There is widespread and deeply ingrained cultural confusion that conflates the role of the gold standard, which is a market-based regulatory process, with gold as a “thing.” This overlays the (generally discredited) monetarist “quantity theory of money” on top of a monetary regime that is rooted in quality — “good money” — and lets the market, rather than the Gosplan of the FOMC, decide how much should be issued (or withdrawn from circulation).
How far back does this popular misunderstanding go? Charles Dickens made fun of it in Nicholas Nickleby:
‘…and I should like him to get up a few little arguments about the disastrous effects of a return to cash payments and a metallic currency, with a touch now and then about the exportation of bullion, and the Emperor of Russia, and bank notes, and all that kind of thing, which it’s only necessary to talk fluently about, because nobody understands it. Do you take me?’
The concern over limitations in supply represents a collapsed distinction when dealing with a unit of account, which is the fundamental property of the definition of the dollar (or any other national currency). There is a vignette , probably fictional but certainly capturing the incisive intellect and firm grasp of the principles of Sir Isaac Newton, inventor, as Master of the Mint, of the classical gold standard:
“Sir Isaac Newton was asked by the British Treasury officials and financiers of his day why the monetary pound had to be a fixed quantity of precious metal. Why, indeed, must it consist of precious metal, or have any objective reality? Since paper currency was already accepted, why could not notes be issued without ever being redeemed? The reason they put the question supplies the answer; the government was heavily in debt, and they hoped to find a safe way of being dishonest. But Newton was asked as a mathematician, not a moralist. He replied: ‘Gentlemen, in applied mathematics, you must describe your unit.’ Paper currency cannot be described mathematically as money. A dollar is a certain weight of gold; that is a mathematical description, by measure (weight). Is a piece of paper of certain dimensions (length, breadth, and thickness, or else weight) a dollar? Certainly not. Is a given sized piece of paper a dollar even if numerals and words of a certain size are stamped on it with a given quantity of ink?
So, this argument is kind of like saying that if the National Bureau of Standards (which, not the Fed, should be in charge of maintaining the integrity of the definition of the dollar) were to hold the length of the inch or weight of the ounce pristine we might run out of yardsticks and measuring cups. Just because our monetary authorities fix the value of the dollar with impeccable integrity doesn’t threaten the supply. (Rather it enhances it through dishoarding.)
This argument confuses the use of the gold as an indicator of the desire for people to hold cash balances — a dashboard light to tell the bankers when to start and when to stop the printing presses. It’s rather like saying that there isn’t enough energy in a thermostat to heat or cool a house. Well, yes, that’s so, but it’s irrelevant — that’s not the job of the thermostat, which simply is a regulatory mechanism. Same idea with the gold standard, it’s a regulatory mechanism. There’s no shortage of gold (or surfeit of dollars) and there’s no need to revalue the dollar to some astronomical sum. That’s a naive linear approach to a nonlinear process.
Finally, the Bank of England maintained the gold standard with great success for centuries without ever having very much gold in the till. Investment advisor and author Nathan Lewis (most famous for a book with a foreword by none other than our own Addison Wiggin) empirically demolished this as a cause for concern .
The amount of metal piled in a vault has little relationship to the value (or quantity) of paper banknotes. In 1779 the Bank of England held 953,066 ounces of gold in reserve. In 1783 this had fallen to 339,261 ounces. One year later, in 1784, it had grown to 1,683,724 ounces. A year after that, it was down to 703,692 ounces, but in 1786 it bounced back up again to 1,535,538 ounces. These gyrations had no effect on the value of the British pound, which was pegged to gold at 3.89375 pounds per ounce.
Nor did banks ever have a 100% reserve of gold. In 1888 U.S. banks had a gold reserve ratio of 34.86%. By 1895 it had fallen to 12.33%. In 1906 it had grown again to 42.42%. None of this mattered to the value of the dollar, which was pegged to gold at $20.67 per ounce.
A gold standard does not place some artificial limit on the supply of money, nor is the supply of money constrained to the output of gold mines. The supply of base money grows or contracts as necessary to maintain the currency’s value in line with the gold parity. Between 1775 and 1900, the U.S. base money supply increased by 163 times–in line with an expanding economy and a population that went from 3.9 million in 1790 to 76.2 million in 1900. Over this 125-year period, the amount of gold in the world increased by about 3.4 times due to mining.
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