http://keithweiner.posterous.com

On June 4, Department of the Treasury Office of the Comptroller of the Currency (OCC), the Federal Reserve System (the Fed), and the Federal Deposit Insurance Corporation (FDIC) issued a joint notice of proposed rulemaking (http://www.fdic.gov/news/board/2012/2012-06-12_notice_dis-d.pdf). On June 18, the FDIC issued a Financial Institution letter with the stated goal of updating banking regulations to implement changes made by the Basel Committee on Banking Supervision and the Dodd-Frank Act (http://www.fdic.gov/news/news/financial/2012/fil12027.html).

Both documents propose a positive for gold. Under the proposed new regulations, gold is to have a zero risk weighting, like dollar cash and US Treasury bonds. This will allows banks to own gold on more advantageous terms, as they won’t need to tie up other capital just to support their gold position.

One can only imagine what stress the banks must be under if the regulators and the Fed are willing to consider this extreme measure! Do they not have sufficient other assets? Or is the issue that most other assets are either garbage or already encumbered?

This segues into a theme that I plan to discuss more in the future. The re-monetization may not take place by passage of a monolithic law, but in increments. This change, and not even in law but in regulation—not even considered by Congress but by unelected bureaucrats—is an important step towards a gold-based monetary system. For the first time in many decades, banks can hold actual gold as part of the backing of their deposits, and not just as a trading position. Regardless that this may be a “hail Mary” pass thrown in desperation and lack of anything else that the government would prefer, I think it heralds a sea change and a highly important milestone in our fight to return to a sound monetary system!

In 1933, when President Roosevelt outlawed gold ownership for US citizens, he removed the only real competition of US Treasury bonds. Those investors who wanted absolute safety of their capital were deprived of the only risk-free financial asset. So they were herded into government bonds, like cattle to slaughter (thus driving down the rate of interest and crushing the debtors).

Now, gold may be a viable competitor to the bond (assuming this proposed rule goes into effect) in the banking system. While individuals can and do buy and hoard gold today, there have been significant disincentives for banks to own gold. Now, what is arguably the biggest obstacle is being removed.

What will the impact be? Obviously, additional demand will come into the gold market. So the price will go up. But The Gold Standard Institute is not about speculating on the dollar price of gold. From a monetary perspective, there are two interesting angles to consider regarding this development.

With competition from gold, some of the demand is taken away from US Treasury bonds. Could this mean falling bond prices, and hence rising interest rates? The wildcard is the Fed and its perpetual purchases of bonds. I don’t think anyone in his right mind would buy bonds in this world, except as a speculation on the next action of the Fed, and the speculators (the survivors) are adept at figuring out what they will do next.

Another interesting thought is that to the extent they switch out of the Ponzi scheme of bonds that are never repaid, only “rolled” into gold, the banks will become more sound. As gold is the one asset whose dollar price can rise without any particular limit, it may be a matter of time before banks are substantially recapitalized simply due to the rising price of gold held outright as an asset on their balance sheets.

This is exciting! I hope every reader goes out tonight and has a glass of wine to toast “to the return of gold!”

http://keithweiner.posterous.com

It is now the second anniversary of a campaign to “crash” JP Morgan by encouraging people to buy silver (see max Keiser http://www.youtube.com/watch?v=H4IBUTHyROs). The idea is that JP Morgan has a large naked short position in silver. If people buy physical silver it will drive the price up and deprive JP Morgan of the metal it would need to cover its short position, thus causing prices to rise further until JP Morgan collapses.

I don’t want to waste any more electrons debunking this conspiracy theory. I have written many times on this topic, most recently in my (Open Letter to Ted Butler).

I want to call attention to something else. There is an old cliche in America, “cutting off your nose to spite your face.” It is usually said in admonition when someone is doing something out of spite, and he will be the primary victim.

If it were true that JP Morgan had a huge short position in silver, and a rising price could cause them to “crash” then is this something that people should want to occur? To answer that, everyone should be clear on two things. First, what happens when a company collapses? And second, who are JP Morgan’s creditors?

