Tuesday, December 27, 2011

Could the US Return to a Gold Standard?

“That if any of the gold or silver coins which shall be struck or coined at the said mint shall be debased or made worse as to the proportion of fine gold or fine silver therein contained, or shall be of less weight or value than the same ought to be pursuant to the directions of this act, through the default or with the connivance of any of the officers or persons who shall be employed at the said mint, for the purpose of profit or gain, or otherwise with a fraudulent intent, and if any of the said officers or persons shall embezzle any of the metals which shall at any time be committed to their charge for the purpose of being coined, or any of the coins which shall be struck or coined at the said mint, every such officer or person who shall commit any or either of the said offences, shall be deemed guilty of felony, and shall suffer death.” –Chap. 16 , Section 19 of the Coinage Act of 1792, passed by the United States Congress on April 2, 1792.  (source)
While driving home the other day, I heard Dick Morris talking about presidential politics.  Nothing new there; this is the guy who helped get Bill Clinton elected, then had "an awakening" and became a conservative.  He was talking about Ron Paul in this instance, calling him an "appalling <blank>hole", then ripping Dr. Paul a new one for advocating a return to the gold standard.  His rip was classic "barbaric relic" rhetoric, about how we got off the gold standard because it "held our economy back", and "the US economy shouldn't depend on some miner in South Africa" succeeding in a gold mine.  Just look at the increase in wealth since we got off the gold standard!

Then he went on to add a disclaimer that, sure, Bernanke has printed too much money and the Fed was troublesome, but "there's a big gap between abstention and alcoholism" and we simply need to be somewhere between those two limits.  (That's his actual quote, as best as I can recall).

For a little necessary background, the term "barbaric relic" for gold is from John Maynard Keynes himself, and has been widely parroted by those opposed to a "real money" standard.  "Seriously, Muffy, no civilized, advanced society need be bound by having actual, physical, gold, must they?  Why, gold is what caused the Spanish to rape and pillage South America, the pursuit of El Dorado, after all!" To keep this down under a million words, I won't get into Ron Paul or any of the other candidates' politics: that's not the point of this. 

The point of this is "could we go back on a gold standard"? (and when I say gold standard, understand it could be any commodity that people value; anything but fiat paper that can be printed in infinite amounts).  Perhaps the place to start is the converse, why did the world go off the gold standard?  From where I sit, they did that so that government spending, and therefore government, could grow essentially without limit.  Is that a good thing?  As one of my heroes, the (now-retired) Mogambo Guru once put it,
Whether or not this theory is true, I don’t know, but I don’t think so, as I have never read anything like, “From the moment that the government started creating and spending large amounts of money, everything got better and better, and the more money that was created for the government to spend, the better things got, until they reached Utopia and everybody lived happily ever after.”
If we were on a gold standard, we would need to spend less - but we wouldn't necessarily have to balance the budget.  Some debt - my rough guess: 20% of GDP - would be possible, as long as other nations and people felt that the interest we paid was reasonable and they were confident they'd get it back.  The free market would have to set interest rates, not Helicopter Ben (or his ilk).  You can bet your butt our interest rates would be much higher and the monetary shenanigans the Fed creates wouldn't be possible.  In turn, that means it would be harder for the government to fund wars or an ever-growing entitlement state; the quantity of gold would have to expand to increase the money supply. Increasing our money supply – the thing that Morris thinks has improved the economy – has (IMO) led to the gradual decline of the middle class.

Buried in Morris' assumptions is that if we go back to the gold standard, we go back to the 1972 dollar, but why would that be?  We could declare a dollar to be worth any amount of gold we wanted between 1972's $35/ounce and today's number of dollars divided by the amount of gold we have.  In other words, 1972's $35/oz - meant each dollar bill was backed by 1/35 oz of gold. According to Wikipedia, the US claims 147.2 million ounces of gold in Ft. Knox.  The amount of dollars in circulation is harder to know, but there are some available estimates of that, called the M1 money supply.  If we simply divided the 2.2 trillion dollars in the M1 money supply by the amount of gold in Ft. Knox, that would bring the price of gold to $14,900 per ounce, so each dollar would be backed by 1/14,900 of an ounce (around 2 milligrams).  I have seen writers suggest that the M1 supply is drastically under reported; that would increase that $14,900 price.  Likewise, if there is less gold in US hands, that also acts to increase the price - which reduces the amount of gold behind each dollar. I'm sure you've heard the people who speculate that there is no gold in Ft. Knox and the Fed took it all.  That would make gold almost unobtainable in dollars. 

