What might have been

There was a chance in 1971 that the world’s monetary system could have been regularized and that the 2008 Crash would never have happened. Instead, America continued to print dollars and spend them like a man with no arms. It also meant that inflation was institutionalized as never before. Massve debts accumulated and completely outweighed the loan side of the world’s balance sheet. That’s where we are now.

After the Bretton Woods Agreement in 1942, the American dollar was placed in a privileged position so that gold — most of it already in America’s possession — could only be bought by dollars. By the late 1960s, however, some European countries had recovered sufficiently from the Second World War to have earned some dollars from trade and were queuing up at the New York Federal Bank’s gold window.

Within a few years, America’s gold reserves hurtled down from 21,000 tonnes to 11.000 tonnes and would have disappeared completely within another year or two had not President Nixon decided to take the American dollar off the gold standard completely. This meant that the American dollar could keep on inflating and America could continue to do what it was doing militarily over the world.

If, on the other hand, he had kept the dollar on the gold standard but allowed gold to find it own free market price without manipulating it, then the world’s balance sheet would be somewhere around zero, as it ought to be. Debts are paid promptly and bankruptcies, even of banks, are encouraged, in eras of no inflation. Certainly the 2008 Crash would never have happened.

Yuans or dollars in future years? A no-brainer

Despite the sneers of most orthodox economists about the gold standard, it is still the case that all the central banks of the world — when they can afford it — are buying gold for their vaults. It is still a currency as far as they’re concerned.

China’s largest bank, ICBC, has just bought Barclays gold vaults in London. Barclays is fast giving up its bad old ways — including gold price manipulation — that brought it to disaster in 2008. The former, it would seem, is now setting up an extension to its Shanghai Gold Exchange whereby anybody with yuans (renminbis) can be paid in gold instead if desired.

Since its inception as an international trading currency about ten years ago, the Chinese yuan now mediates about 17% of world trade and is growing steadily. This compares with about 75% of world trade using American dollars — and steadily declining. Within about 20 years it will be 50:50 and then multinationals will be able to choose to trade in yuans or dollars.

When one currency will be able to be backed up with gold and thus be automatically self-balancing, and the value of the other subject to the whim of the American government, it’s a no-brainer to ask which will then become the preferable currency.

Non-currency money

A reader has written to me today asking me to explain what I meant by personal cheques being “non-currency money” in my gold standard posting of yesterday. When bank-printed personal chequebooks first began to be used in the 1870s each cheque could, instead of being paid into someone’s bank account, be used again. All that a recipient had to do was to countersign the cheque on the back and use it again when paying someone else. Thus, although the cheque wasn’t currency it was, if counter-signed, acting as additional money in the system.

From the amount of space available on the back of a cheque it could be used at least twenty times. Thus a personal cheque for £10 could be successively used. taking the place of £200 of banknotes that would otherwise have been needed.  However, a little reflection will inform you that the personal cheque system could have been used for a ‘black economy’.  In due course, large numbers of transactions could be carried out between thousands of people without the knowledge of the bank or — much more importantly — the government’s tax system. This is why, about 50 years ago, countersigning was stopped and personal cheques became one-stop conveniences.

Thus, from the 1870s, although a gold standard was supposed to be in existence, personal cheques meant that considerable inflation was actually going on. It didn’t so much reveal itself as higher prices of goods in the shops — as it would today — but as much higher wages in the factories and fully absorbed in spending.  For the first time in a hundred years, workers were able to start spending  on the increasing variety of consumer goods appearing the shops as well as being able to enjoy themselves on holidays or paying to to watch soccer matches

During the First Great Depression (1873 to 1896), when much new industrial investment was failing due to lack of sound money, there was hardly any subsequent unemployment and the working classes in the textile, coalmining, shipbuilding and railway industries hardly noticed

If, however, someone with banknotes wanted to cash them at the bank for gold coins, the banks could usually do so quite comfortably because a good bank during that period would have least 20% of gold reserves. In Germany and America at that time — our main competitors — there were many times more banknotes than coins, far more than there were gold reserves in their banks. The so-called ‘gold standard’ was never strictly so, only partially effective.

