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LIMITATIONS OF FULL RESERVE GOLD BANKING

100% Gold banking is limited only by the stupidity of governments. If you wish to have true full reserve gold banking, then all governments must cease to exist. However, in an imperfect world where governments may co-exist with full reserve banking, the following limitations will still remain:

  • Government economic planning or directed economy. The stupidity of planning bureaucrats cannot be cured by gold.
  • Tax increases. Again, gold cannot cure insatiable politicians’ greed, but it can punish and limit it to a degree.
  • Bad labor laws. For as long as these laws continue to interfere with market operations, there will be drawbacks that gold cannot resolve.
  • Gold cannot ensure a free market. Government interference in market operations will always exist for as long as governments exist.
  • Gold cannot precipitate the shrinking and control of governments. Governments must be forced into accepting gold and then let it act. Gold, in turn, will protect us from government expansion.

And so, when we advocate the use of Full Reserve Gold Banking, we do so fully recognizing that it won’t cure all economic illness. Governments will always place limitations on gold; however, even with limitations, gold is still infinitely more preferable to nothing-based fiat currencies enabling the orgy of government spending.

CRITIQUES OF THE FULL RESERVE GOLD BANKING

There are many critiques as to why Full Reserve Gold Banking “can never work”. It reminds us of an inventor who created a better mouse trap and when confronted with theoreticians saying it would never worked, he apologized for making it work since he did not know “it would never work”.

These critiques are all interesting academic exercises, but in the end they are all confronted with an incontrovertible fact: gold works. It did so for thousands of years. Period.

Not enough money

This point of view states that because the amount of gold is limited, the amount of money will be too which will cause shortages. However, as we have seen in our lesson Fake Money For A Fake Economy, once money is established in the market, its quantity is irrelevant. This is so because money is a medium of exchange; if there is more money, then more money will be needed for the same good or service. We don’t need more money. And so the question shifts to: is there enough money to establish gold as money? It is obvious that if we have a market of a few billions per year, a few kilograms of gold won’t be sufficient. The answer to this question is a resound yes! This is one of the reasons why gold was chosen by markets to act as money in the first place. Its quantity is “just right” and proof is in the history books. Gold would not have survived as the preferred money if its quantities would not have satisfied free markets.

Hoarding

People may raise the purchasing power of gold by hoarding it. So what? People desire to increase the purchasing power of their holdings all the time. This is just another method. Besides, the amount of available gold world-wide, makes this proposition extremely implausible.

Banks would go bankrupt

This is, of course, galloping nonsense. If 100% gold banking business would be so un-profitable, then all the big banking houses of the Renaissance would have never existed. Yet, they not only existed but became virtual monarchs in their regions!

Price instability

Because the amount of gold changes over time or is more or less desirable due to natural or man-made positive or negative events, price levels will change. In first place, price levels always change, no matter what is used as money. Secondly, 100% gold banking never promised fixed pricing. Lastly, the amount of price fluctuation under a 100% gold standard will be negligible when contrasted with gigantic movements in the fiat system and continuous depreciation. By comparison, gold is a rock!

Gold shortages

Some countries have larger economies than others; therefore they would naturally store more gold. In doing so, countries with weaker economies may run out of gold. This argument is ridiculous. Every person of every country will decide by themselves where to store gold and how much. Therefore they will all naturally reach the most adequate level for every country.

Private minting

Yet another concern is that if every person is allowed to mint (which in practice is translated as every mint), then what would prevent these coins to be debased or even counterfeited? Simple. The market. Coins of different values will circulate but its value will be linked to gold content which, if pure, can easily be determined by weight with a simple, cheap balance. But what about purity? Gold assay has become a fairly simple affair since many decades ago. Now days it is easy to assay coins effectively, efficiently and rapidly. Furthermore, companies will set up to do just that and sell this information. People will have lists of trustworthy coins and shady ones. How do we know this will happen? Because it is happening today with a myriad of products. We don’t have to imagine it; it is an unstoppable reality furthermore amplified by the internet. If any mint would to cheat, it would be pretty much instantly punished by the market.

Producers will benefit

And this would be a problem because? Gold producers do not produce gold out of thin air. The cost of gold mining is actually quite high. Gold mining is an economic activity, just like any other. As such, gold miners deserve to be compensated.

Gold producing will spur inflation

Strictly speaking, this is correct. However, the amount of gold required to induce gold inflation in a full reserve banking system is so large, that in practice it is a physical impossibility to obtain those quantities by mining in the required time. The first and last time there was a significant gold inflation anywhere in the world, was in Spain immediately after the conquest of Latin America. This happened because the Conquistadores simply stole Incas’ gold and brought it back to Spain. In practice, they took the entire Inca gold production of a few centuries and dumped it in the Spain market within a few years. This is not something likely to be repeated any time soon. In reality, economic manufacturing efficiency will create about 100 times more deflation than any inflation gold mining could generate.