Gold at about $15,000/oz. would shake the jewelry business to its core, making gold only practical for plating, if that, and making platinum, palladium and silver the jewelry metals.  (I'm sure you've seen rhodium plated items, often considered cheap jewelry, but rhodium costs about as much as platinum).  Platinum is currently cheaper than gold; they crossed this past summer (IIRC) for the first time I can recall.  The market for scrap gold, the rings and things that people have and just keep for no particular reason, would probably drop well below that price as the supply would spike like crazy - as would theft of gold jewelry.  There are still many industrial uses for gold; it's used in electronics for plating contacts of many kinds, in optics, and dental work, of course.  Electronics would either increase in price, or alternatives would be found - probably less reliable alternatives.  I believe the price of gold would cascade into the other metals, too, but can't predict how much they'd go up. 

Backing the dollar with $15,000/oz gold wouldn't affect today's prices in fiat dollars, like going to $35/oz gold would.  It wouldn't scale prices to 1971 levels; your $250,000 house wouldn't suddenly be priced at $583 (the same ratio as 35/15000).  I think that sort of disruption is what people opposed to the gold standard are thinking of.  If we said dollars had to be backed at $35/oz of gold, we'd either have to drastically multiply our supply of gold (not bloody likely) or drastically decrease the number of dollars.  That would be quite a disruption. But any move in the direction of a new standard would cause disruptions world wide - and guess what? they're happening already. 

Note that we haven't devalued the dollar with respect to 1972, we just pegged it in place to the current supply of gold we have.  Devaluing the dollar from being backed by about 900 milligrams of gold to 2 milligrams is what the Fed has been doing since we got off the gold standard, and ultimately since their formation in 1913. The dollar has about 3% of the value it had when the Federal Reserve started. While it's true (as Morris said) that Bernanke has been printing too much money, the majority of that decrease in value, percentage-wise, was long ago and was handed to Bernanke by Alan Greenspan.  When the full series is plotted, you see that the dollar is worth about 5 cents in 1913.  When you look at this plot, you can see that Bernanke has decreased the value of the dollar, but most of the damage was done by his predecessors.  This is one of the arguments against what Dick Morris said.
So when Dick Morris or anyone says our economy has grown since 1972, has it really grown, or is it just inflation - the same as devaluing the dollar?  Another aspect of the Fed's action and the way the government reports statistics is that it's harder to tease this information out.  Inflation has the effect of making the economy look better and the country look richer, while it's actually robbing the people.  You have more dollars, but more are required to buy what you need.  This appearance of a growing economy is what the government wants, though – the better to fool you with.  Most people don't think of this: they see their house price is up, or the Dow is hovering around 12,000 and never think that without the last year's inflation alone, the Dow would be about 11,000.

One way to measure whether or not wealth is actually increasing or if you're just seeing inflation is to divide GDP by the population: normalize GDP per capita.  Porter Stansberry's research group produced this chart of an inflation adjusted GDP per capita.  It shows that the per capita GDP went down drastically during the 70s (Nixon and Carter) with a strange, but short, reversal in about 1977 and slowly increased until around 9/11/01 (through Reagan, Bush 1 and Clinton).  Since the middle of Bush 2's term, wealth has been in a nose dive and is now the lowest it has ever been. 
Stansberry's graph only extends back to about 10 years before the final death of the gold standard, not to the start of the Federal Reserve Bank.  Nevertheless, it completely disproves Morris' statement that getting off a gold standard has led to increased wealth.  

This plot is an example of one of the most important ideas in economics, the marginal utility function.  The simple idea here is that if you have one dollar, another dollar is very useful; but if you have a billion dollars, the next dollar doesn't have much utility – and that's the hole that Bernanke finds himself in now.  He has flooded the world with dollars, and there simply isn't much more utility in the next dollar being created.  The next round of QE – whatever they call it – can't be as useful as the first one.  Which wasn't very useful.