Thus although we’ve had a currency standard ever since 1717 when Sir Isaac Newton fixed it, and a gold standard legally defined in the 1844 Banking Act, it has never come about that every single English banknote was fully covered by 1/3.83rd of an ounce of gold either in a high street bank or at the Bank of England. The Gold Standard was never fully brought into existence, only an approximation to it.

If the Chinese ever bring about a free digital yuan for use as a world trading currency, then they will certainly make sure that every single one will be covered permanently by a definite fraction of a gold yuan coin or of an ingot in the vault of its central bank. This is what the Americans were not able to do in 1972, thus allowing the dollar to inflate out of all sense and causing massive lop-sidedness between surplus countries and deficit countries. This is now producing an impasse which seems insoluble.

The big fallacy of The Gold Standard

[ KH: The following is a long posting. It is the first history of the gold price that I’m aware of — and I have read well over 100 books on and about gold in the last 20 years. Because I have written this extempore in one session, as I do all my postings, one or two details may be wrong but for anybody who wants a simplified, albeit accurate, bird’s-eye-view of the history of gold as currency, please read on.]

The big fallacy of the gold standard for national currencies is due to the fact that there has never has been one yet — except for a few weeks or months 400 years ago. So when proponents of The Gold Standard talk glowingly of it, or antagonists scorn it, then neither is speaking of what it really is — or could be — as the stable foundation of stable national currencies.

And here what must be interpolated is that the ‘gold’ part of the gold standard need not be exclusively that of the yellow metal. Several other items would also serve as a gold standard. It could be silver, or platinum, a bag of mixed wheat, rice, millet and oats, a certain number of kilowatt-hours, nitrogen, oxygen, average solar radiation received per square metre of the earth’s surface, etc. In short, anything that is both valuable, measurable and stable in quantity from week to week and year to year would do as well — in theory.

In practice, although it has turned out that the best material was gold during the 18th and 19th centuries — and when the term ‘gold standard’ came into ordinary parlance — it was far from being stable in quantity during that period. The amount of gold that was mined leap-frogged during the 1850s (California), then again in the 1870s (South Africa) and again in the 1890s (Australia).

Many more deposits have been found around the world since then but no single source of anywhere near the same size as any of the above three. Because all of the earth’s surface is now being constantly examined by geologists for all sorts of reasons,we can take it that quantity of gold that is now being mined and refined year is modest in comparison from year to year.

The reason why an apparent strict gold standard only applied for a short while is that, after Sir Isaac Newton had fixed the value of one ounce of pure gold in terms of English gold sovereigns — or ‘specie’ — considerable English trade was going on with Europe and the real value of both the sovereign coin and gold (in England) was changing very slightly — but hardly measurably because trade was largely balanced from year to year.

The price Newton settled on in 1717 was 3 sovereigns (gold ‘specie’) 7 shillings (silver coins) and 10 pence (copper coins), or, in present day terms, £3.39. In America, it was $18.93. (Strictly speaking there were no gold dollars in America in 1717 and the $18.93 price applies to the 1800s and onwards. However, during all that time the price of gold in England was still £3.39.

At the time that Newton established the price of gold as £3.39 this only applied to England. Some of the gold had come to England via pirating or as profits from trade, but this was still only a relatively small proportion of the total. Most of the English gold had been mined — or panned — in England, Wales or Scotland. But this local production of gold applied in many other parts of the world also and, as in England, mainly used for personal jewellery or lavish ornamentation in churches or palaces or in rich men’s houses.

