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A Road to Prosperity: Part I

By:  Lewis E. Lehrman

The case for a modernized gold standard.

Gold, a fundamental, metallic element of the earth’s constitution, exhibits unique properties that enabled it, during two millennia of market testing, to emerge as a universally accepted store of value and medium of exchange, not least because it could sustain purchasing power over the long run against a standard assortment of goods and services. Rarely considered in monetary debates, these natural properties of gold caused it to prevail as a stable monetary standard, the most marketable means by which trading peoples worldwide could make trustworthy direct and indirect exchanges for all other articles of wealth.

The preference of tribal cultures, as well as ancient and modern civilizations, to use gold as money was no mere accident of history. Nor has this natural, historical, and global preference for gold as a store of value and standard of measure been easily purged by academic theory and government fiat.

gold coinsGold, by its intrinsic nature, is durable, homogenous, fungible, imperishable, indestructible, and malleable. It has a relatively low melting point, facilitating coined money. It is portable and can be readily transported from place to place. Gold money can be safely stored at very low cost, and then exchanged for monetary certificates, bank deposits, and notes—convertible bills of exchange that efficiently extended the gold standard worldwide.

Like paper money, gold is almost infinitely divisible into smaller denominations. But paper money has a marginal production cost near zero. Producing gold money, like other articles of wealth, requires real labor and capital.

This investment of real labor and capital gives gold an objectively grounded value on which to base proportional exchanges—a value that can be compared to that invested in producing a unit of any product or service. Prices for goods and services always vary with subjective preferences. But the real costs of production persist as an underlying market-price regulator. Despite subjective preferences, a mutual exchange of real money—a gold monetary unit—for a good or service is a transparent, proportional, equitable exchange, grounded by real costs of production, namely labor, capital, and natural resources.

In contrast, almost no marginal labor or capital is required to produce an additional unit of paper money. Thus, legal tender paper money is subject only to quantitative control and the discretion of political authorities. Historical evidence shows that inconvertible paper money is overproduced, tending always toward depreciation and inflation, interrupted by bouts of austerity and deflation. Over the long run, government-forced and spurious paper money has not maintained equitable exchanges between labor and capital. Market exchanges based on depreciating paper money and floating paper currencies issued through the banking system always lead to speculative privilege of insiders, generally the financial class.

Because of its imperishability and density of value per weight unit, gold can be held and stored (saved) permanently at incidental carrying costs. Precious metal monetary tokens (gold and silver) survived millennia of experiments with inferior alternatives such as shells, grains, cattle, tobacco, base metals, and many others. These alternatives are either consumable, perishable, bulky, or of insufficient value for large-scale commercial exchange over long distances. For example, perishables like wheat or cattle are not storable for long periods at very low cost; nor are they portable cheaply over long distances to exchange for other goods; nor are they useful and efficient to settle short- and long-term debts promptly.

Through a process of long-term economic evolution in tribal, interregional, and national trading markets, gold’s natural properties were discovered and utilized in almost all cultures. Gold thus became universally marketable and acceptable as the optimum long-term store of value, uniform standard of commercial measure, and durable medium of exchange. Universal marketability and acceptability is a hallmark of global money. Silver, with its much lower value per unit of weight, was the suboptimal monetary metal of modern civilization, exhibiting many but not all of the properties required for large-scale international exchange.

Merchants, bankers, farmers, and laborers may not have consciously considered these facts, but over the long run, they behaved as if they did. Thus gold became an unimpeachable, universally accepted currency, to be held as reserves and passed on as a reliable store of future purchasing power. People, even hostile nations, freely accepted gold, a non-national currency, from one another in exchange for other goods, even as they rejected the sovereign risk of holding national currencies as their exclusive reserves. All who cherished the value of their saved labor—pensioners, working people, those on fixed incomes—came to rely on the gold monetary standard as a stable, long-term proxy for goods and services to be purchased later, perhaps much later.

Today’s global stock of aboveground gold in all its forms is approximately 5 to 6 billion ounces, perhaps more—close to one ounce per capita of the world population. Because of gold’s lasting value from time immemorial, and the human incentive to conserve all scarce resources, these 5 to 6 billion ounces represent most of the gold ever produced. Yet the aboveground gold stock today may be enclosed in a cube of approximately 70 feet on each side. Gold may be easily converted to substantial amounts of monetary coin to underwrite convertible paper money and bank deposits for convenient exchange in the market.

Moreover, the empirical data demonstrate that the stock of aboveground gold has grown for centuries in direct proportion to the growth of population and output per capita. The average, annual, long-run growth of the stock of gold in the modern world is approximately 1.5 percent. This remarkable fact accounts for the unique, long-run stability of its purchasing power. New output of gold money, joined to its rate of turnover, is sufficient for both economic growth and long-run stability of the general price level, as modest but regular output of gold does not affect the relative value of the large existing stock.

This hidden but crucial commercial equation of the social order was a fundamental reason why the true gold standard, i.e., gold-based money, became the foundation of the monetary institutions of modern civilization. Gold-based money not only stabilized the long-term price level, but its network effects also integrated and compounded the rapid growth of the advanced, competitive trading nations of the Western world during the Industrial Revolution. For the purpose of global trade, exchange and investment currencies convertible to the universally acceptable gold monetary standard had engirdled the earth by the beginning of the 20th century.

As the technology and productivity of the payments mechanism evolved, banknotes and checking account deposits (among other credit and transfer systems), came into modern circulation as substitutes for physical, monetary tokens. But these banknotes and checks derived and sustained their value from the fact that everyone knew they were credit instruments convertible to gold. Still, actual gold transfers were used to settle residual balance-of-payments deficits among nations, a necessary and efficient international adjustment mechanism by which to rebalance domestic and international trade and exchange.

Despite legal tender inconvertible paper money and the disabilities presently imposed on gold by the political authorities, gold retains the same inherent properties that make it the least imperfect monetary standard. Indeed, all inconvertible paper money systems, based on contemporary fractional reserve banking, use the vestigial forms but not the substance of their original convertible currency systems.

In sum, gold is natural currency, not least because it provides in a single, indestructible substance the primary functions of money—i.e. a standard unit of account, a stable medium of exchange, a stable store of value, and a stable deferred means of payment. By reason of these facts, the market guided the authorities over time to bestow on gold coin the status of an official monetary standard. Gold money was, moreover, endowed by nature with profound but simple national and international networking effects, the digital standard by which free prices could be communicated worldwide. Thus, the gold standard exhibited natural economies of global information scale, a necessary virtue in the present electronic age. The adoption of the gold standard by the major trading nations in the 19th century led to a radical reduction in the settlement costs of international trade and transactions, a crucial confidence and reliability factor stimulating an unparalleled boom in trade that was constantly and promptly rebalanced by residual deficit settlements in gold.

[Editor’s Note:  Next Up – What Lehrman Writes on a Just Social Order and Economic Growth]

Article Reprinted here from Spectator.org – October 2012 issue.  Reprinted With Permission