When a company collapses, it defaults on its debts. The creditors of JP Morgan are “we the people” including our bank accounts, our employers’ payroll accounts, our pension funds, our insurance funds, our annuities, our brokerage accounts. Creditors also include farms, grain elevators, food processing plants, the electric power companies, etc. Other banks are creditors of JP Morgan as well; it is implausible that any would survive the collapse of JP Morgan.

Without any money in the bank, and without a job to earn more, how will you buy food? What happens when everyone else faces the same desperate circumstances?

If you want to buy silver, go buy silver. It is one of the two monetary metals. It won’t cause any banks to collapse. The silver price may rise or fall in the short term, though it is in a long-term rising trend.

We face a serious crisis. While the banks have played their role and it may be tempting to wish ill upon them, causing a banking collapse is not a serious solution. Many of us are working to avoid collapse. Accelerating collapse does no good for anyone.

Keith Weiner
Nov 21, 2012

http://keithweiner.posterous.com

In Part I (http://keithweiner.posterous.com/unadulterated-gold-standard-part-i), we looked at the period prior to and during the time of what we now call the Classical Gold Standard. It should be underscored that it worked pretty darned well. Under this standard, the United States produced more wealth at a faster pace than any other country before, or since. There were problems; such as laws to fix prices, and regulations to force banks to buy government bonds, but they were not an essential property of the gold standard.

In Part II (http://keithweiner.posterous.com/unadulterated-gold-standard-part-ii), we went through the era of heavy-handed intrusion by governments all over the world, central planning by central banks, and some of the destructive consequences of their actions including the destabilized interest rate, foreign exchange rates, the Triffin dilemma with an irredeemable paper reserve currency, and the inevitable gold default by the US government which occurred in 1971.

Part III is longer and more technical, as we consider the key features of the unadulterated gold standard. It could be briefly stated as a free market in money, credit, interest, discount, and banking. Another way of saying it is that there would be no confusion of money (i.e. gold) and credit (i.e. paper). Both play their role, and neither is banished from the monetary system.

There would be no central bank with its “experts” to dictate the rate of interest and no “lender of last resort”. There would be no Securities Act, no deposit insurance, no armies of banking regulators, and definitely no bailouts or “too big to fail”. The government would have little role in the monetary system, save to catch criminals and enforce contracts.

As mentioned in Part I, people would enjoy the right to own gold coins, or deposit them in a bank if they wish. We propose the radical idea that the government should have no more involvement in specifying the contents of the gold coin than it does specifying the contents of the software that runs a web server. And this is for the same reason: the market is far better at determining what people need and far better at adapting to changing needs.

In 1792, metallurgy was primitive. To accommodate 18^th century gold refiners, the purity of the gold coin was set at around 90% pure gold (interestingly the Half Eagle had a slightly different purity than the Eagle though exactly half the pure gold content). Today, much higher purities can easily be produced, along with much smaller coins (see http://keithweiner.posterous.com/pieces-of-50). We also have plastic sleeves today, to eliminate wear and tear on pure gold coins, which are quite soft.

If the government had fixed a mandatory computer standard in the early 1980’s (some governments considered it at the time), we would still be using floppy disks, we would not have folders, and most of us would not be using any kind of computer at all, as they were not user friendly. When something is fixed in law, it is no longer possible to innovate. Instead, companies lobby the government for changes in the law to benefit them at the expense of everyone else. No good ever comes of this.

We propose the radical idea that one should not need permission to walk down the street, to open a bank, or to engage in any other activity. Without banking permits, licenses, charters, and franchises, the door is not open to the game played by many states in the 19^th century.

“To operate a bank in our state, you must use some of your depositors’ funds to buy the bonds sold by our state. In return, we will protect you from competition by not allowing out-of-state banks to operate here.”

Most banks felt that was a good trade-off, at least until they collapsed due to risk concentration and defaults on state government bonds.