Each gold mine would have had an invisble radius of people around it who bought it for their own use. Thus there were many different prices of gold all over the world with hardly any trading of it between them. However, because gold was also useful to merchants as balances when bartered goods didn’t quite match, then hundreds of different gold coins, each with its own standard weight, began to be minted. Gradually some sort of commonly accepted coin exchanges began to be set up, especially in the great Champagne and other Fairs that stretched throughout Europe in the late Middle Ages. But the approximately common price of gold was still not applicable in the whole world over.

A common price only emerged when the industrial revolution burst forth in England from about 1780. The countries which wanted to send gold to us in exchange for our goods had to accept the English price of gold whatever their own local valuations. Some local gold would have been much less valuable than English gold so people in gthose countries would have had to work harder to pay for their imports. Some local gold would have been more valuabe than English gold so they would have had a double bonus when trading with us. They not only received the goods they wsnted at comfortable cost but also their surplus of locally produced gold became inflated and thus expanded their internal money circulation.

Becausd we were the principal aupplier of cotton thread and then a host of other highly desured manufactures during the 19th century then countries all over the world — about 40 of them — gradually adopted our valuation of gold as expressed in their own national coins. By and by, however, by about the later 1800s, the valuation of gold was so common that tbeir own currencies began to have a fixed valuation and slowly began to be accepted for trade instead of gold ingots or bullion.

But this would only happen between counries whose merchants fully trusted the national currencies of other countries. The English, for example, would accept the gold currencies of neighbouring countries we traded the most with. The Bank of England (BoE) would sometimes keep French gold francs and gold German marks in its vaults as well as gold pounds but few others.

However, by about 1900 althoough there was a common valuation of gold throughout the world — mainly the 40 largest trading countries — there was nothing like a world gold price. But the huge quantities of gold mined on California, South Africa and Australia didn’t have the slightest effect on world-wide trade resulting from the industrial revolution.

As gold miners are not noted for wearing personal jewellery, most of the above gold soon passed through their banks and thence into trade with goods from England But the Bank of England still quoted the value of gold as £3.93 per ounce even though its real price was was much higher compared with goods. The same applied to all the other gold currencies around the world. They were all carrying an invisible premium of much higher value in which their currencies were expressed.

This new valuation of gold had to remain invisible until the additional tranches of Californian, South African and Australian gold had finally worked their way into all world-wide trade. By about 1920, increasing pressure was applied to the Bank of England to go back onto the gold standard which had been temporarily set aside at the beginning of World War I in 1914.

Thus by the 1920s to 1930s there was a need for a world Gold Exchange so that even small differences between different national valuations of gold could be remedied. Also by that time, and mainly because of its economic growth during World War 1 — in supplying armaments to Europe — America had become the dominant trading nation in the world.

It was the world-wide price of gold in dollars that was more appropriate from the 1920s onwards. Because England had gone back onto the gold standard in 1925 and off it again in 1931, it was the dollar price of gold that carries the narrative forward from now onwards. In 1933, aware that the supposed price of $18.93 was too low, President Roosevelt wanted to raise the value of the reserves of gold in the vaults of its central bank, the Fed. This now had about 80% of all non-privately owned gold in the world.

Roosevelt raised the price of gold by making the private ownership of gold illegal in America. On pain of imprisonment owners had to sell their gold to the banks which then sold it on to the Fed. When all or most of millions of people’s gold coins had been gathered in, he then raised the price arbitrarily to $34! This appropriation — illegal under any notion of common law — is something that an American president would never get away with these days. The millions who owned gold dollar in the 1930s were not as well informed as those of today.

But the new price of $34 was still not the free market world price of gold even though, in London, there was now a London Gold Exchange which established a supposed fair price every day. But it could never be a true price because the largest central banks, and the American Fed most of all, had far more gold than any private buyers and sellers in the world, and so some of the largest governments could control the price. Which they did from then onwards because they wanted to make sure that the printed currencies they were now issuing would be the only currencies they would accept for taxation or pay out for services.

