Bring Back the Gold Gilt

This essay was submitted to the Richard Koch Breakthrough Prize for 2017.

Executive Summary

Our monetary system imposes a form of central planning, based on an irredeemable paper currency managed by central banks. Monetary planning is the last holdout. The world learned from the collapse of the Soviet Union, and is learning today from Venezuela, that central planning does not work. However, the wealthy and most of the economics profession believe that money is the exception, that unlike goods and services, the quantity of money and the interest rate are best administered by wise men.

This arrangement stunts growth, accumulates debt, and prevents people from achieving to their potential. And it hits the bottom third particularly hard. With its falling interest rate, irredeemable paper currency pushes down their wages, makes saving for retirement impossible, and renders their jobs redundant.

There is a simple and elegant solution. We should bring gold back into the monetary system, starting with the government bond.


One policy area stands out as the perfect fit for the Richard Koch Breakthrough Prize. In what other area do free marketers promote the central planners’ own propaganda? In what other area does the most strident criticism of the central planners consist of advice on how to tweak their economic plan? In what other area does nearly everyone accept that central planning is necessary and good? In what other area does the free market arrangement of a bygone era generate so much silly and ignorant criticism?

I refer to monetary policy.

Free Marketers Promote Central Banking

Sound money once meant a system in which coins had a known weight of fine gold, and paper currency was redeemable for gold. Today, advocates define it as when a currency’s purchasing power is not declining. This is a curious standard, as every producer is constantly working to reduce costs and hence prices. If a central bank devalues its currency at a matching rate, then currency losses cancel out industrial efficiency gains. The net result is that prices don’t change. Stable purchasing power is a smokescreen that provides cover for central banks.

There are two raging policy debates among free marketers. One is whether price stability or GDP makes the best target for monetary policy. The other is whether to use the quantity of money or the interest rate to hit this target. When the only discussion concerns the formulas directing the central plan, then central planning has won.

Even among gold standard advocates, the most popular view is that central banks’ central planning needs to take gold into account. Recently in Switzerland for example, the people voted on a referendum to require the Swiss National Bank to keep a percentage of reserves in gold. In the States, leading gold standard advocates want the Federal Reserve to target the gold price. These policies are not about gold per se, but directing the central planners how to expand the supply of paper currency.

Most economists and social thinkers believe that the gold standard didn’t work. They will tell you that it caused the Great Depression. They insist that we need a pure paper currency, and wise central banks to administer it. They mutter that there is not enough gold, not enough liquidity, not enough flexibility, and not enough room for monetary policy. They make no economic or logical sense. In the 1890’s—at the height of the gold standard—there was 150 tons of gold in London (the Bank of England today has over 5,400 tons).

The Problem with Irredeemable Currency

We have an irredeemable currency system today. It is imposed by law, because people would not accept it if free to choose. Who would trade their labor, their sweat and blood, for mere pieces of paper (or electronic bank deposits)? In the halcyon era before the Great War, currency was redeemable for the gold coin which it represented. Currency was more convenient, and divisible to the smallest fraction. It was trusted by most people in most circumstances, because everyone knew that the bank would exchange it for gold coins.

Paper was preferred most of the time. However, people would tend to switch their preference if the interest rate fell too low. In such cases, the security of gold metal outweighs the convenience of paper. Of course, demanding redemption of a deposit induces the bank to sell a bond, thus pushing the bond price down and the interest rate up (bond price and yield are strict mathematical inverses, like a seesaw).

This choice is very important to understand, because people have been disenfranchised today. They no longer have any input into the interest rate. And therefore, the interest rate is unhinged. It can rise relentlessly, as it did after the Second World War. By 1980, it hit unprecedented heights. Since then, it has been falling for the last 36 years and has now hit an historical low.

The central planners and their free-marketing enablers think about interest rates, only in light of the quantity of money and its purported effect on consumer prices. Whatever that effect may be, the Bank of England has been failing to hit its price stability remit—which has an Orwellian definition of a two percent per annum increase in prices.