State and federal government bonds are an important issue. We will leave the question of whether and when government borrowing is appropriate to a discussion of fiscal policy. There is an important monetary policy that must be addressed. Government bonds must not be treated as money. They must not become the base of the monetary system (as they are today). If a bank wants to buy a bond, including a government bond, that is a decision that should be made by the bank’s management.

An important and related principle is that bonds (private or government) must not be “paid off” by the issuance of new bonds! Legitimate credit is obtained to finance a productive project. The financing should match the reasonable estimate of the useful life of the project, and the full cost must be amortized over this life. If the project continues to generate returns after it is amortized, there is little downside in such a conservative estimate (though it obviously makes the investor case less attractive).

On the other hand, if the plant bought by the bond is all used up before the bond is paid off, then the entrepreneur made a grave error: he did not adequately deduct depreciation from his cash flows and now he is stuck with a remaining debt but no cash flow with which to pay it off. Issuing another bond to pay off the first just extends the time of reckoning, and makes it worse. Fully paying debt before incurring more debt enforces a kind of integrity that is almost impossible to imagine today.

With few very limited and special exceptions, a bank should never borrow short and lend long. This is when a bank lends a demand deposit, or similarly lends a time deposit for longer than its duration. A bank should scrupulously match its assets to its liabilities. If a bank wants to buy stocks, real estate, or tulips, it should not be forcibly prevented, even though these are bad assets with which to back deposits. The same applies to duration mismatch.

Banks must use their best judgment in making investment decisions. However, the job of monetary scientists is to bellow from the rooftops that borrowing short to lend long will inevitably collapse, like all pyramid schemes (see the author’s paper: http://keithweiner.posterous.com/duration-mismatch-necessarily-fails).

There should be no price-fixing laws. Just as the price of a bushel of wheat or a laptop computer needs to be set in the market, so should the price of silver and the price of credit. If the market chooses to employ silver as money in addition to gold, then the price of silver must be free to move with the needs of the markets. It was the attempt to fix the price, starting in 1792 that caused many of the early problems. While “de jure” the US was on a bimetallic standard, we noted in Part I that “de facto” it was on a silver standard. Undervalued gold was either hoarded or exported. After 1834, silver was undervalued and the situation reversed. Worse yet, each time the price-fixing regime was altered, there was an enormous transfer of wealth from one class of people to another.

Similarly, if the market chooses to adopt rough diamonds, copper, or “bitcoins” then there should be no law and no regulation to prevent it (though we do not expect any of these things to be monetized) and no law or regulation to fix their prices either.

If a bank takes deposits and issues paper notes, then those notes are subject to the constant due diligence and validation of everyone in the market to whom they are offered. If a spread opens up between Bank A’s one-ounce silver note and the one-ounce silver coin (i.e. the note trades at a discount to the coin) then the market is trying to say something.

What if an electrical circuit keeps blowing its fuse? It is dangerous to replace the fuse with a copper penny. It masks the problem temporarily, and encourages you to plug in more electrical appliances, until the circuit overheats and set the house on fire. It is similar with a government-set price of paper credit.

A market price for notes and bills is the right idea. Free participants in the markets can choose between keeping their gold coin at home (hoarding) vs. lending their gold coin to a bank (saving). It is important to realize that credit begins with the saver, and it must be voluntary, like everything else in a free market. People have a need to extend credit as explained below, but they will not do so if they do not trust the creditworthiness of the bank.

Before banking, the only way to plan for retirement was to directly convert 5% or 10% of one’s weekly income into wealth by hoarding salt or silver. Banking makes it much more efficient, because one can indirectly exchange income for wealth while one is working. Later, one can exchange the wealth for income. This way, the wealth works for the saver his whole life, and there is no danger of “outliving one’s wealth”, if one spends only the interest. In contrast, if one is spending one’s capital by dishoarding, one could run out.