In the late 1960s, the larger countries of the world — those we know today as the G7 — allowed the price to creep up to $41 an ounce but otherwise no further. Already by then some of the more successful European countries such as Germany, France and England, realising that gold still had enormous reputational value, and wanting more of it for their central banks, began knocking on the Fed’s door asking to change some of their marks, francs and pounds for gold at $41 an ounce. America had to start to sell. By 1972, the Fed’s stock of gold had been reduced from 24,000 tonnes to 11,000 tonnes and president Nixon, decided that America would soon be cleaned out of gold

In 1972 Nixon took the American dollar off the gold standard and thus protected his stock og gold from further buying pressure. The next year the price of gold rose from $41 to $97 an ounce, and by 1974 it was $154. It rose to almost $2,000 an ounce in 2011 but has since declined to $1250 where it appears to be steady for the time being. Many experts think the $750 dip has been was caused by American manipulation because of the desperate need of the Fed to maintain the dollar as the world trading currency. There is evidence for and against manipulation and the jury is still out on this.

However, there is also evidence that China has been buying large quantities of gold ever since 2000 when the euro started life. Suffice n it to say that huge quantities of gold have been drifting from the West to Asia in the last 15 years. However, although China have said for many years that its official stock of gold is only about 1,000 tonnes of gold nobody believes this. China is also the largest producer of newly mined gold. Because it is also the largest refiner of scrap jewellery gold in the world and the Shanghai Gold Exchange is now larger than London’s then some think that China actually has 10,000 tonnes of official gold in its central bank, the People’s Bank of China (PBOC).  This compares with the 8,000 tonnes in the US Fed.

China has said officially that it wants to make its own currency, the yuan — or renminbi — into the main competitor to the dollar as the world’s main trading currency. At present about 20% of world goods are transacted in yuan. Although America will do as much as it can to prevent a yuan takeover, or even an equal share of world trade, it is difficult to know how it could succeed if the yuan is gold-backed — and therefore guaranteed against devaluation by inflation.

Meanwhile we still haven’t a free market gold price. We still haven’t arrived at a true gold standard. It’s a fallacy to say that what went on in late 19th century England was a true gold standard because millions of personal cheques — a recent innovation — were also in circulation This was, in effect, a huge addition of non-currency money — and certainly not covered by the gold reserves of the high street banks and the BoE.

Thus we have never actually had a true gold standard yet even though we say we had. This is something that economists, particularly young ones with no firm view about the gold standard, whether possible or not, whether likely to come or not, should bear in mind when several eminent ex- and current central bankers — as experienced and knowledgeable as anybody — say that a monetary catastrophe as least as bad as 2008 is coming.

The only question to ask about gold

Gold will always be a valuable metal because for one thing it is rare and for another its properties are such that it makes it a perfect material for personal ornamentation.

Personal ornamentation, along with hairdressing and quality and style of clothes, is the method by which we initially judge the social status of a new acquaintance. Social status, apart from eating, sexual activity and our propensity to work and relax in groups, is the most characteristic aspiration humans have.

Aspiration for social status varies in one dimension by means of being strongest in childhood, adolescence and young adulthood and mostly wearing off by the age of about 30 years for most people when the brain is largely fully developed. Aspiration for social status varies in another dimension from the masses through to higher strength and discernment among the higher social classes.

Aspiration for high social status affects all infrequent ambitious individuals whether in artistic, scientific, intellectual, political or business circles. Some want wide public acclaim of their status, others want only for personal reputation among their own kind, however small.

The need for gold, either worn personally for status or as the necessity for currency somewhere among the practice of one’s occupation will thus be maintained as long as man will remain.

The question then is: When the next monetary crash occurs will gold be re-established as the basis for a non-inflatable currency either by:

(a) a rapid coming together of all nations and agreement of a new monetary system  within days;

(b) a rapid gold-backed Chinese yuan as a replacement for a worthless American dollar;

(c) a rapid coming together of multinational corporations to use a gold-backed digital currency in order to keep the world’s trading economy going.

