Gold can be pretty to look at, but it can also be quite depressing. Economics joke. Oftentimes we hear people of a particular political and ideological persuasion insist that gold is “money”. Afterwards, they declare that we should all remain silent whilst they lecture us, drawing upon their vast storehouse of anti-knowledge, asserting that currency must have intrinsic value and then demanding that we restore the gold standard. Such ideas are the product of pure fantasy, propaganda and historical revision rather than reality-based scientific thought.
What is Gold?
Contrary to popular opinion, gold is not “money”. A sack of gold dust is not a monetary instrument. A gold bracelet is not a monetary instrument. Gold is a commodity like corn. To have a monetary instrument requires an issuer and a face value among other things. In other words, you need an entity which issues the monetary instrument. So, a government like the US government can issue coins containing gold, stamp them with its seal and give the coin a face value, but even then, the gold itself in the coin isn’t the monetary instrument. The coin is.
For instance, the US government could stamp a gold coin with a face value of $1. Generally speaking, it’s prettier to look at than a plain, metal coin. But still, the gold coin can only buy $1 worth of stuff. So, if you took your gold coin to Walmart, you could buy something as long as it was priced below $1 plus tax. Wow, ok. Just… wow. You can do the same with a fiat dollar too. The point here, then, isn’t to argue prices, but to explain that what makes the coin “money” is not the gold, but the fact that the coin is a product of the US government, that it has a declared face value of $1 and that the US government promises to accept it for payments. So, again – “Money” can contain a certain amount of a commodity or it can be paper and pegged to a certain amount of a commodity, but the commodity itself is not “money”. If you still think that gold is “money”, take some gold dust or your jewelry to Walmart and try buying some groceries. Better yet, try paying your federal taxes with a 24 karat gold cuff link or a sack of gold dust. Good luck with that.
What a US Dollar Is and What Makes a US Dollar a Monetary Instrument
The US Dollar is a monopoly product issued exclusively by the US government. It is not a commodity. A US Dollar is just a number with a “$” symbol in front of the number. The “$” symbol is called the unit of account. This, then, allows us to distinguish numbers produced by the US government from the numbers produced by the UK government. For instance:
Nice. The number “100”. Swell. Fascinating. Bravo. Well done.
One hundred “what” though?
One Hundred US Dollars.
Now, “100” is One Hundred British Pounds.
“Data, data, data – I cannot make bricks without clay.” – Sherlock Holmes
And so, we have data which helps clarify the number “100”. If you guessed that I am proposing that science be made a part of macroeconomics, then you are right. But let us not guess. Let us do science instead, and leave guessing games for the mainstream and gold worshippers.
The US Dollar is a monetary instrument because it has an issuer (the US government), it has a face value and it will be accepted by the US government for payments. But what causes the US Dollar to be acceptable as “money”?
The US government simply declares a tax and that the tax must be paid only in US Dollars. In doing so, it creates a problem, or in mainstream econobabble, a “conundrum” for everyone who resides within the United States. There is a tax that people must pay, but the only way to pay it is to have some US Dollars. Damn! How then to pay such a tax if no one has US Dollars? Simple, really. The US government needs labor, chairs, carpet, paper, pencils, pens, printers, computers, light bulbs and a jet fighter that cannot fly. The market offers labor, chairs, carpet, paper, pencils, pens, printers, computers, light bulbs and a jet fighter that cannot fly for sale to the US government and the US government determines the price in its own currency that it is willing to pay for these items. The market sells the goods and services to the government and the government then pays the price that it is willing to pay for these items with its own currency. Now, the people have the US Dollars on hand and so, they can pay the tax, a market is set in motion by the US government and the government becomes the currency-issuing and regulatory authority as well as the price setter. This reality demonstrates that prices are actually exogenous, because ultimately, the federal government determines the price of goods and services when it purchases goods and services with its own currency.
Because numbers are infinite and the US Dollar is just a number with a “$” label, the US Dollar is also infinite in supply to the US government. The government simply cannot run out of US Dollars. Without a commodity peg, meaning as long as there is no gold attached to the US Dollar, the US government doesn’t need to tax or borrow to fund its spending operations. It merely credits a bank account somewhere with numbers when it wishes to spend. That ability gives the US government flexible policy options to deal with domestic economic issues, such as unemployment and poverty. A gold standard, on the other hand, causes unnecessary havoc, instability and chaos.
The Gold Standard
A gold standard is a currency regulation scheme based on a certain amount of gold being attached to the currency in question which then gives that currency an unnecessary “intrinsic” value. For the system to function, the national government had to be ready to exchange its currency for that certain amount of gold. In other words, if a person brought US Dollars to the US Treasury and demanded gold in exchange, then the government would take back its US Dollars and give the person the amount of gold the US Dollars were worth.
