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Posts Tagged ‘gold standard’

Five reasons Ben Bernanke hates the gold standard

Here are five reasons why Federal Reserve Chairman Ben Bernanke hates the idea of moving the U.S. off its fiat currency:

1) The gold standard helped create the Great Depression. Pegging the dollar to gold led to financial panics during the Great Depression Bernanke argued during a recent speech at George Washington University (per Politico).

“The gold standard would not be feasible for both practical reasons and policy reasons,” he said. “I understand the impulse, but I think if you look at actual history the gold standard didn’t work well.”

I disagree as much of the world operated on some form of precious metals-based monetary standards between the late 1700s and the 1970s. Financial panics occur when the public loses faith in a government’s ability to meet it debt obligations (and it doesn’t matter if that country’s operating with a gold standard or a fiat currency). Rather than a history of failed gold standards, I think it’s more likely that the world will look back on fiat currencies as something that “didn’t work well.”

2) There’s not enough gold to go around. Bernanke claims this is one of the biggest problems with a return to the gold standard. In fact, the move would just require valuing gold at a much higher level. The often-quoted figure is $10,000 per ounce.

3) Less control over the economy. It’s no secret that the Fed uses the dollar as way to manipulate the economy. It gooses a tough economy with easy cash or it caps off a good economy with higher interest rates when it shows signs of overheating. If the U.S. returned to a gold standard, the Fed would no longer have that control.

4) Fiscal discipline would be imposed. Washington’s putting lots of pressure on the Fed to ensure the country can continue offering touch-point social programs: things like Medicare and Social Security. So long as Washington is unwilling to make cuts to those programs, the Fed will have little choice but to keep printing money to pay for them.

5) Gold standards benefit creditors. Gold standards inject price stability into an economy. That means governments can’t “inflate” their way out of debt by printing more “cheap” cash to pay off long-standing bills. Putting the U.S. on a gold standard with a national debt north of $15 trillion would be a form of financial suicide. Bernanke knows that, and the rest of Washington does, too. That’s why they’re publicly lobbying against a gold standard. If another country moves to it first, though, we may not have any choice but to follow.

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The pros and cons of going back to the gold standard in the U.S.

In the wake of the news that Utah has officially made gold and silver into currencies, Bloomberg TV hosted some heavy hitters on to ask them point blank: what’s the case for bringing back the gold standard in the U.S.?

[Check out our post It’s law: Gold and silver approved as currency in Utah for more on the gold standard.]

“It’s the ultimate currency,” Rob McEwen, CEO of McEwen Mining, says in the interview. “It can’t be replicated quickly, and it’s a store of value that’s crossed the millenium. Right now, we’re seeing the purchasing power decrease, and they’re taking away from everybody that puts money in the bank.”

“The horse is already out of the barn,” Michael Crofton, CEO of Philadelphia Trust, retorts. “I don’t think (a gold standard) could ever work given the amount of financing we have to do; both deficit financing and just operational financing.”

If there’s enough will for a new economic model, though, politicians could make it happen. It just wouldn’t come for free. There are a number of pros and cons to a gold standard. We’ve outlined several of the biggest here based on the interview with McEwen and Crofton and our own research.

Pros of bringing back the gold standard in the U.S.

  • Reducing the likelihood of another black swan event (hyperinflation, the collapse of financial institutions, etc.) that could cripple the global economy
  • Bringing back fiscal discipline in Washington – forcing politicians to clean up programs like Medicare and social security
  • It can be done. There’s precedent for it, with many nations – including the U.S. – operating with gold-backed currency for more than 100 years
  • Price stability
  • A reduction in the number of economic booms and busts
  • A system that rewards savers rather than debtors

Cons of bringing back the gold standard in the U.S.

  • Switching to a gold standard would shift the power from debtor nations (like the U.S. and Europe) to creditor nations (like China).
  • The gold standard would eliminate the need for a reserve currency – stripping yet more power away from the U.S.
  • Limits would be imposed on how much governments can borrow during crises/li>
  • Gold prices would need to be set by governments, and that could potentially give governments the power to manipulate currencies
  • Less ability for governments to stimulate growth in their economies

A different approach to the gold standard

While I do think there needs to be a return to fiscal responsibility, I’m not sure a single sovereign government could make the transition alone. A more likely solution? A federation of countries or global financial institutions that align to back a fee-based debit card system that lets buyers and sellers convert credits into physical gold or silver.

This electronic system could take deposits in any number of currencies. That cash could then be spent like cash in a normal debit account or redeemed for metal.

