The big fallacy of The Gold Standard

[ KH: The following is a long posting. It is the first history of the gold price that I’m aware of — and I have read well over 100 books on and about gold in the last 20 years. Because I have written this extempore in one session, as I do all my postings, one or two details may be wrong but for anybody who wants a simplified, albeit accurate, bird’s-eye-view of the history of gold as currency, please read on.]

The big fallacy of the gold standard for national currencies is due to the fact that there has never has been one yet — except for a few weeks or months 400 years ago. So when proponents of The Gold Standard talk glowingly of it, or antagonists scorn it, then neither is speaking of what it really is — or could be — as the stable foundation of stable national currencies.

And here what must be interpolated is that the ‘gold’ part of the gold standard need not be exclusively that of the yellow metal. Several other items would also serve as a gold standard. It could be silver, or platinum, a bag of mixed wheat, rice, millet and oats, a certain number of kilowatt-hours, nitrogen, oxygen, average solar radiation received per square metre of the earth’s surface, etc. In short, anything that is both valuable, measurable and stable in quantity from week to week and year to year would do as well — in theory.

In practice, although it has turned out that the best material was gold during the 18th and 19th centuries — and when the term ‘gold standard’ came into ordinary parlance — it was far from being stable in quantity during that period. The amount of gold that was mined leap-frogged during the 1850s (California), then again in the 1870s (South Africa) and again in the 1890s (Australia).

Many more deposits have been found around the world since then but no single source of anywhere near the same size as any of the above three. Because all of the earth’s surface is now being constantly examined by geologists for all sorts of reasons,we can take it that quantity of gold that is now being mined and refined year is modest in comparison from year to year.

The reason why an apparent strict gold standard only applied for a short while is that, after Sir Isaac Newton had fixed the value of one ounce of pure gold in terms of English gold sovereigns — or ‘specie’ — considerable English trade was going on with Europe and the real value of both the sovereign coin and gold (in England) was changing very slightly — but hardly measurably because trade was largely balanced from year to year.

The price Newton settled on in 1717 was 3 sovereigns (gold ‘specie’) 7 shillings (silver coins) and 10 pence (copper coins), or, in present day terms, £3.39. In America, it was $18.93. (Strictly speaking there were no gold dollars in America in 1717 and the $18.93 price applies to the 1800s and onwards. However, during all that time the price of gold in England was still £3.39.

At the time that Newton established the price of gold as £3.39 this only applied to England. Some of the gold had come to England via pirating or as profits from trade, but this was still only a relatively small proportion of the total. Most of the English gold had been mined — or panned — in England, Wales or Scotland. But this local production of gold applied in many other parts of the world also and, as in England, mainly used for personal jewellery or lavish ornamentation in churches or palaces or in rich men’s houses.

Each gold mine would have had an invisble radius of people around it who bought it for their own use. Thus there were many different prices of gold all over the world with hardly any trading of it between them. However, because gold was also useful to merchants as balances when bartered goods didn’t quite match, then hundreds of different gold coins, each with its own standard weight, began to be minted. Gradually some sort of commonly accepted coin exchanges began to be set up, especially in the great Champagne and other Fairs that stretched throughout Europe in the late Middle Ages. But the approximately common price of gold was still not applicable in the whole world over.

A common price only emerged when the industrial revolution burst forth in England from about 1780. The countries which wanted to send gold to us in exchange for our goods had to accept the English price of gold whatever their own local valuations. Some local gold would have been much less valuable than English gold so people in gthose countries would have had to work harder to pay for their imports. Some local gold would have been more valuabe than English gold so they would have had a double bonus when trading with us. They not only received the goods they wsnted at comfortable cost but also their surplus of locally produced gold became inflated and thus expanded their internal money circulation.

Becausd we were the principal aupplier of cotton thread and then a host of other highly desured manufactures during the 19th century then countries all over the world — about 40 of them — gradually adopted our valuation of gold as expressed in their own national coins. By and by, however, by about the later 1800s, the valuation of gold was so common that tbeir own currencies began to have a fixed valuation and slowly began to be accepted for trade instead of gold ingots or bullion.

But this would only happen between counries whose merchants fully trusted the national currencies of other countries. The English, for example, would accept the gold currencies of neighbouring countries we traded the most with. The Bank of England (BoE) would sometimes keep French gold francs and gold German marks in its vaults as well as gold pounds but few others.

However, by about 1900 althoough there was a common valuation of gold throughout the world — mainly the 40 largest trading countries — there was nothing like a world gold price. But the huge quantities of gold mined on California, South Africa and Australia didn’t have the slightest effect on world-wide trade resulting from the industrial revolution.

