Why a Gold Standard?

Submitted by Guest Contributor – Dan Popescu

Keeping it Simple

In this article I want to approach the idea of a gold standard from a more “regular people” perspective rather than from a “high academic” economic/finance and, sometimes, legalistic perspective. I constantly read books and articles full of mathematics written by the economic academia, trying to show why a gold standard is a relic of Antiquity, unsuitable for the modern world.

Still, as a physicist, I would like to remind economists that they would not be able to write their papers on a PC, communicate with an iPhone, drive a car or fly on a plane, if it weren’t for two relics of Antiquity essential to scientists and more than 3,000 years old that have barely changed since then: algebra and geometry.

gold-ingots-1-gramGold prepared for small-scale transactions.

When I was a child, my father, an engineer, used to tell me over and over again, “If you can’t explain it in simple words, it’s because it makes no sense or you don’t understand it yourself”, and “keep it simple”.

Recently, while doing research for an article on the gold standard, I stopped and thought about a “new” (not from Antiquity) standard: the metric system. I realized how exceptional and how humble those scientists were when they created it. I just couldn’t believe it.

Here is a system designed to correct a problem faced only by scientists, which is to measure quantities at the angstrom level (10−10) and at the astronomical level (1010) that the old system couldn’t handle. They could have designed a system that only they can understand. Who cares if the common people don’t? Too bad for them… They will have to hire us to do the calculations.

However, look at the system they designed. It allows those highly educated “rocket” scientists to work in fields like particle physics and astrophysics but at the same time is so simple that even an illiterate person can learn it fast. They used the base 10, which is the easiest to learn and use. One doesn’t need a diploma to multiply or divide by 10. For temperature, they chose as limits the freezing point as zero and the boiling point as 100. Again, base 10 and the range humans deal with most of the time. No need to do sophisticated calculations to understand it.

Why do I tell you this? Because every time I talk to an economist (Austrians excepted) about a new monetary standard he comes up with complicated formulas of a triple integral of a basket of 100 commodities, weight adjusted, etc. No, I don’t exaggerate much. I am also often asked after presentations why gold and not oil or water? The Ph.D. proudly remarks to me that they are much more valuable and useful than gold.

far side - four wrongs squaredModern-day economists trying to create money

Cartoon by Gary Larson

I usually tell them that if I brought a 10 year-old illiterate person from the streets of Cairo or Los Angeles, he would have no problem answering this question without hesitation. After thousands of years of trial and error, gold has always been preferred. Gold is almost perfectly suited as money. Even during the last 100 years of fiat paper currency, gold remained in the background and is brought back into the limelight in crisis situations at the speed of light (2008 financial crisis).

Some economists argue that the unit of account is the most insignificant aspect of money. Well I don’t think so. Try to go to a store not knowing how much a kilogram or, for the Americans, a pound is from place to place and from one day to another. But that is what we have now with fiat currency and more recently electronic currency.

No PhD Required

For thousands of years coin clipping was a crime punishable by death. Today under the very academic name of inflation, it is a highly regarded monetary policy instrument for the management of the economy and the international monetary system. Recently it was replaced by the “higher level language” of QE (Quantitative Easing). I am surprised they didn’t call it Quantum Electrodynamic Easing (QEDE).

Sorry, professor Feynman, for degrading your theory (which by the way I understand better than professors Bernanke’s QE). Also, for those of you who didn’t study economics and wasted your time on medicine or engineering, in plain and common English, inflation is coin clipping and, for thousands of years, equivalent to stealing, often punishable by death.

Recently there has been talk of an international monetary standard based on a formula called P-gold, and another based on a basket of fiat currencies called the SDRs (Special Drawing Rights). Jim Grant, publisher of the Grant’s Interest Rate Observer, says about it that, “… Gold is instantly and optically recognizable as money. SDRs, like a bad joke, have to be explained.” I couldn’t have said it better. P-gold (Paper-gold) is linked to Friedman’s k-percent rule. I am not going to explain k because then I would have to explain GDP, and then on and on.

Let me tell you the story of the gold prospector who met St. Peter at the Pearly Gates. When told his occupation, St. Peter said, ‘Oh, I’m really sorry. You seem to meet all the tests for getting into Heaven. But we have a terrible problem. See that pen over there? That’s where we keep the gold prospectors waiting to get into Heaven. And it’s full – we haven’t got room for even one more.’