No discussion on banking would be complete without addressing the issue of fractional reserves. Many fundamental misunderstandings exist in this area, including the belief that banks “create money”. Savers extend credit to the banks who then extend credit to businesses. The banks can no more be said to be creating money than an electrical wire can be said to be creating energy.

Another error is the idea that two or more people own the same gold coin at the same time. When one puts gold on deposit, one gives up ownership of the gold. The depositor does not own the gold any longer. He owns a credit instrument, a piece of paper with a promise to pay in the future. So long as the bank does not mismatch the duration of this deposit with the duration of the asset it buys, there is no conflict.

If people want to vault their gold only, perhaps with some payment transfer mechanism, there would be such a warehousing service offered in the market. But this is not banking. It’s just vaulting, and most people prefer the convenience of fungibility. Who wants the problems of a particular vault location and a delay to transfer it elsewhere? And who wants a negative yield on money just sitting there?

A related error is the claim, often repeated on the Internet, is that a bank takes 1,000 ounces in deposit and then lends 10,000 out.¹ Poof! Money has been created—and to add insult to injury, the banks charge interest! The error here is that of confusing the result of a market process (of many actors) with a single bank action. If Joe deposits 1,000 ounces of gold, the bank will lend not 10,000 ounces but 900 ounces (assuming a 10% reserve ratio).

Mary the borrower may spend the money to build a new factory. Jim the contractor who builds it may deposit the 900 ounces in a bank. The bank may then lend 810 ounces, and so on. This process works if and only if each borrower spends 100% of the money and if the vendors who earned their money deposit 100% of it, in a time deposit. Otherwise, the credit (this is credit, not money) simply does not multiply as Rothbard asserts.

This view of money multiplication does not consider time as a variable. Gold payable on demand is not the same as gold payable in 30 years. It will not trade the same in the markets. The 30-year time deposit or bond will pay interest, have a wide bid-ask spread, and therefore not be accepted in trade for goods or services.

This process involving the decisions of innumerable actors in the free market may have a result that is 10X credit expansion. But one cannot make a shortcut, presume that it will happen, and then assert that the banks are “swindling.”

If one confuses credit (paper) with money (gold), and one believes that inflation is an “increase in the money supply” (see here for this author’s definition: http://keithweiner.posterous.com/inflation-an-expansion-of-counterfeit-credit) then one is opposed to any credit expansion and hence any banking. Without realizing it, one finds oneself advocating for the stagnation of the medieval village, with a blacksmith, cobbler, cooper, and group of subsistence farmers. Anything larger than a family workshop requires credit.

Credit and credit expansion is a process that has a natural brake in the gold standard when people are free to deposit or withdraw their gold coin. Each depositor must be satisfied with the return he is getting in exchange for the risk and lack of liquidity for the duration. If the depositor is unhappy with the bank’s (or bond market’s) offer, he can withdraw his gold.

This trade-off between hoarding the gold coin and depositing it in the bank sets the floor under the rate of interest. Every depositor has his threshold. If the rate falls (or credit risk rises) sufficiently, and enough depositors at the margin withdraw their gold, then the banking system is deprived of deposits, which drives down the price of the bond which forces the rate of interest up. This is one half of the mechanism that acts to keep the rate of interest stable.

The ceiling above the interest rate is set by the marginal business. No business can borrow at a rate higher than its rate of profit. If the rate ticks above this, the marginal business is the first to buy back its outstanding bonds and sell capital stock (or at least not sell a bond to expand). Ultimately, the marginal businessman may liquidate and put his money into the bonds of a more productive enterprise.

A stable interest rate is vitally important. If the rate of interest rises, it is like a wrecking ball swinging into defenseless buildings. As noted above, each uptick forces marginal businesses to close their operations. If the rise is protracted, it could really cause the affected country’s industry to be hollowed out. On the other hand, if the rate falls, the wrecking ball swings to the other side of the street. The ruins on the first side are not rebuilt. But now, capital is destroyed through a different and very pernicious process: the burden of each dollar of (existing) debt rises at the same time that the lower rate encourages more borrowing (see: http://keithweiner.posterous.com/a-falling-interest-rate-destroys-capital). From 1947 to 1981, the US was afflicted with the rising interest rate disorder. From 1981 until present, the second stage of the disease has plagued us.