Individuals could use the system to protect themselves from inflation or as a shelter during tough economic times. The global binge on cheap credit has to come to an end at some point, and the solution just might be a mix of fiat and gold-backed money.

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It’s law: Gold and silver approved as currency in Utah

Three weeks ago, Utah quietly became the first state to recognize gold and silver as an alternative currency. Utah Governor Gary Herbert signed House Bill 157 along with 37 other bills on March 27, 2012. Here’s what HB 157 does:

First, you can’t expect to use your Canadian Maple Leafs or Chinese Pandas as legal tender. Utah’s bill identifies exactly what types of gold and silver the state will accept as legal tender, and that’s only “gold or silver coin that is issued by the United States.” Utah calls U.S.-issued gold and silver coins, “specie legal tender.”

Line 72 in the bill states “Specie legal tender is legal tender in the state.” That means gold and silver coins are exempt from sales and use taxes, and it allows for a tax credit when exchanging “one form of legal tender for another form of legal tender.”

Now, Utah gold and silver investors won’t have to pay capital gains taxes when they sell their gold and silver for paper money (even if they’ve made a substantial profit). Of course, investors will still owe the Federal government capital gains, but at least Utah’s holding out a small umbrella for gold and silver investors.

There are some tricky issues that crop up when paying in gold and silver. What happens, for instance, if you want to mail a Silver Eagle as payment for goods and the spot price of silver drops 5 percent while your coin is in the mail? If we extend the logic in the bill, that shouldn’t matter because the amount of gold or silver due at the time of the sale (as determined by using London spot prices) will stay the same. If silver drops shortly after you’ve made a purchase using the silver, the seller’s the one “taking a loss.”

The bill addresses this issue in the context of paying taxes. Should the state of Utah decide it wants to tax specie legal tender, it lays out how the process would work. Namely, the seller would need to note:

  • The purchase price in specie legal tender
  • The amount of tax due
  • The tax rate
  • The date of the transaction
  • The most recent London fixing price

It creates some extra paperwork for sellers, but I imagine the people who don’t trust paper money are just fine with that. Utah’s paving the way for other states to follow suit (specifically it looks like Missouri might be next). The real kicker would be if we could get the Federal government on board. But, if we somehow get to that point, I suspect Congress will have bigger fish to fry – things like riots and bread lines.

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Gold standard in the U.S. by 2016?

The notion that the U.S. might one day return to the gold standard got a big boost in credibility yesterday when Steve Forbes, founder of the influential business news magazine and Web site, Forbes, predicted the U.S. would revert back to a gold standard in the next five years.

“People know that something is wrong with the dollar,” Forbes told Human Events. “You cannot trash your money without repercussions.”

Forbes offered several justifications as to why he thinks the move is “likely” by 2016. Among them:

  • A stronger dollar
  • An end to reckless federal spending
  • Smaller and less damaging economic booms and busts

Since the U.S. adopted a fiat currency during the 1970s, we’ve almost been conditioned to accept inflation as a fact of life. It hasn’t always been that way, though, and it shouldn’t. In 2008, Representative Ron Paul (sitting Chairman of the Subcommittee on Domestic Monetary Policy) drove this point home when arguing against HR 5512 – a bill that called for alternative metallic content in U.S. pennies and nickels:

“At the time of the penny’s introduction, it actually had some purchasing power,” Rep. Paul said. “Based on the price of gold, what one penny would have purchased in 1909 requires 47 cents today. It is no wonder then that few people nowadays would stoop to pick up any coin smaller than a quarter.”

The value of the dollar has fallen to the point where the metals required for our coinage outstrip the cost to produce those coins. If inflation weren’t endemic, pennies might actually be worth something.

“HR 5512 is a sad commentary on how far we have fallen, not just since the days of the Founders, but only in the last 75 to 100 years,” Rep. Paul continued. “We could not maintain the gold standard nor the silver standard. We could not maintain the copper standard, and now we cannot even maintain the zinc standard. Paper money inevitably breeds inflation and destroys the value of the currency.”

As more and more people realize that current rates of inflation are unsustainable, our country’s leaders will have some tough decisions to make. We can either take the hard medicine we need, and slash government spending while simultaneously raising interest rates, or we can send the fiat dollar to its grave.

Younger Americans probably don’t realize that the fiat dollar was an unprecedented experiment. Forbes drives this point home in his interview with Human Events by pointing out that country successfully ran on the gold standard for 180 years before it was abolished just four decades ago.

