All Commentary
Sunday, June 1, 1975

Gold Standards

Charles Curley is the author of The Coming Profit in Gold (Bantam), and is a founding member of the National Committee to Legalize Gold.

Many free market advocates are familiar with the gold standard, and why a gold standard is preferable to a fiat standard. But there are several different kinds of gold standards, each with its own characteristics and its own implications for the economy.

The earliest and simplest form of gold standard is trading for gold in the form of gold dust or gold bullion. There are no banks or money substitutes whatever, and the total money stock is simply the total amount of gold in the trading area. This form of gold standard requires no government intervention in the economy at all, and requires of the government only the prosecution of fraud, which is easy to prove since contracts (written or verbal) are defined in terms of a specified amount of gold in a specified form.

Gold for this purpose is constantly being provided by gold mines or foreign trade and refined into recognizable forms by known refiners. If the purchasing “power”* of money (gold) increases, then it will become profitable to mine or import more gold (by exporting more products). This will bring about an expansion of the gold stock, which, other things being equal, will reduce the purchasing “power” of money until the profitability of mining or importing gold is comparable to the profitability of other activity, and the marginal mines and importers will cease production. I put the term “power” in quotes to avoid confusion with political power, which purchasing “power” is not.

This is one example of how, with no government intervention, a commodity standard money tends to keep a constant purchasing “power” by a simple market mechanism, based on the profit motive of the people involved. Notice that neither gold miners nor anyone else are concerned with such things as the stock of money or other esoteric economic concepts, yet it is they who act to stabilize the purchasing “power” of money when it becomes necessary.

Primitive and Inconvenient

This gold standard is rather primitive, as it requires the inconvenience of weighing out amounts of gold for each purchase, and the fact that one must carry one’s gold around with him, an obvious temptation to muggers.

The solution to the first problem is to manufacture slugs of gold in uniform amounts with a uniform purity so that one can tell at a glance how much gold is in the slug. Since the gold content is known, the manufacturer can alloy the gold with other metals to harden the coin, thus reducing wear. The manufacturer’s name and the weight of fine gold are stamped on the coin. A modern example is the Krugerrand, which is minted by the South African Chamber of Mines (all the government does is provide the dies). It carries the legend, “FYNGOUD 1 OZ. FINE GOLD” (in Afrikaans and English).

Because the gold is what is valued, and not the alloy or fancy designs on the two faces, the unit of weight of fine gold becomes identified with the coin. For example, the dollar was at one time defined as 1/ 20th of an ounce of gold simply because the United States coin of one ounce was labeled “20 Dollars.”

Of course, there is always a possibility of fraud on the part of the minter, and the objection is usually raised at this point: “Why, we can’t trust people to mint coins! That function has to be turned over to the government!”

We can trust private manufacturers to mint coins according to the market’s specifications just as we can trust private firms to manufacture nuts and bolts to specification, or carry the mail. Advocates of the free market maintain that private enterprise can provide every other product or service better than the government can. Why not coins?

But the introduction of coins still leaves two problems: storage and convenience. The convenience problem is two-sided. In the case of large purchases, one must transport a lot of gold around to make the payment. One runs into the problems of transportation and security. Small purchases, say a piece of bubble gum, would require the availability of a coin small enough to pay for it or make change if a large coin is presented. This problem would be solved by the market by the use of a bimetallic system, as where gold and silver circulate side by side.


Bimetallism here simply means that the market accepts either gold or silver as money. This is a decision that must be left to the market. It is like having two currencies. The idea of having two (or more) currencies is far more disturbing to Americans than to Europeans, who might have to deal in sterling one minute, Swiss francs the next, and then dollars. It simply requires that people express their prices in terms of both gold and silver, just as many European shops express their prices in both dollars and the local currency. The bimetallic system simply means that the monetary metal with the lower purchasing power per unit of mass would be used to make the smaller purchases, such as bubble gum.

