A Brief Note on Gold As a Currency

With the refinements our ideas on money in Understanding Money: Part 5 – It’s All Money, we decided to apply them to a topic we have addressed in the past, that of the return to a gold standard.

There is an audience for the idea that the change from a gold standard to a pure fiat paper currency is a root cause for the current financial crisis. In particular, a paper currency allows for the expansion of the monetary base in an undisciplined fashion. We suggest that a pure fiat currency and a gold-backed currency both represent MZMc or the currency component of money with zero maturity whose composition or nature is irrelevant to the money creation process. To understand our thinking, refer to the series of articles on “Understanding Money” at the end of this essay.

Our current financial crisis is the result of  unregulated money creation. Consider the ratio of total credit market debt to currency in circulation:

By the time the US went off the gold standard in 1971, the rate of increase of leverage in the total money supply (total credit market debt) had been roughly constant (linear) for the 20 years prior that data exists, and continued roughly at that rate until the latest recession caused a sharp drop. In other words, the gold standard had nothing to do with uncontrolled money creation.

In fact we would argue that capital accumulation in financial institutions of all kinds allowed this money supply/credit expansion. Richard Duncan, in his book The Corruption of Capitalism, in chapter 9, details a number of events that over 50 years, the span of the above graph, contributed to this unregulated growth through the development of new unregulated financial markets, new financial instruments, and the removal of credit market regulation put in place after the Great Depression. Highlights include (from Duncan):

  • starting in the late 1960s the Eurodollar market facilitated the unregulated creation of large sums of money;
  • government budget deficits beginning in the late 1960s caused the loss of control over money and credit;
  • the removal of interest rate ceilings on CDs in 1973;
  • the Depository Institutions Deregulation and Monetary Control Act (1980) and the Garn-St. Germain Depository Institutions Act (1982) which resulted in the S&L crisis;
  • the development of securitization products beginning in the 1970s with mortgages;
  • the relaxation of numerous aspects of the Glass-Steagall Act through the 1980s and 1990s ending with a final repeal in 1999;
  • the Commodity Futures Modernization Act (2000) which allowed trading of financial derivatives;
  • the deregulation of derivatives leading to the creation of the massive over-the-counter derivatives market with a nominal value of several hundred trillion dollars.

The massive leverage that peaked at over 60 times the monetary base could have happened equally well if the currency had been gold-backed because it was independent of the base currency. The reason for this is simple. All money creation starts from MZMc. The nature of MZMc is unimportant. The importance is it is currency and has a zero maturity. The ability to expand MZMc has nothing to do with the degree of leverage in the total money supply which is the root of our current financial crisis that peaked at the start of the last recession.

The Series

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