What Is The Gold Standard? by Sprott Money
What is “the gold standard?” Many readers would consider this a simple question and perhaps even an obsolete one. It is for precisely this reason that a mere definition is inadequate as an answer. A definition conveys no understanding and thus does nothing to eliminate the many misconceptions surrounding this concept.
In order to provide sufficient context so that the definition provides meaning to readers, it is necessary to explore several, tangential subjects. As such, this discussion will contain:
- A brief review of the abolition of our gold standard.
- An examination (and assessment) of the criticisms of the gold standard, past and present.
- An examination of the monetary system that resulted from the abolition of the gold standard.
- An examination of the financial system that resulted from the abolition of the gold standard.
- A chronicling and explanation of the extreme price suppression of the gold market, a situation which has persisted for most of the post-gold standard era.
In its simple definition, a gold standard a monetary system based upon the “hard” backing of our currencies – that is, backing them with gold. It is a “standard” in that the price of gold is fixed, and thus all currencies, and (by implication) all goods are valued in relation to that fixed price.
The “gold standard” in its modern form was a monetary system that existed for roughly a century. While many nations (and empires) have based their monetary systems upon precious metals, this was most often done directly, via the usage of gold and/or silver money.
Real “money” is distinct from currency because, among other reasons, money preserves the wealth of the holder, while currency does not. Thus, we get our first inkling of why any nation would want to use a gold standard as their monetary system: to preserve and protect the wealth of the citizens of that nation, and thus the nation itself.
The End of an Era
On August 15th, 1971, the Nixon administration “closed the gold window,” which effectively put an end to the last vestige of our gold standard. Further elaboration is necessary. In the final decades of our “gold standard,” we no longer had a full gold standard, but rather only “partial convertibility” in our monetary system. What does that mean?
With a true, hard gold standard, where official currency is fully and directly backed by gold, these (paper) currencies can be fully converted into gold at the option of the currency-holder. However, in the Bretton Woods Agreement of 1944, the global monetary system was officially altered.
It became a system of partial convertibility, with the U.S. dollar as “reserve currency,” meaning that only one currency – the U.S. dollar – was still convertible to gold. Thus the only mechanism to convert paper to gold was for nations to exchange their U.S. dollars with the U.S. government in exchange for some of its gold reserves. Therefore, when the U.S. government “closed the gold window” in 1971, it defaulted on its gold obligations to the rest of the world, and the requirement that it convert U.S. dollars to gold at the option of the currency-holder. What caused this system to implode?
Here it is essential for readers to grasp that, in a monetary system of perfect integrity, there would have been zero incentive for other nations to redeem or convert their U.S. dollars into gold; each would be equally valuable. Only one possible factor could have provided nations with an incentive to engage in such conversion: the fear (and knowledge) that the system had lost its integrity.
In order to finance the war in Vietnam, the U.S. government had been printing too many U.S. dollars for several years. This meant it was expanding the supply of money beyond the corresponding size of its gold reserves.
U.S. dollars were officially convertible to gold, but because of this deliberate over-supply they were no longer fully “backed” by gold. The currency was being debauched, so the gold was worth significantly more than the actual value of the U.S. dollar. It was effectively monetary fraud. As the fraud became larger and more apparent, the drain on the U.S.’s gold reserves relentlessly grew.
This left only two options for the U.S. government: re-impose monetary discipline (on itself) and thus restore the integrity of the U.S. dollar, or default on its international obligations. The U.S. government chose the latter.
It is important to note that former Federal Reserve Chairman Paul Volcker has since stepped forward to claim personal credit for abolishing the gold standard. It is here where readers are introduced to the love/hate relationship between central bankers and gold.
This was one of history’s most emphatic (and prophetic) warnings against monetary crime. But what, precisely, does it mean?
Here readers must first forget everything they think they know about the word “inflation.” “Inflation” (verb: to inflate) means to expand, or inflate, the supply of money. This is the correct, economic definition of that term.
What most people think of as “inflation,” the increase in the price of goods, is simply the inevitable consequence of inflating the supply of money. It is very important that readers never forget this crucial distinction. As an academic, Alan Greenspan was fully cognizant of the correct definition of inflation, and was using it in that context.
There is no way to protect the confiscation of savings (theft of wealth) via an increase in the supply of money. Why? As more, new currency is printed, all existing currency is worth less, effectively confiscating some of the wealth of those existing currency-holders. This is nothing more than the concept of dilution.
If you add water to lemonade, you dilute all the lemonade, and each unit of lemonade is worth less. If a company prints more shares, it dilutes its share structure, and each share is worth less, and some of the wealth of existing shareholders has been “confiscated.” More importantly, it is the company that prints these new shares that has confiscated that shareholder wealth. This is why the (corporate) concept of “dilution” is utterly despised by shareholders.
If a government (i.e., central bank) prints new currency, thus diluting the money supply, each existing unit of currency is worth less. The principle is identical. Each time our central banks print more “money” (i.e., our paper), they dilute the value of all existing currency and confiscate some of the wealth of existing currency-holders.
When we go to the supermarket and pay $2 or $3 more for a dozen eggs, it’s still the same dozen eggs. The eggs haven’t changed. It’s the paper currency in our wallets that has lost half of its value due to “inflation” – the inflation of the supply of money, and the dilution (in value) that must accompany it.
Where does this confiscated wealth go? How and why is this confiscation of our wealth (via inflating the supply of money) an act of theft? It’s very simple. When our central banks print new currency, they don’t distribute it evenly amongst the entire population. They hand every single unit of that new currency (virtually for free) to the Big Bank syndicate.
Give me control of