Another innovation solves several problems. The introduction of warehouses for money solves, of course, the problem of safely storing one’s money. The warehouse would store your gold for a fee and give you a receipt for the gold. It is still your gold, and the fact that it is in someone else’s storehouse does not mean that title to the gold passes to him or that he has any other claim to the gold (except possibly to ensure payment of the storage fees). Because it is your gold, the warehouse has no more right to use it for any purpose than an employee in a furniture warehouse has to sit on your chair. Also, the warehouse must deliver your gold upon demand, just as the furniture warehouse must deliver your chair when you want it.

The receipts are usually in the form of bearer receipts, which means that the warehouse will deliver the gold to whoever presents the receipt for redemption. This carries with it the obvious implication: don’t lose your receipts! But it also carries the implication that, instead of trading the physical gold, clients of warehouses can trade the receipts back and forth. But, still, as with the coins, the value is attributed to the gold, not the piece of paper.

A Modern Example

A modern example of the gold warehouse is the gold certificate offered by the Bank of Nova Scotia. Although the certificates are issued in ten-ounce lots with a minimum purchase of twenty ounces, the principle of the gold warehouse is maintained, as the Bank of Nova Scotia keeps on hand all the gold which its certificates represent. The storage fee is defined as 3t per hundred ounces per day, or $10.95 per year for up to one hundred ounces.

An alternative to issuing one or several receipts which would circulate in place of gold is to have the warehouse give the depositor a book of checks which he could use to make payments of exact amounts of gold, limited only by the availability of coins or bullion to make the exact amount of the check. (If the smallest amount of gold available is 5 grams, it does no good to write out a check for 9 grams, because no one makes small enough gold bars to pay the check.) This makes it easier to make purchases in that the buyer need only fill out the check for the exact amount of the purchase. However, the purchaser must not only establish the trustworthiness of his warehouse, but also whether he has enough gold in his account to cover the check.

Full Reserves

What I have described here is called 100 per cent reserve banking, which means that for every ounce worth of receipts outstanding, the warehouse has an ounce of gold in the vaults. The receipts are substitutions for rather than additions to the gold in the vault, and the money stock stays the same as gold flows into or out of the warehouse. The 100 per cent reserve banking system also differs from other bank systems in that the gold is considered to belong to the holder of the receipt, not to the bank or warehouse.

Because the warehouse operator is in the business of handling money, it is only natural that he should make a market for the use of it. When a warehouse operator matches up savers and borrowers so that the savers can earn interest on their savings, he becomes a banker. He facilitates this money market by accepting deposits of gold over a specified time and lending the money out over the same or a lesser period of time. He charges the borrower a higher rate of interest than he pays the depositor, the difference being the banker’s profits. A modern example of this is the certificate of deposit, where the bank can pay you a higher interest rate than on a regular checking or savings account because it knows that you are going to leave the money on deposit for a specified period of time.

However, soon enough a banker will notice that most of the gold on deposit in his bank, even though in demand deposits, will be left in the bank for years, as the receipts are traded back and forth. If no one is going to redeem this gold, he reasons, why shouldn’t I lend it out to someone else? Of course, the fact that he is lending out money that doesn’t belong to him, that was entrusted to him, doesn’t bother him; no one will find out, will they?

Even easier is to continue to hold the gold in his vault and instead lend out receipts for gold that doesn’t exist. No one will find out; our banker won’t lend out so much money that receipts brought for redemption will remove the entire gold stock from his vault. Of course, the fact that he is lending out gold that doesn’t even exist doesn’t bother him in the least, even if it is fraud.

Fractional Reserve

When the banker lends out the gold in his vaults, or lends out false receipts, he obviously no longer has enough gold in his bank to pay off the obligations of the bank. He has gone from 100 per cent reserves to fractional reserve banking. He also has created more circulating medium (money) than there was previously, but without the limiting device of the costs of mining or importing gold. It costs less than an ounce of gold to mine an ounce of gold, but, as more gold is mined than lost through wear, and as the purchasing “power” of money goes down, eventually the marginal mines find that it costs more than one ounce to mine one ounce of gold, and so they cease production. With pseudo-receipts, the limiting cost of production is the cost of printing!

