Wednesday, October 27, 2010

Gold bugs me

One thing that bugs me about Libertarians (and many libertarians) is their fetish for gold. Megan McArdle takes a shot at explaining some of the things that bug me (economically) about the gold standard here and here. In particular, the gold standard seems to be a solution for a symptom instead of the underlying disease. That disease, of course, being, an untrustworthy government. As Megan says:

"In short, you don't get anything out of a gold standard that you didn't bring with you. If your government is a credible steward of the money supply, you don't need it; and if it isn't, it won't be able to stay on it long anyway. (See Argentina's dollar peg). Meanwhile, the limitations on the government's ability to respond to fiscal crises, the necessity of defending against speculative attacks in times of crises, and the possibility of independent changes in the relative price of gold, make your economy more unstable."

But I have another problem with the gold standard. How are you going to implement it? First of all, there's no way today that the economy will work on actual coins of intrinsic worth. At what appears to be a value for gold of almost $900/oz troy, a dollar coin would have to be almost all base metal anyway. Figuratively, it would have "the density of gold in seawater". The last few attempts we've had at fiat dollar coins haven't taken off anyway, and at any rate, the amount of "money" in just the US economy is mostly virtual anyway. So we're still looking at an economy where the vast majority of transactions are book-keeping, with a small amount of tokenized money. But the book-keeping and tokenized money must match up to an amount of gold in someone's hands.

Per the US Mint, there is 147.3 million ounces of gold in Fort Knox, at a book value of $42.22 per ounce. So the government says they have (147.3 * 10^6) * $42.22 = $6,219,006,000 - in round numbers $6.2 billion. That's not a lot of money - per Forbes "The Worlds Billionaires" Bill Gates had an estimated net worth of US $40.0 billion (down from US$56 Billion in 2007), over six times this value. Per the CIA World Factbook, the population of the USA is 307,212,123 as of October 2010 - if we divide this out, we get a value of $ 20.25 or so per man, woman, and child in the US, more or less. (the CIA does not specify if this is citizens or inhabitants). Now, that book value is highly misleading, since the spot price for gold is $1,342 per ounce as of this writing. That changes the value to be $197,676,600,000 - $197.6 billion in round numbers. Bill Gates is worth one-third of the US Federal Gold Reserves, and the per capita value is a fraction over $643.45.

(Historical notes: In the original version of this post, 3 years ago, Bill Gates had almost 10x the “book value” of Ft Knox, the spot price of gold was $885, Mr. Gates was worth HALF the “market value” of the gold, and the per capita market value was $432.89)

In a gold-backed economy, you can't have more money outstanding than there is gold to redeem it with. Otherwise, how is it a gold-backed economy? But the US money supply is at least $1.99 trillion if you only include the physical currency plus exchangeable reserves (M0). If you measure M2 (essentially all the cash, exchangeable reserves, checking, saving, money market accounts, and CDs less than $100,000) it is about $8.36 trillion. (Source is Wikipedia - see for a somewhat more rigorous definition of M2. If you have better numbers, by all means comment, but Wikipedia's sources are the government). That's anywhere for ten times to forty times the value of the gold in Fort Knox at market rates. To go to a gold-based economy, you have to devalue the entire US money supply by a minimum of a factor of 10. 90% of the value of the money in the economy, gone. And you can't fix this by renominating the money supply - if you declare that the Newdollar is worth 10 old dollars, an ounce of gold is only worth $88.50 in Newdollars.

(Historical notes: 3 years ago, M0 was $1.37 Trillion, M2 $7.02 Trillion, and the max value was 70 times, not 40 times).

Even if you somehow managed to back the money with all the refined and available gold in the world (some 120,000 to 140,000 tonnes per this website, Wikipedia has a slightly higher figure, sourcing the World Gold Council) it would still only be worth around $2.72 trillion (probably a bit more, the number I used for the price of gold is about 30% higher; based on our relative valuing of the Fort Knox gold). And then you would have no gold left over for non-cash uses; essentially, the vast majority of gold would have to be stored in Fort Knox to account for just the amount of US paper money in circulation; with little left over for other countries. It still doesn't cover all the money on deposit in the US banking system, much less the world.

(Historical Notes: the value of gold the US needs to cover our money is larger than in 2007, but because of the increase in the price of gold, less physical gold is needed and less of the value of the gold supply is needed, leaving more gold and value outside of Ft. Knox)

Finally, a question for all of you out there in favor of the Gold Standard. How many of the gold bugs actually believe the government when they say there's 147.3 million ounces of gold in Fort Knox? As I went to research the numbers for this post, I stumbled onto the persistent belief that the US Government has (usually for nefarious reasons) moved all the gold out of Fort Knox and either sold it or used it as collateral for some scheme or other. The very first hit for the search string "how much gold in fort knox" entertains this possibility, as does the Wikipedia entry on United States Bullion Depository. If you believe this tale, how can you trust the government to keep up a gold standard?

Plus, remember why the US rather suddenly needed a gold repository in 1933 - FDR and the US Congress declared private ownership of gold to be illegal. That would be one way for the government to make up the shortfall of gold to run the economy on - to confiscate the gold again. Except, there isn't enough.

In short, we cannot afford a gold standard, it would be too confining of the economy. There is not enough gold in the world to implement a gold standard for the US, much less in the government's reserves. There is no reasonable way in the short term to change this. And if there ever is a way to have to have the gigatonnes of gold minimum that the US would need, it would be worth that much less because of the expansion of the gold supply. Now if someone would only tell Ron Paul this...

(This post is a rerun, though I have updated the numbers. Originally posted January 17, 2008)

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