It has been said that an ounce of gold buys today about what it did at any point in the past.  Stephen Harmston, former economist at Bannock Consulting, wrote that “across 2,500 years, gold has retained its purchasing power, relative to bread at least” which is seemingly proved when one considers that “It is said that an ounce of gold bought 350 loaves of bread in the time of Nebuchadnezzar, king of Babylon, who died in 562 BC” which is roughly what it buys today, a stretch of 2,500 years.  With some judicious selection of the exact brand of bread, you get remarkably close to 350 loaves (and I'm sure there was some variation in what a loaf of bread cost even in King N's day).  Likewise, you'll hear that an ounce of gold would buy a good toga and sandals in pre-Christian Rome, and buys a well-tailored suit and shoes today, or you'll hear that a $20 gold piece bought an 1851 Colt Single Action Army revolver, and today buys a good grade 1911.  The point of all of these is that the price of gold is a standard by which other things can be measured.  Sure, technology marches along and brings down the cost of some things, but most things that increase in price over the long term do so because the currency inflates.  

It is not true that a gold standard removes inflation and deflation, and it's not true that depressions are impossible with a standard.  The 1800s had a few periods of inflation over 5%, including a big jump for the civil war, to over 25%; but after those inflation periods, the government took their medicine and dialed back the spending to reign things back in.  In 1895 during a bad depression, J.P. Morgan personally bailed out the US; in 1907, Morgan and John Rockefeller bailed out the country together (ref).  In those cases, the Federal government was small enough that individuals, although millionaires, could bail it out.  So even though the gold standard could not prevent inflation and deflation, the standard kept inflation and recession under more control, so that they weren't as bad as they could have been.  In 1900, the “cost of living” was actually lower than it was in 1800, a reflection of improved productivity in farming and other aspects of life.

It's hard to actually get numbers because the way the statistics were kept over the years has varied.  The Federal Reserve Bank of Minneapolis has calculated a time series and posted it.  I take this with a grain of salt because I can't help but believe they do things to make themselves look better.  For last year, for example, they use an inflation value of 1.7%, which certainly uses the BLS statistics, not the way it was calculated before.  Shadowstats, using the 1980s algorithm, says the rate was closer to 10% which would make these plots look even worse for the Fed.  That said, I think these plots don't make them look good at all, so just look at these and say “it's really worse than that”.    
The increase in the "CPI since 1800" plot shows the compound interest effect of that "Inflation Since the Birth of the Fed" graph almost always being centered above zero, and especially since the final decoupling of the gold standard in 1971.  Note how in the 1800-1912 period, the inflation graph stayed centered around zero more of the time.  

The Keynesians are right about one thing: there is nothing inherent to gold that makes it a standard.  Nothing besides the fact that people have always valued gold, wanted gold, and very probably always will.  A currency does not need to be based on a gold standard.  As I've said before, we could have a fiat dollar and just not debase it.  Our leaders and central bankers would have to not play politics with the dollar, not use the printing press to buy votes, not try to change the dollar's value to tweak other countries (cough - China - cough) and they would have to live within a constrained budget.  They should not be allowed to print money to fund foreign wars or the welfare state.  All they would have to be would be grown up, mature leaders.  

In other words, we're screwed.  We could and should return to a gold standard. The details will be messy and need to be watched like a hawk.  But these are messy times, and they're fixin' to get messier. 


  1. I'm not sure I buy this, and I'm absolutely sure I don't buy the "Americans are getting poorer - fast" chart. There's simply no way that we've lost two thirds of our per-capita real GDP in the last decade.

    I do think that there's very good reason to be suspicious of government figures, especially about inflation (and also unemployment). But I don't agree that two thirds of per-capita real GDP has evaporated since 2000.

  2. I understand. So how would you correct for the effects of inflation without using BLS inflation numbers? You need some sort of yardstick, and they chose commodities.

    "We took the government numbers for nominal GDP and measured them first against commodity prices, and later (after it began to trade freely) gold. We used a standard commodity index (the CRB) up to 1975 and gold post-1975. The result of this analysis shows you the real trend in U.S. per-capita GDP, as measured on a real-world purchasing power basis." Now Stansberry is the guy who produced that "controversial, may be offensive" video about the coming collapse of the dollar that he pushes (link at the bottom of his article I link to), and it's clear he thinks extremely bad times are coming. I know he's a gold bug, but how else do you measure this?

