly–that we will buy and sell gold and silver from our national stocks–at market prices. If people are convinced that precious metals will increase in value, they will buy gold and silver from the Fed, which will decrease the money supply. If people are convinced that gold and silver will fall in price, they will sell those metals to the Fed, which adds needed currency to circulation. Thus, we have a self-correcting mechanism.

      Other forms of monetary and interest rate manipulation should be eliminated, as redundant, or worse, sending false signals to the market (The Federal funds rate should be set at inflation plus two to three percent, and left there.).

      With this reform, both inflationary and deflationary forces should be at bay, because too much money will automatically shrink its supply, and too little money will bring an infusion or needed cash.

      Do I make sense?

    18. Steven Danderson Says:

      One other thing occurs to me: The mere buying and selling of gold and silver will tell the world market that we mean to have a strong dollar, and will do what it takes to get it. This should take some of the wind out of gold and silver’s price-sails.

    19. Robert Schwartz Says:

      I wrote: “If the Fed were to attempt to peg the price of gold 33% under market, it would have to shrink the currency supply.”

      Craig wrote: “Precisely! That’s the point — *that* would become the new market price.”

      Not necessarily. The Fed might simply sell its entire gold supply and not peg the price. Sometimes the currency speculators win. That is how Soros made his money. Not only that, but they could shrink M1 to the point where we have a deflationary spiral of the magnitude of the Great Depression. In in effect this is precisely what the Fed did during the Hoover administration trying to hold the value of the dollar at 1oz/$20.67. I don’t think they would do that again.

      Jonathan wrote: “The idea here is to remove discretion from monetary policy. Given discretion’s poor track record, I would think that gold-price targeting would be more popular.”

      Those of us who were adults during the 1970s know that however poorly we think the Fed is doing right now, they can do a lot worse. On the day in January 1980 when I bought our wedding rings, Gold hit what was then its all time high around $850/oz, (I call it a bargain, the best I ever had.) and when we signed a mortgage commitment in April the nominal rate was 17%.

      At that time I was prepared to remove all discretion from the Fed, and so were many other people. Sometimes it is better to be lucky than smart. Volker got a grip on things and the last generation has been relatively tranquil.

      More to follow tomorrow.

    20. Steph Says:

      “The fact that almost no one uses gold as currency suggests that there are strong reasons to prefer paper dollars.”

      It actually showes that money is a network phenominon, that is the more people who use it the better it works.

      The whole arguement that “their is not enough gold” is vacuous. At what price? Their is always a clearing price. If the gold supply of the fed is 260 million ounces and the money supply M1 is about 1.5 trillion Dollars, then the clearing price is about $5,767. That is the price of conversion that would not result in deflation.

    21. Tyouth Says:

      Robert, “Bargin” is, IMO, one of the best ever “torch songs”.

    22. Tyouth Says:

      Steph, if the clearing price for gold was pegged by the govt. at $5767 not many would buy but many would be glad to sell the metal…deflation resulting.
      But really, it’s not germane because the idea is (although I’m not completely clear about how it could be done without pegging to the market price at a specific date) is to influence the market into valuing (or, at least, manipulating the perception of the market into valuing) the dollar at the $500/oz gold.

    23. Steph Says:

      “Steph, if the clearing price for gold was pegged by the govt. at $5767 not many would buy but many would be glad to sell the metal…deflation resulting.”

      No they would sell it to the fed for aditional dollars, inflation would result. That is a reslut of my lazzily just using the fed gold holding’s to calculate the conversion price. One should actually take the propotion of the world gold supply equal to the proportion of the american economy in the world economy. That would result in a price of around $3000-$4000

    24. Tyouth Says:

      Opps, “inflation”, right.

      In any case one doesn’t have to balance dollars with reserves exactly since the currency need not be directly tied with the commodity – if it is perceived to be adequately sound and stable.

    25. Steph Says:

      Tyouth, that is true if you want to keep the fed. If like me you believe in a free market for money and credit, then not so much.