I back the third scenario but you may have your own views — unless you believe that all governments have the world’s economy well in hand and that a worse catastrophe than the 2008 Crash won’t happen.

Why so many banknotes?

In his book, The End of Alchemy, Mervyn King, the ex-Governor of the Bank of England, wrote:

“For centuries, alchemy has been the basis of our system of money and banking. Governments pretended that paper money could be turned into gold even when there was more of the former than the latter.”

Unfortunately, in his otherwise excellent book, even the ex-Governor can’t tell the gold story entirely correctly. There was only supposedly more paper money than gold because the value of the gold was held down rigidly during the latter half of the 19th century when the gold standard operated. There was no conspiracy to hold the price of gold down. England simply kept to the value of gold as originally laid down in 1717 by Sir Isaac Newton during his time as Warden of the Royal Mint (as a reward for what he’d done for science). There was, in fact, no world gold-pound exchange — as there is now — by which the value could be changed.

If there had been, then, despite large new gold discoveries in California (1840s), South Africa (1850s) and Australia (1860s) gold would have been valued several times higher than it was (almost £4 an ounce), such were the stupendous profits being made all through the 19th century — and thus stupendous quantities of paper money needing to be circulated as cash by a rapidly prospering population.

Waiting for the next catastrophe

Whenever you hear that gold standard currency was a disaster — as used in the 19th century by over 40 trading nations — and that gold is a largely useless yellow metal except for personal ornaments, don’t believe a word of it.

The facts are that: (a) most central banks buy gold from time to time to build up stocks because they still regard it as a fundamental currency; (b) gold continues to be mined even though it is becoming more difficult to find; (c) When the euro currency — the epitome of paper currency — was started 15 years ago, the European Central Bank (ECB) made sure that it had plenty of gold bullion in its vaults; (d) Special Drawing Rights (SDRs) — an invention of the International Monetary Fund (IMF) designed to do away with gold as a currency — are simply not used. The IMF also keeps gold bullion in its vaults.

In other words, don’t pay attention to what government officials say about gold, look at what they do with it. It is no wonder, therefore, that China and Russia, already the largest producers of gold in the world are not letting up. They’re producing against the day when the next 2008-type dollar catastrophe hits the world and when a new trading currency can be introduced which is not dependent on the deliberations of bureaucrats for its value.

Digging up gold and then burying it again

With reference to what I wrote in the previous posting concerning the need for a permanent depository of a valuable asset in order to back up a world digital currency, a correspondent has written to me quoting the charge that’s often made against the gold standard.

Apparently, this is something that Warren Buffet used to say:  “What’s the point of digging up gold out of the ground and then burying it again in a bank vault !”

The above usually raises a laugh but, if a valuable asset like gold is ‘buried’ in a bank vault for long periods of time, its very inactivity is actually serving an important psychological service.  It gives you the assurance that if an economic panic is in the offing and the value of your banknotes is in question, then you can always exchange them for an asset with a respectable value however the economy turns out.

Regaining the original invention of money

Reflecting on yesterday’s blog, “Saving the world from starvation” then, if there were another crisis of 2008 proportions — or, more likely, more catastrophic — the initial reaction of governments may well be the same as before.  They would need to ensure that the banks had enough money to supply the cash machines.  But would they be able to move further and institute another wave of quantitative easing (QE)?

And would this be even half-way acceptable to businesses and people all round the world?  After all, if QE hasn’t done anything constructive to repair the world monetary system in the last seven years, what guarantee would there be that another bout of QE would be the best way to go forward?  None at all.  There’s be eruptions from all round the world from business, the media and people for something really constructive to be done next time.

And the most constructive solution of all would be a new gold-backed digital currency.  It could come into operation immediately once a handful of multinationals agree to use the new currency between them and to insist that their suppliers and customers use it also.  Once initiated, it would mean that businesses and individuals with any cash at all would buy into the new currency as soon as possible before the price of gold rises too quickly. Governments with no cash — most of them — would have to go onto debt with a world gold depository — which, later, oould become the central bank of all the world banks.