Now, at this point, a reasonable person can see the pointlessness of the act since gold itself isn’t “money”. The US government could have placed the US Dollar on the dog shit standard and stood ready to exchange dog shit for dollars. It could have been platinum, titanium, corn, diamonds, Picasso paintings, flan, jelly, mangos in syrup, salt, strands of rope, copies of Homer’s “Illiad”, or low fat cottage cheese just as easily. It really doesn’t make a bit of difference. The monetary instrument is the US Dollar, not the dog shit, or the gold.
So, the national government agreed to fix the value of its currency to a certain amount of gold, requiring that government to maintain gold reserves in order to exchange its currency for gold on demand. This is where things become dicey. The amount of currency in circulation was dependent on the amount of gold reserves. If the nation had loads of gold, it could circulate more currency. But if the nation in question had meager supplies of gold on hand, then its supply of currency would also be meager. Currency, not gold, is necessary to create and maintain a situation of full employment, so a nation with small gold reserves would experience problems with domestic unemployment. The impact of international trade highlights the problem with gold.
Gold was used as a method to settle international trade payments. If there was a trade imbalance, gold had to be loaded into ships and floated over to the nation to whom payment was owed. So, the nation with the trade deficit paid in gold the nation which had a trade surplus. Using the US and the UK as an example, let’s look at the effects.
We will assume that the US has a trade deficit with the UK, which has a trade surplus. The US loads up a ship with gold and sends the boat across the Atlantic to the UK. Upon arrival, the UK has more gold and so, the UK can expand the amount of British Pounds in circulation giving it an overall better ability to address any domestic unemployment. If there is room for output, things are fine. But if there is no room, then the extra currency would cause inflation.
The US, on the other hand, shipped off a massive supply of its gold reserves. Because currency in circulation needs to match the gold reserves, this means that the amount of US Dollars in circulation must be reduced by the US government. When the US government removes US Dollars from circulation, the act is deflationary and unemployment rises. In order to deal properly with rising unemployment, the US government needed more gold.
So, if we look at real world examples during the gold standard, we see some nations who are quite powerful economically and some who are weak. The gold standard imposed a persistent deflationary/recessionary bias on nations who had weak trading positions. When these nations shipped off gold, the resolution of a trade imbalance could take a very long time and in the meantime, with currency in circulation reduced to match the lower gold reserves for an extended period, the weak nation experienced rising unemployment. Because of the gold standard, deficits could not be ran to address domestic economic issues and political unrest followed as people demanded work to survive. In the event of a major financial crisis, consumer spending would collapse, unemployment would soar and the gold standard would prevent the government from taking proper action, thus prolonging the downturn. Simply put, because of currency attacks and that high levels of unemployment could not be properly addressed, the gold standard was abandoned during the Great Depression.
“Gold can be pretty to look at, but it can also be quite depressing.” Economics joke.
After WWII, nations came together in a place called Bretton Woods and agreed that since the US was powerful, awesome, and well, just so super, that the US Dollar should be the thing that everyone would convert their currencies into. The US government agreed to convert US Dollars into gold at $35 per ounce. Participating governments could now sell gold to the US in exchange for US Dollars and the focus was on building and maintaining US Dollar reserves. All nations were then bound to observe and maintain at all times a fixed exchange parity. So, Bretton-Woods, essentially, was just another fixed exchange, currency conversion fetish. And just like gold, the supply of US Dollars to these governments was finite, because only the US government issued US Dollars. Therefore, quite similar problems to the gold standard would continue to occur.
Just like the gold standard, the problem again was that fiscal policy was hampered. Because of the requirement to maintain a fixed exchange parity, the currency supply could not be expanded, otherwise it would mess up the parity. If there was a deficit in the balance of payments, then the nation’s central bank would be forced to mop up its excess currency using US Dollar reserves in order to maintain the fixed exchange parity. And again, this would have the effect of contracting consumer spending and unemployment would rise. Similarly, if the national government tried to address rising unemployment by expanding its deficit too much, then the central bank would end up reacting to that expansion, contracting the currency in circulation in order to maintain the exchange rate.
So, that was fun, right?
Again, like the gold standard, Bretton-Woods imposed upon nations with poor trade positions a persistent deflationary/recessionary problem that was not easy to correct. Political unrest due to high unemployment made nations desirous to abandon Bretton-Woods. With Japan becoming a rising economic power and a host of other problems, the US began losing gold reserves and so, Nixon said, “to hell with this shit” and ended Bretton-Woods, leaving the US Dollar to float freely on an exchange, the rate determined by market forces and the US government no longer agreed to convert US Dollars into anything but US Dollars.
In short, a free-floating, inconvertible fiat currency regime has been in place since the early 1970’s. Because there are no gold reserves to defend, the US Dollar is just a number with a “$” symbol in front of the number. Numbers are infinite and thus, so is the supply of US Dollars available to the US government today. The US government no longer taxes or “borrows” to fund spending, because it does not have to keep the amount of currency in circulation matched to the supply of gold on hand.
Today. the US government is free to pursue full employment and prosperity at will; its deficit spending constrained only by the real productive capacity of the United States.