How to Introduce a Gold Standard

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The idea of restoring gold to its former monetary status (or, as it is often described, “returning to the gold standard”) seems to be increasingly popular all around the world. The main reason is the continuous debasement of all paper currencies that forces people to look for ways to protect their wealth. Additionally, it is commonly expected that the ongoing monetization of sovereign debts will lead to much higher inflation down the road. There is also a growing awareness that the government’s, or central bank’s, interference in the monetary sphere leads to various detrimental economic consequences such as distortions of price signals or inadequate levels of interest rates. Therefore, there is a need for a commodity money that would be hard to control and manipulate, and gold is the most obvious candidate to perform that role. Apart from that, it is becoming increasingly evident that the ability to create money by arbitrary decisions, which is a feature of fiat monetary systems, is a source of tremendous power and opens space for various forms of corruption. There are also many advocates of the idea of a global currency that would facilitate trade by removing costs, inconveniences, and risks connected with foreign exchange. Gold would fit perfectly. With all these arguments gaining popularity, also among those who are in power, it is not all that unlikely that, in the not-too-distant-future, the governments of some countries will decide to abandon fiat currencies and introduce some form of a gold standard. Those governments will need a plan of how to achieve this goal. Such plans exist, but most of them, or at least most of those known to the author this text, are based on a questionable assumption that the monetary reform should involve establishing a fixed exchange rate between gold and the unit of the existing legal currency, or, if you prefer, “defining” this currency unit as an amount of gold, and making the currency redeemable in gold on demand owing to backing it with the government’s gold holdings.[1] The first problem that any reform based on the above principle may encounter is the insufficiency of gold for redemptions. This concerns mainly countries with modest reserves of the precious metal, but also countries whose reserves are relatively large are not in a comfortable position either. To illustrate this point, let us look at the example of the United States of America – the country with the largest reserves of gold in the world.

The US government officially holds 8,133.5 tons, or 261.5 million ounces, of gold.[2] At the current price of gold of approximately $1,600 an ounce this stock of gold is worth about $418 billion. Let us assume that holders of dollars are allowed to redeem their money for at least as much gold as the market currently offers. Would there be enough gold in the reserves to satisfy every claim? To answer that question we need to compare the existing stock of dollars with the value of the reserves (about 418 billion dollars). Here, however, a problem occurs. Measuring the amount of money in existence, or, in other words, the money supply, is a difficult matter and a subject of dispute in economics. Clearly it is not enough to count only the existing banknotes and coins, as an overwhelming majority of the money that people own has only the form of digital records, without any material representation. That is why various aggregates are constructed as measures of the money supply. The Federal Reserve calculates, and periodically announces, two aggregates, M1 and M2. M1, the narrower of the two, consists, roughly, of cash in circulation and demand deposits. In June 2012 this measure stood at 2266 billion dollars. As we can see the amount of money expressed by this aggregate is sufficient to buy all the US gold reserves 5 times over at the current price. Or, in other words, if all the M1 dollars were to be exchanged for the gold held in the reserves, there would be 5 times too little gold. The situation is much worse if we take into account M2, the broader aggregate. This aggregate comprises, again roughly, the M1 components plus savings deposits and time deposits in amounts of less than $100,000. In June 2012 the M2 money supply amounted to 9933 billion dollars. If all dollars expressed by M2 were to be redeemed, there would be 23 times too little gold.

Of course, not everyone has to immediately rush to redeem their money. However, if such a large disproportion between the money supply and the stock of gold for redemptions is to be a feature of the new currency system, then it seems very likely that, sooner or later, a shortage of gold will occur and the currency’s redeemability will have to be suspended or terminated.