Thus, when a bank goes off 100 per cent reserves, its action results in more circulating media, which tends to lower the purchasing “power” of money. In other words, while 100 per cent reserve banking cannot be inflationary, fractional reserve banking must be.

Governments benefit from inflation. A very simple example is where politicians promise to “stimulate the economy” and proceed to inflate the currency in order to do so. Sometimes they are under the mercantilist mistake that more currency is the same thing as more wealth, so they encourage banks to create more currency. Obviously, in order to create more currency, the banker has to resort to fractional reserve banking. Usually, when the government is in on the deal, it will help out by giving banks a special status. The government simply removes the title to the gold from the holder of the receipt and gives the title to the bank. Notice that fractional reserve banking in all its variations requires this invasion of property rights, this intervention in the market.

At this point, the biggest thing that the bank has to fear is the possibility of a bank run, where all the depositors line up to retrieve their gold (that isn’t all there). In order to avoid the temptation to create so much paper money that a bank run is precipitated, the government steps in, not to enforce the fraud laws, but to set reserve requirements, which specify what per cent of outstanding notes the bank must have in gold in its vaults. For example, if the government sets a reserve requirement of 25 per cent and a bank has $250,000 in outstanding currency, then the bank must have at least $62,500 in gold in its vaults.

The lower the reserve requirement, the more money the bank can create and lend out. If the government raises the reserve requirement, then banks may have to call in outstanding loans in order to meet the new requirements.

Debtors Gain

A government in debt (like any debtor) has much to gain from inflation. A rate of price increases of 10 per cent means that the government gains 10 per cent while the lender loses by that amount. As the federal government is the largest single debtor in the U.S., it obviously has much to gain by inflation: both in reduced value of the debt, and in having available newly created dollars which it can borrow without the politically objectionable side effect of higher interest rates.

One way to decrease the reserve requirements without running the risk of a bank run is to make it more difficult for people to redeem bank notes in gold. By raising the minimum lot for which one could trade his paper, banks make it harder for note holders to get gold. Thus, Britain, after World War I and a great decrease in reserve requirements — changed the minimum amount of gold from a sovereign (a fraction of one ounce) to 400 ounces.

This restrictive gold standard is called a gold bullion standard, and stands in opposition to the original U.S. gold standard, where one could get gold for as little as $5, which was called a gold coin standard. The gold bullion standard allowed the Bank of England to continue with its wartime reserve requirements of 18 per cent instead of returning to the pre-war level of 52 per cent. This, in turn, meant that the British banking system did not have to deflate in order to return to the level of credit imposed by a 52 per cent reserve requirement.

Restricted Redemption

Another way to limit gold outflow is to limit the people to whom the bank will give up the gold. The U.S. did this quite abruptly in 1933 by prohibiting Americans from owning gold, and hence, from turning in their paper for gold. This meant that only foreigners could trade their dollars for gold.

Although still nominally tied to gold, at this point the dollar was really a fiat currency; at any time the link between the dollar and gold could be severed, as we saw in August of 1971. In the late 1960′s, it became apparent that Europeans were willing to buy all the gold that the U.S. would offer on the London gold market. Rather than deflate, the U.S. authorities ceased selling gold on the free market, and established the two-tier market in 1968. The free market price of the dollar soon moved down to 1/ 42nd of an ounce of gold, while central banks continued to trade gold at the old price of 1/ 35th of an ounce. Then, in 1971, even the central banks were banned from trading their dollars for gold. The U.S. had, for the first time since the 18th century, a completely fiat currency, in both the economic and legal sense.

