Here is a random political thought that I’ve had for some time. It’s about the gold standard and a possible return to a standard somewhat similar to it. A few weeks ago, my daughter Rachel and I were discussing the gold standard (she’s very interested in history) and I talked about my idea. She wanted me to write a blog post about it, so this is for her. I welcome any comments however. Obviously it’ll never happen… but I still think it’s an idea worth looking at, if for no other reason than to recognize some of the important weaknesses of our current system.
When I look at the financial foundation of our country over time, one of the means of economic regulation was the gold standard. The gold standard had several advantages and disadvantages that I’m pretty interested in. I am by no means an economist, so my depth of understanding is definitely limited, but I want to mention a couple characterisics here.
The most important characteristic was that money was linked directly to gold. In theory, every dollar bill was backed by a tangible asset; namely a dollars worth of gold held in reserve somewhere. The federal government set the price of gold at a given number of dollars per ounce. In theory, that value could be changed, but in practice it was largely static and set in negotiation with other nations participating in the gold standard to help regulate international trade, making it easier and less of a financial risk. As a result, although the federal government was able to change the value of gold, it actually stayed quite constant. For example, from 1900 to 1933, the value of gold remained unchanged. In 1934, the price changed but was then static until 1971 when the gold standard ended.
As a direct result of this, the federal government’s role in the economy was actually fairly limited. Although it had the power to potentially alter the value of the dollar (and it did in 1934 when the price of gold was changed), in practice that was a power that it was not able to wield on a regular basis. Because the value of the dollar was tied to something so tangible, the government wasn’t able to realistically wield it’s power regularly. Instead, the gold standard actually put a check on the government’s ability to print money. Since the gold standard required that each dollar theoretically be backed by actual gold (in practice, there were elements of the fractional reserve system even in the gold standard, and the amount of gold in reserve was not actually enough to replace all active currency).
Because the gold standard tied the wealth of the nation to a tangible asset, under normal economic conditions the standard provided stability to the economy. Fluctuations in the value of money (i.e. infation and deflation) were supressed. The economy was also far more transparent. Having a tangible asset as the basis for the money allows more informed financial decisions at every level from that of a personal transaction to a multinational financial treaty.
One other characteristic of the gold standard that sticks out to me is that it greatly segregates the economic roles of various institutions. The federal government’s role was to largely to maintain a reserve of gold upon which the currency would be based on. It set the value of the assett, but this power was quite limited in the ability to excercise it. Also, the federal government printed the currency that would be used but this was limited to the amount of the assett, so this was less of a power and more of a simple management process. Banks would be able to store the wealth in safety, and make loans based on that wealth. And perhaps most importantly, the production of wealth was assigned to a completely separate group: gold miners. They were the only ones who could actually produce the asset upon which the wealth was based.
As I see it, there were two main disadvantages to the gold standard.
The first was the limited flexibility of the government to respond to an economic crisis. Under normal circumstances, the stability of the economy based on the gold standard was a tremendous advantage, but when the world wars occured, or the great depression, the gold standard limited the ability for the federal government to respond to those crises.
The second disadvantage was the limitations on the amount of wealth available. The demand for money greatly exceeded the ability of the gold miners to produce it. This placed an artifical barrier on the growth of the economy. It was not that the economy was growing at an unsafe rate. It was simply that the tangible asset upon which the currency was based was limited.
As a general rule, I am a huge fan of the advantages of the gold standard. I like the stability of tying the currency to a tangible asset. As I am a huge fan of separation of powers and the concept of checks and balances, separating out the roles to separate groups very much appeals to me. And because I see the power of the federal government expanding beyond it’s constitutionally mandated limits, the limitations of the gold standard on the federal goverment are much desired.
When the United States determined that the gold standard did not allow the creation of enough money to meet the needs of the economy, it was replaced with the current fractional reserve system. There were two aspects of this. First, money was no longer tied to a tangible assess. As a result, money actually became a symbolic, rather than actual representation of wealth. The federal government was no longer limited in their ability to print money. Money could be printed as needed (desired) rather than based on the amount of gold in a reserve. Second, although under the gold system, banks were not required to actually have 100% of the gold necessary to back all of the money, the reserve was sufficient to cover a significant portion of it. With the switch to the fractional reserve system, banks no longer needed to have much reserve. Since the switch, banks have not been required to have more than 10% reserve (and in March 2020, that amount was actually reduced to zero… a truly terrifying thought).