Today, under the paper standard, the rate of interest is volatile. The need to hedge interest rate risks (and foreign exchange rate risk, something else that does not exist under the gold standard) is the main reason for the massive derivatives market. In this market for derivatives, which is estimated to be approaching 1 quadrillion dollars (one thousand trillion or one million billion)², market participants including businesses and governments seek to buy financial instruments to protect them against adverse changes. Those who sell such instruments need to hedge as well. Derivatives are an endless circle of futures, options on futures, options on options, “swaptions”, etc.

The risk cannot be hedged, but it does lead to a small group of large and highly co-dependant banks, who each sell one another exotic derivative products. Each deems itself perfectly hedged, and yet the system becomes ever more fragile and susceptible to “black swans”.

These big banks are deemed “too big to fail.” And the label is accurate. The monetary system would not survive the collapse of JP Morgan, for example. A default by JPM on tens or perhaps a few hundred trillion of dollars of liabilities would cause many other banks, insurers, pensions, annuities, and employers to become insolvent. Consequently, second-worst problem is that the government and the central bank will always provide bailouts when necessary. This, of course, is called “moral hazard” because it encourages JPM management to take ever more risk in pursuit of profits. Gains belong to JPM, but losses go to the public.

There is something even worse. Central planners must increasingly plan around the portfolios of these banks. Any policy that would cause them big losses is non-viable because it would risk a cascade of failures through the financial system, as one “domino” topples another. This is one reason why the rate of interest keeps falling. The banks (and the central bank) are “all in” buying long-duration bonds, and if the interest rate started moving up they would all be insolvent. Also, they are borrowing short to lend long so the central bank accommodates their endless need to “roll” their liabilities when due and give them the benefit of a lower interest payment.

The problems of the irredeemable dollar system are intractable. Halfway measures, such as proposed by Robert Zoelick of the World Bank that the central banks “watch” the gold price will not do.³ Ill-considered notions such as turning the IMF into the issuer of a new irredeemable currency won’t work. Well-meaning gestures such as a gold “backed” currency (price fixing?) might have worked in another era, but with the secular decline in trust, why shouldn’t people just redeem their paper for gold? One cannot reverse cause and effect, trust and credit. And that’s what a paper note is based on: trust.

The world needs the unadulterated gold standard, as outlined in this paper, Part III of a series.

In Part IV, we will look at one other key characteristic of the Unadulterated Gold Standard: The Real Bill…

Keith Weiner
Dec 5, 2012

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¹ http://www.lewrockwell.com/rothbard/frb.html

² http://en.wikipedia.org/wiki/Derivatives_market

³ http://www.ft.com/intl/cms/s/0/54a44c3e-ec7c-11df-ac70-00144feab49a.html#axzz2E5yPbbUQ

http://keithweiner.posterous.com/

In Part I (http://keithweiner.posterous.com/unadulterated-gold-standard-part-i), we looked at the period prior to and during the time of what we now call the Classical Gold Standard. It should be underscored that it worked pretty darned well. Under this standard, the United States produced more wealth at a faster pace than any other country before, or since. There were problems; such as laws to fix prices, and regulations to force banks to buy government bonds, but they were not an essential property of the gold standard.

The essential was that people had a right to own and trade gold coins. They had the right to deposit them in a bank, if the bank offered attractive terms (especially the payment of interest). Banks had a right to take deposits, to buy assets, and to pay interest. Banks had a right to issue paper notes that were claims against gold. Banks had a right to lend their deposits (fractional reserves).

