When Gold Backed Currencies Make Sense

Economic analysts, political analysts, and others are talking and writing about China, Russia, various Islamic countries and possibly other countries instituting a gold – backed currency. They believe that China, Russia, and other countries have been acquiring large quantities of gold in anticipation of going to a gold – backed currency.

Some of these commentators imply that instituting a gold – backed currency is returning to the gold standard. Others admit that it is not. These latter commentators are correct. A gold – backed currency without redemption on demand, especially by the common people, is meaningless — except perhaps for propaganda purposes.

I will use the United States as an example. When the United States ended the gold standard in 1933 and refused to redeem paper money in gold, they still had a gold – backed currency. From 1933 to 1945, Congress required 40 percent of the federal reserve notes to be backed by gold. In 1945, it changed the requirement to 25 percent backing. Then it ended the hypocrisy in 1968 by eliminating all gold backing. However, gold continued to back the U.S. currency, and foreign governments and their central banks could redeem their dollars in gold. In 1971, the United States ceased redeeming dollars in gold. (From 1944 to 1971, t he United States redeemed dollars under a gold exchanged standard. Under this gold exchanged standard, only foreign governments and their central banks could redeem U.S. dollars in gold.)

Even after abandoning all pretenses of a gold – backed currency, the United States and the Federal Reserve System continued to back the U.S. dollar with gold. To the extent that the gold held by them is considered an asset, this gold backs the U.S. dollar. Along with all the land owned by the U.S. government and, more important, the military might of the U.S. government, this gold is part of the “full faith and credit” backing the dollar. (Gold is not really credit as it is no one else’s liability.)

Likewise, to the extent that a foreign government or its central bank holds gold, its currency is backed by gold. Although it has no statutory requirement to maintain a specific amount of gold to back its currency, its currency is still backed by gold. As shown with the United States, whenever a statutory limit is approached, the law is changed to reduce the requirement.

Any kind of gold-backed currency is meaningless unless free coinage of gold is allowed and the common people can redeem paper money in gold on demand. Moreover, the country would have to define its monetary unit as a specific weight of gold; it would not be fixing the price of gold. (For example, the Gold Standard Act of 1900 defined the U.S. dollar as 25.80 grains of standard gold, which is 23.22 grains of fine gold. It did not fix the price of gold at $20.67 per o unce.) Furthermore, a country would not have to stockpile gold before returning to the gold standard. It would not need to possess any gold in order to return to the gold standard. All it needs to do is to define its monetary unit as a specific weight of gold, allow the free coinage of gold, and to require paper money to be redeemed in gold on demand by anyone.

Author: Thomas Allen, posted in The Gold Standard Institute

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