Many plans of introducing a gold standard assume establishing an exchange rate that would be some quotient of the stock of gold in the reserves and the money supply indicators – for example, the number of ounces divided by the number of dollars in the M1 aggregate (according to contemporary data, so calculated one dollar would be about a 1/9000th of an ounce). In this way a better coverage of the existing money stock with gold could be achieved. However, if the official rate is worse than the market price in terms of gold offered, enforcing it will require making it illegal to refuse accepting payment in gold according to the official parity. For example, let us suppose that the American government announces that the dollar is a 1/9000th of an ounce of gold. The legal parity will allow someone who owes another person 9000 dollars to extinguish the obligation with a one-ounce gold bar and his creditor or contractor will be forced to accept it. Without such a law, and with the price of gold remaining about the same as it is now, no one will accept a payment in gold as they would receive several times less gold than what the market offers. In that case the parity will be a fiction. The market price will not adjust to it and it will function independently. Most likely making gold legal tender in the way described above would cause great perturbation and be very unpopular. Another problem, and a reason for the reform to be hated, is the fact that the redefined money may have a much smaller value, especially as far its value on the international market is concerned. Let us suppose that the American government really manages to turn the dollar into a 1/9000th of an ounce of gold. The question is: will the dollar’s value on the foreign exchange market fall to the value of this amount of gold priced in other currencies, or will the value of gold rise, or will the outcome be something in between? The dollar is the medium of exchange in the largest economy of the world so it may drive the value of gold up, making it more expensive in all currencies, yet it is doubtful that the international value of the American currency will remain unaffected. If the above parity were established today, the international value of gold would have to rise almost six times to retain the dollar’s purchasing power in terms of foreign currencies. It is not impossible, but such a total “victory” of the dollar seems very unlikely. Still less likely is maintaining its value by a relatively unimportant currency of some small country, if a similar reform were introduced there.

Considering all the problems connected with establishing a parity, it will be appropriate to ask whether such a solution is really necessary. What if a different route could be taken? Henry Hazlitt believed that people should simply be allowed to use any currency they want, and an international gold standard would eventually emerge.[3] Perhaps he was right, and perhaps his proposal would be the best solution. But it can hardly be called a plan to establish a gold standard, while it seems a good idea to have such a plan in the case some government wishes to create a gold-based monetary system without waiting for the market’s decision in this respect (rightly or not, let us call it “the second best option”). Anyway, Hazlitt pointed at the right direction by postulating that gold should be allowed to replace the old currencies through voluntary decisions of market participants, without any fixed exchange rate being imposed. There is, however, one problem: people are generally conservative, distrustful of what is unfamiliar to them and reluctant to change their habits. They may not abandon the currencies they have been using all their lives unless some very high rates of inflation are experienced. Therefore, if we want to introduce a gold standard relatively quickly, before some inflationary calamity occurs, it may not be enough to simply allow people to use the yellow metal as money – they should be encouraged to do so. This article will present an outline of a monetary reform that involves such encouragement.

First, however, let us deal with some basic issues. Primarily, it must be decided in what form gold is supposed to perform the currency function. One possibility is to issue a new gold currency that would have its own name, e.g. “gold dollar”.  Another is to declare “gold” as such an official currency. If a new gold currency is to be issued, at least some of its denominations must have the form of specie, coins or bars, but for the sake of comfort of cash transactions it should also be issued in the form of banknotes and low denominations coins made of cheaper metals. The new currency would get into circulation gradually, as people would buy it from the issuer.

Who would be the issuer? It could be the government, the central bank or a private institution. Multiple gold currencies could also be allowed. If gold as such is to be the new currency, the government will have to specify in what forms gold would be accepted as payment, at least as far as tax payments are concerned (will, for example, jewelry pieces be accepted?). In the further analysis by “gold currency” we will understand either a new currency (or currencies) or simply “gold” as substance.

Let us now pass to the question of incentives that would make the reform gain traction. One such incentive could be a reduction of tax obligations if they are paid in the new currency. For example, let us suppose that someone is obliged to pay $30,000 in income tax. This amount could be reduced by, say, 20 percent, to $24,000, if this person choses the gold currency as the medium of payment – the tax would be paid in an appropriate amount of the gold currency according to the exchange rate on the day of payment. Due to such an incentive people will buy the new currency in order to pay taxes in it. Some will buy more and try to spend it. Others will accept it as payment for their goods and services, knowing that they will soon have use of it anyway.

