What the pound has still to learn from gold

Today, as there are so many politicians meddling around trying to get things right in our economies, people are concerned about money; not only about having more (or any), but also about having a sound currency.

Where can we find good quality money? For centuries, and civilization after civilization, gold (and silver too) have consistently won out in the long-running contest against livestock, grain, cowrie shells, feathers, etc., to find an economic good that people can use as “money” for their trades. Something valuable and stable in its value to organise complex divisions of labour in societies. So if the pound and the other fiat currencies want to replace gold as money for the next 3,000 years, they had better listen to what this “barbarous relic”, in Keynes’ words, has to teach them.

First of all, no rulers or brilliant minds ever had the great idea that gold could play the role of money in society. Instead, they had to accept what people used and agreed to in their trades. In fact, rulers have always hated gold as money because of the power it has taken from them. They tried to bypass the laws of physics and chemistry and create gold from nothing, but the most they achieved was to debase their currencies, a blatant trick that has been condemned since time immemorial. They also tried to replace gold with something of low value they could control. Something that they could give to people (or force them to accept) in exchange for their properties and labour so they could continue with their grandiose schemes, wars and white elephants. Rulers had to wait until they invented fiat money (backed only by governments’ promises to maintain its purchasing power) for their dreams to come true.

We accept fiat money and the rationale behind it. It is true to say that if central banks print paper money, an economic good devoid of any other utility (except for collectors), this fiat money releases gold from its social function as money, and becomes more available for other purposes. Jewellery, ornaments, medallions and many other beautiful things you can make with gold are, thus, more affordable. However, we accept this rationale with a serious note of caution. Behind fiat monies there are governments historically eager to indulge in public spending and irresistibly tempted to create money by simply running the central bank’s printing press.

If we compare fiat money with gold, there are a few lessons that fiat money has already learnt from gold –namely, its physical characteristics. Fiat monies, like gold, tend to be scarce, valuable, divisible, transportable and incorruptible, which makes them as efficient means of exchange as gold.

However, physical characteristics alone were not all that made gold the most efficient means of exchange. Gold production is also limited and not manipulable. To produce this scarce, valuable, divisible, transportable and incorruptible substance it must be mined from the ground, which is a slow, expensive and risky business. In stark contrast, producing fiat money is not a slow, expensive and risky process. It is simply a political decision that only requires an accounting entry in the central bank’s books. This makes fiat currencies political creatures more than anything else, which gives them a nasty taste (except for those in with the political power). And here is where the serious lessons from gold start kicking in.

As counterfeiters know, central banks have the monopoly over fiat money production. They produce it on the basis of their “monetary policy” decisions, which are taken by top-ranked official committees based on the research of highly-trained central bank staff. Monetary policy is discretionary but not capricious. It is governed by general rules and objectives, and legal provisions ensure that central banks have independence to resist political and industry pressures, and this is a good thing. Monetary policy is at the core of central banks, and all economists (except, perhaps, the Austrian School) cannot conceive a modern economy without a centrally planned monetary policy that exercise an effective influence over interest rates, the prices at which people are willing to lend and borrow funds and clear the “available-funds-to-lend” markets.

However, if we again put fiat money and gold together, we see that gold has been able to act as sound money without centrally planned production decisions taken by top-ranked official committees. Gold has been produced simply by mining it from the ground, perhaps the most credible measure to ensure that money creation is going to be free from political an industry pressures.

This “mining-from-the-ground” lesson to produce sound money could be a tough lesson for today’s mainstream monetary theorists, but if central banks wished to replicate it for their fiat money production, they would, first, have to establish the strictest possible operational independence that ensures low and predictable fiat money creation, free from any political and industry pressures; and, second, they would have to abandon any idea of conducting a scientific monetary policy as a means to justify discretionary money production, and simply let the supply and demand of loanable funds determine interest rates.

In addition to monetary policy, central banks today can also produce fiat money when they are instructed to monetise public debt. In contrast to monetary policy, this is not elegant economics. If abused, this is plain State villainy but it is something that may happen with fiat money. If ancient rulers, no matter how powerful they were, had problems paying their debts, they opened their vaults, counted how much gold there was, and decided whether to tax their subjects more or to tell creditors that they would have to wait. If modern governments have problems paying their debts, they can tax their people further, declare default, or ask their central banks to print more fiat money and avoid unpopular announcements.

Removing from fiat monies their ability to monetise whatever deficit might be needed to keep governments profligate and in power is another tough lesson that gold would pass on to fiat money production. However, for those who want currencies “as good as gold,” central banks must turn a deaf ear to the requests of government, the mighty and the powerful to produce more fiat money for them (and to the detriment of everyone else), and remain steadfast gatekeepers of the fiat money they produce.

Does current fiat money production wish to learn these lessons from gold production, and set low, predictable, and non-manipulable paths of fiat money creation? Will central banks abandon monetary policy and the monetization of deficits? Are these wise moves? This is something to be discussed. As a final consideration, though, in a world of honest money, when people want more pounds, what they do is not lobby the Bank of England or influence its monetary policy decisions, but instead to work hard and exchange the wealth they have produced for pounds. This is the way by which they will have many pounds more.