I did not write the following message, but copied it from a Facebook forum. My intention is not to start a discussion on the efficiency/soundness of a gold standard vs. the current system, but the practical problem of re-implementing the gold standard today. I hope the message will inspire to some interesting debate:
Does anybody know how much gold there is (or isn’t) in Fort Knox? For all I know, that piggybank hasn’t been audited since the 50’s.
The US is a USD 13 trillion economy. I don’t think there is USD 13 trillion of available gold to purchase in all the world. And if there were, with what kind of money is the Government going to purchase it? With dollars created out of thin air? You’ll run into a hyperinfalion worse than Weimar.
So, to begin with, you cannot get the physical gold.
Even if you had it, the 13 trillion dollar US economy grows at a potential 3 to 3.5% per year. New gold dug out from the ground is much less in dollar terms than that. So you’ll end up with a deflation if you run on a gold standard.
End of your gold standard backed by physical gold in a US vault.
What’s next? You could say that the USD is backed by the price of gold at current spot prices. In other words, USD 800 will always buy one troy ounce of gold (how far we’ve come from the USD 35 per ounce). This has the same restrictive problem of growth creating deflation.
But there’s a much bigger problem. And it’s the problem that has caused all the debasement of your currency. And it’s not the Fed.
It’s the irresponsible politicians in your Legislative and Executive Branch. They have been spending far beyond their means. Like all Americans apparently also do (you have a negative savings rate).
Why does the Fed create money? Not to give it to those monopolic bankers and rich people like the J.P. Morgans or Rockefellers you depict in your alarmist videos. It is to give it to your Government who has spent much more than what they have collected in taxes.
Some of you may argue “but we have read of all the liquidity injections the Fed is pumping into the market to save the big Wall Street firms”.
What the Fed does is “repos”. I.e. repurchase agreements. The big banks who have access to Fed funds give the Fed a collateral of, say one billion dollars in debt they have due, and they receive a very short term loan of one billion dollars, for one day or two days. Maximun two weeks, after which they have to return the money back to the Fed PLUS interest and get their collateral back. These injections of cash are not money that stays in the market. It gets repaid. Yes, it’s true that in these troubled times the banks roll over and over the repos. But that’s the money that’s being talked about when they say the Fed has “injected liquidity”. It’s the same money that comes out from the Fed and goes back in again in a couple of days.
But back to the problem when the Fed REALLY creates money out of thin air. Your politicians have created such an awesome number of entitlements, subsidies, pork barrel spending and other types of spending that what the Government receives in revenues, mostly from taxes, is not enough to cover the spending.
So in order to pay for that excess (over budget) spending the Treasury issues Treasury Bonds to be bought by the Federal Reserve, who buys these bonds and issues the money to the Government. They don’t use dollar notes out of the printing presses like shown in your alarmistic videos. They automatically “deposit” the money by electronically increasing the cash & bank balance of the Treasury in exchange for the notes or bonds the Treasury gave to the Fed.
If your Government would spend less than it collects, or at most exactly what it collects, no more money would be created out of thin air.
Solving that problem, the only entities which create money will only be now the banks through the fractional reserve system. The fractional reserve can be manipulated at will by the Fed. Just as it can say that for demand deposits the required reserve is 10%, therefore multiplying the money in the banks’ reserves by 10, it can decide to fix the required reserve in 50%, therefore multiplying the banks’ money by only 2. And even require reserves to be 100% of deposits when no additional money can be created.
This is a bit more complicated in real life. Just to give an example, demand deposits may require 25% of reserve requirements. But time deposits, or CD’s can require less than 25%, maybe only 10-15%, becausethe owner of the time deposit can only request his money after the time of his deposit has expired, whereas the money in a checking account (or demand deposit) can be retrieved right away. Therefore, a “run” on a bank can be triggered by demand deposits but not by time deposits. So the required reserves for demand deposits should be higher.
So by adjusting the fractional reserve requirements the Fed can increase or decrease the money supply depending on external factors such as money demand or price levels or whatever the Fed is mandated to do.
The Fed is really not a problem. The problem is that it is mandated to do two different things, as opposed to most other countries where it has only one mandate, which is price stability.
The US Fed is mandated to achieve price stability AND, to put it more simply, low unemployment. Actually, economic growth at reasonable interest rates with reasonable employment levels. Now, that is too much for a Fed to do, especially since in certain periods (like today) these can become mutually exclusive objectives.
I believe there is nothing wrong with a Fed mandated to maintain price stability only, like the European Central Bank (ECB) and many others, but ridden of it’s power to set interbank overnight interest rates, commonly known as the Fed funds rate. I believe the Fed could control the price level purely manipulating the money supply and leaving the interest rates to the free market economy.
What you really have to get rid of is politicians (except Ron Paul). You are now facing such an enormous future debt that your only chance is to inflate yourself out of it. That is, you’ll have to tax all your people and your descendants with a 15%+ rate of annual inflation. Inflation is a tax. The IRS doesn’t come to collect it, but it takes away your purchasing power anyway.
There is no way your current entitlements for Medicare, Medicaid and Pensions could be funded by taxes. We’ll leave that decision to Ron Paul.
As for the future, you’ll have to curb your politicians from spending. Where I hail from there is a law that mandates Government to maintain a minimum structural 2% surplus of the Government’s annual budget. I don’t know if something like this will work in the US. Especially when a President can decide to invade a foreign country and spend one trillion dollars without, for one moment, worrying where that money is going to come from. (From you, of course, dear taxpayers).
I know Ron Paul wouldn’t do these unconstitutional things. But, then again, you already have a big mess to fix. He should have been elected 30 years ago. Now, if he gets elected (let alone nominated), he will first have to mend a broken country. But I don’t think he will be President. He doesn’t have the necessary political skills. He is not a populist. He won’t promise things that he knows the country can ill afford. He has to do these things. He has to lie to the people. That’s how politicians get elected. And then keep on lying. And I don’t think he would do that. He has to promise healthcare to everybody. And when healthcare money runs out, the politicians of the day willl just order the Fed to print the necessary money.
It’s not the Fed that has to be eliminated. It’s those rotten politicians. But don’t forget: It is YOU who elect them.
Ernst