It was during this period that the concept of a “price of gold” first came into use. When a currency is divorced from gold so that its purchasing “power” becomes different than that of the amount of gold which the currency originally was defined to be, then it can be said to be a fiat currency. It still may have ties to gold, such as the rather tenuous link between the dollar, the SDR, and gold from 1971 to 1973; but these are mere legalisms. As the fiat currency loses purchasing “power” relative to gold, then an ounce of gold will buy more and more units of the currency. This readjustment can be done occasionally and abruptly, via the mechanism of devaluations, or over a period of time via daily quotes on an organized private market such as the London Gold Market or the Commodity Exchange in New York. Thus, the monetary unit was divorced from gold in the eyes of the market as well as the government, and the dollar, for example, became defined as… well, a dollar, instead of 1/ 20th of an ounce of gold. Once this mental division is made, it is possible to talk of a “price of gold” just as one can talk of a “price of Swiss francs” or a “price of roast beef”: each is a separate commodity from the unit of account — the (fiat) dollar.

Central Banking

During this century, the United States also moved away from free banking by modifying the reserves that banks could use for their deposits. Before the establishment of the Federal Reserve (in 1913), banks used gold, either bullion or coins, as reserves. However, with the establishment of the Fed, banks were allowed to deposit dollars with the Fed and count these deposits as reserves (still fractional).

The Fed learned rapidly how it could manipulate these reserves. Not only could it modify reserve requirements, but it could change the level of reserves in the banking system. The mechanism is very simple: the Fed buys an asset, any asset. To pay for it, the Fed writes out a check to the seller. The seller deposits the check in his bank, and the bank credits his account with the proper amount. Then, the bank presents the check to the Fed for collection. Instead of simply paying the bank so many dollars, the Fed credits the bank’s reserve account with the Fed with the amount of the check. The bank’s reserves are now expanded by the amount of the check, and the bank can now create and lend out additional dollars.

Any Debt Will Do

It is important to note in passing that the Fed can expand reserves by buying any asset. The most popular assets with the Fed are Treasury debts; and why not: they are buying the obligations of their parent organization, the U.S. government. But simply balancing the Federal budget will not deprive the Fed of assets to buy; simply balancing the budget will not stop inflation. After all, if the Fed couldn’t get Treasurys, it could always buy New York City ‘s! This system of expanding reserves means that the banking system can expand its reserves without regard to gold. Now, the Fed can inflate the money supply whenever anyone wants to go into debt, a not uncommon event! Even if the U.S. were to sell off all the gold in the Treasury stock, the Fed could continue to inflate, simply because someone would be willing to go into debt to buy that gold, or something else.

We have traced an evolution away from free banking toward the completely state-managed money system. Each step in between has been given a label, such as “gold exchange standard” or “gold bullion standard,” each calculated to imply that the new setup was some form of gold standard. Even the Bretton Woods system was called a “gold-dollar standard” (not that the central banks even traded gold among themselves unless they had to — Gresham ‘s Law applies to central bankers too).

Market Money or Political Money

The essence of the gold standard is that the gold in a bank’s vaults regulates the credit that it can extend, and that the stock of money is regulated by the free market (specifically, the profitability or lack of profitability of gold mining), and not by the decisions of the bankers, especially the central bankers! Each step that was taken away from a 100 per cent reserve gold standard also made it both more necessary and easier to take the next step toward regulation. Each step also reinforced the idea that every time the banking system got into trouble, the government could bail it out, and do so by changing the banking system. Thus, later standards were gold standards only by virtue of a formal, legal link to gold. There was no commitment to gold, so whenever the banking system got itself into trouble, it was bailed out by the government — by another step away from gold.

Each step was supposed to make the banking system “more flexible,” to make it easier to “meet the legitimate needs of business.” But, as we have seen, each step has really had the effect of making it easier for the banking system to inflate. If we turn this around, we can see that each step was a step away from sound money, market-controlled, toward money controlled by a government with a vested interest in inflation.

It is in the interest of the free market advocate to understand the different varieties of gold standards and mixed gold-fiat standards that have existed. This is the only way in which one can answer the many myths that surround money and banking. For example, careful study shows that it was not capitalism that failed in the 1930′s, but central banking that failed in the 1920′s.