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By Root 917 0

of gold kept in trust for the holder of the dollar and redeemable at will. Under this pure gold standard, it is impossible to expand the money supply without expanding the gold supply through new mining output or other purchases. This system would inject a mild deflationary bias into the economy since global gold supply increases about 1.5 percent per year whereas the real economy seems capable of consistent 3.5 percent growth under ideal conditions. All things equal, prices would have to fall about 2 percent per year to equilibrate 3.5 percent real growth with a 1.5 percent increase in the money supply, and this deflation might discourage borrowing at the margin. The pure gold standard would allow for the creation of credit and debt through the exchange of money for notes, but it would not allow for the creation of money beyond the amount of gold on deposit. Such debt instruments might function in the economy as money substitutes or near-money, but they would not be money in the narrow sense.

All other forms of gold standard involve some form of leverage off the existing gold stock, and this can take two forms. The first involves the issuance of money in excess of the stock of gold. The second involves the use of gold substitutes, such as foreign exchange or SDRs, in the gold pool on which the money is based. These two forms of leverage can be used separately or in tandem. This type of gold standard—call it a flexible gold standard—requires consideration of a number of design questions. What is the minimum percentage of the money supply that must be in gold? Is 20 percent comfortable? Is 40 percent needed to instill confidence? Historically the Federal Reserve maintained about a 40 percent partial gold reserve against the base money supply. In early April 2011 that ratio was still about 17.5 percent. Although the United States had long since gone off a formal gold standard, a kind of shadow gold standard remained in the ratio of gold to base money, even in the early twenty-first century.

Other issues include the definition of money for purposes of calculating the money-gold ratio. There are different definitions of “money” in the banking system depending on the availability and liquidity of the instruments being counted. So-called base money, or M0, consists of notes and coins in circulation plus the reserves that banks have on deposit at the Fed. A broader definition of money is M1, which includes checking accounts and traveler’s checks, but does not count bank reserves. The Fed also calculates M2, which is the same as M1 except that savings accounts and some time deposits are also included. Similar definitions are used by foreign central banks. In April 2011, U.S. M1 was about $1.9 trillion and M2 was about $8.9 trillion. Because M2 is so much larger than M1, the selection of a particular definition of “money” will have a large impact on the implied price of gold when calculating the ratio of gold to money.

Similar issues arise when deciding how much gold should be counted in the calculation. Should only official gold be counted for this purpose, or should gold held by private citizens be included? Should the calculation be done solely with reference to the United States, or should some effort be made to institute this standard using gold held by all major economies?

Some consideration must be given to the legal mechanism by which a new gold standard would be enforced. A legal statute might be sufficient, but statutes can be changed. A U.S. constitutional amendment might be preferable, since that is more difficult to change and could therefore inspire the most confidence.

What should the dollar price of gold be under this new standard? Choosing the wrong price was the single biggest flaw in the gold exchange standard of the 1920s. The price level of $20.67 per ounce of gold used in 1925 was highly deflationary because it failed to take into account the massive money printing that had occurred in Europe during World War I. A price of perhaps $50 per ounce or even higher in 1925 might have been mildly inflationary