Hello fellow armchair economists! I have an interesting article for you that I found on the DGC blog website. The original source of the article is located here at the getliberty.org website. If you’ve been following my blog for a while you probably already know that I’m a bit fan of gold (even a goldbug one might say) and that I do support and believe in the idea of a using gold as money. While I agree with the author that at present the case can be made for a strong need to go back to some form of a gold standard, I’m not so sure about the fundamental soundness of the version suggested by Mr. Woodhill. He suggests that the value of the dollar should be pegged at $500/oz, but if this arbitrary value is to be achieved it would require a massive contraction in the existing money supply. Wouldn’t it make more sense to first figure out just how much dollar are floating around and also the size of the world’s gold supply (roughly) and peg the dollar at some realistic and reasonable rate that closely links the TOTAL quantity of dollars to the TOTAL quantity of gold.
In this – dare I say, bastardized – “modern gold standard” gold would not be money, and monetary operations would not create any additional demand for gold. I believe the root of the problem is the concept of fractional reserve banking. If fractional reserve banking were to be abolished then we wouldn’t have to worry about this problem. If banks could NOT create money out of thin air (and this applies to the Fed too) by monetary operations then we would not have to worry about creating any additional demand for gold. By its very nature the fractional reserve principle is inflationary and even if you tie the dollar to gold via the method espoused by Mr. Woodhill you would still not be able to put a halt to inflation. In conclusion I would say that what’s needed is not a “modern” gold standard but the revival of the classical gold standard and the abolition of fractional reserve banking. Such a monetary system would bring back monetary stability and faith in the soundness of the dollar. Then truly the dollar would be good as gold. Gold IS and SHOULD be used as money.
Anyways, I’m done my monologue and if you made it this far in my post I encourage you to share your opinion on this matter at my forum. Follow the link below. I look forward to hearing from you.
Now, without further ado – and comments from me – I present you with the article itself. Enjoy!
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“Because, ‘Without integrity, nothing works’, the only way out of our current mess is to restore integrity to the dollar. We must have a monetary system that is not based upon a lie. A ‘modern gold standard’ would do the trick.”—Louis R. Woodhill, “Time for a Modern Gold Standard,” June 17th, 2008.
One of the most-reported stories of the year also happens to be the biggest problem most-ignored by politicians: inflation and the weak dollar. Plenty has been written about the problem, but very few have written anything in the way of solutions, and even fewer leaders in Washington have responded with anything other than band-aids and bromides.
Fortunately, that may be starting to change. Yesterday, writing for Real Clear Markets, Congressman Ted Poe (R-TX) in his piece “Congress Must Stabilize the Dollar” outlined his bill, H.R. 6690, the “Sound Dollar and Economic Stimulus Act of 2008”. It would set the value of the dollar to one five-hundredth of an ounce of gold. In his words:
“At $804/oz, the current market price of gold reflects the expectation (and fear) of future inflation. I believe that fixing the value of the dollar now in terms of gold at $500/oz will stop the current inflation without causing deflation. However, my bill also provides a powerful supply-side stimulus, in the form of first-year expensing of all capital investment, to ensure that economic growth accelerates at the same time that inflation is being stopped.
“Bringing the dollar price of gold down to $500 will bring the price of gasoline down from its current $3.50/gallon to less than $2.50/gallon. It will strengthen the dollar against foreign currencies. Most important, it will prevent Americans’ incomes and savings from being stolen by inflation.”
This mirrors a proposal from Louis Woodhill of June 17th. In response to publisher Steve Forbes’ call for a “modern gold standard” in his June 16th piece, “Unilateral Disarmament,” Mr. Woodhill outlined his plan to stabilize the U.S. dollar with just such a standard amid soaring inflation over the past decade:
“Under a modern gold standard, the Fed would use its Open Market operations to force the COMEX price of gold down to (say) $500/oz and keep it there. At that point we would have a fiat currency whose value was defined in terms of the market value of gold. Unlike the old gold standard, gold would not be money, and monetary operations would not create any additional demand for gold. The monetary base would automatically expand and contract in response to market demand. Because the Fed has the power to deliver on a commitment to stabilize the value of the dollar against gold, a modern gold standard would have integrity.
“Under a modern gold standard, the world would be certain of future value of the dollar. All of the economic costs currently devoted to hedging fluctuations in the value of money would be avoided.”
This proposal differs from the old gold standard because under that standard, gold was money. Governments using the standard would redeem the paper currency for gold at a fixed price upon demand. The problem, according to Mr. Woodhill, was that “[f]rom the beginning, there wasn’t enough gold in the world to honor this promise. This was a fundamental lie… [that] was implemented via ‘fractional gold coverage’ laws that allowed central banks to issue (typically) up to 2.5 times as much base money as the value of their gold holdings.”
In contrast, this modern gold standard would simply peg the value of the dollar to the value of one five-hundredth an ounce of gold at $500/oz without requiring the nation’s central bank to stockpile bullion to match the dollar printed. According the Mr. Poe, instead, the amount of money would be “determined by the demand for money, which depends upon the transactions people want to do and how much money they want to hold.”
To justify this course, he writes, “What matters about money is not its quantity but its value…” which would be pegged to gold at $500/oz.
A potential flaw to Mr. Poe’s plan is if the quantity of dollars exceeded the actual demand for dollars. Under those circumstances, the value of gold would plummet, as would the value of the dollar. Therefore, the way that the demand for dollars is measured would be of critical importance to enacting the Poe plan. Would it simply be the amount of money borrowed? Would it include population growth? Economic growth?
Of course, that’s the same problem that exists today: Inflation is up because the supply of dollars currently exceeds the actual demand. Dollars are worth less, so prices are marked up. A potential upside outlined by Mr. Poe is pegging the value of the dollar to gold is that it would increase the demand for dollars:
“I believe that the demand for the newly-stable dollar will be so great that the Fed will actually have to expand the monetary base… Once the Fed implements its new directive from Congress, every dollar in the world will have the same market value as one five-hundredth of an ounce of gold. From then on, the monetary base will expand and contract automatically in response to market demand.”
And then the American people’s purchasing power would increase, prices would stabilize, and the economy could begin long-term growth based upon the certainty of costs. And two of the biggest problems facing the economy would be solved at one and the same time: inflation and the weak dollar.