As gold miners are not noted for wearing personal jewellery, most of the above gold soon passed through their banks and thence into trade with goods from England But the Bank of England still quoted the value of gold as £3.93 per ounce even though its real price was was much higher compared with goods. The same applied to all the other gold currencies around the world. They were all carrying an invisible premium of much higher value in which their currencies were expressed.

This new valuation of gold had to remain invisible until the additional tranches of Californian, South African and Australian gold had finally worked their way into all world-wide trade. By about 1920, increasing pressure was applied to the Bank of England to go back onto the gold standard which had been temporarily set aside at the beginning of World War I in 1914.

Thus by the 1920s to 1930s there was a need for a world Gold Exchange so that even small differences between different national valuations of gold could be remedied. Also by that time, and mainly because of its economic growth during World War 1 — in supplying armaments to Europe — America had become the dominant trading nation in the world.

It was the world-wide price of gold in dollars that was more appropriate from the 1920s onwards. Because England had gone back onto the gold standard in 1925 and off it again in 1931, it was the dollar price of gold that carries the narrative forward from now onwards. In 1933, aware that the supposed price of $18.93 was too low, President Roosevelt wanted to raise the value of the reserves of gold in the vaults of its central bank, the Fed. This now had about 80% of all non-privately owned gold in the world.

Roosevelt raised the price of gold by making the private ownership of gold illegal in America. On pain of imprisonment owners had to sell their gold to the banks which then sold it on to the Fed. When all or most of millions of people’s gold coins had been gathered in, he then raised the price arbitrarily to $34! This appropriation — illegal under any notion of common law — is something that an American president would never get away with these days. The millions who owned gold dollar in the 1930s were not as well informed as those of today.

But the new price of $34 was still not the free market world price of gold even though, in London, there was now a London Gold Exchange which established a supposed fair price every day. But it could never be a true price because the largest central banks, and the American Fed most of all, had far more gold than any private buyers and sellers in the world, and so some of the largest governments could control the price. Which they did from then onwards because they wanted to make sure that the printed currencies they were now issuing would be the only currencies they would accept for taxation or pay out for services.

In the late 1960s, the larger countries of the world — those we know today as the G7 — allowed the price to creep up to $41 an ounce but otherwise no further. Already by then some of the more successful European countries such as Germany, France and England, realising that gold still had enormous reputational value, and wanting more of it for their central banks, began knocking on the Fed’s door asking to change some of their marks, francs and pounds for gold at $41 an ounce. America had to start to sell. By 1972, the Fed’s stock of gold had been reduced from 24,000 tonnes to 11,000 tonnes and president Nixon, decided that America would soon be cleaned out of gold

In 1972 Nixon took the American dollar off the gold standard and thus protected his stock og gold from further buying pressure. The next year the price of gold rose from $41 to $97 an ounce, and by 1974 it was $154. It rose to almost $2,000 an ounce in 2011 but has since declined to $1250 where it appears to be steady for the time being. Many experts think the $750 dip has been was caused by American manipulation because of the desperate need of the Fed to maintain the dollar as the world trading currency. There is evidence for and against manipulation and the jury is still out on this.

However, there is also evidence that China has been buying large quantities of gold ever since 2000 when the euro started life. Suffice n it to say that huge quantities of gold have been drifting from the West to Asia in the last 15 years. However, although China have said for many years that its official stock of gold is only about 1,000 tonnes of gold nobody believes this. China is also the largest producer of newly mined gold. Because it is also the largest refiner of scrap jewellery gold in the world and the Shanghai Gold Exchange is now larger than London’s then some think that China actually has 10,000 tonnes of official gold in its central bank, the People’s Bank of China (PBOC).  This compares with the 8,000 tonnes in the US Fed.

China has said officially that it wants to make its own currency, the yuan — or renminbi — into the main competitor to the dollar as the world’s main trading currency. At present about 20% of world goods are transacted in yuan. Although America will do as much as it can to prevent a yuan takeover, or even an equal share of world trade, it is difficult to know how it could succeed if the yuan is gold-backed — and therefore guaranteed against devaluation by inflation.

Meanwhile we still haven’t a free market gold price. We still haven’t arrived at a true gold standard. It’s a fallacy to say that what went on in late 19th century England was a true gold standard because millions of personal cheques — a recent innovation — were also in circulation This was, in effect, a huge addition of non-currency money — and certainly not covered by the gold reserves of the high street banks and the BoE.

Thus we have never actually had a true gold standard yet even though we say we had. This is something that economists, particularly young ones with no firm view about the gold standard, whether possible or not, whether likely to come or not, should bear in mind when several eminent ex- and current central bankers — as experienced and knowledgeable as anybody — say that a monetary catastrophe as least as bad as 2008 is coming.

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