They regard the interest rate as either a means to an end, or as collateral damage. They’re wrong. The interest rate is central to everything.

Let’s look at the Bank of England’s purchases of gilts—called quantitative easing. Obviously, this pushes up the price of gilts. It also takes gilts out of the hands of market participants. What is an investor to do, such as pension fund, bank trust department, or insurance company? They buy other assets.

Falling interest rates—i.e. rising bond prices—is a recipe for rising prices of all other assets. The lower the interest rate on the risk-free asset, the lower the yield on the other assets. All assets trade at a spread to gilts.

Asset managers in the City do well in a bull market. Corporate CEOs also benefit, as their compensation is typically tied to the company’s share price. The wealthy who own assets, often with leverage, see their net worth skyrocket. However, other people do not receive any windfall. They get just the opposite.

Let’s focus on the bottom third. These are not the salaried middle managers, but unskilled laborers and many semi-skilled and some skilled workers. Their employers often face a tradeoff between buying machines or hiring people. The wage of every worker who does work that could be performed by a machine is capped. This is because if the total cost of ownership of the machine is lower than the fully burdened cost for the worker, the company will buy the machine.

When the interest rate falls, it lowers the monthly payments on the machine.

As just discussed above, the interest rate has been falling for over three decades. This is a pernicious force, pushing down wages and ultimately employment. The pressure is most acute on the bottom third.

This principle is so important that it merits a brief discussion of the theory. Finance has the concept of Net Present Value to determine the price of a stream of payments to be made or received in the future. Suppose a bond pays £1 per year. You cannot simply add up the future payments, because a payment in one year’s time is worth less than a payment today. A payment to be made in 2027 is worth less than a payment to be made in 2018. All future payments are discounted by the market rate of interest.

If the interest rate is 10%, then the bond is worth £1.00 + £0.90 + £0.81 + £0.73 + … = £10. But watch what happens when the interest rate is cut. At 5%, the bond is worth £1.00 + £0.95 + £0.90 + £0.86 .. = £20. With each halving of the rate of interest, the Net Present Value doubles.

What does this have to do with the worker’s wage? A wage, like a bond, is a stream of payments to be made in the future. The Net Present Value of this stream is calculated exactly as a bond’s payments are calculated. To the employer, the worker feels more and more expensive as interest drops lower and lower. Workers had better increase their productivity commensurately, or else be made redundant.

This is supported by anecdotal evidence, too. A typical complaint is that fewer workers are expected to do more work than ever.

Falling interest hits poor people another way. The poor are not the class which owns stocks, real estate, or an investment-grade 1980 Chateau Lafite Rothschild. They keep their meagre savings in a bank account (at least the ones who plan to improve their lives). However, they get less and less interest income.

Albert Einstein is reported to have quipped that man’s greatest invention is compound interest. With it, one can set aside 10 percent of one’s wage and retire at age 65. With it, one can live the same lifestyle in retirement, just on the interest.

The central banks have un-invented it. They have deprived wage earners of both means and motive to accumulate a nest egg. They have also deprived retirees of the ability to live on the interest. Now, they must live on the principal. We have achieved what economist John Maynard Keynes called the “euthanasia of the rentier”. He thought this was a good thing—and Benito Mussolini called one of Keynes’ books, “a useful introduction to fascist economics.”

The regime of irredeemable currency fails to serve the people, hitting those at the bottom especially hard. The problem is not runaway prices. It is the collapse of interest, and the concomitant downward pressure on employment, wages, and savings.

People need a better solution.

The Solution

The pound, euro, franc, yen, and dollar are not serving the needs of those at the bottom third of society well at all (or anyone else, though the top have been lulled by the so-called wealth effect of rising asset prices, and the middle third mostly cling to hope they can rise to the top third). They need an alternative money, one not subject to the central planning of central banks, collateral damage of monetary policy, the erosion of their life savings through price stability, and the wage pressures of falling interest rates.

