Why The Future Money Is Gold And Silver

For a medium of exchange to be effective, it must be accepted by everyone in a community of people who divide their labor, and if one community is to benefit from trading with other communities, it must be accepted more widely for the exchange for goods. But we know that confining transactions to coins or metallic money by weight is an inefficient form of money. This is why fiat currencies started out as gold or silver substitutes in the forms of both cash and bank deposits, exchangeable into physical metal on demand at a fixed rate.

The convenience of being able to pay in sound money substitutes cannot be underestimated. A national currency fully fungible with gold or silver was central to the economics of the industrial revolution and is the basis of the currencies of the great nations of today. Markets in them developed, such as discounted bills, loans, bonds, stocks, and trade finance. Gold and silver substitutes were trusted. Businesses developed internationally, exchanging their money substitutes for commodities, importation of consumer goods, and goods of a higher order. While Country A’s money did not circulate in Country B it was accepted and could be redeemed for its money at a cross rate fixed by their gold standards, or alternatively exchanged for physical gold. This was the basis of global trade before the First World War.

The monetary system based on the free exchange of gold and silver substitutes was so successful that it brought the nations that benefited from the arrangement out of feudal subsistence living into the greatest economic advancement for mankind since the ending of barter. It set the basis for modern economies and their technological advancement. Money could be trusted. You could save it, making it accessible for entrepreneurs to finance their production, knowing that gold or silver-backed money would retain their purchasing power over time. It was fundamental to the evolution from medieval societies into free markets.

Through their money substitutes it was governments and their central banks which cheated on metallic money. Starting with the suspension of gold standards to finance the First World War, European nations failed to return to them and some currencies collapsed. Britain eventually introduced a gold bullion standard in 1925, replacing its gold specie standard at the pre-war rate. By only permitting the exchange of pounds for 400-ounce bars and removing the pre-war commitment to swap paper pounds for sovereigns, the general public effectively lost the gold substitute facility. The UK’s bullion standard only lasted until September 1931, when it was “temporarily” abandoned, never to be reintroduced.

The flaw in the system was not the fault of gold, or in earlier times, silver. The fundamental problem was that banks were free to expand the quantity of money in the form of credit, which when drawn down and spent was indistinguishable from gold substitutes. Following the Bank Charter Act of 1844 which permitted the existence of unbacked bank credit, the cycle of bank credit expansion was broadly self-liquidating through periodic bank crises. That changed when the Bank of England adopted the role of lender of last resort, subsequently copied by the Fed.

The credit tail had begun to wag the monetary dog, and led to the situation today, where money originating from bank credit makes up the bulk of money in circulation. Without a reform of the banking system to restrict the role of bank credit, the reintroduction of gold and silver substitutes is corrupted and cannot work for long. This must be addressed when fiat dies, otherwise, the cycle of bank credit will destabilize the new monetary system.

If bitcoin is to be the money of the future, it will need enormous degrees of persuasion for the public to accept it as sound money compared with gold or silver. That persuasion is unlikely to come from markets, which are the sum total of people’s transactions, so it can only come from the state. An establishment agency of some kind, a revolutionary government in agreement with other revolutionary governments would have to successfully impose a cryptocurrency, over which no state has distributive control, on the general public whose traditional concept of money is very different. Not only is this proposition illogical, but it is logically the consequence of assuming the state decides what is money and not the people.

Official sanction of the new money

The last thing any government or central bank would wish is to lose control over money. These agencies will continue with fiat until the last possible moment and will then want to determine its replacement. Intellectually, they are not suited to the task, believing that the state must retain control of its national money at all times in order to manage economic outcomes. It sees free markets as the enemy of state-imposed order.

The collapse of fiat currencies will demolish the state theory of money, and not for the first time. Irrespective of how long it takes, the rapid loss of fiat currencies’ purchasing power means that governments will no longer be able to finance their obligations. There will, therefore, come a point where fiat money must be abandoned in the search for monetary stability. The demise of fiat is the demise of state money and the function of its replacement will be to restore public trust.

It is theoretically possible for trust to be restored without abandoning fiat, but that would be to act in anticipation of a monetary crisis. Cutting government spending to an economically sustainable level, balancing budgets, reforming the banking system, and abandoning regulatory and other interventions in favor of free markets would have to be a deliberate policy. But it is unlikely that the necessary reforms would be possible politically ahead of a major economic and monetary crisis. Therefore, the crisis comes first, and then the state responds with an electorate fully aware of the consequences of failure.

At some stage in the collapse of a fiat money’s purchasing power it will have to be halted. In November 1923, Germany’s paper mark was finally exchanged for a new mark notionally tied to the gold mark at the rate of one trillion to one. The reasoning behind the conversion rate was it enabled the new Reichsmark to enter circulation. Today, the replacement of fiat currencies with the new money will almost certainly follow a similar procedure.

The replacement money can only be based on something in governments’ possession. And either in their treasury departments or central banks, other than each other’s fiat they only possess gold in their monetary reserves. It may take a few debilitating attempts by states to avoid it, but we can be certain that the only replacement for fiat money will be to back them with gold. It is necessary to stabilize everyone’s money. The other actions, reducing the scope of government and freeing markets from intervention will also have to be addressed. But following the increasingly obvious prospect of a total monetary collapse, stabilizing the currency by turning it into gold substitutes exchangeable for gold coin should then become a politically viable solution.

It is not the intention to make light of the difficulties involved, nor to dismiss the political consequences. Based on the German experience following the collapse of its paper mark, Hayek’s The Road to Serfdom is instructive reading. The demise of the dollar raises geopolitical questions because China has effectively cornered physical gold markets and there is evidence that she has accumulated very large quantities of non-monetary gold. Gold as circulating money would enhance her power relative to that of the United States. Russia’s central bank has also built her gold reserves at the expense of the dollar and can be assumed to have accumulated significant amounts of physical gold not otherwise declared.

The time taken for a fiat monetary collapse is another important factor not addressed in this article but will have significant consequences. If it is as much as a year from now, governments might introduce price controls and attempt to confiscate gold — these are traditionally resorted to in the past, going back as far as Roman times. The introduction of central bank digital currencies might just be advanced, hurried along by a falling purchasing power for traditional fiat. And the impoverishment of the middle classes through monetary inflation must not be ignored.

But eventually, a movement towards gold substitutes is bound to occur, and silver can then become supporting coinage. But one thing is clear, and that is a publicly distributed ledger cryptocurrency not in possession of the state cannot be adopted as a substitute for its fiat currency because states do not have the means to introduce it.

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Disclaimer: The views and opinions expressed in this article are those of the author(s) and do not reflect those of Goldmoney, unless expressly stated. The article is for general information ...

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