The Gold Standard The traditional alternative to fiat money is what is commonly called the gold standard. There are three types of gold st...
The Gold Standard The traditional alternative to fiat money is what is commonly called the gold standard. There are three types of gold standards that have been used in different stages of history (Paul, R. 2009). The first is the gold specie standard which is when actual gold coins or monetary units are used and exchanged. This gold standard is what America was using prior to President F.D. Roosevelt doing away with and switching the U.S to the gold exchange standard in 1932 (Rauchway, E. 2013).
The gold exchange standard doesn't involve the circulation of gold coins but makes it so that government guarantees a fixed exchange rate to the currency for gold. This creates a de facto gold standard. However, President F.D. Roosevelt confiscated all US citizens' gold through the Gold Reserve Act of 1934 at $20 an ounce and then made the fixed exchange rate $35 an ounce, creating a $15 per ounce profit for the U.S government essentially out of thin air at the expense of the citizens who could no longer legally own gold (Richardson, G. 2013). The third gold standard option is gold bullion standard in which gold coins don't circulate, but government agrees to sell gold bullion at a fixed price for currency. It wasn't until 1975 when President Ford signed bill Pub.L. 93-373 allowing U.S citizens to purchase, hold, sell and deal with gold.
Now the average citizen could at least own gold again, even though the dollar was no longer connected to gold but instead to the trust and credit of the United States government. It was President Nixon in 1971 that officially and completely took the American dollar off of the quasi-gold standard that Bretton-Woods system had created. No longer was the dollar redeemable for any amount of gold at all. It was just paper backed by trust in the U.S. Government and nothing more. While President Lincoln had taken the United States off the gold standard during the civil war and created greenbacks, they were abolished and American switch from a fiat currency back to the gold standard with no major issues ensuing (Bye, J. 0. 1963). Roosevelt's damage to the gold standard through confiscation was the second major blow to the gold standard, but Nixon put the final nail in the coffin. This act was completely unconstitutional and was known as the Nixon shock (Paul, R. 2009).
This was unconstitutional because it clearly states in the U.S Constitution Article I, Section l 0: "No state shall. .. make anything but gold and silver coin a tender in payment of debts."
The effects of the Nixon shock caused the US to initiate price controls for ten days through Executive Order 11615. Price controls were something the U. S. hadn't used since World War 11. As well the Nixon shock was a primary cause of the stagflation that occurred in the l 970's and causing the dollar to lose a third of its value just within the decade (Ghizoni, S. 2013). Why is the gold standard so powerful and so important It primarily comes down to inflation. A stable money supply that is backed by gold cannot be inflated in the way that fiat money can be inflated. Currently the Fed doesn't even need a printing press, everything is done digitally, with a few strokes of some keys, and trillions of dollars can be created. In fact this was done for quantitative easing after the Great Recession of 2009 up to 2014 when the Fed was printing tens of billions of dollars a month (Finger, R. 2013). With a gold standard, the Fed cannot create money out of thin air. It forces countries, banks, corporations, and politicians to have financial discipline because they cannot use inflation to create money to bail their way out of bad situations. Moral Hazard Created by Central Banks The term moral hazard, according to dictionary.com, means "the risk that an individual or organization will act irresponsibly or recklessly if protected or exempt from 13 THE EFFECTS OF CRYPTOCURRENCIES ON THE BANKING INDUSTRY AND MONETARY POLICY the consequences of an action". Having the Fed act as a lender of last resort for banks motivates banks to make riskier and riskier loans because they know they will be bailed out and their customers deposits protected thanks to FDIC. The Fed is technically an independent organization that is not officially part of the Federal Government. However, all of the Feds "profits" go into the treasury and all of its board members are hand selected by the President and approved of by the Senate.
Also the Fed must report twice annually to congress and at technically any moment congress could vote to abolish the Fed, the Fed is as "independent" as a five year old child is independent of adults (Zarlenga, S. 2008). The Fed allows the government to expand, offer welfare programs, and enter into wars, more easily because the government can use inflation to pay for everything and not direct taxation. While congress doesn't explicitly ask the Fed to do such things, the underlying effects of the Fed purposefully creating inflation has this effect for politicians. Remember that inflation is bad for the economy but greatly benefits the first spenders of newly minted money. Since the Fed's "profits" go to the treasury first, government is one of the first spenders.
The Fed allows politicians to make more promises for social welfare programs that don't require explicit taxation or bonds to pay for. This allows politicians to essential "bribe" the public for votes by offering favorable programs and projects to the demographics that vote them in. This process weakens everyone's dollars instead of directly and overtly confiscating those dollars from them in the form of traditional taxes. Allowing moral hazards to create mat-investments is what caused the financial crash of 2008 and nearly all crashes that have come before (Mises, L. V. 2007)
The other reason is that, unlike gold, using a fiat currency allows the Fed to distort price signals. In his book The Theo,y of Jvloney and Credit (1 953) Ludwig Von Mises explains that prices are signals in a market place that tell investors, entrepreneurs, and consumers, how to behave in the market. Expanding upon this, Nobel laureate F.A Hayek wrote about the phenomena for his highly influential article The Use of Knowledge in Society (1 945). In the article he explains that no central organization regardless of how intelligent it may seem to be, can know all of the information necessary in an economy to know what the prices should truly be. The true price should be what the market demands under the laws of supply and demand. When a person, group, or organization attempt to control prices and they don't obey the laws of supply and demand, they distort the market and create artificial shortages and surpluses. True prices are when businesses are allowed to set their own prices, unhindered, based on supply and demand. When the Fed sets interest rates, they are using price controls and distorting the market, sending out unclear signals into the market. For Mises, distorted price signals are what causes mat-investment and causes bubbles and thus booms and busts in the economy. The boom is from people thinking that there is wealth and resources that are being created because of a bubble in the economy. The bust when the bubble bursts and people start to realize that it was all illusionary and there is truly little or no value in what they were investing.
Bubble bursts come from the market fixing itself and re-stabilizing to where it should naturally be, although this can often take years or even decades depending on how severe the Fed has artificially tampered with the economy. The market is constantly trying to guess what the Fed is going to do and when the Fed will do certain things. which creates what historian Robert Higgs (1997) calls "regime uncertainty". He THE EFFECTS OF CRYPTOCURRENCIES ON THE BANKING INDUSTRY AND MONETARY POLICY explains that this is a large reason why markets sometimes take so long to recover from monetary mistakes and distortions. Often the worse the Fed tampers with prices, rates, and markets, the longer the recovery will take. Inflation and Money YS \Vcalth There is a very important distinction to make between money and wealth. 15 According to Dictionary.com, money is simply a medium of exchange, meaning it's a unit of measurement and has value that people are willing to exchange goods and services for.
There is nothing intrinsically valuable about money. Having all the money in the world and nothing to spend it on makes having trillions of dollars not only useless but also pointless. Wealth is simply stuff. Wealth is a bed, a car, a book, anything of value to the owner. It's very easy, and very dangerous to confuse money for wealth. This confusion can cause bankers, politicians and bureaucrates to try and manipulate money, thinking they will change wealth. They are only changing the units of what valuable things are worth, not actually creating any new wealth. New wealth is only created by entrepreneurs in the market who build businesses that sell products or services that other people in the market find valuable (Dom, J. 2007).
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