Perhaps the government of the United Kingdom and the governments of the other developed nations can take advice from one of Winston Churchill’s sharp witticisms. “You can always count on Americans to do the right thing — after they’ve tried everything else.”

We have tried everything else. We tried a gold bullion standard. Some years after the Great War, Britain made the pound redeemable again. But not in gold coin. One had to bring in enough pound notes to redeem a whole 400-ounce gold bar. This regime ended during the Great Depression. After the Second World War, the world tried the Bretton Woods scheme. This was a gold exchange standard, whereby central banks fixed the prices of their currencies to the US dollar while the US government made the dollar redeemable in gold to them at a fixed rate. The Bretton Woods arrangement collapsed after the US government had been abusing its exorbitant privilege for too long. Since 1971 when President Nixon defaulted on the US government’s gold obligations, the whole world has been on the current regime of irredeemable paper currency, with gold banished entirely from the monetary system.

It is past time to give it a proper invitation to come back in.

Having just established that central planning doesn’t work, we cannot simply say that the Bank of England should somehow determine the right gold price and then somehow fix it. In the first instance, there is no right price of gold or anything else. In the second, the Bank of England does not have that power. It cannot fix the price of gold or anything else.

Nor can we just attempt to abolish the Bank of England, much less the US Federal Reserve. This would be politically intractable, and unfeasible besides. There are trillions of pounds out there in circulation, not to mention about one quadrillion dollars’ worth of derivatives. It’s not so simple to declare an end to central banks.

Gold must be introduced in parallel to the pound. Gold can serve as a pressure-relief value for those who need an alternative to the irredeemable pound, whilst those who wish to continue using irredeemable currency will not be affected.

I propose two measures. The first measure clarifies the legal status of gold as money, and not mere tangible property. There should not be a tax levy on any form of gold. Gains in its price are just the mirror image of central banks debauching their currencies in pursuit of price stability. They are not real gains, and people should not be taxed when they exchange gold and currency.

Additionally, taxpayers should be allowed to make an election to keep their books in gold and pay income tax based on gains in gold. There is already precedent for electing the accrual basis, or electing a fiscal year. These elections are not tax loopholes, so much as allowing an option for circumstances where it is warranted.

Legal tender laws provide that if one party pays in pounds, then a creditor in a dispute or bankruptcy cannot expect to get anything else. However, the people need to be free to put gold clauses in long-term contracts such as employment, real estate lease, or a loan. They need to count on the courts to enforce a gold clause. Otherwise, if the gold price changes then one party benefits by redenominating the debt in pounds using the price of gold at the time of the contract or bankruptcy. This undermines the use of gold, and gives everyone a powerful incentive to stick with pounds.

The second measure is that HM Treasury should issue bonds denominated in gold, with interest and principal paid in gold. These will be gold-gilts, if you will.

As we discussed above, falling interest is a big part of the problem. Therefore, restoring stable interest is central to the solution. A gold-gilt has two advantages. Obviously, the Bank of England cannot make gold go down, thereby depriving savers of their savings. Nor can it drive down the rate of interest. A stable interest rate gives low-wage workers both the means and motive to save for retirement and accumulate wealth. It will give retirees a means to live on the interest, no longer fearing they will outlive their money.

A gold-gilt paves the way for corporate issuers of gold bonds. While the Bank of England and the City may (at first) eschew gold interest-bearing investments, those who need it the most will have the option. Soon enough, of course, asset managers and banks will no longer be able to resist putting an allocation of gold bonds in their portfolios.

It is important to note that the gold-gilt does not force the banks or the Bank of England to change their preferences. It does not threaten their prerogatives or monetary policy. An Act of Parliament to authorize the issuance of gold-gilts, or clarify tax and court administration of gold should not incite a political ruckus the way that a change to monetary policy or the authority of the Bank of England would do.

The gentle reintroduction of gold to the monetary system as described above achieves the objectives of the Koch Breakthrough Prize: increasing the prosperity of the bottom third, and increasing economic freedom for everyone.

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