The gold prospector thought for a minute and said, ‘Would you mind if I just said four words to those folks?’ ‘I can’t see any harm in that,’ said St. Peter. So the old-timer cupped his hands and yelled out, ‘Gold discovered in Hell!’ Immediately, the gold prospectors wrenched the lock off the door of the pen and out they flew, flapping their wings as hard as they could, heading for the lower regions. ‘You know, that’s a pretty good trick,’ St. Peter said. ‘Move in. The place is yours. You’ve got plenty of room.’ The old fellow scratched his head and said, ‘No. If you don’t mind, I think I’ll go along with the rest of them. There may be some truth to that rumor after all.’

This story from Ben Graham that Warren Buffett likes to tell is actually about an oil prospector, but it’s just as fitting with a gold prospector. Why am I telling you this story? Because inflation (coin clipping) has the same effect on humans. There comes a time when even those who created the rumor (inflation) end up believing in it and its beneficial effects.

I have found myself very often in the company of wealth managers, investment advisors or economists who would mistake price rises due to changes in supply and demand with inflation, which is a devaluation of the medium of exchange (dollar, euro, etc.). Moreover, devaluation of the medium of exchange lets the State create confusion, to the point that people no longer know how to protect themselves, even those supposed to have created and studied it. After having created inflation, they themselves end up believing in it and its nominal imaginary benefits, just like the gold prospector believes his own rumor.

Recently, at the famous annual gathering of the world’s central bankers in Jackson Hole, USA, according to the Wall Street Journal, even “Central bankers aren’t sure they understand how inflation works anymore”. As if they ever did.

Charles-de-Gaulle (1)Former French president de Gaulle, a life-long supporter of gold’s monetary role

Photo credit: picture-alliance / United Archiv

Gold, while being so simple to understand, has the best physical characteristics for the role of money as it has been recognized for thousands of years by millions of people from every culture, level of education and on every continent. No Ph.D. in economics or physics necessary. The president of France, General Charles de Gaulle, said it best:

“The time has come to establish the international monetary system on an unquestionable basis that does not bear the stamp of any country in particular. On what basis? Truly, it is hard to imagine that it could be any other standard than gold. Yes, gold whose nature does not alter, which may be formed equally into ingots, bars or coins; which has no nationality and which has, eternally and universally, been regarded as the inalterable currency par excellence.”

Charles de Gaulle in the mid-1960s, predicting the dollar crisis of the 1970s.

Not Perfect, but Close to Perfection

Robert Mundell, Nobel Prize of economics, said, “Gold has fulfilled the role of a de facto universal money, a standard of value, the link between the past and the future and the cement linking remote parts of the human race to one another.” Alan Greenspan, former chairman of the Fed, said, “Gold still represents the ultimate form of payment in the world. Fiat money, in extremis, is accepted by nobody. Gold is always accepted.

Gold is not perfect money but it is, in my mind, the closest to perfection and simplicity you can get to. Many examples are given of the stability (even if not perfect) of gold as a standard of medium of exchange, but I will just mention one I like, because I have a simple brain, and that is the example of bread priced in gold 2,500 years ago and today.

562-bc-oz-goldBread priced in gold – unchanged for 2500 years.

In conclusion, I would like to show you the evolution of the gold price in nominal British pound terms since 1260 and in the next chart the gold price since 1560, wholesale prices and the purchasing power of the gold price index, beautifully prepared by Nick Laird of Sharelynx.com, based on Roy Jastram’s book The Golden Constant. What do you think happened in 1900?

long-terme-uk-gold-prizeUK gold prices since the 13th century – click to enlarge.

UK-indexes-price-gold-commodities-purchasing-powerThe price of gold, wholesale prices and the purchasing power of gold – click to enlarge.

Are we possibly in yo-yo economic times? Doesn’t inflation give you dizziness? It certainly makes me dizzy. I would undoubtedly feel better after some acrobatic flying than I feel after QE to infinity.

So, why do I like a gold standard? Because it’s simple, logical and it works. That’s why.

200-years-dow-gold-ratioThe Dow-Gold ratio during two different monetary eras. Note the immense volatility associated with the fiat money era – click to enlarge.

Charts by sharelynx, Dan Popescu