The process of paying taxes in the new currency should be made as easy as possible. For that purpose it would be helpful to create an institution serving as an intermediary between taxpayers and the government. That institution would receive the old currency from tax payers, buy the appropriate amounts of the gold currency, and make electronic or physical money transfers. It should also be equipped with the ability to store large amounts of cash. With time its functions could be taken over by commercial banks, but some entity should be ready to provide the abovementioned services from the start.

Another tax incentive that the monetary reform may involve consists in setting a lower tax rate on income (or revenue) received in the new currency. For instance, the rate of income tax could be 5 or 10 (or more) percentage points lower for wages received in the gold currency. Consequently, wage earners will be encouraged to demand payment in the new money, as in that case they will pay a lower rate of income tax. A similar rule could apply to sales or VAT taxes (in countries where those exist). For illustration, let us assume that in some country the basic VAT rate is 25 percent. This rate could be lowered to, say, 15 percent, if the payment is made in the gold currency. Not all goods need to be immediately subject to such a regulation. It may initially embrace only selected goods, such as those whose price exceeds a certain threshold. This sort of tax incentive will make people more willing to accept the new money as the means of exchange. Performing transactions in it will be beneficial to both sellers and buyers. Forcing them to do so is neither necessary nor desirable.

The existence of the reliefs will, of course, cause some diminution of tax revenues. However, the reliefs will have to be substantial only as long as the use of the new money does not become widespread. With time they can be lowered, and, at some stage, supplemented or replaced with tax raises on the use of the old currency. Also, various solutions could be implemented in order to keep revenues under control. For example, the number of tax payers entitled to take advantage of the relief could initially be limited to 10,000. Then this number could be increased while the relief would be reduced.

With the increase of the amount of the new money in circulation the supply of the old one should fall accordingly, or the latter will vanish in a hyperinflationary collapse. Although such a collapse may be desirable from the point of view of successful currency replacement, it will be painful for those who will not dump their old money fast enough. That is why the central bank should follow the policy of reducing its supply. The more successfully this task is performed the more of the old money’s purchasing power will be saved. Its final remains could be removed (by being bought) with the use of the government’s gold reserves which, in this case, could be no more than modest. The policy of removing the old currency from circulation and preserving its value could be additionally supported by the introduction of a special lump-sum tax paid exclusively in this currency, imposed on most citizens (certain groups, such as low income earners, could be exempted). The money received through this tax would not be spent. Instead, it would be withdrawn by the government from its accounts as cash and destroyed.

For the monetary transformation to be complete banks, or other credit institutions, should begin to give loans in the new currency on a regular basis. These credit transactions will have to be regulated by law. One option is that no special regulations will be passed concerning credit operations in the new currency. The other option is that the new money will be treated differently. Particularly, it is possible (and likely) that law makers will decide to introduce a one hundred percent reserve requirement in order to protect stability of the fledgling money system. In this context, it will be worthwhile to devote some time to a certain important issue.

When the subject of the one hundred percent reserve system is debated concerns are often raised that in such a system, no matter what currency is used, banks will have little money available for credit, as it will be forbidden for them to tap demand deposits in order to obtain money for loans, and, at the same time, people will be reluctant to make time deposits, because it will be impossible to terminate them before the maturity date. Although those concerns are not without substance, the problem of general reluctance to make time deposits could largely be remedied by providing depositors with a convenient way to sell the rights to their deposits. This is about how it should work: Let us suppose that a bank’s customer makes a deposit for five years for a certain rate of interest. After, say, two years she comes to the conclusion that she urgently needs her money back. The deposit cannot be terminated but she can sell her deposit to someone else by intermediation of the bank or perhaps some other institution. The original depositor will lose some of her money, the buyer will earn. The amount the original depositor will lose will depend on the market: it may be part of the interest income, all of the interest income or even part of the principle. The better developed and organized the “deposit trading market” becomes, the smaller losses the sellers will incur (all other things being equal). In the age of computers it will be much easier to develop such a market than it would have been in the past. Of course, the idea of tradable deposits can also be employed by fractional reserve banks. Such a solution is simply less necessary for them, although, still, it could be useful.

