Tweet

FULL RESERVE GOLD BANKING

What it is?

This one is simple to answer. It means that Banks are simply warehouses where gold is stored. They issue warehouse receipts that are fully redeemable in gold on demand. It is also called 100% Gold Backing or Banking.

Why Full Reserve?

Because we had plenty of experience with “fractional reserve” banking (this is counterfeiting, fraud and embezzlement as explained in our lesson Fake Money For A Fake Economy). We know how it works and we know the disasters it causes. We also know that, to a degree, it works. But why settle for something that benefits only bankers and creates so much pain (inflation to hyperinflation, devastated economies, poverty and desperation), when we can have something that benefits us all?

In ultimate analysis, the answer is simpler: it works! How do we know this? Because it worked for thousands of years. If there is something else out there that worked so well for so many millennia, we don’t know what it may be.

How would it work?

Quite simply people would deposit their gold in banks with either two options:

1. Safekeeping
2. Investing

In the first option, banks will simply guard the gold and charge a fee for it. The gold remains physically in their vaults. In the second option, the bank acts as an intermediary and lends this gold to other people for a percentage of the charged interest.

BENEFITS OF FULL RESERVE GOLD BANKING

Control of government

Consider the following benefits:

• Any artificial government inflation of currencies becomes impossible.
• Politicians become far more honest when forced to deal exclusively with tax incomes.
• People become much more aware as to where their tax money is going.
• People and politicians are forced to live within their means.
• Countries and all other artificial political divisions (such as provinces, municipalities and towns) face bankruptcy which leads to prudent spending.
• Budget financing through printing becomes impossible. With this almost all boom & bust business cycles disappear.
• Endless borrowing and printing comes to an end and so the economy becomes isolated from deficits.
• Interest rates stabilize at a natural level instead of being widely volatile and completely un-forecastable. Business planning returns to a sound footing.
• Market failures proceed in an orderly fashion without government bail-outs which leads to high rates of market efficiency: serve your customers or be extinct.
• Long term bond markets are revived. Currently they are dead in most countries because long term interest rates are inherently un-forecastable. Because of this, long term business planning is exceedingly risky.
• Economic activity (i.e. productivity) will increase once government interference is removed leading to purchase power gains through deflation.
• Unemployment will decrease due to lower government intervention (government would only able to intervene through legislation but not through money printing, as they do today).
• Frantic market speculation creating boom and busts by power elite groups gorging on cheap money will end. Mega bubbles such as S&L, Mortgages, Stocks, Derivatives and many other so-called investments will suddenly come to an end. Speculation will be curtailed by prudence, not by regulation. This will make all markets much more stable.
• Wars will be made very unlikely events as citizens realize their real price since money will be taken directly from their pockets through taxation.
• Government borrowing will be held in check, since it will only happen when people would agree to loan money. But this will only happen when governments become trustworthy in the sense that people would not have any doubts that they will see their investments return before they get a return on the investment.

Common monetary system

All countries would have universal money that cannot be counterfeited by anyone. All problems of inflation, national “reserves”, balance of payments, artificial deflation, etc. are all product of the fractional reserve system which would disappear automatically with a 100% gold standard. In ultimate analysis, all these problems are due to the fact that national currencies have national boundaries. Every government does as it pleases within their boundaries and therefore these problems appear when a comparison or interaction with other currencies is established. By having a universal monetary system, governments are precluded from performing any such damage.

Personal gains

• Preservation of rights of property: As gold cannot be manipulated by governments, properties cannot be artificially valuated or de-valuated by them.
• Price stability: A commodity-based currency has been proven quite stable throughout millennia. Fiat currency is stable over periods of perhaps a few months. Which one would you prefer? Consider this, in ancient Rome (before the debasement of their currency), one gold coin purchased one good toga. Today, one gold coin purchases you a good suit. That, is price stability.
• Savings rate: will increase and hence generate a stable investment floor for new business to flourish using this capital. These savings will also be stable, leading to accurate forecasts of future needs. Long term financing will revive.
• Low Interest rates: as with the Scottish experiment described below, loans will have interest rates in the order of 3 to 5% per year (short and long term). We know this because it did happen in the past. Furthermore, business planning would not have to deal with the effects of inflation on interest rates.
• Higher (possibly even full) employment. Honest money always spurs business activity. This activity invariably needs labor. However, this can only happen if governments are not allowed to interfere with the setting of wages by the market.
• Endless economic growth of about 2 to 3% real GDP for all countries. Let us remark this again real GDP. The calculation of current GDP includes inflation. If we subtract it, we are left with the real GDP. If you perform this calculation for all world countries, you will realize that almost all of them have negative real GDPs! Is then a surprise that unemployment is “endemic” when we have negative real economic growth?

Experiment

Do we have any modern historical period during which 100% Gold (or Silver) banking was attempted? And if so, what were the results?

We have at least one that approaches our description: Scotland between 1714 and 1884.

During this period there were no legal tender laws, no banking regulations, no monetary policy and no restrictions to create a bank and issue money. Furthermore, the environment was so free, that not even 100% Gold or Silver banking was mandated. Fractional reserve procedures were completely allowed. Bank shareholders were fully and un-limitedly financially responsible for all bank loses. Results?

Many banks were formed and most of them issued their own paper money backed by gold and silver. Most of the banks operated on a fractional reserve mode, but they were quite close to a Full Reserve due to the necessity of redeeming their notes to other banks. Efficient clearing mechanisms were developed. All banks that attempted to use the modern fractional reserve system (i.e. low backing in gold or silver, high printing) became bankrupt very quickly.

More results?

Most notes traded at par (or close) and were freely redeemable. Bank bankruptcies were few and when happened they had small impacts. Banking competition was fierce. Interest paid to depositors increased. The number of branches exploded. Banks had smaller profits since interests charged on loans were also low due to competition. There were a large number of small to mid-size banks, serving people. All this made their collective money so good and desirable, that their notes circulated throughout the entirety of UK! They also survived the multiple financial panics of that age (5 to be precise) much, much better than their English counterparts, who collapsed left, right and centre. Scottish banks were able to support each other while English ones were left to fall by the Central Bank of England.

More results?

Counterfeiting was quite low because note turnover was large and banks adjusted rapidly. Furthermore, in many occasions banks knowingly redeemed counterfeit notes to their unsuspecting customers to maintain trust in their notes!

The End

Only when Scottish people were prohibited from starting banks and issuing notes, was this incredible market destroyed. Regulation killed competition. End result? To this day Scottish banks continue to issue fully fiat-money notes which are as worthless as any other fiat currency.

Note: please see the Glossary if you are unfamiliar with certain words.

Continue to Gold is a shiny beacon of hope - Part 4