Despite some government interference, the Classical Gold Standard enabled a Golden Age of prosperity and full employment that is totally out of reach today (not to be confused with the rapid development of technology). This is not to say there were not business failures, bank failures and panics – what were later called depressions and now recessions. A free market does not attempt to guarantee that no one can ever lose money. It is merely an environment in which no one is forced to subsidize someone else’s risks or losses.

Unfortunately, by the early 20^th Century, the tide had shifted. Europe was inexorably moving towards war. The US was abandoning the principles on which it had been founded, and exploring a different kind of government: an unlimited government that could centrally plan and manage the economy and the lives of the people.

In 1913, the US government created the Federal Reserve. Much has been written about this now-hated organization. At the time, the Fed was supposed to be the re-discounter of Real Bills. Real Bills arose spontaneously in the market centuries before banks or central banks. They are credit used for clearing. When a wholesaler delivers goods to a retailer, the retailer accepts the goods and signs the bill. Commercial terms were commonly NET 90. It turned out that in the free market, these bills would circulate as a form of currency, with a value that was based on the discount rate and the time until maturity. Real Bills were the highest quality earning asset, and the highest quality asset except only gold itself.

For many reasons, politicians felt that a quasi-government agency could make better credit decisions than the market. To “discount” a Real Bill was to pay gold and take the Bill into one’s portfolio. The Fed, as re-discounter, would offer the banks unlimited liquidity in exchange for their bills. Almost immediately, the Fed also began to buy US government bonds. What better way to expand credit than to push down the rate of interest? The Fed could use much more leverage than if they were restricted to buying bills (which would all mature into gold in 90 days or less!) This time, they thought, there was no limit to how far down they could push interest, nor for how long.

The Fed almost certainly enabled the government to borrow at lower rates than would otherwise have prevailed, but even so the rate of interest rose during World War I. This is because the government was borrowing unprecedented amounts of money. The interest rate peaked in 1919. Then it began to fall, not bottoming until after World War II.

The net effect of the Fed was to totally destabilize the rate of interest. In looking at this graph (http://static.cdn-seekingalpha.com/uploads/2012/6/7/saupload_Screen_shot_2012-06-07_at_3.44.58_PM.png) of the 10-year US Treasury bond from 1790 to 2009, one thing is obvious. There were spikes due to wars and other threats to the stability of the government. But for long periods of time, the rate of interest moved in a narrow range. For example, from 1879 until 1913 (i.e. the period of the Classical Gold Standard), the rate of interest was bound to a range of 3% to 3.5%. During World War I, the rate spiked up to 5.5% and then began to fall to well under 2% after World War II. Then the rate began its ascent to over 17% in 1981. After 1981, the rate has been falling and is currently under 1.7%. It will continue to fall, but that is a discussion for another paper.

The US, unlike Europe, did not suspend redeemability of the currency into gold coin. In Europe, the toll of the war in terms of money, property, and of course lives, was much higher. The governments felt it necessary to force their citizens to deal in paper money only. After the war, they had problems returning to gold. For example, Germany was prohibited from freely trading with anyone. One consequence of this was that the Real Bills market never reemerged.

In 1925, Britain initiated a short-lived experiment: the Gold Bullion Standard. The idea was that paper money would be backed by gold, but the gold would be kept in the banking system in the form of 400-ounce bars. Technically, the paper was redeemable, but the bars were so large that, for all practical purposes, the money may as well have been irredeemable to ordinary people. Britain abandoned this regime in 1931, in part due to gold flows to the US.

In 1933, the President Roosevelt told American citizens that they must turn in their gold for approximately $20 per ounce. Once the government got all the gold they could, Roosevelt revalued gold at $35 per ounce. The dollar was never again to be redeemable to Americans.

After World War II, Europe was physically and financially devastated. European gold had largely moved to the US either because of the coming war, or to pay for munitions. The Allied powers knew by 1944 that they would be victorious, and so met at Bretton Woods to agree on the next monetary system. They agreed to what could be called the Gold Exchange Standard.

