Gold is Not Enough, II: Gold and Supply and Demand

Today’s posting continues the most recent letter we sent to Virginia Delegate Bob Marshall.  (We split it up for easy reading and edited it somewhat for continuity — necessary when you split up a single letter over several days’ worth of blog postings.)

In today’s posting we look at a few (more) reasons why a “return” to an all-gold currency simply isn’t realistic (aside, of course, from the fact that such a thing has never existed in the history of the world).  In any event, if you think Bob should be talking to CESJ president Norman Kurland, send Bob an e-mail at delegatebobmarshall [at] Hotmail [dot] com to that effect.

Last week we looked at Henry Simons’s “Chicago Plan,” which was (to oversimplify) to abolish the Federal Reserve as a central bank, and back the entire money supply 100% with government debt.

Simons’s proposal was, in effect, an updating of the British Bank Charter Act of 1844.  The Act had established a debt ceiling of £14 million to back the paper currency.  Any increase in the money supply was supposed to come from the importation of gold as the price of gold rose in response to the scarcity of money.

Naturally, gold didn’t flow in fast enough or, sometimes, at all.  This is because the vast bulk of commercial transactions did not involve gold or paper currency.  Most commercial transactions were carried out using bills of exchange and mortgages.  These were either used directly as money (merchants and trade acceptances), or discounted or rediscounted at a commercial bank.  The commercial bank would issue a promissory note and use the note to back new demand deposits.

Consequently, a deficit in the supply of gold did not cause a rise in the price of gold that would presumably have encouraged imports of gold to increase the supply.  Instead, the lack of gold was made up by increased use of bills and mortgages to back demand deposits as a ready and more convenient substitute for gold as the medium of exchange.

Gold did not rise in price to encourage imports because a substitute was available at a lower cost.  This kept the price of gold down, encouraging export to countries where the price of gold was higher instead of imports.

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