A transformation of the monetary system based on the above measures has many advantages.

First, the new currency is not enforced on the population. People can accept it or reject it, despite the incentives. The decision is ultimately theirs.

Second, no gold reserves are required on the part of the government or the central bank, except for the possible purchase of the remains of the old currency. However, the existence of such reserves is not essential for the monetary transformation to be successful. If the country does not have its own currency (for example, because of being in a monetary union), the problem of what to do with the old currency does not occur.

Third, the reform does not have to be at once implemented in an entire country. It may initially be limited to a region, or even a single city, and then expanded. Of course, such a solution would pose some legal problems, but if it is possible for special economic zones to exist within various countries, it seems possible to create special monetary zones as well.

Fourth, there is no necessity for the monetary transition to be “completed”. Instead, a system of parallel currencies could be established. It might, for example, be a useful solution for a country wishing to remain in an existing monetary union (or zone), but any country could choose such an option as a precautionary measure for the eventuality of a collapse of the current monetary system.

In a sense the first steps to implement the above reform, or a similar one, have already been made. Last year Utah passed a bill allowing stores to accept gold and silver coins as legal tender according to their market, not face, value, and some other states are considering doing the same.[4] The next step could be encouraging people to take advantage of this opportunity by means of tax reliefs, such as those presented in this text, or other. If it works, and citizens are happy with their government’s efforts to give them more choice in the monetary sphere, an example would be set for other states and countries to follow.


[1] Some plans of the introduction of the gold standard, presented by their authors or other writers, can be found in: Murray N. Rothbard, The Mystery of Banking, Richardson & Snyder, 1983, p. 152-156; Ludwig von Mises, The Theory of Money and Credit, New Edition (1952), Liberty Fund, Indianapolis 1981, p. 477-500; Jesús Huerta de Soto, Money, Bank Credit and Economic Cycles, Second Edition, p. 788-803; available at: http://www.jesushuertadesoto.com/madre2.htm/; Lewis E. Lehrman, The True Gold Standard. A Monetary Reform Plan without Official Reserve Currencies, Lewis E. Lehrman, 2011, p. 51-88; James Rickards, Currency Wars, Penguin Group, New York 2011, p. 235-247; Ron Paul, The Political and Economic Agenda for a Real Gold Standard, in: Llewellyn Rockwell (ed.), The Gold Standard, Perspectives in the Austrian School , Ludwig von Mises Institute, Auburn, Alabama, 1992, p. 129-140; Bettina Bien Greaves, How to Return to the Gold Standard, “The Freeman”, November 1995, available at: http://www.thefreemanonline.org/featured/how-to-return-to-the-gold-standard/; Joseph T. Salerno, The Gold Standard: An Analysis of Some Recent Proposals, The Cato Institute 1982, available at: https://www.cato.org/pubs/pas/pa016.html; Larry White, Making the Transition to a New Gold Standard, presented at the Cato Institute Annual Monetary Conference, available at: http://www.freebanking.org/2011/12/22/making-the-transition-to-a-new-gold-standard/; Jeffrey M. Herbener, Leave Money Production to the Market, available at: http://mises.org/daily/6044/Leave-Money-Production-to-the-Market.

[2] Source: World Gold Council.

[3] See Joseph T. Salerno, The Gold Standard: An Analysis of Some Recent Proposals, op. cit.

[4] Stephen Dinan, Utah Legislature Goes for Gold, Silver as Currency Options, “The Washington Times”, March 10, 2011, http://www.washingtontimes.com/news/2011/mar/10/utah-legislature-goes-gold-silver-legal-tender/

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About Rafał Rudowski

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