Why The Future Money Is Gold And Silver

Monetary flexibility

It is a mistake to think that a sound money is one that doesn’t vary in its quantity. The point behind sound money is that it is the users, the general public and businesses, who decide the quantity required and not the state. It was Georg Knapp’s State Theory of Money, published in 1905 that led to Germany’s inflationary financing that ended with the paper mark collapsing in 1923. It was Knapp’s theory and his Chartalist fellow travelers that permitted Germany to arm itself ahead of the First World war and then to prosecute it at no visible cost to the taxpayer. It is not a strict limitation on the quantity of money that is the problem, it is who determines its quantity.

We are told that above-ground stocks of gold total some 200,000 tonnes and that its extra supply is about 3,300 tonnes of annual extraction. Growing at about 1.5% annually, that is wrongly taken to be gold’s money supply. Monetary gold is just one function of the metal, and only 35,220 tonnes are officially monetary gold. In addition to official holdings, there are vaulted bars on behalf of governments and their agencies not officially designated as money, as well as hoarded bars owned by the general public. And with an estimated 60% in the form of jewelry and other uses, that leaves a global gold money supply of about 80,000 tonnes.

This gives gold enormous scope for increasing its monetary use. If gold is used as backing to turn fiat currencies into credible gold substitutes, its purchasing power becomes the determinant of the quantities of scrap acting as an arbitrage between uses. Free markets will decide how much gold is needed, and the supply is available if required.

With its predominantly industrial uses, silver acting as money is a more complex issue. Increasing values relative to gold will diminish industrial demand until the time monetary stability eventually returns, leaving the majority of an estimated 840 million ounces annual mine supply then feeding into the quantity of monetary silver. But unlike gold, above-ground silver stocks are minimal, and furthermore, ownership of monetary silver by government agencies is virtually non-existent. And having been generally abandoned as monetary backing for note issues in European states as long ago as the early 1870s, silver is likely to have a future monetary role only secondary to gold. But its reintroduction as coinage would serve as a public affirmation, along with higher value gold coins, that currency reform is soundly based.

Unlike metallic-backed money, for its hodlers the virtue of bitcoin is the strict limit on its quantity, meaning that so long as governments expand their fiat money quantity, its price is bound to rise. But if the general public is to determine the future of money through free markets, they will need a form of money whose quantity is not dictated by government and the banks. Under a bitcoin standard one country can only expand the quantity of its bitcoin in circulation by obtaining them from another country. The economic mechanism is for the country to have lower prices of goods and services than the others so that it obtains bitcoin in payment for net exports. Assuming no change in the proportion of savings relative to immediate consumption, this would require the government to increase its surplus of revenues relative to spending in an attempt to supress demand in its own economy and thereby lower prices.

Consequently, a bitcoin standard requires government intervention to operate, with governments setting marginal demand. But they cannot act in concert. And if one country contrives to increase its quantity of circulating bitcoin, it causes more accute deflation in the others. The lack of any monetary flexibility is bitcoin’s Achille’s heel.

Financial flexibility

Following the ending of the post-war Bretton Woods agreement, over the last fifty years financial markets have developed on the back of an unprecedented expansion of the quantity of money. In the US alone, since August 1971 broad M3 money supply has increased from $685bn to $19.4 trillion, a multiple of twenty-eight times. And the major US banks have increasingly diverted credit expansion from financing production to financial activities. These include purchases of government and other debt, rising from $160bn to $4.92 trillion over the same timescale. The expansion of regulated futures markets and the far larger over-the-counter markets have been explosive, with the Bank for International Settlements estimating the notional amounts outstanding of OTC contracts at $609 trillion in June 2020.

While much of these increases are the consequences of monetary inflation, there can be little doubt that having the ability to hedge risk, which is what derivatives are all about, is demanded by economic actors in any monetary system. In fact, futures, forwards and options existed long before the current fiat regime. We must therefore assume that financial markets will continue to find these services demanded, but perhaps in lower quantities.

A replacement monetary regime must therefore allow for derivatives and other financial activities, such as trade finance and the provision of credit to the non-financial sector to continue. The fact that derivatives have a longer history than fiat money is proof that metallic monies are no obstacle to them. Similarly, bond markets existed alongside bank credit, which are necessary to facilitate production and therefore consumption.

With prices generally stable, the purchasing power of metallic money increases over time as a result of competition driving manufacturing innovation along with the development and application of new technologies. Consumers can save in the knowledge that they are safeguarded from monetary debasement by the state and that their standards of living will improve over time along with the purchasing power of their savings.

None of this would be possible with a form of inflexible money strictly limited in its quantity. Instead of the current situation of wealth being transferred from depositors to borrowers through currency debasement, wealth would tend to flow strongly the other way, only offset by contracting economic activity to act as a counter-pressure on a tendency for a rise in the purchasing power of a fixed-quantity form of money. The world as a whole would find itself in a permanent depression led by a decline in production.

Banks would be unable to fund themselves beyond sight deposits, with negative interest rates likely to offset the fixed money supply leading to its increasing purchasing power. Bond markets would be driven by negative yields increasing along the yield curve. In this upside-down world no entrepreneur would consider financing production from initial investment to final product sales, because prices for final products in that fixed currency would almost certainly fall substantially over time. And the wisest choice a consumer might make would be to spend nothing except on the barest essentials in order to hoard as much of this fixed quantity money as possible. These would be the basic conditions under a bitcoin currency regime.

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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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