At 10%, a bank gets a deposit of $1000. It can then loan out $900 of that. But that loan ends up in another bank, which means that that bank can now loan out $810, which ends up in another bank, and so on. So, what has happened is that the banks are now creating the wealth AND profiting from it through interest and the federal government is creating money to match the wealth being produced by the banks.
There are some benefits to this system: namely that the amount of money available for loans is tremendously increased compared to the gold system. However, there is no such thing as economic stability in that system because wealth is not tied to anything. And perhaps worst of all, virtually all aspects of the economy (wealth production, wealth storage, money printing) are directly controlled by either the federal government or the banks.
So, how to solve this? The solution should (in my opinion) involve several characteristics.
First, wealth needs to be tied to a tangible (or at least measureable) assett. There absolutely needs to be some sort of check on the ability to create money that is not backed by something real.
Second, many of the current powers given to the federal government and banks needs to be stripped from them and given to other groups or organizations. No one organization should have so much power.
Third, as in the gold standard days, the production of wealth should belong to someone other than the government. In the gold standard days, it was the gold miners. We need something similar.
Fourth, the amount of wealth needs to be somewhat dynamic. If it is too static, it actually stifles the economy. On the other hand, if it is too dynamic, it becomes like our current system and actually produces economic instability.
One of my initial thoughts was to have the tangible asset be the land. Unfortunately, there is a very specific amount of land available, and it’s not increasing. As a result, the only way to allow fluctuations of wealth would be to induce changes in the value of land. Land value does change based on what is going around it, what resources are discovered on that land, etc., but those fluctuations are basically a result of the economy. As our economy discovers that it needs lithium, then land with lithium ore increases in value. But what we really need are fluctions that can actually both assist and regulate the economy. If more wealth were needed, we would need to be able to raise the value of the land even before the new resource was discovered, and given the strictly limited source of land, that would mainly just be the same as inflation. So, we need an asset that can grow (and to be honest, the ability to shrink would also be useful), but not in an uncontrollable fashion.
After further thought, I couldn’t really think of a good strictly tangible asset, so I shifted to thinking about measurable assets instead. And I arrived at one that I like: work.
So, without further ado, here’s the system I propose.
First, the wealth producers will be the people who work, and they will be divided into states. So every person who works at a job in Florida will produce wealth that will accrue in a reserve in that state. I don’t want to go into details (such as full-time vs. part-time; remote work; etc.) but I do want to address one detail here. I would not differentiate between the types of work, so a person doing yard work would be valued the same as a CEO of a global company.
Second, the federal government will set the value of the work. I would hope that this would be done in cooperation with other countries. In the gold standard days, the value of gold was coordinated between a number of countries on the gold standard. It would be great if the same thing could be done with this work standard. That would place a nice check on the federal government’s power since I want that value to be fairly static. The value of each worker would be the same for all states (so the federal government could not force individual states to behave in some way by altering how their workers were valued).
Third, every year, based on the number of workers in a state and the value of the workers based on the federally set rate, the states would accrue a new amount of wealth that was created that year (or quarter or month or whatever).
Fourth, the states would then distribute that wealth to banks for a fee. That fee would be set exclusively by the states without any interferance by the federal government. They could use that fee to help drive their economny. For example, the fee imposed might be significantly smaller if the bank guaranteed that that wealth would be used to fund in-state business loans or mortgages, as opposed to wealth that would be used out-of-state or internationally. This would definitely involve introducing visibility into the banking system which would be a marvelous side effect.
Fifth, the fees paid by the banks to access the state-produced wealth would then be used to fund some portion of the state’s costs, potentially reducing taxes, or increasing services provided by the state.
In this system, economic processes would be divided among people (the actual wealth producers), the states (who now act as an important link between the wealth producers and the banks), the banks (who now are no longer allowed to actually produce wealth at the rates they currently do), and the federal government.
This would also allow the states to take over some parts of the power currently wielded by the federal government. That would be a nice affect as the power of the states has dwindled as that of the federal government has skyrocketed.
Obviously, there would be tons of details to work out. But what do you think?