Gold standard cause panics, crashes, booms and busts

This is a plain mis-interpretation of historical facts. As we have explained previously, there were booms and busts during the “classic” gold-standard period. However, we need to remember that the so-called gold-standard period was actually a wild fractional-reserve system at work, not a full reserve banking system. It was the action of governments using and abusing said fractional reserve system that brought panics and crashes to bear, not gold.

Gold increases speculation

Yet another groundless accusation based on current events. If we look at the past when a 100% gold standard was in use, we notice that there was no gold speculation! How could it be? The only way to increase the value of gold would be through hoarding (i.e. less gold for the same amounts of goods). Hoarding was simply impossible because of the amount of available gold and the influx from other geographical places.

And what about current, modern times? People buy gold as investment (or speculation) because they seek profit (or protection) from the mindless fluctuation of fiat currencies! Think about it. If the USD or the EUR or the CAD or any other currency would not fluctuate, would there be any point in buying gold as speculation or investment? Of course not! Gold is being speculated and invested into because of the existence of fiat currencies. Remove such currencies and all investment or speculation (monetary) disappears.

There will always be a small amount of gold speculation for manufacturing purposes, but this speculation would be so tiny as to be irrelevant. We must not forget that gold is also a commodity with industrial uses.

TRANSITION TO A FULL RESERVE GOLD BANKING

Let’s assume for a second that all governments throughout the entire world are suddenly affected by 100%-golditis and decide to switch to a 100% gold weight standard. How are they to proceed? There are many practical ways in which this could be done, none of them easy or painless. The cancer of fiat-money is too far advanced. Let’s take a look at some of them.

Recommendation #1

Method

  1. Stop printing fiat money.
  2. Establish the true value of each fiat currency by dividing its quantity by the gold stored in each Central Bank (e.g. 100 million Pesos and 1000 Kilograms of gold yields 1 Peso = 0.01 milligram of Gold or 100 Pesos = 1 milligram of Gold).
  3. Return the gold to private banks (from Central Banks) in relation with their fiat-currency claims (e.g. if a bank has 10 million Pesos, they receive 100 Kg of gold).
  4. Declare all fiat money fully convertible into gold.
  5. Close down Central Banks and repeal all so-called “legal tender” laws. No government organization must be allowed to issue any kind of money at any level whatsoever.
  6. Allow banks to issue warehouse certificates in exchange for the former fiat-money with the proviso that only 100% gold reserve is allowed.
  7. Allow banks to use any other currency they feel appropriate (typically silver) but with the proviso that only 100% reserve banking is allowed.
  8. Allow banks to coin their own precious metals coins and close down government mints.
  9. Specify taxes to be paid only in gold or silver and remove all taxation from all gold and silver operations, including minting.
  10. Repeal all laws creating entry barriers into the banking industry. Banking should be just like any other business.
  11. Open borders to all financial transactions without exception.

Consequences

Economies will go into immediate recessions as governments stop buying goods and services and paying debts with inflated money.

Also, as current the exchange rate of fiat currencies is purely subjective, it will not be the same as the exchange rate once they are converted into a gold-weight standard. In other words, if today the exchange ratio of CAD to JPY 1:100, overnight it may become 1: 88 or 1:157. Which means that there will be huge winners and losers throughout the world. Those who hold depreciated currencies will lose purchasing power; those who hold stable currencies will win purchasing power. You would be surprised who would win and who would lose (e.g. the USA would be one of the major losers because its insatiable printing thirst). It will be a time of upheaval until the markets re-establish equilibrium. Strong medicine with significant side effects but ultimately well worth it.

Recommendation #2

Method

Same as the method above, but for Step #2 reduce the amount of fiat money to an arbitrary amount so that when the borders open, the exchange rate would be favorable, or at least neutral.

Consequences

Economies will go into immediate recessions as governments stop buying goods and services and paying debts with inflated money.

Also, this would prevent upheaval after the transition, but it could create a depression before it. This step advocates for a drastic reduction in money liquidity, which will cause a major economic slowdown if done incorrectly. The correct form of doing this is overnight and communicating this information simultaneously to all citizens. For example, over a financial holiday of 48 hrs the government declares that all fiat currency drops two or three zeros and it is now called New Fiat Currency or Tamarindo Pesos or Blue Dollar or whatever other fancy name they choose. Over time (a few months) all previous fiat money is retired and replaced with the new currency. We know that this is possible because third world countries have vast experiences in so doing when inflation gets out of control and the number of zeros on currency notes approaches a number too large to fit in it!

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

Continue to Gold is a shiny beacon of hope - Part 5

 

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