The Big Six of the IT world  — Alphabet (the new name for Google), Alibaba, Amazon, Apple, Facebook and  Microsoft — with considerable expertise in various forms of secure digital payment already, could supply the software within days.  They would do so not only because it would be a matter of life and death in keeping the bulk of the world’s economy going but literally so in ensuring the continuity of the food chain.

What has been described above is not business taking over governmental functions but of business regaining its original role in inventing money in the first place — around 900BC in Lydia and China/

The big mistake of 1925

However multiplex the real world may be, the world’s economic system ought to be only an aggregation of simple transactions when we exchange money for goods or services.  At bottom, nothing ought to be simpler.  Instead it has become a vast web of intrigue and deception,  unknowable even to those who are supposed to be experts.

The first ‘working’ day of the week yesterday became yet another day of panic and turbulence on the stock markets with  bank shares showing the greatest weakness.  Whereas the stock of status goods in the advanced countries are as complete as they need ever be for persons have the time and energy to enjoy them and, at the same time, show their social rank in life, the future is becoming increasingly apprehensive for many.

For increasing numbers of young adults in the advanced countries the prospect of ever owning or comfortably renting a house and thus being able to raise a family is receding year by year.  For increasing numbers of middle aged persons, worries are growing whether their pensions — private or state — are going to be adequate in 10 or 20 years’ time and whether they’re going to get the heath care they know is theoretically available, but is increasingly gruesome already for many in retirement homes, are becoming stark and, frankly, scary.

It ought not to be like this.  Yes, the present situation is unknowable even to the experts.  But it’s to be remembered that experts are human, and all humans can be bowled along by peer pressure once a fashion starts — particularly if it starts at the top of the pecking order.

And the peer pressure that permeates the minds of most economists today — mainly because most economists text books have been Paul Samuelson’s and Keynesianism still reigns — is that gold standard currencies are not the answer to the present total monetary mess.

There was nothing wrong with going back onto the gold standard in 1925 following the First World War — apart from not being done in 1919.  What was wrong was going back at the rate of £4 to the world value of one ounce of gold. This was the pre-war value to suit the feelings of the City of London and the Bank of England.  It should have been done at something like £10-£12, the pound having been devalued more than two fold during the war by money printing   If a sensible rate of exchange had been arrived at then, the great exporting industries of England — textiles, coal, ships, heavy engineering — could have resumed at something like their pre-war quantities and a million and a half need not have been thrown out of work. As it was, they were pole-axed and our own version of the Great Depression ensued.

Is Isil going on the gold standard?

Apparently Abu Bakr al-Baghdadi has decided to have gold coins minted. This doesn’t mean that the putative caliphate is going onto the gold standard.  All it will mean is that some of its currency — probably only a microscopically small proportion of the total — in everyday use will be, or might be, gold coinage.  It will be far from being on a gold standard because virtually no-one in Isil’s present domain will be able to exchange their normal banknotes — Iraqi dinars or Syrian pounds — for gold at a bank.

Isis had no gold to start with 18 months ago and has only been able to get hold of it by — perversely — selling oil from Syrian wells it has commandeered in the north of the country back to its enemy, the Syrian government in the south, its only possible commercial outlet. But Syria has lost half of its reserves already and there’s not a great deal left. When that’s gone, Isil will not be able to get hold of gold from anywhere because it has no export trade at all otherwise. Besides, rumour has it — apparently from German journalists — that Isil’s gold coins are only plated ones.

Even if Isil had an export trade, no other country would use gold to pay for their imports because all countries these days keep a zealous hold of their gold against the day that they might have to use it in extremis or if America puts the dollar back onto the gold standard — which it left in 1972 — or China backs up its yuan against gold when the yuan is as heavily in use for normal world trade as the dollar.  Isil’s re-creation of gold coinage is as much of a fantasy as the re-creation of the caliphate itself.