Making the transition to a new gold standard.

• Author: White, Lawrence H.
• Position: Essay

Suppose for the sake of argument that we all agree to the following proposition: If we could change the monetary regime with zero switching cost, merely by snapping our fingers, we would prefer the United States to be on a gold standard. In the most general terms, a gold standard means a monetary system in which a standard mass (so many grams or ounces) of pure gold defines the unit of account, and standardized pieces of gold serve as the ultimate media of redemption. Currency notes, checks, and electronic funds transfers are all denominated in gold and are redeemable claims to gold. (1) We then face the question: What would be the least costly way for the United States to make the transition to a new gold standard? We need to choose a low-cost method to ensure that the agreed benefits of being on the gold standard exceed the costs of switching over.

Two transitional paths suggest themselves (1) let a parallel gold standard grow up alongside the current fiat dollar, and (2) set a date after which the U.S. dollar is to be meaningfully defined as so many grams of pure gold. This second, more conventional path, was followed after the suspension of the gold standard during the U.S. Civil War. It is more commonly described as establishing an effective parity stipulating so many dollars per fine troy ounce of gold. In our present situation, where Federal Reserve liabilities (book entries and currency notes) and Treasury coins constitute the basic dollar media of redemption for bonds and commercial bank liabilities, that implies converting the Federal Reserve System's liabilities and the Treasury's coins into gold-redeemable claims at so many grams of gold per dollar (or equivalently so many dollars per ounce of gold).

We see analogs to these two transitional paths when we observe how two countries have made the transition to using the U.S. dollar. In Ecuador in 1998-2000, a parallel unofficial U.S. dollar system emerged as the annual inflation rate in the local currency rose from low to high double digits, then to triple digits. The private sector of the economy was already heavily dollarized when the plug was finally pulled on the heavily depreciated local currency unit in 2000. In El Salvador in 2001, the government chose to permanently lock in the dollar value of the currency--by switching from a dollar-pegged exchange rate to outright adoption of the U.S. dollar--while inflation was low and the local currency still dominant. In a nutshell, when the official switch to the harder currency came in Ecuador, it was an act of necessity in the midst of a hyperinflation crisis. In El Salvador it was an act of foresight, to rule out such a crisis.

Allowing a Parallel Gold Standard

Clearing away the legal barriers to a parallel gold standard is fairly simple and can be done without immediately altering existing financial institutions. Rep. Ron Paul's HR1098, the Free Competition in Currency Act of 2011, represents one straightforward approach. It would (1) ensure the enforceability of contracts denominated in units other than fiat dollars by removing legal tender status from Federal Reserve notes and Treasury coins, (2) remove taxes on gold and silver coins that Federal Reserve notes do not face, and (3) remove sections of the U.S. Code that have been used to criminalize the victimless activity of privately minting distinctive pieces of metal intended to circulate as money (White 2011). If these steps seem unprecedented, note that Federal Reserve notes did not become legal tender until 1933. Bank of England notes are not legal tender today in Scotland or Northern Ireland, where private banknotes (also not legal tender) predominate. Note also that in Switzerland "the purchase and sale of Gold is not subject to taxes (such as value-added tax or capital gains tax) under current Swiss law" (Ledoit and Lotz 2011: 2).

Further legal and regulatory changes are necessary to allow citizens who adopt the parallel gold standard to have access to gold-denominated banking services. Banking services, including the issue of gold-redeemable paper currency notes and token coins, are of special importance for the success of a gold standard given the awkwardness of making small--or very large--transactions in physical gold coins. Either existing bank holding companies would have to be free to operate separate gold-denominated subsidiaries, or new gold-based institutions would have to be free to open.

The case for a level playing field between the fiat dollar and other monetary standards rests on the simple proposition that the well-being of consumers is better served by competition than by monopoly. Keeping alternatives to fiat dollar at a legal disadvantage, like silver- and gold-backed bank-issued monies, or foreign currencies, limits the options of American consumers to their disadvantage. The option to use an alternative to the fiat dollar is naturally most valuable in an environment of high dollar inflation. Consumers who don't like the ongoing shrinkage of the value of the currency in their pocketbooks and wallets are then not limited to complaining, or trying to lobby the Fed or Congress for better policy, but can "vote with their pocketbooks" to protect their assets by moving into less inflationary alternative currencies.

We should not expect a spontaneous mass switchover to gold, or to Swiss francs, as long as...