Now that experiment has run its course, we’ve seen it’s too difficult to limit spending when there’s nothing in our way but an arbitrary debt ceiling. In such an environment, a return to a gold-backed currency might be the only workable solution. Linking the dollar with an asset that we can’t reproduce on a computer or printing press makes fiscal responsibility not a necessity but an absolute requirement. Forbes understands that, and it looks like the public’s starting to as well.

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Utah gold standard takes pot shot at the Federal Reserve

Utah just got a lot of street cred by firing the first bullet in the war against the Federal Reserve’s loose monetary policies. The state’s Governor Gary Herbert signed a bill into law last month that recognizes gold and silver coins issued by the U.S. Mint as legal tender in the state.

Unfortunately, the bill doesn’t go so far as letting you exchange gold and silver for goods and services based on the value of the underlying metal. Instead, Utah residents would have to use face value on the coins to purchase goods and services. That means people probably won’t be using Eagles to pay their mortgages or car payments (since the face value is far less than market value), but nonetheless it’s a symbolic jab at the Fed. And it’s a jab that’s representative of the pent up anger out there.

It’s not just Main Street that’s upset about government spending; it’s state governments, businesses and voters, too. And there are few voices speaking more loudly against rampant inflation than Texas Congressman Ron Paul.

“The gold standard would keep you from printing money and destroying the middle class,” Paul says. “Every country where you have runaway inflation, there’s no middle class. Mexico, there’s no middle class, you have a huge poor class, and a lot of wealthy people. Today we have a growing poor class, and we have more billionaires than ever before. So we’re moving into third world status.”

While Utah’s bill stops short of recognizing all forms of gold and silver as currency, it does contain a nice tax benefit. Utah investors who buy and sell gold and silver coins for investment purposes no longer have to pay state capital gains taxes on the metal.

A number of other states appear to be following Utah’s lead by introducing their own gold and silver currency bills. Georgia and Iowa have put forth legislation that would mandate state taxes be paid in gold and silver, according to MotherJones. Indeed, more than a dozen states have floated or are in the process of debating alternative currency bills.

It’s a step in the right direction, but I’m still not convinced we’ll start seeing progress until banks are allowed to issue gold- and silver-backed debit cards that can electronically exchange bullion for U.S. dollars at checkout terminals.

I wrote about just such a scheme recently in my post How would a gold standard work in the 21st Century? It’s Utopian thinking right now, but if the government can’t rein in spending before we’re subject to runaway inflation, I suspect I wouldn’t be the only one who would sign up for a gold- or silver-backed debit card.

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How would a gold standard work in the 21st Century?

The recent news that Utah representatives have passed a bill that could usher in a gold standard, got me wondering what it might be like to have a gold standard that co-exists alongside the U.S. dollar.

Traditionally, the gold standard worked by fixing the value of the dollar to a set amount of gold. Consumers bearing dollars could visit a local bank and exchange their dollars for bullion at an exchange rate determined by the government.

The problem, of course, was that by fixing the value of the dollar to a specific commodity, the government no longer had the means to artificially increase the monetary supply. If authorities wanted more dollars in circulation, they’d have to increase gold holdings in order to back those dollars.

Utah’s proposal presents an interesting wrinkle on the gold standard, though, by allowing an official alternate form of legal tender to co-exist with the dollar. Businesses and consumers could exchange dollars OR Federally-issued gold and silver coins during financial transactions.

[Related: Utah gold standard could become a reality]

Would such a proposal be feasible? Perhaps. To illustrate, let’s imagine a world where your bank or financial institution offered you a special, gold-backed savings account. By transferring dollars from your checking account into your gold-backed savings account, you’d effectively be “buying” and holding gold. Rather than being denominated in dollars, cash in your savings account would be denominated in XAU (the currency symbol for gold).

For its part, the bank would allocate physical gold holdings to your account whenever you transferred cash into your gold account. The bank would store this gold in a vault and, presumably, charge you a fee for the service. Under such a scenario, if the price of gold rises relative to the dollar, your savings would rise, too.

Ideally, your bank would also allow you to make purchases directly from your gold-backed savings account. You’d swipe your debit card as you always do, the gold in your account would be exchanged for dollars at prevailing rates and your purchase would be processed in dollars.

[Related: China gold reserves too small, adviser says]

The beauty of such a scheme is the value of gold to dollars wouldn’t be set by the government as it was in the past, but rather, it would be electronically determined by the current market price for gold.

Sounds like a win-win for everyone. There are dangers in such a plan, though. If the public started to show a preference for holding gold over dollars, the value of the dollar would plummet and the price of gold would rise dramatically. Banks would have difficulty backing your savings with physical gold and investor confidence in the dollar might crumble – not just here but around the world.

