Understanding the Gold Standard Part 1

Most people today know nothing about the gold standard. Or if they’ve heard of it they associate it with crackpots. Well, I can assure you that I’m not a crackpot. I also don’t think its possible or necessary to put the United States back on the gold standard. I do, however, find the study of the gold standard quite fascinating. Understanding why gold was money, how it ceased  circulating, and why it was eventually abandoned as money altogether sheds light on a lot of our current economic problems.

In the beginning, there was no money. People had to make for themselves almost everything that they wanted to consume. There was limited trade, which took the form in the form of direct barter. It was difficult to reach agreeable terms for a trade, though. You had to find somebody with exactly what you wanted who, in return, was desirous of exactly what you had to offer. If you happened to have a surplus of 20 pounds of fire wood and you needed 5 shirts you had to go out and look for somebody with 5 shirts who happened to need 20 pounds of firewood. Needless to say, the non-money economy was very inefficient.

Over the course of time, people began to agree on items that could serve as a medium of exchange, or money. Money wasn’t a government invention, rather it emerged as the result of centuries of voluntary human interaction. In order to accept money as payment for an item, people had to be sure that other people would also accept it as payment. Various commodities were able to serve the function of money over time. Cocoa beans, shells, salt, livestock, and eventually precious metals like silver and gold were used as money.

With money, a man wanting to sell 20 pounds of fire wood could sell his produce to the first person who wanted it. He would take money as payment and then go looking for a person with 5 shirts to sell. It didn’t matter what the shirt seller’s household needed. He’d take money too and then go buy whatever he wanted with it.

This led to specialization and the division of labor. People focused on becoming experts at producing specific items. They knew that they could exchange their goods for money and buy everything else that they would need on the market. Human civilization progress rapidly as the world’s economies became much more efficient and productive.

Over a long period of time, the people of the world decided that gold and silver were the best types of money. The metals were durable, easy to divide, and highly marketable. People felt comfortable that anybody and everybody  would accept them as payment. It wasn’t risky to sell their stuff for gold and silver.

As the years went on, people started accumulating a lot of gold and silver. It became a pain carry it all around with them all the time. There was also the risk that thieves would come and steal their savings. So, people started leaving their gold and silver in the first banks. They would pay a small fee and the banker would keep an eye on their money. Whenever they needed some money, they could come back and withdraw it. You see, the money belonged to the depositor, not the banker.

A common practice began to emerge. The banker would issue a little slip of paper indicating how much each depositor had left with the bank. When people went out shopping, instead of lugging gold with them, they’d give merchants the little slip of paper as payment. These were the first checks and debit cards. As long as the seller felt comfortable that the person’s account actually had the money in it, the transaction proceeded as normal.

Soon, most transactions were being carried by exchanging claims to money instead of money itself. The gold and silver stayed in the bank for the most part. Maybe if somebody was moving out of town they might come in and redeem their checks and take the money. Otherwise it was safer and more efficient to just leave the gold and silver with the banker.

Some bankers started to come to a devious realization. If people very rarely ever came in to claim the gold, couldn’t they just write a bunch of slips for themselves and buy stuff with them?

Of course, this was clearly fraudulent. The bankers were paying for things with IOU’s to money that they didn’t actually have. If everybody holding the bank slips came to the bank at the same time, the bank wouldn’t be able to meet all the claims.

The bankers went even further. They started loaning out the counterfeit bank slips and collecting interest on them. As long as people believed that there was enough gold in the bank to satisfy all of the claims, they accepted the slips as payment. The slips continued to circulate as money.

When confidence in the bank was lost, bank runs occurred. Everybody went in to redeem their gold at the same time. The bankers were forced to admit their shameful activities and go belly up.

The bankers were sophisticated and they could keep the confidence game going for a long time. In the meanwhile, they used their counterfeit notes to amass huge sums of wealth for themselves. They bought off politicians and they loaned money to the government.

The government should have been cracking down on the banks. Fraud is a crime and the bankers were clearly defrauding their clients. They were promising to pay money that they knew good and well didn’t exist. Just the opposite occurred.

Government and the banking industry became very close. During times of war, when funds were desperately needed, the government looked to the banking system for funding. Kings went to the bankers to undertake their royal projects. Princes borrowed money to go on lavish vacations. Dukes used bank funds to expand their estates. The money was provided in exchange for protection.

Well, sooner or later the people started to get pretty upset. They wanted the government to do something about these damned dishonest bankers. The government needed to either make the banks stop printing money or take over holding the gold themselves.

More to come…..

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