    There are certainly going to be supply vs. demand effects on the price of gold in there. Since nobody in the world has retained a gold standard, there are no yardsticks in the ground to measure the tide against - IMO, by design. The absolute low in the price of gold was about Y2K, when I first got interested in getting involved. That downward slope after ~ 2002 partly reflects the bull market that gold is in. Part of the reason for a bull market in gold is a genuine shortage, partly caused by investors chasing the tech bubble and not funding mining companies. It takes about 10 years from the discovery of a gold deposit until the metal starts pouring, so the supply changes should be coming online in the next five years (as a guess).

    I think their curve is essentially right, but the ratios and details of the slopes may be wrong. It is simply a hard thing to measure.

    Looking at the other data, the Federal Reserve data I used (the source is at that link) shows the CPI has gone up 31% since 2000 - and that's using the Fed's numbers. When you consider the Shadowstats approach, I don't think a 60% increase is too hard to envision.

    As always, I'm open to alternative explanations, so have at it.

  3. I agree that it's hard to measure. I just think that if real per capita GDP had declined 65% in ten years that there would be riots in the streets. Not this Occupy Wall Street silliness, real actual riots.

  4. Graybeard,

    Your best post yet on economics and well thought out. You even covered the gold to bread purchasing power which BTW is .1 gram for a loaf of bread in certain parts of Africa:


    A loaf of bread should be 1.5 to 2 lbs --capable of actually feeding people, making them feel full and providing a useful amount of protein.

    Americans need to keep in mind that the cost of a loaf of bread is heavily subsidized (just like in the former USSR) and it's relatively cheap thanks to modern mass production and fossil fuels. Substandard ingredients are also used in modern bread. Like many things about modern America, our forefathers would vomit out a slice of modern American bread. Also, a loaf of bread should be measured by WEIGHT not the number of bagged bundles of whipped air and wheat fluff that can be bought at the big box store. (Notice how Americans will cite that they can buy 2-3 loaves for $5 and never comment on weight or quality of ingredients).

    One other comparison to consider is the historic cost of ammunition and that it too is relatively cheap today:


    (the Sears catalog link within the above is very important --bookmark it for yourself for future reference)

    Again, remove mass production from the underground mine to the cartridge factory as well as cheap fossil fuels and the cost per round goes up significantly. Consider the prices in terms of silver dollars (which were NOT a full ounce) and that helps conceptualize the cost on the ground for the average shooter.

    My posts above will be available for 3 more days.

  5. GardenSERF - very cool post that you link to. Unfortunately, the 1898 Sears catalog misses, well, everything invented since then. .45ACP, .40S&W, 9mm, 7.62xanything, etc. I realize those cartridges are still around, but it would be more fun.

    It's interesting to see that cartridges similar to today's are around $25 for 50, using your inflation estimator. The lower price today could be productivity improvements from modern machinery.

    The improvements in agriculture, including the development of hybrid wheat varieties and fertilizers, together make up "improvements in productivity" (a term economists love). It is feasible that these could be lost for a variety of reasons: a disease that affects the wheat variety grown this year, or drastic increases in the price of the fertilizers or fuels, and so on. Still, the almost constant price of bread leads me to think that these are modest improvements at best.

  6. yes, i realize this is commenting to a dated post, but...

    "The Keynesians are right about one thing: there is nothing inherent to gold that makes it a standard."

    Nope. They are wrong, again.

    Gold is inherently difficult to locate, remove & extract. It is, in a word, scarce. God made it that way. Not only is it scarce, but it has innate beauty, desirable physical properties, it is fungible & divisible and recognized worldwide - throughout history - all of history - as something of value.

    Yes, gold does not always serve - as when a glass of water or loaf of bread is more needed - other than such occasions though it does pretty well.

    I'm not sure that Keynes got anything correct.


  7. What I meant by that was that sound, stable economies can exist on other commodity standards - it doesn't have to be gold. Would you have a problem with a platinum standard? Silver? Both have always been valued in their own right. The Yap islanders used limestone "Rai Stones", and apparently had a stable system for generations.

    The one thing a stable monetary system absolutely cannot be based on is debt. It's a very old observation that all paper money eventually returns to being worth what it's raw material is worth. Same goes for "money" created by digitizing numbers in an account.