[Related: Why invest in silver?]

The biggest threat to any currency, of course, is a loss of faith in that currency. We’ve seen that happen in South America during the ’70s and ’80s, Germany after World War II, even during the dying days of the Roman Empire. If consumers were to lose faith in the dollar, they’d be eager to spend their dollars for whatever material goods they could get their hands on and prices would begin to rise quickly.

Utah’s plan to create an alternate legal tender might accelerate a rush out of the dollar. But it seems to me that process has already started. Perhaps what we’re seeing play out is simply a symptom of a bigger problem: the U.S. debt burden has become too large. No matter how much Americans might like to return to our post-war lifestyles, the balance of power is shifting East. Our consumption levels have to fall more in line with reality, and that’s going to cause pain along the way.

If there is a way to have the dollar peacefully co-exist alongside an alternate tender in the U.S., though, the solution lies in the banking system. Give me the ability to sign up for a gold-backed money market account or a gold-backed savings account, and I’ll happily sign on the dotted line.

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Utah gold standard could become a reality

If you’re not convinced the threat of inflation in the U.S. is real, there’s a handful of Utah senators (17 to be exact) who respectfully disagree. The Utah Senate passed HB317 yesterday, 17-7, moving the state a few steps closer to a gold and silver standard. The bill allows businesses and individuals to exchange federally issued gold and silver coins instead of paper dollars in financial transactions.

The gold and silver would be valued at face price instead of the underlying value of the gold and silver. A state committee will now look at whether Utah should recognize an official alternate form of legal tender. Utah Governor Gary Herbert, who has not taken an official stance on the bill according to the Washington Times, will have the final say to veto or sign it into law.

If the bill ultimately becomes law, the implications would be interesting. On one level, it’s a symbolic move designed to send a message to Washington. On another, actually using gold and silver as legal tender would be difficult as users would have to file federally required transaction reports, according to the Deseret News.

If inflation becomes a reality, though, the appeal of such a system might be worth the headaches. Just last month, J.P. Morgan announced it would take gold as collateral for loans. It’s a sign that more sophisticated gold and silver transactions could be on the way.

Here’s a hypothetical (that won’t play out in Utah): what if employers could pay employees in gold and silver? That amount could be electronically deposited into employee accounts not in USD but in XAU (the currency symbol for gold) or XAG (the currency symbol for silver). Banks could then issue special debit cards so that purchases could also be made in XAU and XAG.

If a business didn’t directly accept gold or silver as tender, credit card companies could apply an exchange rate for the gold or silver in the account, charge a fee to the purchaser and convert the purchase amount to USD at prevailing prices.

If the dollar were in the midst of a free fall, the consumer who’s holding gold or silver in the bank rather than dollars, would win. Utah’s law is a symbolic step in the right direction, but until we can use gold and silver as currency based on the underlying value of the metal, we’ll still be a long way off from a true gold standard.

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Not enough gold in the world to return to a gold standard, Bernanke says

Rumblings that the U.S. should return to a gold standard have started trickling into the media as the public grows wary of a ballooning budgetary deficit. In an appearance before the Senate Banking Committee earlier this week, Federal Reserve Chairman Ben Bernanke was asked directly about the possibility of the U.S. returning to a gold standard.

“It did deliver price stability over very long periods of time, but over shorter periods of time it caused wide swings in prices related to changes in demand or supply of gold. So I don’t think it’s a panacea,” Bernanke said.

The soft response to questioning from Sen. Jim DeMint (R., S.C.) – a long-time Bernanke detractor – leaves a tiny window of hope that a gold standard might be something the Fed’s actually considering. “It’s not a cure-all, but it could be helpful,” Bernanke seems to be saying.

It’s difficult to imagine Bernanke would endorse a gold standard. He’s long maintained that the Federal Reserve kept too tight of a grip on the money supply by raising interest rates during the Great Depression. Once the public began losing faith in the dollar, they were all too eager to trade greenbacks for gold, which further contracted the money supply and ultimately led to deflation.

Linking the dollar to a fixed amount of gold would constrict the Fed’s ability to prop up the money supply. Bernanke himself pointed to another flaw he sees in a gold-backed currency: namely, that there’s not enough gold in the world to go around.

“I don’t think that a full-fledged gold standard would be practical at this point,” Bernanke said.

He could be implying a watered-down gold standard of sorts is possible in the future, but I’m not convinced Bernanke believes that. Inflation is one of the few tools the Fed has to spur growth (or at least the perception of growth). Giving power up is always more difficult than accepting it, and – so long as the public retains faith in the dollar – it would serve little purpose.

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