A note on the viability of an 'indirectly convertible' gold standard.

• Author: Sumner, Scott

1. Introduction

   A recent set of papers by Dowd [1; 3], and Schnadt and Whittaker [5] examined the feasibility of an indirectly convertible gold standard. Schnadt and Whittaker (S-W) argued that Dowd was mistaken in asserting that a gold standard could be operational without direct convertibility. Dowd [3] responded that the problems discussed by S-W could be avoided by linking indirect convertibility to a futures targeting approach. This paper will demonstrate that the S-W critique is inappropriate to the system proposed by Dowd. The critique by S-W is not relevant to a system based on a commodity traded in centralized, auction-style markets. And in his rejoinder Dowd conceded too much by arguing that futures targeting could overcome the objections raised by S-W.

   The paradox of indirect convertibility is briefly explained in section II. In section III I use both theoretical arguments and historical evidence to demonstrate that the objections raised by S-W are not applicable to a gold standard. Section IV includes a discussion of what type of media of account are not suitable for a monetary system featuring indirect convertibility.

2. The Paradox of Indirect Convertibility

   Dowd [3] discusses the paradox of indirect convertibility by using an example where $1 notes are convertible into an amount of silver sufficient to purchase a specified quantity of gold. In his example, if the price of the defined unit of gold rose to $1.20, then banks would pay out 20% more silver than previously for each currency note. This would immediately reduce the market price of silver by a proportionate amount, however, unless the price of gold immediately fell to $1, the bank would be required to again increase the amount of silver paid out to redeemers of each currency note. This would result in a collapse in both the currency stock and the price of silver.

   Dowd then argues that for this paradox to occur, the price of gold would have to be "relatively slow" in returning to par. While Dowd takes no position on the issue of whether gold prices are sticky, S-W state that adjustments in the price of gold "presumably take time to occur." Yet S-W offer no theoretical model or empirical evidence to justify this assertion. The next section will provide evidence that gold prices are not so inflexible as to render ineffective a system of indirect convertibility into gold.

3. Gold Markets: Past and Present

   Gold is currently traded in highly efficient commodity exchanges in a number of major financial centers. The price of gold in these exchanges often fluctuates by relatively large amounts over extremely short periods of time. Nor is this volatility a recent phenomenon. During 1933, monetary policy...