In this new standard, the US dollar would be the reserve asset of the central banks and commercial banks of the world. They would end up with dollars on both sides of their balance sheets, and pyramid credit in their local currencies on top of this reserve. The dollar would continue to be redeemable to foreign central banks (but not to US citizens).

This regime was unstable, as economists such as Jacques Rueff and Robert Triffin realized. Triffin proposed that there is a dilemma for the world and the US. As the world demanded more money, this meant that the US had to run a trade deficit to provide the currency. But a chronic trade deficit would cause the value of the dollar to fall, with wealth being transferred from foreign creditors to domestic (US) consumers.

Throughout the 1960’s, European central banks, and most visibly France, redeemed dollars. By 1971, the gold was flowing out of the US at a rate of over 100 tons per day.¹ President Nixon had to do something. What he did was end the Gold Exchange Standard and plunge us into the worldwide regime of irredeemable paper money.

Since then, it has become obvious that without the anchor of gold, the monetary system is un-tethered, unbounded, and unhinged. Capital is being destroyed at an exponentially accelerating rate, and this can be seen by exponentially rising debt that can never be repaid, a falling interest rate, and numerous other phenomena.

In Part III, we will look at the key characteristics of the Unadulterated Gold Standard…

Keith Weiner
Nov 6, 2012

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¹  http://en.wikipedia.org/wiki/Nixon_Shock#cite_note-1

http://keithweiner.posterous.com/

Dear Mr. Price:

I read your piece: “On the Use of Gold Coins as Money” (http://www.plata.com.mx/mplata/articulos/articlesFilt.asp?fiidarticulo=196). I think you ask the right question. This is the elephant in the room. Why do gold and silver not circulate?

I love your analogy of the Swiss asserting that they will “allow” gold to have a monetary role, this being like “re-hydrating water.” It is not within the power of foolish governments either to imbue water with wetness, or gold with moneyness.

Gold is already money. It is the commodity with the tightest bid-ask spread. It is the commodity with the highest ratio of inventories divided by annual mine production (stocks to flows). And it is the commodity whose marginal utility does not decline. These statements are as true for gold today as they were under the gold standard 100 years ago.

Let’s look at marginal utility. I think you hit the nail on the head: people will pay in anything but gold, if it is possible to do so. People prefer to keep gold, and this preference has nothing to do with the amount of gold they or anyone has.

What is the practical effect of this? There are two things that individuals could theoretically do with their gold. The first is that they could hoard it. It does not produce a yield, and it does not finance production. But if there is no other option available this is what people must do.

So long as people are taking gold from circulation to hoard it, then the circulation mechanism is broken. An equilibrium is reached when all the gold is in private hoards.

People could also save gold. They could buy bonds (or deposit it in a bank that will buy bonds). The enterprises that borrow the gold will use it to finance production. Gold will continue to circulate.

You make a very important point that is underappreciated, if not lost, in the dialog today. A piece of paper is a promise. A gold coin is a tangible good. I love your analogy to the engagement ring. If a man gives a woman a contract that says the wedding will be on such-and-such date that is not equivalent to a gold ring!

You make the case that if people have no other means of making payment, they will pay in gold and silver. You acknowledge this could take a long time. Let me propose another way to go forward to the gold standard.

There is one thing that will motivate people to place their gold at risk, and give up possession (temporarily).

Interest – paid in gold.

Interest can lure the gold and silver out of hoards and to the twin tasks at hand: recapitalizing the financial system and financing production. Then it is just a matter of time. First bondholders and then suppliers are paid in gold. Gold begins to circulate.

If one has a gold income then one is free to accept gold liabilities, such as leases and employee wages. For the firs time since 1913, the monetary system would be on a good path.

But without interest, without the promise of a gain to tempt gold hoarders to part with their metal, they will, as you say, find any alternative currency with which to pay. The world will continue on its inexorable march towards permanent gold backwardation.

That is what I think you and I are both working to try to prevent!

Regards,

Keith Weiner